The New California Hybrid Forms Hit the Street January 1, 2012: The Benefit and Flexible Purpose Corporations

As a result of California laws enacted on October 9, 2011, entrepreneurs and existing corporations have two additional “hybrid” corporate forms to choose from beginning January 1, 2012: “Benefit” and “Flexible Purpose” corporate entities. Prior to the enactment of AB 361 (Benefit Corporation, California Corporations Code sections 14600-14631) and SB 201 (Flexible Purpose Corporation, California Corporations Code sections 2500-3503), entrepreneurs were forced to choose between forming as for-profit or nonprofit corporations.

Previously, directors of for-profit corporations engaging in charitable acts or promoting socially responsible policies would do so at the risk of the perception that they were impermissibly putting social purposes ahead of shareholder returns. Similarly, nonprofit corporations might risk losing tax-exempt status if they were perceived to engage in profitable activities rather than serving the 

public interest. As a Benefit Corporation or Flexible Purpose Corporation, organizations can legally pursue both socially responsible and profit-producing purposes at the same time. Both entities will be subject to the same taxes as for-profit corporations.

AB 361: The Benefit Corporation

The idea behind Benefit Corporations has been around since the early days of the United States when states began chartering corporations to achieve a specific public purpose, such as building bridges, roads and other infrastructure. Many argue that social ills came about as corporations became bound to maximize profits and were no longer chartered with a public purpose. Benefit Corporation legislation allows corporations to legally return to pursuing a specific public purpose.

Maryland enacted the first Benefit Corporation law in April 2010. Subsequently, Hawaii, New Jersey and Vermont enacted similar laws. Benefit Corporation laws are pending in Colorado, New York, North Carolina, Pennsylvania and Michigan.

Under the new law, the articles of incorporation of a Benefit Corporation must state that the corporation is being “formed for the purpose of creating general public benefit,” defined as a “material positive impact on society and the environment . . . as assessed against a 3rd-party standard.”

Specific public benefits can include providing low-income or underserved individuals or communities with beneficial products or services; promoting economic opportunity for individuals or communities beyond the creation of jobs in the ordinary course of business; preserving the environment; improving human health; promoting the arts, sciences or advancement of knowledge; increasing the flow of capital to entities with a public benefit purpose; accomplishing any other benefit for society or the environment.

Benefit Corporations will likely be utilized in a variety of industries, including companies that provide food, clothing apparel, office supplies and legal services.

SB 201: The Flexible Purpose Corporation

California is the first state to enact a law authorizing Flexible Purpose Corporations, although Colorado tried and failed to pass similar legislation.

In California, existing corporations and other business entities may merge or convert into a flexible purpose corporation by satisfying certain requirements, including approval of the conversion by a 2/3 vote of shareholders (or a greater vote, if the articles require). The law will also allow flexible purpose corporations to convert into a nonprofit corporation, a corporation, or other domestic business entity upon satisfaction of certain requirements.

Flexible purpose corporations may pursue profit and a “special purpose” at the same time. “Special purposes” include “charitable or public purpose activities that a nonprofit public benefit corporation is authorized to carry out” and “promoting positive short-term or long-term effects of …the flexible purpose corporation’s activities upon” the corporation’s employees, suppliers, customers and creditors or the community and society, or the environment.

Conclusion

These corporate forms join the ever-expanding list of potential structures for pursuing social enterprise in a for-profit context (along with regular corporations, limited liability companies, joint ventures, private-public partnerships and L3C’s). By allowing greater latitude for the establishment of businesses that do not neatly fit into for-profit or nonprofit categories, one hopes these new laws encourage businesses to stay and expand in California.