California Passes Legislation Creating New Structures for Social Enterprise

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Increasingly, social entrepreneurs struggle to choose a legal form for their ventures. The traditional legal forms are not suited to blend social and profit-making purposes.

Managers of a for-profit socially responsible business can find themselves liable to shareholders for failure to maximize profit at all costs. Conversely, managers of tax-exempt nonprofits conducting social entrepreneurial activities can find themselves liable to the IRS when they try to reward investors and incentivize results.

In an effort to create not one, but two legal forms tailored to accommodate socially responsible business models,  California Governor Jerry Brown signed into law Benefit corporation (AB 361) and flexible purpose corporation (SB 201) legislation.

The passage of this new legislation creates two new options for socially responsible business models in California. Generally, benefit corporations are corporate entities that are required to pursue social and environmental objectives in addition to seeking profits. Flexible purpose corporations are corporations that seek profits and at least one broader social or environmental goal.

New Structures for Social Enterprise in California

Benefit Corporation

Beginning January 1, 2012, organizations can incorporate in California as benefit corporations formed for the purpose of creating a general public benefit. A general public benefit is defined as a material positive impact on society and the environment, taken as a whole, as assessed against a 3rd-party standard.

Additionally, existing California corporations can convert to benefit corporations by amending their Articles of Incorporation by a 2/3 shareholder vote as specified by AB 361.

In addition to general public benefits, benefit corporations may identify specific public benefits such as: providing low-income/underserved individuals or communities with beneficial products/services, providing economic opportunity beyond the creation of jobs, preserving the environment, improving human health, etc.

The board of a benefit corporation is required to consider multiple stakeholders including the shareholders, the employees, customers who are beneficiaries of the general or specific public benefit purposes, and the environment.

Benefit corporations are protected from liability from rules governing the fiduciary duty of directors and officers to maximize shareholder value. Specifically, a suit for breach of fiduciary duties may only be enforced in a benefit enforcement proceeding.

Essentially, creating a benefit corporation is a useful way for a socially responsible company to maintain its focus on generating profits while also pursuing certain benefits to society as a whole.

Flexible Purpose Corporations

As with benefit corporations, flexible purpose corporations will be able to incorporate January 1, 2012, and existing California corporations will be able to convert to flexible purpose corporations. Among other requirements, flexible purpose corporations will need to include their special purposes, in addition to any other lawful purposes, that the corporation will engage in their Articles of Incorporation. These special purposes may include but are not limited to, charitable and public purpose activities.

Additionally, managers and directors would be required to specify objectives for measuring the impact of the corporation’s efforts relating to its special purpose. Most importantly, the flexible purpose structure would shield board members from claims that they have violated their fiduciary duties of maximizing shareholder profit by pursuing social or environmental goals.

While these structures are ideal for corporations that would like to be held to a higher standard of social and environmental responsibility, neither will provide tax advantages to the organization. Also, while both have been signed into law and are not mutually exclusive, it is unclear which structure will produce the best results.

Ellis Carter is a nonprofit lawyer licensed to practice in Washington and Arizona. Ellis advises tax-exempt clients on federal tax matters nationwide.

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