Business Law by Tom Ramsey
August 14th – For longer than memory can recall, the California Corporations Code has permitted the formation of for-profit corporations. The additional designation of such corporations as “C” or “S” does not affect their structure. It merely reflects an election by the corporation with regard to how it will be taxed under Federal law: That is the only effect of such an election.
Additionally, the code has allowed three versions of nonprofit corporations – public benefit, mutual benefit and religious benefit.
Effective January 1, 2012, the addition of §§14600-14631 to the California Corporations Code sanctions a new type of corporation known as a “benefit corporation.” In making this move, California joins six other states that have already enacted similar legislation. Existing corporations are permitted to become benefit corporations by following the provisions of the new code sections. Additionally, new corporations can be initially formed as benefit corporations.
Also effective January 1, 2012, was the addition of §§2500-3503 to the California Corporations Code sanctions what will be known as a “flexible purpose corporation.” Unlike the benefit corporation legislation, California is the first state to enact statutes allowing the formation of a flexible purpose corporation.
The fuel for these additional corporate forms is the belief that a business may want to give back to the community and leave a positive footprint on society, its workers and the environment. As a general rule, a corporation’s directors have a duty to maximize profits and to promote long-term value growth for the shareholders. Traditionally, a corporation could engage in actions that resulted in societal or environmental benefits as long as those actions were primarily pursued for the benefit of shareholder returns. However, a potential risk for directors has always existed if their actions are not aligned with the corporation’s purpose or objective to maximize shareholder value. Although the directors have broad power to exercise their business judgment, they could nevertheless be liable if there is no basis for the action in light of the corporation’s purpose. In this setting, directors have traditionally avoided decisions that could result in benefits both to its shareholders and to society. The hope of the new law’s backers is that one of the new corporation forms will be a vehicle that can be utilized to minimize this dilemma.
Most writers believe the benefit corporation will appeal to a wider audience than the flexible purpose corporation. Based on this assumption, and with the mission of this article not to exceed the verbiage of a textbook, the remainder of this installment will deal only with the benefit corporation.
The first step in the formation of a benefit corporation is the filing of its Articles of Incorporation. The articles must state that the purpose of the corporation is to create a general public benefit, defined as a material positive impact on society and the environment as assessed against its business and operations. The articles may, but are not required to, state one or more specific public benefits, examples of which are: providing low-income or underserved individuals or communities with beneficial products or services; promoting economic opportunity for individuals or communities beyond the creation of jobs in the ordinary course of business; preserving the environment; improving public health; promoting the arts, sciences or advancement of knowledge; increasing the flow of capital to entities with a public benefit purpose.
Although such programs are not required to be in the Articles of Incorporation, they must nevertheless be in writing, prepared by an entity that has no material financial relationship with the benefit corporation or any of its subsidiaries. The plan must create a general public benefit. Public comment in this process is required. All such information must be made publicly available. Beyond adopting such a plan, the benefit corporation must follow it. An assessment is periodically undertaken to determine whether the benefit corporation has adequately carried out the plan.
Once in existence, the board of directors of a benefit corporation must consider the impacts of any action or proposed action upon all of the following: its shareholders, workforce, suppliers, customers, community and societal considerations, the local and global environment, and the short- and long-term interest of the corporation.
The directors of a benefit corporation, and the corporation itself, are not liable for monetary damages for any failure of its actions to actually create a general or specific public benefit. Annually, the benefit corporation must prepare and distribute a report to its shareholders and post it on its internet web site. The code sets forth the subjects to be covered in such a report.
The resulting benefit corporation receives no tax benefits. It will be taxed the same as any other for-profit corporation.
In the event a for-profit entity (corporation, limited liability company, partnership) is transformed into a benefit corporation, the dissenting shareholders, members or partners are entitled to have their interests purchased at fair market value as of the day before the announcement of the transformation.
These concepts are in their infancy in California. The first of the California benefit corporations will be working through a process that has no history in California and will, in all likelihood, borrow to the extent possible from the experiences of like efforts undertaken in the six remaining states. Unfortunately, such a luxury does not exist with regard to the formation and governance of a flexible purpose corporation. Additionally, the Internal Revenue Service has not yet waded into how to deal with the tax liability of a flexible purpose corporation.
Once a procedural and paper trail becomes reality, the task of forming such corporations will in all likelihood become a bit easier. At present, the process is akin to exploring a jungle for the first time.
Of course, it will be interesting to see how many takers step up to the task and the resulting changes in the way they will do business.
(Tom Ramsey is a Long Beach attorney who has specialized in business law for more than 40 years. He may be reached at firstname.lastname@example.org.)