California creates new corporation types that reward doing good

By: Kyle Westaway

Even as Wall Street is being occupied and corporations are reviled, there is a revolution quietly raging across the country that empowers corporations to be a strong force for good. This week, California joined that revolution when Governor Jerry Brown created two new classes of corporations for businesses that seek to pursue both profit and purpose: Benefit Corporations and Flexible Purpose Corporations.

These new legal structures are revolutionary in two ways. First, they broaden the duty of a company beyond maximizing shareholder value to include maximizing stakeholder value, such as operating the business in an environmental and social responsible manner. Second, they increase transparency and accountability.

Though it is the first state to pass the Flexible Purpose Corporation type, California is the sixth state to approve the Benefit Corporation classification.

Here is a look at exactly what Benefit Corporations and Flexible Purpose Corporations are, and what they could mean for your company.

What is a Benefit Corporation?

The Benefit Corporation is a new class of corporation that allows companies to pursue profit as well as a strong social and environmental mission.

Under current corporate law, a company’s sole mandate is to maximize shareholder value — make as much profit as possible –for its shareholders. If a corporation takes other stakeholders into account in its decision making — such the environment, community, employees or suppliers — and that adversely affects the profits of the corporation, the shareholders may file a lawsuit against the directors of the corporation for failing to maximize shareholder value. Obviously, this poses a huge problem for socially and environmentally responsible corporations.

The new Benefit Corporation structure addresses this problem in two primary ways.

First it mandates that, in addition to shareholders, the board of directors take the environment, community, employees and suppliers into account when they make decisions. This is known as the shift from maximizing shareholder value to maximizing stakeholder value.

Secondly, it mandates a high level of transparency and accountability. Within 120 days after the end of each fiscal year, a Benefit Corporation is required to publish a Benefit Report, which states how the Benefit Corporation performed that year on a social and environmental axis. The Benefit Corporation is held to a third party’s independent assessment that measures social and environmental impact. The most prominent is currently B Labs Assement. The Benefit Corporation has to then share this assessment of its performance publicly, which increases transparency and accountability.

What is a Flexible Purpose Corporation?

Benefit Corporations and Flexible Purpose Corporations are, by and large, similar legal structures. However there is one primary difference between these two pieces of legislation: The Flexible Purpose Corporation (FPC) allows a corporation to select a specific mission, in addition to profits, that it will pursue.

Just like the Benefit Corporation, a Flexible Purpose Corporation broadens the duties of its board of directors, from solely maximizing shareholder value to also pursuing an additional purpose that is clearly stated in the FPC’s organizing documents.

The Flexible Purpose Corporation allows the directors to choose a their own “special purpose,” such as employing people from an underprivileged community. The FPC must clearly state its specific purpose, outline goals to achieve that purpose, and publish an annual report disclosing how well it has achieved that purpose. The premise is that clearly stating the positive purpose of the company and being transparent in an annual report will create better business.

The special purpose chosen by a FPC can be anything that generally benefits society, but can include the following:

• One or more charitable or public purpose activities that could be carried out by a California nonprofit public benefit corporation.
• The purpose of promoting positive short-term or long-term effects of the Flexible Purpose Corporation’s activities upon stakeholders, the community and society, or the environment.
• The purpose of minimizing adverse short-term or long-term effects of the corporation’s activities upon stakeholders, the community and society, or the environment.

What are the advantages of these structures?

The benefits of these new structures for a company are, first, that it has the ability to make decisions that are in the best interest of all stakeholders without risking a shareholder suit. Second, it allows a company to differentiate itself from any competing companies that are green washing.

The benefits for shareholders are that they can now invest in companies that are serious about running in a sustainable manner.

By mandating that corporations only focus on profits, the current system almost assures a negative outcome for society. By removing mandating stakeholder primacy and increasing transparency and accountability, directors are freed up to use the market as a force for good without risking suit from their shareholders.

How do you become a Benefit or Flexible Purpose Corporation?

If you have an existing company, two thirds of the shareholders have to vote to make a change into either of the new forms.

If you have a new company, you simply register as one of these new classes of corporation. The FPC classification requires that you list your “special purpose” in the organizing documents.

Author:

Kyle Westaway is an attorney and social entrepreneur. Kyle is the founding partner at Westaway Law, an innovative New York City law firm that counsels social entrepreneurs. Kyle is a Cordes Fellow. He lectures at Harvard Law School and Stanford Law School. He launched Socentlaw — a blog about the legal side of social enterprise, and has helped build Biographe, a sustainable style brand that employs and empowers survivors of the commercial sex trade.