Arizona recently passed benefit corporation legislation (SB 1238). Arizona joins fifteen other jurisdictions including California, New York and the District of Columbia that have already passed legislation. While the new law is not effective until December 31, 2014, the Arizona benefit corporation offers social entrepreneurs an important new option to consider when forming a new venture.
Traditional Corporations. To better understand the necessity of the benefit corporation, a little background is in order. Beginning when the Dodge brothers sued for dividends from Henry Ford, building shareholder wealth has been the primary goal of for-profit corporations. As a result, board members of for-profit corporations are required by existing law to focus their efforts on maximizing profits. Thus, decisions that benefit the community and environment to the detriment of profit could be deemed a breach of a corporate director’s fiduciary duties.
Business Judgment Rule. Individual board members are protected from liability by a legal concept known as the “business judgment rule.” The business judgment rule essentially protects boards from personal liability for the consequences of their decisions so long as their decisions are made in compliance with their fiduciary duties of loyalty, good faith, and due care.
As time progressed, courts have expanded the business judgment rule to give corporate boards broader flexibility to engage in socially beneficial behavior so long as there is a reasonable argument that doing so advances corporate interests. Even so, there is always the looming possibility that shareholders will sue corporate boards for a breach of their fiduciary duty when their decisions fail to maximize corporate profits.
Need for a New Corporate Form. In recent years, corporate social responsibility efforts have taken off as more and more entrepreneurs and investors have sought a triple bottom line of pursuing profits while acting as a positive force for people and the planet. Prior to the benefit corporation, there was no legal entity that neatly accommodated both the pursuit of profit and environmental and social goals.
Benefit Corporations. Enter benefit corporations. Corporations wanting to pursue a social or environmental mission in addition to profits can now gain protection from breach of fiduciary duty claims for pursuing public benefit to the detriment of profit. In addition, mission driven investors now have a mechanism to hold directors accountable for the specific public benefits the company was formed to pursue.
According to B Lab, the nonprofit organization championing the benefit corporation concept, the “[b]enefit Corporation is a new class of corporation that 1) has a corporate purpose to create a material positive impact on society and the environment; 2) redefines fiduciary duty to require consideration of non-financial interests when making decisions; and 3) reports on its overall social and environmental performance using recognized third party standards.”
Becoming a Benefit Corporation in Arizona. To become a benefit corporation, an Arizona corporation must file Articles of Incorporation, or amend their existing Articles, to state that the corporation is a benefit corporation and to identify the general or specific public benefit it will pursue. “Specific Public Benefit” is defined to include the following:
- 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 normal course of business;
- protecting or restoring the environment;
- improving human health;
- promoting the arts, sciences or advancement of knowledge;
- increasing the flow of capital to entities with a purpose to benefit society or the environment; and
- conferring any other particular benefit on society or the environment as specified in the benefit corporation’s Articles of Incorporation.
New Fiduciary Standard. While directors of benefit corporations are still subject to the traditional fiduciary duties of loyalty, good faith, and due care, they are also permitted to consider the effects of any action or inaction on:
- the shareholders of the benefit corporation;
- the employees and workforce of the benefit corporation, its subsidiaries and its suppliers;
- the interests of customers as beneficiaries of the general or specific public benefit;
- community and societal factors, including those of each community in which offices or facilities of the benefit corporation, its subsidiaries, or its suppliers are located;
- the local and global environment;
- the short and long-term interests, including benefits accruing from its long-term plans;
- the possibility these interests may best be served by its continued independence; and
- the ability to accomplish the benefit corporation’s general and specific public benefit purpose.
The new law states the consideration of such factors will not violate a director’s fiduciary duties.
Annual Benefit Report. Benefit corporations must prepare an annual benefit report. Generally, the report must include a narrative description of:
- the ways in which the benefit corporation pursued general public benefit during that year and the extent to which a general public benefit was created;
- the ways in which the benefit corporation pursued the specific public benefit stated in its Articles and the extent to which the specific public benefit was created;
- any circumstances that have hindered the benefit corporation in creating general public benefit or a specific public benefit;
- the process and rationale for selecting or changing the third-party standard used to prepare the benefit report; and
- An assessment of the overall social and environmental performance of the benefit corporation against a third-party standard.
Third Party Standard. The annual benefit report must be prepared pursuant to a “third party standard” that is independent from the benefit corporation, comprehensive, credible and formulated in a manner that is transparent. Currently, B Labs is the most well known of the standards organizations but there are a number of other standards organizations that can fufill this role some of which are industry specific. Some examples include Ceres, Food Alliance, and Global Reporting Initiative.
Transparency. Finally, the new law stipulates a benefit corporation’s annual benefit report must be:
- provided as part of the annual report to each shareholder within 120 days following the end of the benefit corporation’s fiscal year;
- simultaneously filed with the Arizona Corporation Commission; and
- posted on the public section of the benefit corporation’s website or made available without charge to any person requesting a copy.
Director compensation and financial or proprietary information included in the benefit reports may be redacted from the publicly available copy.
Benefit Enforcement Proceeding. The new law prohibits a person from bringing an action or asserting a claim, except in a benefit enforcement proceeding. A benefit enforcement proceeding can be brought against a benefit corporation either because of (i) a failure to pursue or create the general or specific public benefit set forth in its articles of incorporation or (ii) a violation of an obligation, duty, or standard of conduct.
In the Alternative – Licensed B Corps. Working with B Labs to become a licensed B Corp. is an alternative to incorporating as a benefit corporation; however licensing does not provide the legal protections of a benefit corporation. Still, for sole proprietors that are not worried about liability to shareholders, becoming a licensed B Corp. is probably sufficient. The B Corp. designation is comparable to a LEED certification for a building. Organizations that qualify are also permitted to display the B Corp. name and logo.
Considerations for Social Entrepreneurs. For corporation’s wanting to build a social or environmental purpose into their organizational DNA, incorporating as a benefit corporation may be a great option but keep in mind that under the business judgment rule and constituency statutes corporations may still direct resources for socially beneficial purposes. In determining the appropriate structure for your organization consider who are the directors potentially liable to? Are the additional reporting requirements worth the liability protection? Do you want the ability to enforce the social benefit aspects of your company? In sum, just how accountable to social impact do you want to be?
Ellis Carter is a nonprofit lawyer licensed to practice in Washington and Arizona. Ellis advises tax-exempt clients on federal tax matters nationwide.