SPE Series Part 2: Benefit Corporations and Fair Trade
Disclaimer: this article generally discusses state corporate law and IRS rules and regulations. Although the author of this article is a licensed attorney, Camino Aztlan is not a provider of legal, financial, or accounting advice or services. We encourage you to seek the advice of a licensed attorney or Certified Public Accountant (“CPA”) if you are interested in pursuing a social-purpose venture. If you need help finding a professional, please submit an inquiry on our Contact Us page and we will do our best to point you in the right direction.
Introduction
This article is Part 2 of a multi-part series discussing Social Purpose Entities (“SPE’s”) and how they may be used as a vehicle for sustainable cross-border projects like Fair Trade ventures and environmentally conscious development projects. This article discusses Benefit Corporations and Certified B. Corps., how these entities are currently being used, and what the future holds for these entities in the cross-border context.
Unless otherwise specified, this article uses the broad term “Benefit Corporations” as a catch-all for both state-chartered entities and companies with a “B Corp” Certification from B Lab, a nonprofit organization that certifies companies that meet specific criteria for ethical and sustainable practices. Though there is significant overlap between Certified B. Corps. and state-chartered Benefit Corporations, not all Certified B. Corps. are Benefit Corporations and vice versa.
Maryland was the first state to enact benefit-corporation legislation in 2010, around the same time that L3C legislation began appearing. The legislation was drafted by Philadelphia lawyer William Clark, Jr. in conjunction with B Lab. The same proponents also drafted Model Benefit Corporation to provide guidance for states to tailor their own legislation to their needs.
The Benefit Corporation under the Model Legislation has three main requirements: (1) a “general public benefit,” meaning a corporate purpose to create a material positive impact on society and the environment; (2) that directors of the corporation consider the interests on non-shareholder stakeholders in addition to shareholders when making decisions; and (3) preparation of an annual “benefit report” of “its overall social and environmental performance using a comprehensive, credible, independent, and transparent third-party standard.”
At least 36 states have enacted legislation to allow for different variations of the Model Benefit Corporation. A prominent example is the Delaware Public Benefit Corporation. The Delaware Public Benefit Corporation must include a specific public benefit in its corporate charter, including the following benefits that mirror the permissible categories for 501(c)(3) companies: “effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific, or technological nature.” Del Code Ann. tit. 8 Section 363(a). The Model legislation is broader, requiring only a general public benefit that has “a material positive impact on society,” which may include a public benefit outside of the specific charitable categories listed above.
An example of a specific public benefit that must be stated in the charter is the following by aimwith PBC, one of the first Benefit Corporations to incorporate in Delaware: “Scale innovative nonprofits and social enterprises’ projects with a focus on sustainable development.” Similar to how an “Inc.” or “LLC” suffix conveys important information to the public and creditors, the “PBC” designation conveys that the company is committed to a social purpose other than profit.
Another variation is the benefit report. Model Legislation requires the company’s benefit report to be made publicly available, whereas states like Delaware do not. The benefit report under the Model Legislation must be based on an objective third-party standard, whereas states like Delaware do not have this requirement and instead allow companies to self-evaluate based on their internal standards.
For states that require third-party evaluation, a popular third-party metric is the B Lab Certification, but a Fair Trade Certification may also satisfy the requirement. For a list of other popular third-party evaluation services, B Lab provides a guide with some suggested third-party services available here.
California’s legislation also illustrates how states may diverge from the Model Legislation. California has enacted two variations of the social-purpose corporation, the traditional Benefit Corporation and the Flexible Purpose Corporation, which contain the following key distinctions:
Benefit Corporations must pursue a General Public Benefit, i.e. a "material positive impact on society and the environment, taken as a whole". Flexible Purpose Corporations need only pursue a specific purpose that has a positive effect on any of the following: its employees, suppliers, customers, creditors; the community and society; or the environment.
Benefit Corporations must evaluate themselves based on an independent third party standard. No such standard is required for Flexible Purpose Corporations.
Benefit Corporations must provide an annual report to shareholders and the general public that includes a comprehensive assessment of its activities in support of its purpose, as measured against the above-mentioned third party standard. Flexible Purpose Corporations may waive the shareholder reporting requirements under certain circumstances.
If you are interested in forming a Benefit Corporation, where you incorporate largely depends on your mission and intended beneficiaries. The following are some questions to consider:
Does your mission mirror those of tax-exempt nonprofits, including charitable, educational, or artistic goals? If your mission does not neatly fit into a specific enumerated goal, the California Flexible Purpose Corporation or similar forms may provide sufficient leeway.
Is obtaining impact investment central to your growth plan? If so, you may want to choose a state that has more stringent requirements for filing a benefit report for the general public. Even though a company could voluntarily disclose a benefit report in states that do not require it, subsequent management could decide that it is too costly and forego this requirement. This uncertainty as to whether a company can maintain its social purpose may dissuade investors seeking a long-term commitment to a particular social cause.
Is your primary goal environmental? A California Benefit Corporation may be ideal, as the legislation makes environmental purpose central to the company’s mission. California’s significant environmental regulatory environment compared to other states is also something to consider, as well as whether this or other states provide benefits like tax credits for renewable-energy ventures.
Will the company be formed as an affiliate of a 501(c)(3) nonprofit organization? Some states like Illinois regulate social-purpose entities through the state’s Charitable Trust laws, which also regulate nonprofits. Due to the complexity of both IRS and Charitable Trust compliance, you will need to perform your due diligence to ensure that your proposed venture remains complaint with both federal and state law in a cost-effective manner.
Regardless of these considerations, you may be constrained by your company’s principal business location. Whereas large publicly-traded companies often operate in one state but are incorporated elsewhere (i.e. Delaware), this option may not be cost-effective for small startups. Fortunately, the vast majority of states recognize some type of Benefit Corporation, and more states are sure to follow. If you are not in a Benefit Corporation state, this guide provides helpful information on how to retain a registered agent in the state where you incorporate.
Balancing Stakeholder Interests
In Part 1 of this Series, we provided a brief introduction of limited liability companies like corporations and LLC’s. We also introduced the relatively new low-profit limited liability companies (“L3C’s”). L3C’s are like traditional LLC’s but must state a specific social purpose in the company formation documents to mirror one of the charitable purposes recognized by the IRS for nonprofit companies. The main benefits to L3C’s are social branding and the potential to solicit impact investment and Program-Related Investments (“PRI’s”) from foundations.
In addition to the benefits of branding and investment potential, Benefit Corporations also provide directors and management more flexibility to pursue social missions without getting sued by shareholders for not maximizing profits. As we discussed in Part 1, traditional corporations have been limited in their ability to pursue social purposes by the “shareholder primacy doctrine,” which requires directors and managers to maximize shareholder value. Benefit Corporations are a direct response to the shareholder primacy doctrine, allowing directors to consider the interests of enumerated stakeholders in making decisions to promote a “material positive impact on society.”
One concern by critics of the Benefit Corporation is the uncertainty as to how directors should prioritize stakeholder interests, especially when there is a conflict among stakeholders. For instance, if there is a conflict between prioritizing labor over the environment, what remedies are available if directors choose to pursue one purpose to the detriment of others? Importantly, who has standing to pursue these remedies?
These questions will have to be ironed out over time, particularly by how courts resolve benefit enforcement lawsuits that are authorized in some states. With traditional corporations, shareholders may bring a “derivative action” against the corporation if directors are taking actions that adversely affect the company or shareholders. The most popular example was the lawsuit brought by the Dodge brothers against the Ford Motor Company when Henry Ford proposed to suspend dividends to reinvest in the company, which we summarized in Part 1.
States like Delaware do not authorize or mention enforcement mechanisms for the state’s Benefit Corporations, but the Model Legislation allows a “benefit enforcement proceeding” to enforce the public benefit. Persons with at least 2% of outstanding shares can bring suit to enforce the board to consider stakeholders or for failure to prepare a benefit report, but no monetary awards are available because the statute explicitly protects board members from financial liability. In any event, it is unclear how monetary damages could be calculated in many of these proceedings. For instance, if impact investors sue a board for not pursuing an environmental purpose but instead took measures that increased profits, there is no direct financial loss to the company on which to calculate damages.
Fortunately, there are no notable instances of dispute regarding a company’s social purpose, as confirmed by Marc Lane, a pioneer of SPE’s who we interviewed for this series. However, disputes are probably inevitable as the business environment evolves, especially if the economy experiences strains that require companies to pursue cost-cutting measures. It will be interesting to see how a court decides the first significant benefit-enforcement proceeding.
SPE’s and Nonprofits
Some commentators distinguish the L3C and benefit corporations’ purposes by arguing that the L3C’s “charitable purpose” language makes the L3C an alternative to a nonprofit charitable company, whereas benefit corporations are intended as an alternative to for-profit corporations.
In practice, both L3C’s and Benefit Corporations are more similar to for-profit entities because they do not enjoy tax-exempt treatment and therefore are not subject to the sometimes burdensome requirements imposed on 501(c)(3) organizations by the IRS and state Charitable Trust regulations.
Despite the lack of tax benefits and the fact that Benefit Corporations can pursue broader purposes than those available for 501(c)(3) nonprofit organizations, some critics argue that Benefit Corporations may divert much-needed funding away from nonprofits. A study conducted in the early days of the Delaware Public Benefit Corporation found that approximately 35% of newly registered Benefit Corporations could have alternatively met the requirements of an organized as nonprofit companies.
The study cited above refers to newly formed corporations and does not necessarily show that these companies would have incorporated as nonprofits without the new legislation. To the contrary, the examples discussed below show that Benefit Corporations are filling a void between for-profit and nonprofit companies. Additionally, rather than taking from nonprofits, Benefit Corporations can more likely supplement and assist existing nonprofits through parent-subsidiary relationships. Under IRS rules, a nonprofit can only perform a limited amount of commercial activities (subject to the unrelated business income tax), and nonprofits risk revocation of their tax-exempt status if their commercial operations are too significant. Examples of commercial activities are museums that generate revenue by selling products in their gift shop. Having a benefit corporation as a separate affiliate entity could allow the nonprofit to outsource most or all of its commercial activities to the for-profit entity and lessen its risk of IRS penalties.
B Corps in Practice, and their Potential for Sustainable Cross-Border Trade and Development
The study cited above analyzed the new Delaware Public Benefit Corporations formed within the first 90 days of enactment. It found the following breakdown:
Professional Services - 31%. This includes business consulting, legal, financial, and architectural. This includes consulting companies like Kairos Society PBC, Inc., an accelerator for businesses innovating in entrepreneurship, science, and technology. This category also includes impact investment firms like RSF Capital Management and Grassroots Capital Management Corporation.
Education - 11%. This includes companies like Ojooido.com PBC, a “blended multimedia curriculum that develops core study skill habits for Latino students.”
Technology and Healthcare - 20%. There is significant overlap between these categories, which include information technology to improve healthcare. For example, Consulti, PBC is a company trying to solve the problem of “one provider to one patient” that is “too costly and time consuming” and results in medical errors.
Non-Perishable Consumer Products - 11%. This includes companies like Raven + Lily PBC, which sells fair trade and eco-friendly clothing and apparel handmade by women in Ethiopia, Cambodia, India, and the United States.
Agriculture - 5%. This category focuses on producing Fair-Trade and sustainable products, including Alter Eco, available at alterecofoods.com.
Energy - 4%. Focus on renewable energy.
Employment and Job Training - 4%. Focus on disadvantaged areas and at-risk persons.
Although this study was limited to early-formed Delaware Public Benefit Corporations, it illustrates the many types of social purposes that this corporate form can pursue. This survey and the breakdown of current Certified B Corps suggests that a significant amount of these companies have a domestic reach. However, certain companies operate in the cross-border context. The following are some notable examples:
SVX Mexico is a boutique consulting firm that aims to increase the volume and efficiency of impact investments in Mexico and Latin America. SVX Mexico’s vision is to ensure capital serves humanity. SVX works to change the conventional business thinking and aims for an evolution of capital deployment from value extraction to sustainable value creation.
Dev Equity is an innovative impact investment manager that provides long-term capital and support to commercially viable, socially responsible businesses. The purpose of Dev Equity is to generate development impact and capital appreciation returns by making investments in small and medium sized companies in a variety of sectors in select low-income countries in Latin America.
Green Libros collects books that would otherwise be sitting in disuse and then sells them online, with a portion of the sales going to promote reading programs and access to materials.
The existence of successful cross-border impact investment firms suggests that there are available resources to fund additional cross-border investment. This type of investment may be facilitated by the imminent passage of the new United States-Mexico-Canada Agreement, which contains new protections for labor and the environment. The following are just a few ideas for new ventures that align with the Camino Aztlan mission:
Direct investment in Central American regions most affected by the current immigration and humanitarian crisis, including job training, education, and Fair Trade artisan production.
Agricultural ventures aimed at preserving and paying fair wages for indigenous-produced projects like heirloom corn in a way that emphasizes indigenous producers rather than on upper-class cuisine.
Tourism agencies that employ local, low-income natives and donate money for projects that mitigate the environmental impact of tourism development.
Our next article will delve further into impact investing, a growing market that is estimated to exceed $500 billion. This growing industry, combined with the rise of talented and driven Latinx entrepreneurs on both sides of the border, can make our suggestions above a reality. If Benefit Corporations and similar entities can begin managing even a small percentage of the over $600 Billion in annual trade between the United States and Mexico, it could help to minimize some of the detrimental effects of globalization like displacement and environmental degradation.
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