Should you consider forming your business as a benefit corporation or perhaps investing in one? Benefit corporations, also called public benefit corporations in some states, are a relatively new form of corporate entity that has grown in popularity in recent years. First recognized in 2010 in Maryland, this form of entity is now available in the overwhelming majority of U.S. jurisdictions. The benefit corporation form of entity takes aim at a key feature of traditional corporate law that can create tension with a mission-oriented or impact-driven business: namely, that directors and officers of corporations may have a legal duty to prioritize the maximization of financial return to shareholders above all else. Failure to do so exposes traditional corporations and their managers to the risk of lawsuits by shareholders for breach of that fiduciary duty.
To be clear, a duty to prioritize shareholder return does not mean that a corporation may never make decisions or expend resources in ways that benefit employees, its host community, the environment, charities or other public good at the expense of short-term financial return to shareholders. Indeed, corporations do that every day. What it does mean is that such decisions or expenditures will be open to legal challenge by shareholders if they cannot be justified as ultimately contributing to maximizing shareholder return. For example, such good works may be justified as maximizing shareholder value over the longer term if they build goodwill associated with the corporation’s brand, enhance customer loyalty or help the corporation attract and retain talent. However, having to justify such actions in terms of how they maximize shareholder value can be frustrating to corporate managers who are interested in serving their view of the public good in addition to driving financial return.
Enter the benefit corporation, which permits officers and directors to consider and prioritize non-financial interests – such as the social and environmental impacts of its actions or the well-being of its employees or surrounding community – in addition to the financial interests of shareholders. This freedom to focus more broadly than on just maximizing shareholder return has made the benefit corporation an increasingly appealing option to those who seek to drive social change (as well as make a profit) through their businesses. Notable examples of benefit corporations include Danone North America, Kickstarter, King Arthur Baking Company, Method and Patagonia.
Note that benefit corporations are distinct from “Certified B Corporations” – or “B Corps” as they are more commonly known – which have garnered increasing attention. The B Corp designation has no legal meaning, but rather is a certification that B Lab, a private nonprofit, grants companies that go through a rigorous assessment process and meet certain requirements. Our companion blog post discusses B Corps in more detail.
The freedom to look beyond shareholder return that comes with being a benefit corporation, however, has some strings attached that merit consideration before forming a benefit corporation. The requirements vary based on the law of the state in which the benefit corporation is organized, but there are certain commonalities. This article uses examples from the applicable statutes in Delaware and in Massachusetts.
Public benefit requirement. The freedom a benefit corporation has to consider social and environmental impacts in addition to financial impacts is not merely an option but rather a requirement. Indeed, a Delaware benefit corporation is required to promote at least one specific public benefit and to operate in a “responsible and sustainable manner” that “balances the stockholders’ pecuniary interests, the best interests of those materially affected by the corporation’s conduct, and the public benefit or public benefits identified in its certificate of incorporation.” A Massachusetts benefit corporation must have, in addition to its specific business purpose, the purpose of creating a general public benefit, which is defined as “a material, positive impact on society and the environment.” The Massachusetts statute enumerates factors that benefit corporation board members are required to consider in their decision-making, including the effects of any action on the corporation’s shareholders, its workforce and suppliers, its customers and clients, its community and the environment.
Being required to consider these factors and perspectives is quite a bit different from being merely permitted to consider them. Before committing to becoming a benefit corporation, managers should carefully consider the impact this requirement will have on the corporation’s decision-making processes, what steps it will want to take to ensure routine consideration of these other factors and how best to document that process.
Supermajority requirements. Becoming (or ceasing to be) a benefit corporation involves amending a corporation’s articles of organization, so a corporation organized in Massachusetts will typically need the approval of holders of two-thirds of its outstanding voting shares to become or to cease to be a benefit corporation. Accordingly, the decision to become a benefit corporation in Massachusetts is not so easily undone, and the need to obtain supermajority shareholder approval of these actions, particularly in connection with a merger or acquisition, can complicate corporate decision-making and exit strategies. Conversely, Delaware’s public benefit corporation statute was amended in 2020 to remove similar supermajority voting requirements.
Appraisal rights. The Massachusetts benefit corporation statute affords shareholders who do not vote in favor of a corporation’s election to become a benefit corporation the same statutory appraisal rights that dissenting shareholders have with respect to merger and acquisition transactions. As a result, Massachusetts corporations contemplating becoming benefit corporations should consider the possibility of dissenting shareholders' exercising these appraisal rights and the resulting possibility of having to pay them fair value for their shares. The 2020 amendments to Delaware’s public benefit corporation statute dispensed with shareholder appraisal rights in connection with the election to become a benefit corporation in that state.
Reporting and transparency. Benefit corporations are required to periodically report to shareholders on the public benefits pursued and attained by the corporation, the standards the corporation uses to measure its success in meeting its objectives, and an assessment of the corporation’s achievement of its objectives. Delaware requires a report at least every other year, while Massachusetts requires a report each year. Benefit corporations often use the benefit report as an opportunity to tout their social and environmental impacts by posting the reports on their website; in fact, Massachusetts benefit corporations are required to post their reports on their websites.
Preparing these reports requires both time and expense, as well as opens up the corporation to a potentially unfamiliar level of scrutiny. While public companies are used to a degree of transparency and disclosure due to public reporting requirements, privately held corporations are typically under no such obligation, and the openness and transparency required by periodic benefit reporting may come as quite a surprise.
Accountability. In the same way that traditional corporations are open to lawsuits by shareholders claiming the corporation has breached its duty to maximize shareholder value, benefit corporations are open to lawsuits by shareholders claiming that the corporation has breached its obligations with respect to its public benefit objectives. The Delaware and Massachusetts statutes do seek to limit the scope of shareholder suits, though in different ways. The Delaware statute limits the ability to bring a benefit enforcement action to those who hold individually or collectively at least 2% of the corporation’s outstanding shares, or for corporations with shares listed on a national securities exchange, shares with a value of at least $2 million if that is less than 2% of the corporation’s outstanding shares. As a result, this creates a significantly higher threshold than that for a typical shareholder suit. There is no similar threshold in the Massachusetts statute, but the statute limits liability by expressly precluding money damages as a remedy.
Because benefit corporations are relatively new and their number remains relatively modest, there is little case law on benefit enforcement actions at this point. Accordingly, it remains to be seen how courts will interpret and enforce the various duties described in the benefit corporation statutes and whether the prospect of liability for failure to live up to benefit objectives will become a material issue for such corporations.
Attracting investors. With any new form of entity comes uncertainty, which may tend to make potential investors skittish. In addition, the requirement that a benefit corporation consider factors other than shareholder return in its decision-making will be foreign to many conventional investors. However, with the growth of impact investing (investing for social and/or environmental return in addition to financial return), there seem to be more and more investors who are actively seeking out benefit corporations. In the near term, it seems reasonable to expect that there will be investors interested in benefit corporations, but it remains to be seen whether the volume of these investors will reach a critical mass such that the same financing options available to traditional corporations will become available to benefit corporations.
Any business considering forming as or converting to a benefit corporation should carefully consider these issues before deciding that a benefit corporation is a good fit for the business and its objectives.
FURTHER INFORMATION
For further information about these matters, please contact Frans Wethly at fwethly@klavenslawgroup.com or 617-502-6285, Sam Rothberg at srothberg@klavenslawgroup.com, or Jonathan Klavens at jklavens@klavenslawgroup.com or 617-502-6281.
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