As of January 2015, Arizona entrepreneurs will be able to form their companies as Arizona benefit corporations. There is quite a bit of misunderstanding about what a benefit corporation is and why an entrepreneur might choose to form one. This article is our attempt to shed light on these issues.
Why a Benefit Corporation?
Because the socially responsible consumer market is exploding and being a benefit corporation may be the proof necessary to distinguish a company from those allocating social responsibility expenses to their marketing departments. According to B Labs, there are over 70 million socially conscious consumers and over 200,000 social entrepreneurs and sustainable businesses; and, these numbers are growing.
Aside from the business reasons, corporations owe a duty to their shareholders to maximize profits and the benefit corporation provides a rebuttable presumption against a shareholder’s claim that the corporation has breached that duty when it directs profits toward social impact.
Although the business judgment rule arguably provides a corporation with all the defense it needs (just look at Starbucks and the many fortune 100 companies with entire Corporate Social Responsibility departments), concerns about such claims can have a chilling effect on an organization’s willingness to make decisions not directly contributing to the bottom line.
If an entrepreneur is committed to creating a social impact, operating as a benefit corporation provides some legal comfort that pursuing social goals is a sanctioned activity.
More importantly, a socially driven investor can enforce the public benefit purpose of a benefit corporation; whereas, in a traditional business form, the investor is limited to derivative and direct causes of action for breaches of the traditional fiduciary duties of care and loyalty. This makes the benefit corporation ideal for an investor who wants to ensure their investment goes towards making a difference.
The benefit corporation is not without some challenges, however. Entrepreneurs need to take account of the additional transparency and accountability requirements of the law. As discussed below, there is additional paperwork, not to mention a legally enforceable commitment to being socially and environmentally responsible.
Forming a Benefit Corporation
A benefit corporation will be formed with the Arizona Corporation Commission just like any other corporation; however, the Articles of Incorporation must include a couple of important provisions, including that it is a benefit corporation and that its purpose shall include the creation of a general public benefit. If the founders so choose, they may further bind themselves to make an impact by identifying one or more specific public benefits the benefit corporation will pursue.
The details of converting an existing business entity into a benefit corporation depend on the existing structure. If the entity is a traditional corporation, its articles of incorporation must be amended to conform to the benefit corporation requirements discussed above and then filing the new Articles with the ACC.
If the entity is an LLC, one option is to form the benefit corporation and then merge the LLC with it. Foreign corporations seeking to convert to an Arizona benefit corporation will need to refer to their state’s domestication statute or will need to merge with a newly formed Arizona benefit corporation. Regardless of how it becomes a benefit corporation, the current entity is required to secure a supermajority status vote (75%) to elect benefit corporation status.
Operating a Benefit Corporation
Accountability and transparency are primary characteristics of the benefit corporation. As we discussed in a previous CharityLawyer Blog Post, the benefit corporation statute creates an additional duty for board members to create a social benefit. Arizona will require board members to affirmatively consider the impact of their decisions on various populations.
In Arizona, the board shall consider the effects of any action or inaction on its shareholders, employees, subsidiaries, suppliers, customers, community, society, local and global environment, as well as the ability of the benefit corporation to accomplish its positive social and environmental benefit.”
If the benefit corporation has defined a specific public benefit, it must consider the impact of its action or inaction on the defined population. Officers have nearly identical duties under statute.
Related read: Taxable Subsidiaries
Benefit corporations are a subset of for-profit taxable business corporations. The benefit corporation designation does not impact the entities’ tax status which will be that of a C corporation unless an S election is made.
Benefit Enforcement Proceedings
A benefit enforcement proceeding is a process by which, either directly or derivatively, the benefit corporation can be forced to fulfill its general or specific public benefit goal. To our knowledge, such a proceeding has never happened, but just in case Arizona is the first state where one does take place, the statute defines who may enforce the public benefit purpose.
Four groups can derivatively force the benefit corporation to act:
(a) a person or group of persons who own at least two percent of the total number of shares . . . outstanding in the benefit corporation;
(b) a director of the benefit corporation;
(c) a person or group of persons owning 5% or more equity interest of a company of which the benefit corporation is a subsidiary; or
(d) other persons as specified in the articles of incorporation or bylaws of the benefit corporation.
It is through this benefit enforcement proceeding that a benefit corporation can be held responsible for executing on its public benefit purpose. Furthermore, the benefit corporation by statute, and the directors and officers unless stated otherwise in the articles of incorporation, are not liable for monetary damages for a failure to execute on its public benefit purpose.
Preparation of Annual Benefit Report
Benefit corporations must prepare and submit an Annual Benefit Report. The report must be delivered to both its shareholders and the ACC and posted to its website (if no website, they must give a free copy of the report to anyone who asks).
The report is useful for consumers and investors because it must detail the extent to which the benefit corporation was able to create its public benefit, what obstacles stood in its way, and how it chose the third-party standard against which it evaluated itself. Further, the report must also include the compensation paid to each director.
Altering or Terminating a Benefit Corporation
Terminating a benefit corporation simply requires a minimum status vote, or 67%, to amend its Articles of Incorporation, deleting the statement that the entity is a benefit corporation. Short of terminating its benefit corporation existence, with a minimum status vote the board can add, amend, or delete the specific public benefit purpose.
It is important to remember, only a general public benefit is required; a specific public benefit purpose is optional. This is to say, the purpose can be changed and the status can be switched to a more traditional legal structure.
The benefit corporation will soon give social entrepreneurs another entity to choose from when they are moving forward on their idea. Just like any time you are moving through the entity selection process, benefit corporations have pros and cons and a knowledgeable attorney can help you choose which form best fits your business plan.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. Ellis advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations. Ellis is licensed to practice in Washington and Arizona and advises nonprofits on federal tax and fundraising regulations nationwide. Ellis also advises donors with regard to major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.