Introduction to the Benefit Corporation
If you’d like to become expert in the newest evolutionary corporate form—the benefit corporation—then this guide is for you. This guide is adapted from one of five articles about the benefit corporation in the July 2016 edition of the American Bar Association's Business Law Today
The Benefit Corporation in the Context of Corporate LawYour understanding of corporate law is directly applicable to benefit corporations because all of the existing corporate codes and common law apply to benefit corporations. Except for the few provisions applicable only to them discussed in this guide, the for-profit benefit corporation is identical to the regular corporation and subject to the same federal and state corporate tax rates.
The Benefit Corporation in the Context of Social Responsibility and SustainabilityIf you are a devotee of sustainability practices, committed to social responsibility or creating a business that has a purpose more meaningful to you than just making money, the benefit corporation may be a corporate form more aligned with your social and environmental values than a conventional corporation. If you want your corporation to not only be the best in the world but also be the best for the world, then the benefit corporation may be your corporate entity of choice.
The Historical ContextUnder the prevailing corporate law of Delaware, the corporation has only one legitimate purpose--maximizing stockholder welfare. This prevailing law coupled with the widespread belief that the corporation exists solely to maximize profit for stockholders becomes the de facto law in most corporate boardrooms. This constrains conventional corporations, other than closely held or family-run corporations, from pursuing other corporate purposes or considering the interests of stakeholders other than stockholders. This real or perceived duty to maximize stockholder welfare often becomes the core guiding principle.
The benefit corporation changes the game because it turns the corporation into a dual-purpose entity with the twin purposes of optimizing stockholder welfare and creating general public benefit. It expressly authorizes corporations to provide a material positive effect on society and the environment while pursuing profits as usual. The legal architecture of the benefit corporation allows ethical corporations to put the full power of corporate law behind their social and environmental values and higher purposes.
The benefit corporation may be the most significant development in corporate law since New York combined limited liability and free incorporation in 1811 because it endows the corporation with a social and environmental conscience and authorizes the pursuit of corporate purposes in addition to maximizing stockholder welfare. The benefit corporation represents a shift in our collective consciousness about business, from a narrow focus on profits to a triple bottom line orientation--planet, people, and profit. Benefit corporations, social entrepreneurship, impact investing, and corporate social responsibility are all part of this global shift in consciousness, which recognizes that humanity needs to take better care of its shared common home with its finite resources.
Since Maryland adopted the first benefit corporation law in 2010, more than 4,000 corporations in the United States have become benefit corporations. Thirty states, including Delaware and DC have adopted benefit corporation legislation. Patagonia, Method, and Ben & Jerry's are some of the more prominent benefit corporations. Laureate Education, a global operator of higher education facilities, is in registration to go public and may soon become the first publicly traded benefit corporation. Italy has adopted benefit corporation legislation and similar national legislation is pending in Taiwan, Brazil, Chile, Argentina, Peru, Paraguay and Columbia.
The Basics: Model Benefit Corporation LegislationMost state benefit corporation statutes, including California's, are based on the Model Benefit Corporation Legislation, which has three principal tenets: general public benefit, accountability, and transparency. As we will see later in this guide, Delaware's law reflects its own unique interpretation of the model legislation.
A benefit corporation must provide a general public benefit, which means "a material positive impact on society and the environment, taken as a whole. . . . from [its] business and operations." In addition to the enterprise-wide commitment to create general public benefit, the model legislation allows corporations to choose one or more specific public benefits and put them in their charters.
Accountability comes from the requirement to measure the provision of such general public benefit against an independent third party standard such as B Labs's Certified B Corporation assessment which measures a business's social and environmental impact.
Transparency comes from the requirement to provide an annual benefit report to the corporation's stockholders and the public about how well the corporation provides the requisite general public benefit.
The Basics: Directors' DutiesAt the heart of being a benefit corporation is the requirement that directors consider the effects of any corporate action or inaction on all of the corporation's stakeholders, including employees, customers, suppliers, the communities in which the corporation is located, society, the environment, and stockholders. This requirement recognizes that a corporation's long-term fiscal health depends on maintaining good relations with all of its stakeholders. As you will see later in this guide, Delaware has its own unique approach to extending fiduciary duties to include other stakeholders. The book, Firms of Endearment: How World Class Companies Profit from Passion and Purpose by Rajendra Sisodia, Jag Sheth, and David Wolfe, shows how corporations that adopt multiple stakeholder models provide a greater rate of return to investors than their conventional peers.
This fundamental change in directors' duties offers a legitimate alternative to the prevailing corporate paradigm in which the corporation exists solely to maximize stockholder welfare and in which fiduciary duties of directors flow exclusively to stockholders. Dodge v. Ford Motor Co., 170 N. W. 668 (Mich. 1919) in which the Michigan Supreme Court observed that a "corporation is organized and carried on primarily for the profit of the shareholders" is often cited as the genesis of this paradigm. Recent court cases such as eBay Domestic Holdings, Inc. v. Newmark, 16 A. 3d 1 (Del Ch. 2010) in which the court observed that directors are bound by fiduciary duties and standards that include "acting to promote the value of the corporation for the benefit of its stockholders" have affirmed this paradigm. The current chief justice of the Delaware Supreme Court, Leo Strine, has made it clear in a recent law review article that directors "must make stockholder welfare their sole end, and that other interests may be taken into consideration only as a means of promoting stockholder welfare." See The Dangers of Denial: The Need for a Clear-Eyed Understanding of the Power and Accountability Structure Established by the Delaware General Corporation Law.
In the prevailing paradigm, the focus on maximizing profits normalizes the practice of externalizing as many of the costs of corporate behavior on society and the environment as possible. Requiring its directors to consider the effect of corporate behavior on all of its stakeholders creates a social, environmental, and pecuniary conscience that encourages the benefit corporation to be accountable for such costs.
Directors' LiabilityAlthough directors' fiduciary duties extend to all of the benefit corporation's stakeholders, only stockholders have standing to sue the corporation for failure to create general public benefit. The model legislation allows stockholders and directors a right of action to bring a benefit enforcement proceeding to compel a benefit corporation to create general public benefit, but the benefit corporation cannot be liable for monetary damages for failing to create general public benefit. The model legislation also contains an express waiver for directors for liability for monetary damages for failing to create general public benefit and affirms that directors are protected by the business judgment rule in fulfilling these expanded fiduciary duties. In addition, directors' and officers' liability insurance is generally as available to benefit corporations as it is to conventional corporations.
The intention behind expressly limiting the liability of the corporation and directors for monetary damages for failing to create general public benefit was to encourage widespread adoption of the form. The model legislation relies on the court of public opinion to inspire benefit corporations to honor their commitment to provide a material positive impact on society and the environment. The fastest growing consumer segment--LOHAS--lifestyles of heath and sustainability--make buying decisions based on the values and qualities of a corporation. The belief is that the transparency requirement of the annual benefit report to the public will inspire benefit corporations to create the desired general public benefit.
The Benefit DirectorThe model legislation includes the option for a corporation to have a benefit director. The benefit director is charged with the duty of preparing the annual benefit report and opining on whether the corporation created general public benefit and whether the officers and directors considered the effects of corporate action upon all of the corporation's stakeholders and, if applicable, how the corporation failed to consider the effects of corporate action on such stakeholders. Although most states, including Delaware, did not provide for a benefit director in their legislation, it is important to understand the concept in case you practice in a state that has authorized benefit directors so that you can explain that that the position should not increase a director's liability exposure because of the liability safe harbors discussed above.
Directors of Benefit CorporationsExcept for the expanded fiduciary duties to all of the corporation's significant stakeholders, serving as a director of a benefit corporation is just like serving as a director of a conventional corporation. This does, however, require new behavior in the boardroom. In a conventional corporation, directors only need to consider the effects of corporate behavior on stockholders but in a benefit corporation, directors must also consider the effect of corporate behavior on all of the corporation's stakeholders, including society and the environment. This may initially feel cumbersome and restricting but the result is often smarter and more comprehensive decisions. As we will see later in this guide, Delaware requires directors of its benefit corporations to balance the effect of corporate behavior on all stakeholders with other considerations.
Converting a Conventional Corporation into a Benefit CorporationIf have you a conventional corporation that wishes to convert into a benefit corporation, you will need to go through the mechanics of the conversion process. The model legislation requires a two-thirds vote to convert an existing corporation into a benefit corporation. Most states, including Delaware, provided additional protection to minority stockholders beyond the super majority vote required by the model legislation and extend statutory dissenters' rights to stockholders who vote against converting into a benefit corporation and wish to be cashed out. Generally, dissenters' rights do not extend to stockholders of publicly traded corporations wishing to convert into benefit corporations.
Directors are often afraid to seek stockholder approval out of concern that the corporation will be forced to redeem shares. To date, however, the Benefit Company Bar Association, which was recently organized by lawyers who helped pass benefit corporation legislation in various states, is aware of only one instance where stockholders of a corporation converting into a benefit corporation exercised dissenters' rights so that possibility is unlikely. Boards can reduce the perceived risk of redemption by reserving the right to remain a conventional corporation if too many stockholders dissent. Management can also reduce the risk of redemption by facilitating a private sale between a stockholder who may who may have expressed an interest in purchasing additional shares and a potentially dissenting stockholder.
Delaware's Public Benefit Corporation LawDelaware's law reflects a unique expression of the three principal tenets of the model legislation. For example, the purpose of creating general public benefit is implied in Delaware's requirement for directors to consider the interests of those materially affected by the corporation's conduct and the precatory statement to operate in a "responsible and sustainable manner." Delaware deviates from the standard of conduct for directors set forth in the model legislation by creating a tripartite balancing test under which directors must balance "the pecuniary interests of the stockholders, the best interests of those materially affected by the corporation's conduct, and the specific public benefit or public benefits identified in its certificate of incorporation."
This balancing test creates some confusion if the term "balance" were read to imply that directors must give each of the three factors equal weight but the test was intended to give the corporation a purpose of creating general public benefit by requiring directors to consider the effect of corporate action on all stakeholders. Delaware provides a liability safe harbor for decisions implicating the balance requirement by affirming that directors of benefit corporations will be deemed to satisfy their fiduciary duties to stockholders and the corporation if their decisions are both informed and disinterested and not such that no person of ordinary, sound judgment would approve.
Delaware requires its public benefit corporations to select one or more specific public benefits from an enumerated list of categories and set such benefit(s) in their charters. This will require you to draft customized specific benefit provisions in your corporation's certificate of incorporation. In Delaware, specific public benefit means "a positive effect (or reduction of negative effects) on one or more categories of persons, entities, communities or interests (other than stockholders in their capacities as stockholders) including, but not limited to, effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific or technological nature."
Delaware makes accountability to a third party standard optional and allows a benefit corporation to use a third-party standard in connection with and/or attain a periodic third-party certification addressing the corporation's promotion of the public benefit(s) identified in the charter and/or the best interests of those materially affected by the corporation's conduct. In addition, Delaware's law does not impose any independence requirement for such third party standard. Delaware intended to provide a measure of accountability by requiring directors to consider the interests of those materially affected by the corporation's conduct.
With respect to the transparency requirement, Delaware requires its public benefit corporations to provide a benefit report to its stockholders biannually. The statute permits a public benefit corporation to also provide the benefit report to the public and report to its stockholders more frequently than biannually.
How to Conform a Delaware Benefit Corporation to the Model LegislationYou may perceive that the lack of an express enterprise-wide commitment to have a purpose to create general public benefit makes the Delaware public benefit corporation vulnerable to so-called "greenwashing." Because the term "benefit corporation" connotes a commitment to have a material positive effect on society and the environment, some worry that Delaware public benefit corporations can take advantage of that connotation without making an express commitment. Their concern is that a Delaware public benefit corporation could "greenwash" by adopting a narrow specific public benefit of a charitable nature such as providing a public playground at its headquarters while marketing itself as a responsible and sustainable business.
You can select a benefit corporation law that is aligned with your values by incorporating your corporation in states that conform to the model legislation or by crafting your Delaware public benefit corporation to conform to the model statute. To add a purpose of creating general public benefit, for example, you can define the statute's precatory statement to operate in a responsible and sustainable manner in the charter to mean providing a material positive impact on society and the environment from the corporation's operations taken as a whole. To conform to the accountability requirement of the model legislation, you can include a charter provision that requires the creation of general public benefit and the chosen specific public benefit to be measured against a third party standard that meets the independence requirements of, for example, Section 14601(g) of the California General Corporation Law. To conform to the transparency requirement, you can include a charter provision that requires the annual provision of a benefit report to stockholders and the public.
ConclusionNow that you understand its basics tenets--general public purpose, accountability, transparency, and extension of fiduciary duties to all of the corporation's stakeholders--you are ready to consider incorporating your corporation as a benefit corporation and join the growing number of businesses that are as committed to having a material positive impact on society and the environment as they are to maximizing stockholder welfare.