In response to many shortcomings of traditional entities, activists have worked to create new entities specifically designed for enterprises that fall within the gray area between purely profit-driven businesses and purely charitable non-commercial organizations.

Converting from a traditional entity to one of these new kinds of entities is relatively simple, especially in the case of an LLC converting to a low-profit limited liability company (L3C) or a corporation converting to a benefit corporation or flexible purpose corporation. This can usually be accomplished with a members’ or shareholders’ vote and an amendment to the entity’s charter.

Low-Profit Limited Liability Company (L3C)

To understand L3Cs, it is necessary to understand Program-Related Investments. Foundations are required to distribute 5 percent of the value of their net assets for charitable purposes each year. To meet this requirement, foundations primarily make grants to charitable organizations. However, foundations are also permitted, under the Internal Revenue Code, to invest this 5 percent of net assets in for-profit entities if the investment meets a three-pronged test:

•  The investment is primarily for charitable or educational purposes;

•  The production of income or the appreciation of property is not a significant purpose for the investment; and

•  Attempting to influence legislation or taking part in political campaigns on behalf of candidates is not a purpose. ¹

The investment (called a Program-Related Investment or PRI) may produce significant income or capital appreciation so long as the production of income or the appreciation of property is not a significant purpose of the investment. PRIs are relatively uncommon because foundations are unwilling to risk having the IRS determine that the investment does not in fact meet the statutory requirements, and thus be exposed to tax liability or risk losing its tax-exempt status.

L3Cs were created in response to this problem. L3C statutes contain language that requires entities formed under the statute to meet the three requirements of a PRI. In all other respects, an L3C is identical to an LLC. For example, Vermont’s L3C statute provides:

“L3C” or “Low-profit limited liability company” means a person organized under this chapter that is organized for a business purpose that satisfies and is at all times operated to satisfy each of the following requirements.

(A) The Company (i) significantly furthers the accomplishment of one or more charitable or educational purposes within the meaning of Section 170(c)(2)(B) of the IRS Code of 1986, 26 U.S.C. Section 170 (c)(2)(B); and (ii) would not have been formed but for the company’s relationship to the accomplishment of charitable or educational purposes.

(B) No significant purpose of the company is the production of income or the appreciation of property; provided, however, that the fact that a person produces significant income or capital appreciation shall not, in the absence of other factors, be conclusive evidence of a significant purpose involving the production of income or the appreciation of property.

(C) No purpose of the company is to accomplish one or more political or legislative purposes within the meaning of Section 170(c)(2)(D) of the IRS code of 1986, 26 U.S.C. Section 170(c)(2)(D).

(D) If a company that met the definition of this subdivision (27) at its formation at any time ceases to satisfy any one of the requirements, it shall immediately cease to be a low-profit LLC, but by continuing to meet all the other requirements of this chapter, will continue to exist as a limited liability company. The name of the company must be changed to be in conformance with subsection 3005(a).

L3C statutes have been adopted in Illinois, Louisiana, Maine, Michigan, North Carolina, Rhode Island, Utah, Vermont, and Wyoming, and by the Oglala Sioux Tribe and the Crow Indian Nation of Montana. ² According to InterSector Partners, L3C, as of May 24, 2013, 834 L3Cs have been formed. ³ Some examples of L3Cs include Urban Worm Girl (worm composting education), Una Bella Vita (vitamin store), and Overflow Coffee Bar.

Because L3Cs are still new, several open questions remain. It is unclear what would happen if an L3C did not comply with the special L3C statutory language. It is also unclear whether the special L3C language will provide enough assurance to foundations to make program related investments in L3Cs. In the meantime, L3Cs can be a useful tool for a for-profit business that wants to demonstrate a strong commitment to charitable and/or educational purposes.

Benefit Corporation

The Benefit Corporation is a new corporate form that has been adopted in several states. B Lab, the nonprofit organization that provides B Corp certification, advocates for its adoption. Maryland became the first state to pass Benefit Corp legislation in April 2010. Vermont followed in May 2010. As of August 2013, 19 states have passed benefit corporation legislation, including Oregon, California, Nevada, Arizona, Colorado, Arkansas, Louisiana, Hawaii, Illinois, South Carolina, Virginia, Maryland, Delaware, New Jersey, Pennsylvania, New York, Vermont, Connecticut, Rhode Island, and Massachusetts. A Benefit Corporation “ha[s] the purpose of creating general public benefit,” which is defined as “a material positive impact on society and the environment . . . as measured by a third-party standard, through activities that promote some combination of specific public benefits.” ⁴

 “Specific public benefit” includes:

(1) providing low-income or underserved individuals or communities with beneficial products or services;

(2) promoting economic opportunity for individuals or communities beyond the creation of jobs in the normal course of business;

(3) preserving the environment;

(4) improving human health;

(5) promoting the arts, sciences or advancement of knowledge;

(6) increasing the flow of capital to entities with a public benefit purpose; and

(7) the accomplishment of any other particular benefit for society or the environment. ⁵

The articles of a benefit corporation may identify one or more specific public benefits that it is the purpose of the benefit corporation to create . . . . The identification of a specific public benefit under this subsection does not limit the obligation of a benefit corporation to create general public benefit. ⁶

The model statute states that pursuing general and specific public benefit is in the best interests of the benefit corporation. This provision is designed to ensure that when the board of directors works to promote public benefit, that it is meeting its fiduciary duty to promote the best interest of the corporation. The statute requires [that the board and officers] in considering the best interests of the benefit corporation:

(1) shall consider the effects of any action upon:

(i) the shareholders of the benefit corporation;

(ii) the employees and workforce of the benefit corporation and its subsidiaries and suppliers;

(iii) the interests of customers as beneficiaries of the general or specific public benefit purposes of the benefit corporation;

(iv) community and societal considerations, including those of any community in which offices or facilities of the benefit corporation or its subsidiaries or suppliers are located;

(v) the local and global environment; and

(vi) the short-term and long-term interests of the benefit corporation, including benefits that may accrue to the benefit corporation from its long-term plans and the possibility that these interests may be best served by the continued independence of the benefit corporation;

(2) may consider:

(i) the resources, intent and conduct (past, stated and potential) of any person seeking to acquire control of the corporation; and

(ii) any other pertinent factors or the interests of any other group that they deem appropriate; and

(3) shall not be required to give priority to the interests of any particular person or group referred to in paragraphs (1) and (2) over the interests of any other person or group unless the benefit corporation has stated its intention to give priority to interests related to a specific public benefit purpose identified in its articles.”

The statute provides, in effect, that consideration of these factors will not result in liability under the Revlon or Unocal tests.

The statute requires the board of a benefit corporation to have a “benefit director” that is independent (i.e., not an employee, shareholder, etc.). The benefit director is required to “prepare . . . a statement whether, in the opinion of the benefit director, the benefit corporation acted in accordance with its general, and any specific, public benefit purpose in all material respects during the period covered by the report and whether the directors and officers complied with [the provisions] . . . relating to standard of conduct for directors . . . and . . . relating to standard of conduct for officers . . . . If in the opinion of the benefit director the benefit corporation or its directors or officers failed so to act, then the statement of the benefit director shall include a description of the ways in which the benefit corporation or its directors or officers failed so to act.”

The duties of directors and officers under the statute and the general and any specific public benefit purpose of a benefit corporation may be enforced in a “benefit enforcement proceeding.” This is a claim or action brought directly by a benefit corporation, or derivatively on behalf of a benefit corporation, against a director or officer for:

(1) failure to pursue the general public benefit purpose of the benefit corporation or any specific public benefit purpose set forth in its articles; or

(2) violation of a duty or standard of conduct under the benefit corporation statute.

Other than a benefit enforcement proceeding, the statute prohibits any person from bringing an action against a benefit corporation or its directors or officers regarding their duties under the statute or the general and any specific public benefit purpose.

A benefit corporation must deliver to each shareholder and post on its website an annual benefit report describing the ways in which the benefit corporation pursued public benefit and various other matters. Achievement of public benefit must be measured against a “third party standard.” ⁷

According to the drafters of the legislation, “the requirement . . . that a benefit corporation prepare an annual benefit report that assesses its performance in creating general public benefit against a third-party standard provides an important protection against the abuse of benefit corporation status.”

Flexible Purpose Corporation in California

In addition to the California Benefit Corporation statute, California has also adopted a Flexible Purpose Corporation statute, both of which were signed into law by the governor on the same day. After California Governor Schwarzenegger vetoed a constituency statute in 2008, a group of lawyers and advocates for socially responsible business got together to design a new corporate form, called, at the time, the H Corporation.

The working group spent about 18 months soliciting input from various stakeholders on the legislation. Eventually, they decided to name the new form the Flexible Purpose Corporation.

The ideas behind the California Benefit Corporation and Flexible Purpose Corporation statutes are similar, though the details differ. The founders of a flexible purpose corporation select (and identify in the articles) one or more special purposes from a list in the statute:

(A) One or more charitable or public purpose activities that a nonprofit public benefit corporation is authorized to carry out.

(B) The purpose of promoting positive short-term or long-term effects of, or minimizing adverse short-term or long-term effects of, the flexible purpose corporation’s activities upon any of the following:

(i) The flexible purpose corporation’s employees, suppliers, customers, and creditors.

(ii) The community and society.

(iii) The environment.

Flexible purpose corporate directors must send annual reports to shareholders concerning the corporation’s activities relating to its special purposes, but are not required to measure achievement of public benefit against a standard developed by third parties.

Social Purpose Corporation in Washington State

By Brian Howe, Vox Legal ⁸

Washington State residents pride ourselves on being a “little different,” and that holds true even for our corporate lawyers. So it’s no surprise that when a Washington State Bar Association Committee began to study “Benefit Corporation” statutes enacted in other states, the 13-member Committee came up with a slightly different structure—the aptly named Social Purpose Corporation (SPC). Like many similarly envisioned structures, the vision behind the legislation is to enable businesses to boldly seek social or environmental impact alongside the primary objective of creating economic value. ⁹

Traditional corporations are expected to prioritize the creation of shareholder profits above other considerations, such as employee benefits, environmental care, or community impact. By establishing Social Purpose Corporations, Washington State is signaling that companies should have the flexibility to make decisions based on the effects the company has on all stakeholders—that is, any person or entity affected by the corporation’s decisions. Because the legislation ¹⁰ is permissive not proscriptive, SPCs are required to create general social benefit but are not told what that has to be or how to achieve it. ¹¹

SPCs have the additional flexibility to name a specific benefit, should the founders or initial shareholders desire to hold themselves to a higher standard. ¹² Articulating a specific social purpose in conjunction with a general social purpose enables founders to ensure that future decisions of the corporation are in line with the founders’ specific vision and not merely in line with the broad strokes of the general purpose requirement. For instance, founders of a local restaurant could conceivably structure as a social purpose corporation by naming the general purpose of promoting the long-term welfare of their employees and the specific purpose of primarily employing homeless and disadvantaged persons.

A third important aspect of the SPC, in addition to the general social purpose requirement and specific purpose option, is that, once established in the articles of incorporation, social purposes of the SPC may only be altered, amended, or eliminated by a two-thirds majority of the shareholders. ¹³ the report is not required to meet third-party
standards unless the company opts into that requirement. This differs from a Benefit Corporation, where outside review and approval is necessary to maintain its special designation. Further, under the proposed SPC statutes, directors and officers of a company are permitted—but not required—to consider one or more of the social purposes in making decisions. ¹⁴

 This is unlike Benefit Corporations, which are mandated to consider the impact of their decisions on stakeholders. Finally, whereas Benefit Corporation legislation allows shareholders to sue a company for failing to achieve a material positive impact on society and the environment (called a “benefit enforcement proceeding”), the proposed SPC legislation makes clear that directors are not liable for any “action taken as a director, or any failure to take any action” regarding achieving social purposes. ¹⁵

Opinions vary on whether the Flexible/Social Purpose Corporation or the Benefit Corporation will result in greater good. Although a supporter of both forms of legislation as helpful experimentation, California attorney Todd Johnson believes that “The ‘benefit corporation’ form seeks to create accountability (beyond reporting) through a system of greater liability, whereas the ‘flexible purpose corporation’ [and the social purpose corporation] seeks to unleash directors from the risk of liability, permitting them to experiment more broadly with the right mix of doing well and doing good, without concerns of personal or corporate suits.” ¹⁶ From the Benefit Corporation standpoint, Jay Coen Gilbert, co-founder of AND 1 and B Lab, responds that threat of litigation is “accountability to shareholders […] not only to make them money, but to do so in a manner that creates a material positive impact on society and the environment […] This doesn’t seem very much to ask.” ¹⁷

The flexibility of a Social Purpose Corporation may reduce fears of conflict over future business plans while providing SPCs with greater access to capital markets. But while the possibility exists for founders to secure designated social purposes, there are few tangible requirements in the statute to give effect to that purpose. As our economy rebounds and we look for ways to promote companies that value long-term growth, sustainability, and positive value for all stakeholders, the Social Purpose Corporation could be a powerful vehicle for Washington-based companies, but the Benefit Corporation should not be overlooked as an additional vehicle for the common good.