Serving Private and Public Interests? Advantages and Limitations of Benefit Corporations

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Is it possible for a business to both maximize value for its owners and prioritize social improvement? Traditionally, business founders have been forced to choose one or other. Taxable limited liability companies (LLCs), partnerships, and corporations typically exist to maximize shareholder or other owners’ value through their commercial enterprises. Nonprofits, on the other hand, have typically addressed non-commercial purposes in various entity forms.

Interest in socially responsible entrepreneurship continues growing, fueled by increasing motivation to address social and environmental needs through business activity. This trend has led to the advent of hybrid corporate forms that combine profit generation with social responsibility. Of these social enterprises, the best known and most common is the benefit corporation, which is now an available corporate entity in the great majority of American states.

What is a benefit corporation, and what are the advantages and disadvantages of adopting this corporate form? Are benefit corporations and B corporations the same thing? What alternatives to benefit corporations are available - like LLCs and limited partnerships – whose leaders may be interested in developing social enterprises? Of critical importance to those who may think twice about starting a nonprofit, when might these benefit corporations serve as a viable alternative to nonprofit corporations? This article addresses common questions and identifies key considerations for business and nonprofit leaders who are evaluating new forms of entrepreneurship.

Background: Owner Interests Versus the Non-Distribution Constraint

In both nonprofit and for-profit organizations, directors owe a fiduciary duty to act in the entity’s best interest. But what is the best interest of the corporation? The answer differs significantly in the nonprofit context from entities organized for profit.

In the nonprofit context, “acting in the best interest” usually means acting in furtherance of one or more tax-exempt purposes as enumerated in the corporate purpose statement and in keeping with one of the subsections under IRC section 501(c). For example, entities described under Internal Revenue Code (IRC) section 501(c)(3) may operate for charitable purposes, organizations under IRC section 501(c)(4) may operate for social welfare purposes, and nonprofits under IRC section 501(c)(7) may operate for social purposes. Such public purposes are in keeping with the so-called “non-distribution constraint,” which prohibits private ownership of a nonprofit and financial benefit from inuring to private interests.[1]

In the for-profit context, however, “acting in the best interest,” traditionally speaking, means the maximization of shareholder or owner value. Under this prevailing theory of shareholder primacy, directors are bound by their fiduciary duties to consider the welfare of the shareholders above all other stakeholders, such as employees or customers, when making decisions for the corporation.

This fiduciary responsibility means that directors may be in danger of shareholder derivative actions or other potential liability when they allow social values to factor into their decision-making. The classic prime example is Dodge vs. Ford Motor Company, the 1919 case in which the Dodge brothers, then minority shareholders in Ford Motor Company, successfully sued Henry Ford for his decision to lower the cost of his Model-Ts to benefit consumers, rather than distribute surplus earnings to benefit company shareholders.

Benefit Corporations – A Statutory Hybrid Model

A benefit corporation (or public benefit corporation in some states) is a recently developed statutory form of for-profit entity designed to achieve a general public benefit in addition to generating profits. As of the year 2021, forty-one states and the District of Columbia had passed legislation allowing for the creation of benefit corporations.[2]

Benefit corporation statutes, such as those passed in South Carolina (2012) and Illinois (2013), provide that the corporate purposes of a benefit corporation must include the creation of general public benefit and may include the creation of one or more specific public benefits, such as preserving the environment or promoting the arts.[3] These statutes further state expressly that the creation of these general and specific public benefits is in the corporation’s best interest, thus protecting directors from possible breach of fiduciary duty claims as they pursue these public goods alongside shareholder value.

Benefit corporations are not the only statutory form of social enterprise tailored to corporations. Social purpose corporations, or “SPCs,” are also for-profit corporations designed to achieve social or environmental good. However, unlike benefit corporations, SPCs offer flexibility by allowing, but not requiring, the corporation to pursue public benefit. Unfortunately, SPC status is available in far fewer states than is benefit corporation status, with only four states allowing for SPCs as of 2021.[4]

Advantages of Benefit Corporations

The choice to form a benefit corporation can benefit the corporation itself as well as the general public. In addition to protecting the governing directors’ freedom to prioritize values other than shareholder value maximization, benefit corporation status can provide companies with a powerful competitive edge in the market for funding, talent, and sales.

As to funding, benefit corporations are likely to attract socially minded investors who want to invest their money responsibly and contribute to specific social causes while building their wealth. This attribute may carry the added benefit of creating a community of investors with shared values who are uniquely motivated to see the business succeed.

Additionally, benefit corporations may be specially poised to attract top talent by drawing employees who believe in the corporate mission and are looking for deeper fulfillment in their work. Finally, in the competition for sales, consumers and trade partners alike may be more likely to do business with a corporation that has demonstrated its commitment to widely held social values.

Limitations of Benefit Corporations

While benefit corporation status provide the above discussed opportunities for businesses, it comes with its own added limitations and potential risks.

To begin with, benefit corporations are taxable, unlike nonprofit corporations that are exempt under IRC section 501(c). As the benefit corporation realizes net revenues, those revenues are subject to tax at the corporate rate, leaving less available to advance the beneficial purposes for which it is operated (at least in part).

Additionally, benefit corporations lack access to revenue streams widely available to nonprofit corporations. For example, benefit corporations undertaking environmental, educational, and other charitable purposes may not receive donor contributions that are tax deductible to the donor. They also generally will not have access to grant funds earmarked for exempt entities especially for those under IRC section 501(c)(3). Recognized nonprofit corporations, on the other hand, routinely leverage such funding sources to further their worthwhile purposes.

Benefit corporations are required as well to prepare annual benefit reports for shareholders describing their performance in achieving their social or environmental aims.[5] They must designate a benefit director and a benefit officer too, to help prepare these benefit reports and monitor the corporation’s beneficent activity.[6]

Another possible disadvantage of benefit corporation status is the potential for increased grounds for liability, as directors and officers are legally required to pursue the corporation’s enumerated public purposes. While benefit corporation statutes limit liability for directors with regard to these beneficial purposes, statutory “benefit enforcement proceedings” may be brought against directors by shareholders, other directors, or stakeholders in the company’s corporate parent.[7]

One final disadvantage to consider is that benefit corporations are new to U.S. law, and as such they are still being explored and understood within the courts. This consideration introduces some level of unpredictability for those businesses taking on benefit corporation status, which would not be present with more traditional corporate forms. But depending on the business, the benefits may more than justify the uncertainty.

Given the lack of access to charitable resources and taxable nature of benefit corporations, many founders have determined such limitations mitigate the usefulness of the hybrid benefit corporations. Instead, entrepreneurs often lean toward to a structure with two affiliated entities: (a) a for-profit, taxable corporation that undertakes commercial activities; and (b) a foundation or other entity exempt under Section 501(c)(3) that focuses on specific charitable and other tax-exempt purposes. Subject to careful planning and due separation between the entities, the for-profit corporation may still participate meaningfully in supporting the tax-exempt entity without putting the for-profit board of directors at risk. Affiliation agreements, corporate contributions, and corporate sponsorships are some of the strategic mechanisms of such philanthropic participation.

B Corp Certification

Benefit corporations are often confused with B Corporations. Despite the similarity in name, B Corporations or “B Corps” are not necessarily statutory benefit corporations. A B Corp is any company that has received “B Corp Certification” by B Lab, an independent nonprofit organization founded in 2006. The “B” in “B Corp” stands for “beneficial,” and certification is available only to companies that “meet verified standards of social and environmental impact,” commit to follow certain transparency requirements, and make themselves “legally accountable to all of their stakeholders.”[8]

As to this legal accountability requirement, B Corps must update their governing documents to prioritize the benefit of all stakeholders, including employees, customers, and the environment, in addition to that of shareholders. This may require B Corps to become benefit corporations, depending on the availability of benefit corporation status in the company’s state of formation.

B Corps must pay an annual certification fee to maintain their certified status, and as noted they must adhere to certain transparency and reporting requirements. However, B Corp certification can help businesses in the marketplace in much the same way that benefit corporation status can, and undergoing the corporate changes needed to meet legal accountability requirements can similarly provide the company’s decisionmakers with added freedom of discretion when it comes to pursuing public goods.

Other Forms of Social Enterprises

What if a business entity’s leaders want to become a social enterprise? Though less widely available than benefit corporation status, other available social enterprise forms are available in various jurisdictions that can be tailored for such purposes. Statutory public benefit limited partnerships, (“SPBLPs”) for example, are for-profit limited partnerships that are formed to pursue public benefits. However, SPBLPs are available only in Delaware.[9]

More common is the low-profit limited liability company, or “L3C,” a for-profit LLC that tracks IRS requirements for program-related investments by private charities. Though the L3C was the first form of social enterprise created in the United States, only eight states had L3C statutes as of 2021.[10] On a related note, benefit limited liability companies, or “BLLCs,” are LLCs that have stated public benefit purposes, much like a benefit corporation, without the L3C emphasis on funding. Only five states currently allow for the creation of BLLCs.[11]

In Closing

Should entrepreneurially minded philanthropists start a benefit corporation or other socially beneficial for-profit business? The answer may well depend on the specific goals in mind, applicable state law, and a careful evaluation of advantages and disadvantages involved with a nonprofit versus a for-profit business model.

 

[1] For more information about this nonprofit fiduciary duty, see our law firm’s blog article here. For more information about prohibited private benefit within the nonprofit context, see our law firm’s blog article here.

[2] The Grunin Center for Law and Social Entrepreneurship at the New York University School of Law; The State of Social Enterprise and the Law 2020-2021.

[3] S.C. Code § 33-38-300; 805 ILCS 40/3.01.

[4] The Grunin Center for Law and Social Entrepreneurship at the New York University School of Law; The State of Social Enterprise and the Law 2020-2021.

[5] See, e.g., S.C. Code § 33-38-500 and 805 ILCS 40/5.01.

[6] See, e.g., S.C. Code §§ 33-38-410, 33-38-430; and 805 ILCS 40/4.05 and 40/4.15.

[7] See, e.g., S.C. Code §§ 33-38-440 and 805 ILCS 40/4.20.

[9] The Grunin Center for Law and Social Entrepreneurship at the New York University School of Law; The State of Social Enterprise and the Law 2020-2021.

[10] The Grunin Center for Law and Social Entrepreneurship at the New York University School of Law; The State of Social Enterprise and the Law 2020-2021.

[11] The Grunin Center for Law and Social Entrepreneurship at the New York University School of Law; The State of Social Enterprise and the Law 2020-2021.