AB2944 CA Benefit Corporation Bill (Vetoed 2011)

SENATE JUDICIARY COMMITTEE Senator Noreen Evans, Chair 2011-2012 Regular Session AB 361 (Huffman) As Amended May 19, 2011 Hearing Date: July 5, 2011 Fiscal: Yes Urgency: No TW SUBJECT Benefit Corporations DESCRIPTION This bill would establish a new corporate business model called the benefit corporation in order to authorize corporations to participate in general and specific public benefits, as specified. This bill would require a minimum status vote, as defined, in order for a corporation to organize as a benefit corporation. This bill also would limit a corporate director's liability to shareholders for decisions in consideration of the general or specific public purpose, and would not hold the director liable for any failure to create a general or specific public benefit. BACKGROUND Increasingly, businesses are interested in finding ways to be profitable while taking care of their employees, communities, and environment. However, corporations organized under traditional corporate forms must be mindful of shareholder interests in the profits of the corporations. As such, directors are subject to the "business judgment rule" which requires directors to utilize good faith in taking actions for the best interests of the corporation and the shareholders. Accordingly, directors are currently liable to shareholders in the event shareholders disagree with not-for-profit activities engaged in by the corporation. Such activities could include donations of corporate property or money to employees and the community. (more)  AB 361 (Huffman) Page 2 of ? Several states have adopted statutes authorizing benefit corporations (B Corps), which allow corporations to engage in activities that benefit non-profit interests. In California, several bills have been introduced in recent years to provide directors with explicit legal authority to consider other factors which the authors and their sponsors believed would give corporations and directors more flexibility to adopt socially responsible policies without fear of lawsuits from shareholders. SB 917 (Alarcon, 2003) would have created a new private right of action, effective in the year 2017, against California corporations and directors for causing material damage to the environment, human rights, public health and safety, the welfare of the communities in which the corporation operates, or the rights of the corporation's employees. Under that bill, any person damaged by the corporate action would have standing to sue, but no director would be liable if: (1) the director voted against the action which led to the harm; or (2) the damage occurred due to an action approved by the corporation prior to the director becoming a board member. SB 917 was referred to this committee and testimony was taken, but no vote was held. SB 1528 (Alarcon, 2004) would have provided that in carrying out his or her duty to the best interests of the corporation, a director may take into account any or all of the following: (1) the corporation's employees, customers, suppliers, or creditors; (2) the economy of the region, state, and nation; (3) the impact on the community; (4) the environment; and (5) the long- and short-term interests of the company and its shareholders. SB 1528 was heard in this committee and passed 5-2, voted out of the Senate 26-13, but died in the Assembly Banking, Finance and Insurance Committee. AB 2944 (Leno, 2008), among other things, would have allowed a corporate director, when making business decisions on behalf of the corporation, to consider several factors, such as the long and short term interests of the corporation and shareholders, the corporation's employees, suppliers, customers, and creditors, community and societal considerations, and the environment. AB 2944 was vetoed by Governor Schwarzenegger and encouraged legislators to find and study alternative business models that would adequately protect shareholder interests. SB 1463 (DeSaulnier, 2010) was introduced as a new business model that would protect shareholder interests while providing  AB 361 (Huffman) Page 3 of ? corporate directors the ability to designate for-profit and not-for-profit activities in which the corporation would participate. SB 1463 was referred to this committee, but was not heard. SB 201 (DeSaulnier, 2011) would create a new corporate business model called the Flexible Purpose Corporation, which also would allow a corporation to participate in for-profit and not-for-profit corporate activities to be stated in the corporation's articles of incorporation, giving the corporate directors the ability to take corporate actions to support these activities. SB 201 has been referred to the Assembly Appropriations Committee. This bill, sponsored by B Lab, a non-profit organization whose stated mission is to create a new sector of the economy that harnesses the power of business to solve social and environmental problems, would create a new corporate business model called the benefit corporation in order to authorize corporations to participate in general and specific public benefits, as specified. This bill would require a minimum status vote, as defined, in order for a corporation to organize as a benefit corporation. This bill also would limit a corporate director's liability to shareholders for decisions in consideration of the general or specific public purpose, and would not hold the director liable for any failure to create a general or specific public benefit. This bill was heard by the Senate Banking and Financial Institutions Committee on June 29, 2011 and passed out on a vote of 5-1. CHANGES TO EXISTING LAW Existing law provides for the formation and regulation of corporations. (Corp. Code Sec. 100 et seq.) Existing law provides for the formation and regulation of non-profit entities. (Corp. Code Sec. 5000 et seq.) Existing law provides a standard of care that a director must use in discharging his or her duties. A director's duties must be performed in good faith, in a manner the director believes to be in the best interests of the corporation and the shareholders, and with the care, including reasonable inquiry that "an ordinary prudent person in a like position would use  AB 361 (Huffman) Page 4 of ? under similar circumstances." (Corp. Code. Secs. 309(a), 5231.) The liability of directors for negligence is extremely limited. When the act or omission involves a question of policy or business judgment, a director cannot be held liable for an erroneous decision or poor choice in the absence of a showing of fraud, bad faith, or negligence. This is usually referred to as the "business judgment rule" for director liability. (9 Witkin, Summary of California Law 10th Ed. Sec. 102.) Existing law provides that directors are liable to shareholders for acts taken in contravention of the corporate or charitable purpose. (Corp. Code Secs. 309, 5231.) This bill would provide for the formation and regulation of a new corporate entity called the benefit corporation. This bill would require a benefit corporation to have the purpose of creating a general public benefit, defined as a material positive impact on society and the environment, as specified, and authorize the benefit corporation to identify one or more specific public benefits as follows: 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; and the accomplishment of any other particular benefit for society or the environment. This bill would define a "benefit enforcement proceeding" to mean a claim or action relating to any of the following: failure to pursue the general public benefit purpose of the benefit corporation or specific public benefit purpose stated in the articles of incorporation; violation of a duty or standard of conduct imposed on a director; or failure of the benefit corporation to deliver or post an annual benefit report, as required. This bill would require at least a two-thirds vote of shareholders, as specified, of the proposed benefit corporation  AB 361 (Huffman) Page 5 of ? to organize as such. This bill would require the board of directors of the benefit corporation to prepare a descriptive statement indicating whether, in the opinion of the board of directors, the benefit corporation failed to pursue its general, and any specific, public benefit purpose. This bill would require a director, when discharging his or her duties with respect to the corporation's general or specific public benefits, to take the following social and environmental factors, in no particular priority, into consideration: shareholders of the benefit corporation; employees and workforce of the benefit corporation and its subsidiaries and suppliers; interests of customers of the benefit corporation as beneficiaries of the general or specific public benefit purposes of the benefit corporation; 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; local and global environment; 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 retaining control of the benefit corporation rather than selling or transferring control to another entity; and The ability of the benefit corporation to accomplish its general, and any specific, public benefit purpose. This bill would limit a corporate director's liability to shareholders for decisions in consideration of the general or specific public purpose, and would not hold the director liable for any failure to create a general or specific public benefit. This bill would require the board of directors to submit an annual statement to each shareholder, including, among other things, an assessment of the overall social and environmental  AB 361 (Huffman) Page 6 of ? performance of the benefit corporation, prepared in accordance with a third-party standard, as defined. This bill would not require this assessment to be audited or certified by a third party. COMMENT 1. Stated need for the bill The author writes: A review of current case law and the code reveals that there is no way for California corporations to emphasize the environment, social welfare and other public benefits without potentially being at risk of suit for breach of fiduciary duty. That is because fiduciary duty has been interpreted narrowly to be synonymous with maximizing profits. That said, California leads the nation in innovation and sustainability; we need the statutory framework to provide California businesses the ability to do both simultaneously. There is tremendous demand from the business community in California and nationally for states to create this new kind of corporation. These visionary entrepreneurs and investors want to build businesses with an eye toward the triple bottom line of people, planet and profit. 2. Creation of a new corporate form This bill would create a new corporate form called the benefit corporation in order to allow corporations to engage in general or specific public benefit activities. Existing law provides that corporations may engage in specified purposes according to the purposes listed in their articles of corporation. (Corp. Code Sec. 202.) Non-profit corporations must state in the articles of incorporation that they are not for profit. (Corp. Code Sec. 5130.) As such, a non-profit corporation is not entitled to operate for the gain of any person. Wendel Rosen Black & Dean (Wendel Rosen) LLP, a supporter of this bill, argues that existing law requires corporate directors to consider shareholder profit at the expense of public benefit. Wendel Rosen argues that corporate directors are fearful of taking actions that, while socially or environmentally beneficial, may be seen as contrary to the for-profit purpose of the corporation. An example of this dilemma, provided by Wendel Rosen, is when "a company decides to keep jobs in California by  AB 361 (Huffman) Page 7 of ? rejecting a proposal to move its manufacturing overseas, or it voluntarily chooses to remove toxics from its manufacturing process," but directors are wary of making positive social and environmental changes because of a shareholder's ability to challenge any director decision that appears to be in contravention of earning higher profits. The author argues that California law "lacks a framework for corporations to voluntarily operate with a greater public benefit purpose than simply pursuing a profit or a narrow corporation social responsibility objective." This bill would provide a new way for corporate directors to make decisions to not only earn profits but also pursue socially and environmentally responsible activities. 3. Transparency of public purpose relating to director's fiduciary duty This bill would allow a corporate director to consider general and specific public benefits when making decisions on behalf of the corporation. Under this bill, the corporate director is shielded from liability to the shareholders when making decisions based on a general or specific public purpose. This bill also shields a corporate director from shareholder liability for any failure of the benefit corporation to create a general or specific public benefit. Existing law requires corporations to set forth the purpose(s) of the corporation. (Corp. Code Sec. 202.) Existing law provides that directors are liable to shareholders for acts taken in contravention of the corporate or charitable purpose. (Corp. Code Secs. 309 and 5231.) This bill would not require a general or specific public purpose to be stated in the benefit corporation's articles of incorporation. Concern has been raised that there is no other document that specifically identifies for shareholders the public benefits in which the corporation is engaged. Wendel Rosen argues that "the Bill dramatically increases transparency by requiring Benefit Corporations to provide shareholders an annual benefit report that assesses the company's performance against a third-party standard that considers the full range of social and environmental criteria." Although this bill would create a private right of action for shareholders to enforce the pursuit of a general or specific public purpose set forth in the articles of incorporation, the shareholders, who arguably would have invested in the benefit corporation based on the public  AB 361 (Huffman) Page 8 of ? benefit represented in the corporation's assessment, would have no recourse if the articles are silent on the benefit corporation's public benefit. This bill would provide that this assessment does not need to be audited or certified by a third party. The Corporations Committee of the Business Law Section of the State Bar of California argues that this bill would allow directors to be "wholly in control of the nature of their fiduciaries. This is because they have the ability to select the third party standard by which their conduct will be measured with no input from shareholders, and there are only vague substantive requirements in the Bill regarding the third party standard. This arrangement presents the possibility that directors will be able to shop for third party standards that suit their purposes to the detriment of shareholders." Potential investors, as well as existing shareholders, should know up front the non-profit activities in which the corporation is engaged. The proponents of this bill have clearly stated that the goal of this bill is to provide investors and consumers an easy and transparent way to differentiate truly socially and environmentally businesses from businesses who merely market themselves as such. To further this intention and provide better transparency for shareholders, the author has agreed to accept an amendment which would clarify that when a specific public benefit is adopted as a corporate purpose, the specific public benefit must be identified in the articles of incorporation. Author's Amendment : On page 6, line 21, after "corporation" insert "and shall identify any specific public benefit adopted pursuant to Section 14610." 4. Conversion of existing corporations into benefit corporation This bill would provide a mechanism whereby existing corporations could convert into a benefit corporation. Existing law authorizes corporations to convert into other forms of corporate entities as long as the shareholders approve of the conversion by at least two-thirds of each class of outstanding shares of that converting corporation unless the articles of incorporation authorize a simple majority vote for conversion. (Corp. Code Sec. 1152.)  AB 361 (Huffman) Page 9 of ? Wendel Rosen argues that this bill "grants Benefit Corporation shareholders the strongest protections afforded to any business entity recognized in the State of California. . . . The Bill only affects companies whose shareholders vote by an overwhelmingly 2/3 majority for the company to become a Benefit Corporation. Dissenting shareholders are protected by the Bill's requirement that the Benefit Corporation purchase their interests upon demand. . . ." This bill would provide that, in the case of a corporation, shareholders of every class or series are entitled to vote on the corporate action, regardless of any limitation stated in the articles or bylaws, and the corporate action must be approved by at least two-thirds of the votes that all shareholders of the class or series are entitled to cast on that action. In the case of a domestic other business entity, the holders of every class or series of interest that are entitled to receive distribution of any kind from the entity, regardless of any other limitation on the voting rights, and the action must be approved by at least a two-thirds vote or consent of these interested holders. Accordingly, this bill strikes a balance between flexibility of corporate special purposes and shareholder protections. Some corporations may require a shareholder vote greater than two-thirds to make significant changes to the corporation. This bill would allow a corporation to convert to a benefit corporation to provide for-profit and not-for-profit activities, which will have substantial effects on the shareholder's financial interest in the corporation. This conversion is a significant change for shareholders. Accordingly, in the event the company's articles of incorporation require a vote higher than two-thirds for significant events such as conversion, the author has agreed to accept an amendment to clarify the minimum status vote to include a vote greater than two-thirds if stated in the corporation's articles of incorporation. Author's Amendments : 1. On page 4, line 20, after "votes" insert ", or a greater vote if required in the articles of incorporation," 2. On page 4, line 36, after "votes" insert ", or a greater vote if required in the articles of incorporation," 5. Opposition's concerns  AB 361 (Huffman) Page 10 of ? The California Society of Association Executives (CalSAE), an opponent of this bill, argues that this bill, by allowing a for-profit corporation to provide public benefits such as "providing low-income or underserved individuals or communities with beneficial products or services," or "improving human health," places these corporations "squarely in the arena of current non-profits." The California Association of Nonprofits (CAN) shares these concerns and argues that although this bill "could expand California's capacity to deal with major problems impacting our people and our environment . . . it could siphon off much-needed resources from effective existing nonprofits by redirecting donor dollars from charitable contributions. . . ." CalSAE and CAN also raise oversight and reporting concerns similar to those discussed under Comment 3. In response, the author argues that a benefit corporation would not be organized for the sole purpose of providing monetary or product donations to the community. Rather, a benefit corporation, as a whole, would be formed for a public benefit while also making profits for shareholders who have invested in the company. Accordingly, the decision to form a benefit corporation is one of director liability to shareholders rather than an attempt to become a non-profit organization. One example is a benefit corporation that makes shoes. Under this bill, this benefit corporation could provide a specific public benefit by utilizing local materials in the manufacturing of the shoes in order to reduce transportation carbon emissions. This benefit corporation also may have a specific public purpose of donating a portion of the shoes made in order to provide low-income or underserved individuals with this beneficial product. In a standard corporation, shareholders could challenge either of these specific public purposes. If the shareholders believed that that the materials used to make the shoes are cheaper in other countries, and the purchase of local materials cuts into the shareholder's profits, the shareholders could bring an action against the directors for failing to act in the best interest of the shareholders. Further, the shareholders could claim that shoe donations are counterproductive to their profit interests and bring a similar action against the directors. However, in a benefit corporation, the shareholders would be aware that, in addition to making shoes for profit, lowered carbon emissions or shoe donations are also part of the mission of the benefit corporation. In situations such as this, there would be no impact on non-profit organizations because the non-profit  AB 361 (Huffman) Page 11 of ? organization arguably has no interest in where the benefit corporation obtains its materials, and the donation of shoes helps low-income individuals whom the non-profits may be serving. The Nonprofit & Unincorporated Organizations Committee of the State Bar of California, an opponent of this bill, argues that "Ýp]romoters of the benefit corporation have also voiced their objectives of seeking the same tax breaks and contract preferences currently enjoyed by nonprofits and minority-run companies. While there is currently no tax advantage to forming a corporation under the Bill in California, it might be expected that the promoters will pursue tax preferences for benefit corporations in California if AB 361 is adopted." In response to this argument, the author argues that, regardless of tax revisions other states make to their own laws, this bill would provide for a new corporate model but would not change the corporation's tax responsibilities under existing law. 6. Author's amendments to address concern of the Secretary of State The Secretary of State expressed concern that the information required in this bill to be included on the articles of incorporation is not specific enough to identify the corporation's organization as a benefit corporation. To address this concern, the author has agreed to take the following amendments: Author's amendments : 1. On page 8, line 9, strike out "a" 2. On page 8, line 13, strike out "The" and insert "In addition to the provisions required by Section 202, the articles of incorporation of a benefit corporation shall contain the statement "This corporation is a benefit corporation. Notwithstanding Section 202(b), the" 3. On page 8, lines 15 through 16, strike out "to create in addition to its purposes under Section 206 and subdivision (a)" 4. On page 8, line 18 strike out "any other" 7. Governor Schwarzenegger's veto of AB 2944 This bill is similar to the enrolled version of AB 2944 (Leno, 2008). In vetoing AB 2944, Governor Schwarzenegger stated:  AB 361 (Huffman) Page 12 of ? While this bill proposes a new model of corporate governance consisting of a package of many intriguing concepts, it is just that; a package of concepts that could produce unknown ramifications and the need for which have not been fully demonstrated. Corporate governance is a serious matter and changes should not be entered into without deliberate study and evaluation. While I have concerns with the approach taken with this bill, I am interested in many of the issues raised in support of this measure. California should be at the forefront of all states in considering alternative models of corporate governance for the new millennium. This is potentially another opportunity for California to once again lead to a new era of innovation. I urge the Legislature to consider and study new styles of corporate governance that can offer alternatives to the current model, but that maintain the vital shareholder protections that have helped turn California into the economic powerhouse of the world. Support : AGSJ; Alliance of Chief Executives; American Sustainable Business Council; Bay Area Council; Beckwith Associates; Build It Green; California Association for Micro Enterprise Opportunity; Center for Dynamic Governance; Clean Fund LLC; Direct Dental; Friends Committee on Legislation of California; Great Place to Work Institute; green age 360; Green America; Green Business Networking; Green Chamber of Commerce; Green Seal; Guayakí Sustainable Rainforest Products; Hanson Bridget LLP; Indigenous Designs Corporation; KINeSYS; Mendocino Wine Group, LLC; Mindful Investors; Minerva Consulting; New Harvest Capital; New Voice of Business; Presidio Graduate School; Public Works, LLC; Quantum Intech; Silicon Valley Leadership Group; Small Business California; Social Venture Network, Solar Works; The Rosebud Agency; The Vianova Group, LLC; Traditional Medicinals; United States Green Building Council California Advocacy Committee; Wendel Rosen Black & Dean, LLP; WorkLore; six individuals Opposition : California Association of Nonprofits; California Society of Association Executives; Corporations Committee of the Business Law Section of the State Bar of California; Nonprofit and Unincorporated Organizations Committee of the Business Law Section of the State Bar of California; two individuals  AB 361 (Huffman) Page 13 of ? HISTORY Source : B Lab Related Pending Legislation : SB 201 (DeSaulnier, 2011) See Background. Prior Legislation : SB 1463 (DeSaulnier, 2010) See Background. AB 2944 (Leno, 2008) See Background. SB 1528 (Alarcon, 2004) See Background. SB 917 (Alarcon, 2003) See Background. Prior Vote : Senate Banking and Financial Institutions Committee (Ayes 5, Noes 1) Assembly Floor (Ayes 58, Noes 17) Assembly Appropriations Committee (Ayes 12, Noes 5) Assembly Judiciary Committee (Ayes 7, Noes 2) **************