An Overview of Benefit Corporations: A Proposed Solution to the Social Entrepreneur’s Dilemma

Erik J. Estrada[1] and Alan H. Frosh[2]

According to the original translation, an entrepreneur is “someone who undertakes.”[3] More specifically, an effective entrepreneur understands his or her passion, formulates a vision from this passion, and takes action to achieve this vision. By engaging in this process, entrepreneurs help advance our economy, our communities, and our nation by creating new products, processes, and services. Social entrepreneurs, a growing subset of entrepreneurs, undertake with both a business purpose and a social purpose.[4] Because of this dual purpose, social entrepreneurs value both earning profit and promoting a certain social objective, such as preserving the environment, improving human health, or promoting economic opportunities.[5]

Under Colorado’s existing legal structure, social entrepreneurs face a dilemma. They can establish either a for-profit entity, such as a limited liability company, or a nonprofit entity, such as a nonprofit corporation. Through innovative drafting in a for-profit entity’s organizational documents, social entrepreneurs may emphasize a social purpose; however, profit-maximization is likely to be the ultimate objective if such an entity is selected and the social entrepreneur enlists other investors. When profit-maximization and the pursuit of a social purpose conflict, social entrepreneurs may favor the former because of the risk of a derivative action brought by an investor.[6] Colorado nonprofit corporations, on the other hand, are generally prohibited from having shareholders.[7] For this reason, a social entrepreneur who establishes a nonprofit corporation will have limited financing options.

To address this dilemma, a number of state legislatures have enacted legislation creating benefit corporations.[8] In fact, as of March 2012 the following states have enacted such legislation: California, New York, Hawaii, Virginia, Maryland, Vermont, and New Jersey.[9] Dana Brakman Reiser, in her law review article entitled Benefit CorporationsA Sustainable Form of Organization?, argues that “[t]he main thrust of benefit corporation statutes is to require these entities to pursue purposes beyond profit-making.”[10] In Colorado, State Senator Bob Bacon introduced in 2011 Senate Bill 11-005, which would have created this corporate form in Colorado.[11] Senator Bacon may reintroduce this legislation in 2012. For this reason, and because a growing number of states have recently adopted this new corporate form, this Article will examine the key features of Senate Bill 11-005, which is similar to the benefit corporation statutes enacted in the foregoing states.

Under this proposed legislation, a benefit corporation must promote the “general public benefit.”[12] This term was defined in Senate-Bill 11-005 as:

A material, positive impact on society and the environment, taken as a whole, as measured by a third-party standard, from the business and operations of a benefit corporation.[13]

In addition to promoting the general public benefit, a benefit corporation may also promote a “specific public benefit.”[14] This term was defined as “preserving the environment, improving human health, or promoting the arts, sciences, or the advancement of knowledge,” among other enumerated definitions.[15] Notably, Senate Bill 11-005 also explicitly provided that “the promotion of general and specific public benefits . . . is in the best interests of the benefit corporation.”[16] This provision was likely included to deter potential shareholder derivative actions arising when the directors favored the social purpose over profit-maximization.[17]

Under Senate-Bill 11-005, a third party would determine whether a benefit corporation is promoting the general public benefit.[18] This third-party provision is modeled after the benefit corporation statutes enacted in other states.[19] Dana Brakman Reiser also addresses this aspect of benefit corporation statutes by stating, “Rather than entrusting a governmental agency to make these initial determinations, the benefit corporation statutes delegate this responsibility to third-party standard-setters.”[20] For example, B Lab, a nonprofit corporation with offices in Pennsylvania, New York, California, and North Carolina, could serve as this third party.[21] B Lab operates a volunteer “B-Corporation” certification process.[22] Any entity, including benefit corporations and low-profit limited liability companies, may apply for the B-Corporation designation.[23] B Lab also tracks the progress of benefit corporation legislation, as it strives to “[build] the market infrastructure necessary to create a new sector of the economy that will redefine success in business.”[24]

Senate Bill 11-005 also included an annual report requirement.[25] Pursuant to proposed section 7-138-401 of the Colorado Revised Statutes, a benefit corporation must prepare an annual report to its shareholders addressing the ways it promoted the general public benefit or the specific public benefit identified, if any, in its articles of incorporation.[26] A third party—most likely the one selected to determine whether a benefit corporation is pursuing the general public benefit—must also conduct an annual assessment of the benefit corporation’s “social and environmental performance.”[27] This annual report must be filed with the Colorado Secretary of State and posted on the benefit corporation’s website, if such corporation maintains a public website.[28] For these reasons, “the benefit corporation form relies significantly on disclosure.”[29] Similarly, nonprofit corporations exempt from taxation under section 501(c)(3) of the Internal Revenue Code of 1986, as amended, with gross receipts over a certain amount must annually file and make publicly available their Form 990s.[30]

Corporate directors are charged with the duties of loyalty and care.[31] Directors of benefit corporations also owe certain fiduciary duties, and benefit corporation statutes explicitly outline certain considerations for such directors.[32] For example, Senate Bill 11-005 states:

[Directors] [s]hall consider the effects of any action, or decision not to act, on: (I) the shareholders of the benefit corporation; (II) the employees and work force of the benefit corporation; . . . (III) the interests of customers as beneficiaries of the general or specific public benefit purposes; . . . (IV) community and societal considerations; . . . (V) the local and global environment; (VI) the short-term and long-term interests of the benefit corporation; . . . and (VII) the ability of the benefit corporation to accomplish its general, and any specific, public benefit purpose.[33]

According to Dana Brakman Reiser, “[t]he intent of this language appears to be broadening the range of appropriate considerations in directorial decision making, in order to give directors discretion to make decisions favoring social mission achievement over profit-maximization.”[34]

Under Senate Bill 11-005, the obligations of directors and officers may only be enforced in a “benefit enforcement proceeding,” which is modeled after similar provisions contained in other benefit corporation statutes.[35] In fact, each of the benefit corporation statutes enacted in the other states, except for the statute enacted in Maryland, confer this right of action.[36] Under Senate Bill 11-005:

A benefit enforcement proceeding may be commenced or maintained only: (a) directly by the benefit corporation; or (b) derivatively by: (I) a shareholder; (II) a director; (III) a person or group of persons that owns, beneficially or of record, five percent or more of the equity interest in an entity of which the benefit corporation is a subsidiary; or (IV) other persons as specified in the articles of incorporation or bylaws of the benefit corporation.[37]

This language does not significantly expand “standing to challenge conduct of benefit corporation fiduciaries.”[38] However, until further legislation or case law addressing this issue is developed, the exact obligations that such fiduciaries owe to the foregoing individuals or groups is unclear.[39]

Finally, Senate Bill 11-005 addressed the possibility of conversion to, as well as termination of, this new corporate form.[40] An existing corporation “may become a benefit corporation . . . by amending its articles of incorporation to include . . . a statement that the corporation is a benefit corporation.”[41] This amendment to the articles of incorporation must be adopted by the affirmative vote of at least two-thirds of “the shareholders of each class or series entitled to cast votes on the action,” in addition to any other consents required by the corporation’s articles of incorporation or bylaws.[42] Similarly, the corporation’s shareholders may terminate this status by amending the articles of incorporation to delete the reference to “benefit corporations” as required pursuant to proposed section 7-138-106 of the Colorado Revised Statutes.[43] Terminating this status, however, does not mean that the corporation has been dissolved. Such action must be completed pursuant to the Colorado Business Corporation Act.[44]

Social entrepreneurs conduct business with a dual purpose of earning a profit while promoting a certain social objective. Accordingly, benefit corporation statutes have been enacted with the hope that this dual purpose may be articulated and pursued through a new corporate form. Patagonia, for example, recently became a California benefit corporation.[45] The foregoing sections of this Article describe the key features of Senate Bill 11-005, Concerning Benefit Corporations, which may be reintroduced in the Colorado legislature in 2012.

 

 


[1] Erik J. Estrada is an Associate with Davis Graham & Stubbs LLP, where his practice focuses on securities regulation, corporate and financial transactions, mergers and acquisitions, corporate governance, and regulatory guidance for businesses, public entities, and nonprofit organizations. He is also an Adjunct Professor and an Instructor at the University of Denver and the University of Colorado, respectively. He is a graduate of the University of Denver Sturm College of Law (J.D.), the University of Colorado School of Public Affairs (M.P.A.), and the University of Colorado at Boulder (B.A.). He is presently pursuing an LL.M. (Master of Laws) from the Boston University School of Law.

[2]Alan H. Frosh is a graduate of the University of Denver Sturm College of Law (J.D.) and the University of Denver (B.A.). Prior to attending law school, he served as a Senior Fellow and Program Director at the El Pomar Foundation located in Colorado Springs, Colorado. He is also the Founding Chairman of the Gordian Fund, a donor-advised fund to encourage young professionals to engage in the next generation of philanthropy.

[3] J. Gregory Dees, Jed Emerson & Peter Economy, Enterprising Nonprofits: A Toolkit for Social Entrepreneurs 3 (2001).

[4] Id. at 4–5.

[5] Id.; S.B. 11-005, 68th Gen. Assemb., Reg. Sess. (Colo. 2011).

[6] Lorelei Laird, Profiting for Good, A.B.A. J., Jan. 2012, at 11.

[7] See Colo. Rev. Stat. § 7-123-102(2) (2011) (“Unless permitted by another statute of this state or otherwise permitted pursuant to section 7-123-101(5), 7-123-101(7), or 7-137-201, a nonprofit corporation shall not authorize or issue shares of stock.”).

[8] Laird, supra note 6.

[9] B Lab, http://www.benefitcorp.net/state-by-state-legislative-status (last visited Mar. 16, 2012).

[10] Dana Brakman Reiser, Benefit CorporationsA Sustainable Form of Organization?, 46 Wake Forest L. Rev. 591, 597 (2011).

[11] S.B. 11-005, 68th Gen. Assemb., Reg. Sess. (Colo. 2011).

[12] See Colo. S.B. 11-005 § 7-138-201 (“A benefit corporation must have the purpose of promoting general public benefit, in addition to the purposes described in Section 7-103-101.”).

[13] Colo. S.B. 11-005 § 7-138-102(4) (emphasis added).

[14] Colo. S.B. 11-005 § 7-138-201(2).

[15] Colo. S.B. 11-005 § 7-138-102(7).

[16] Colo. S.B. 11-005 § 7-138-201(3).

[17] Reiser, supra note 10, at 598.

[18] Colo. S.B. 11-005 § 7-138-102(4).

[19] Reiser, supra note 10, at 600.

[20] Id.

[21] B Lab, http://www.bcorporation.net/contact (last visited Mar. 16, 2012).

[22] J. Haskell Murray & Edward I. Hwang, Purpose with Profit: Governance, Enforcement, Capital-Raising and Capital-Locking in Low-Profit Limited Liability Companies, 66 U. Miami L. Rev. 1, 20 (2011).

[23] Id.

[24] B Lab, http://www.benefitcorp.net/state-by-state-legislative-status (last visited Mar. 16, 2012); B Lab, http://www.bcorporation.net/The-Non-Profit-behind-B-Corps (last visited Mar. 19, 2012).

[25] S.B. 11-005, 68th Gen. Assemb., Reg. Sess. § 7-138-401 (Colo. 2011).

[26] Id.

[27] Id.

[28] Id.

[29] Reiser, supra note 10, at 615.

[30] IRS, http://www.irs.gov/charities/article/0,,id=169250,00.html (last visited Mar. 16, 2012). 

[31] Murray & Hwang, supra note 22, at 33.

[32] Reiser, supra note 10, at 598.

[33] Colo. S.B. 11-005 § 7-138-301.

[34] Reiser, supra note 10, at 599.

[35] Colo. S.B. 11-005 § 7-138-304.

[36] Reiser, supra note 10, at 605. 

[37] Colo. S.B. 11-005 § 7-138-304.

[38] Reiser, supra note 10, at 605–06.

[39] Id.

[40] Colo. S.B. 11-005 §§ 7-138-107 to -108.

[41] Id.

[42] Id.; Colo. S.B. 11-005 § 7-138-102.

[43] Colo. S.B. 11-005 § 7-138-108.

[44] Colo. S.B. 11-005 § 7-138-105; Colo. Rev. Stat. §§ 7-101-101 to -117 (2011).

[45] John Tozzi, Patagonia Road Tests New Sustainability Legal Status, Bloomberg, Jan. 4, 2012, http://www.bloomberg.com/news/2012-01-04/patagonia-road-tests-new-sustainability-legal-status.html.