A fundamental tenet of corporate law is that a business corporation is organized and carried on for the benefit of its stockholders. In recent times, an increasing number of for-profit organizations have formed in order to pursue social and environmental goals. There is a growing investor movement toward the financial support of organizations that have social benefit purposes at the center of their existence. However, it may be difficult for directors and officers of these organizations to pursue these social purposes without running afoul of traditional fiduciary duties requiring corporate managers to maximize shareholder value.
In order to address these concerns, a group of lawyers and academics have proposed a new form of enterprise, the benefit corporation. The idea behind this organizational form is to create an enterprise that can utilize the tools of business financing and management to address social and environmental issues. In order to deal with the legal issues involved with organizing a business enterprise for broader goals, the proponents of this idea have crafted Model Benefit Corporation Legislation.
Since 2010, the model legislation has been adopted in whole or in part in seven states, including California, New Jersey and Virginia, and is under consideration in a number of others. New York’s version became law on February 10, 2012. Although the model legislation’s provisions address a number of issues, the “heart” of the model benefit corporation legislation is its provisions addressing concerns related to potential director and officer liability.
In this post, I examine the circumstances that have led to the proposal for the development of the benefit corporation concept; the specifics of the organizational form described in the Model Benefit Corporation Legislation; and the aspects of director and officer liability addressed in the legislation. I conclude with my thoughts about the proposed organizational form, including the implications from both a liability and insurance standpoint.
My analysis of these issues relies heavily on the November 16, 2011 paper entitled “The Need and Rationale for the Benefit Corporation” (here). A number of contributors participated in the creation of this document, but the paper’s principal authors are William H. Clark, Jr. of the Drinker Biddle law firm, and Larry Vranka of Canonchet Group LLC. I also refer below to the Model Benefit Corporation Legislation, which can be found here. Information about benefit corporations generally can be found at the Benefit Corporation Information Center. The January 7, 2012 article in The Economist magazine the first piqued my interest in benefit corporations can be found here.
Background
Two recent trends have come together to create the need for a new form of business enterprise. On the one hand, there is a growing class of investors joining the socially responsible investing movement. These investors hope to create a direct social impact through targeted equity and debt investments. (A November 2010 J.P. Morgan study on impact investing can be found here.) On the other hand, for-profit social entrepreneurs, who are interested in pursuing mission-driven businesses, are increasingly common.
An earlier initial response to these developments was the 2007 formation of the B Lab, a non-profit organization whose purpose was to devise and implement a certification system for companies interested in distinguishing themselves in order to try to attract the socially focused investors. B Lab promulgated a number of certification standards for these companies. The difficulty is that these standards were to be adopted within the existing legal framework.
A critical component of the existing legal framework is the basic principal that business corporations exist to maximize shareholder value. This principal constrains the ability of businesses, at least within the existing framework, to consider the interests of constituencies other than shareholders. To be sure, a number of states, in response to takeover battles in the 80’s, did implement so-called “constituency” statues that enable boards and senior company officials to take in account community interests when considering a takeover bid. Unfortunately, among the states that have not adopted constituency statues is Delaware, the place of incorporation for many companies. In addition, even in the states that have adopted constituency statutes, there is a dearth of case law interpreting the statutes, and so there is very little guidance on what other interests a board may consider and to what extent. In addition, constituency statutes are often merely permissive, not mandatory.
Owing to the absence of clear legal standards in these areas, directors may be hesitant to consider social goals or the interests of other constituencies for fear of breaching their fiduciary duties to shareholders. The legal uncertainties and need for greater clarity have led to the proposal of a new form of business enterprise to address the needs of for-profit mission-driven businesses.
The Benefit Corporation
In order to address the legal concerns, reformers have proposed the benefit corporation. The three distinct aspects of the benefit corporation are that it has 1) a corporate purpose to create a material positive impact on society and the environment; 2) expanded fiduciary duties of directors that require consideration of nonfinancial interests; and 3) an obligation to report on its overall social and environmental performance as assessed against third-party standards.
These attributes are embodied in the Model Benefit Corporation Legislation, which has provided the basis for the benefit corporation statues that have been enacted in the seven states. (The seven states are Maryland, Hawaii, Vermont, Virginia, California, New Jersey and New York. Four other states are currently considering similar legislation.)
Under the model legislation, the benefit corporation is required to have a purpose of “general public benefit” and allowed to identify one or more “specific public benefit” purposes. The model legislation lists seven non-exhaustive possibilities for specific public benefit goals, which include: providing products or services to low income individuals; providing economic opportunities for individuals or communities; preserving the environment; improving human health; promoting the arts or sciences; increasing the flow of capital to public benefit enterprises; or the accomplishment of any other particular benefit to society or the environment.
The model legislation further provides that in considering the best interests of the corporation, the directors of the corporation “shall consider the effects of any action or inaction” on the shareholders; the employees of the corporation; the customers; community or societal factors; the local and global environment; the short-term and long-term interests of the benefit corporation; and the ability of the benefit corporation to accomplish its general and specific benefit purposes.
In addition to providing this broad array of factors directors must consider, the model legislation provides certain protections for the benefit corporation directors (and officers). First, the model legislation provides that consideration of the interests of all stakeholders shall not constitute a violation of the general fiduciary duty standards for directors. Second, the model legislation expressly exonerate the directors and officers from monetary damages for any action taken in compliance with the preexisting standards for director duties; and for the failure of the benefit corporation to pursue or create its stated general or specific public benefit. These provisions are intended to eliminate directors’ concerns that they could face damages liability for the enterprise’s failure to fulfill its purposes or for considering the interest of constituencies other than shareholders.
The model legislation does provide for a form of injunctive relief action, to require the benefit corporation to live up to its commitments. Under these provisions, shareholders have the right to bring a legal action in the form of a “benefit enforcement proceeding” on the grounds that a director or officer has failed to pursue the stated general or specific purpose or failed to consider the interest of the various stakeholders identified in the statute. However, only shareholders or directors can bring a benefits enforcement proceeding; beneficiaries of the corporation’s public purpose have no right of action. The exclusion of any right of action by third parties protects the benefit corporation from unknown, expanded liability that might create disincentives to becoming a benefit corporation
Discussion
The purpose of the benefit corporation is to provide an appropriate enterprise vehicle for for-profit mission-driven businesses. Among the objectives in structuring the benefit corporation form is the need to address critical issues regarding the duties and potential liabilities of directors and officers. The key objectives of the model legislation are to ensure that directors and officers of the benefit corporation do not incur liability for considering the interests of constituencies other than shareholders and to ensure that the directors and officers do not incur monetary liability for allegedly failing to fulfill the organization’s general or specific benefit purposes.
It is important to note that although the model legislation provides that the directors and officers cannot be held liable for damages under the benefit corporation provisions, the benefit corporation provisions do not exempt the directors and officers from liability for violating general standards of fiduciary care. The exemption from monetary damages in the model legislation provide only that directors is “not personally liable for monetary damages for (1) any action taken as a director if the directors performed the duties of office in compliance [existing statutory provisions specifying the duties of directors generally]; or (2) failure of the benefit corporation to pursue or create general public benefit or specific public benefit.” Parallel provisions provide similar protections for officers.
The point is that the exemption from monetary damages under the benefit corporation provisions does not exempt the directors and offices from claims for damages for violation of their general fiduciary duties. By the same token, however, the model legislation specifies that the directors and officers of the benefit corporation cannot be held liable for considering the interests of constituencies other than shareholders.
The model legislation does provide for a “benefits enforcement action,” for shareholders to pursue injunctive relief if the organization is not pursuing its benefits objectives or providing required reporting. Even though this action does not allow for damages, it does create a context within which defense costs could be incurred.
In other words, not withstanding the liability protections in the model legislation, directors and officers of a benefit corporation continue to face the possible liability exposures and defense expense exposures.
As a for-profit venture organized to pursue a public good, a benefit corporation does not really fit within the usual D&O insurance framework, which divides the world between non-profit and commercial enterprises. In addition, the benefit corporation regime has unique aspects that could have insurance implications, such as the possibility of a benefit enforcement action.
In just over two years, seven states have enacted legislative provisions allowing for benefit corporations. Implementing legislation is under consideration in several more states. It seems likely that adoption of benefit corporation legislation will become more generalized in the months and years ahead. It also seems likely that as the benefit corporation form become more widespread that insurers will be called upon to address the insurance needs of this new type of enterprise. The unique features of these organizations raises the possibility that new insurance solutions, targeted to the unique needs of these kinds of companies, will be required.
In any event, benefit corporations represent an interesting innovation on the corporate enterprise landscape. If, as seems likely, more states adopt benefit corporation enabling legislation, the issues involved in addressing these companies’ insurance requirements will become an increasingly common concern.