A bill stalled out in the Texas legislature last week that would have permitted a new type of corporate organization intended to promote social entrepreneurship. Introduced by state Rep. Stephanie Carter, H.B. 2565 – on the ropes for now, always capable of coming back – would have let Texas businesses operate as “benefit corporations.”
Spread of Benefit Corporations
Benefit corporations are structured so that they allow corporate directors and officers to pursue ends other than profit maximization. The Boston Globe has explained: “The idea of a benefit corporation is to weave some social responsibility into the DNA of the company itself through its charter.”
In the last three years, more than a dozen states have enacted benefit corporation statutes, including economic heavy-hitters like California, New York Pennsylvania and Illinois. Legislation is currently pending in Florida, North Carolina, Nevada, Colorado and even the great redoubt of corporate law that is Delaware.
Legislation varies among states but derives from the same DNA: model language drafted by the nonprofit B Lab. A recent report from the Worldwatch Institute found that about 200 American companies have registered as benefit corporations but that benefit corporation statutes have yet to be subjected to legal challenges or judicial scrutiny.
Benefit corporation legislation generally includes three key features: (1) it establishes that benefit corporations must serve a beneficial purpose; (2) it expands fiduciary duties to require that officers and directors consider nonfinancial interests; and (3) it requires benefit corporations to regularly assess their performance in achieving beneficial purposes.
Challenges of Benefit Corporations
Observers have recognized certain potential downsides to benefit corporations:
Conflicting Purposes: Benefit corporations could serve any number of purposes; some purposes could conflict with others (i.e., serving the interests of low-income consumers by providing low-cost goods could be inconsistent with serving the interests of low-income workers by providing living wages).
Discretion: Benefit corporations could give excessive discretion to officers and directors to chart their preferred purposes and to determine the degree to which to pursue those purposes. Without proper accountability, benefit corporations could end up chasing after shareholder profits like traditional corporations while giving short shrift to stated beneficial purposes. One potential solution: requiring benefit corporations to hit nonfinancial benchmarks (like creating a certain number of jobs or preserving a certain amount of critical habitat) before disbursing profits. Such restrictions could complicate financing, however (see below).
Enforcement: Benefit corporation legislation creates mechanisms of accountability by allowing officers or shareholders to bring beneficial purpose enforcement actions. But enforcement actions can provide only so much accountability. Other stakeholders/beneficiaries – such as employees or local communities – would not have standing (though giving them standing could open the litigation floodgates and cripple benefit corporations).
Financing: Benefit corporations that regard financial returns as subordinate concerns could struggle to attract equity investors. Similarly, because they expose lenders to greater risks, benefit corporations could face higher borrowing costs than strictly profit-oriented counterparts. Socially responsible investors manage significant assets (more than $3 trillion, according to one study) and would presumably show a preference for benefit corporations. But their funding would probably not be sufficient for benefit corporations to fully overcome the financial disadvantages related to their benefit corporation status.
Reputation: In the marketplace, benefit corporations should ideally enjoy reputational advantages based on their beneficial purposes. But with traditional profit-oriented corporations promoting the social or environmental virtues of their products, consumers could overlook the dedicated missions of benefit corporations in a whirl of greenwashing.
Texas Benefit Corporation Legislation
In Texas, H.B. 2565 attempts to unlock the potential of benefit corporations while addressing the above issues through the deployment of best practices. The most notable features of the legislation would add the following provisions to the Texas Business Organizations Code:
Corporate Purpose: Benefit corporations would “have a purpose of creating a general public benefit” in addition to the corporate purposes provided under existing statutes. “General public benefit” is defined as a “material positive impact on society and the environment, taken as a whole, assessed in accordance with a third-party standard, from the business and operations of a benefit corporation.” In addition, a benefit corporation may commit itself in its certificate of formation to a “specific public benefit,” which could include:
- 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 the purpose of benefiting society or the environment; and
- Conferring any other particular benefit on society or the environment.
Director Duties: The fiduciary duties of directors are expanded to require consideration of the effects of corporate action/inaction on: (1) shareholders; (2) employees of the corporation – and of subsidiaries and supplies; (3) customers; (4) “community and societal factors, including those of each community in which offices or facilities of the benefit corporation or subsidiaries or suppliers are located;” (5) the environment; and (6) the short-term and long-term interests of the corporation. Except for under Benefit Enforcement Proceeding (see below), directors cannot be held liable for a failure to “pursue or create” a general/specific public benefit.
Officer Duties: Officers must consider the same factors as directors (shareholders, employees, etc.) if the officers have discretion in related matters and “it reasonably appears… that the matter may have a material effect” on the general/specific public benefit. Like directors, officers are generally shielded from liability for general/specific public benefits.
Benefit Enforcement Proceedings: A proceeding can be brought to enforce general/specific benefit obligations only by the benefit corporation itself or as a derivative action. Derivative actions, in turn, can only be brought by shareholders (owning at least two percent of shares in a class/series), directors, persons specified in the certificate of formation, or persons owning at least 5 percent of a parent company of the benefit corporation. But even if an enforcement proceeding is successful, “[a] benefit corporation is not liable for monetary damages under this subchapter for any failure of the benefit corporation to pursue or create” a general/specific public benefit.
Benefit Directors and Benefit Officers: Because of the complications involved in identifying, weighing and assessing general/specific public benefits, benefit corporations must designate a benefit director and may designate a benefit officer. The same person may serve in both roles, which operate as their name implies. The benefit director (and, if applicable, benefit officer) must prepare an annual benefit report (see below). In addition, the benefit officer “has the powers and duties relating to the purpose of the corporation to create a general public benefit or specific public benefit provided by the bylaws, or absent a controlling provision in the bylaws, a resolution or order of the board of directors.”
Benefit Report: The benefit director (and, if there is one, benefit officer) must prepare an annual benefit report. The reports must assess how well the benefit corporation is achieving its general/specific public benefit. The assessment in the report must be conducted in accordance with a “third-party standard.” A challenge for benefit corporations across the country has been that there is currently an abundance of potential third-party standards; no one standard has emerged as the norm. But H.B. 2565 tries to mandate some level of objectivity and reliability by imposing certain requirements in its definition of “third-party standard.” These requirements provide, for instance, that a standard must be developed by a third party that has appropriate expertise and is unrelated to the benefit corporation. In addition, a standard must make public its criteria and their relative weight.