By James W. Constable, Esq. 2013
It is self-evident that owners of for-profit businesses attempt to generate the greatest possible return on their investment. On the other hand, founders and directors or trustees of non-profit corporations have charitable and civic goals in mind. Both public and private for-profit corporations are governed by stockholders, directors and officers. Each of these classes has a fiduciary duty.
The fiduciary duties are to operate the corporation primarily for the benefit of the owners. A director must perform his or her job in good faith, with the reasonable belief that any decision made is in the best interest of the corporation “[w]ith the care that an ordinary prudent person in a like position would use under similar circumstances.” (Maryland Annotated Code, Corporations and Associations Article, 2-405.1.) Maryland, like most other states, mandates that a business operate to maximize shareholder value. In fact, stockholders have the right to sue an officer or director or even another stockholder for mismanagement that jeopardizes the value of the enterprise. A director or officer who meets the standards will be shielded from liability for claims by third parties or stockholders.
Recent trends in the marketplace have created challenges for businesses attempting to satisfy the growing consumer demand to know where products are made, how they are manufactured as well as what the business is doing for the local community. Many businesses seek to take socially responsible actions to please consumers, but cannot do so because of the possibility of diluting shareholder returns. For instance, a business may feel an obligation to utilize or sell a cheaper product or one that has an adverse impact on the environment in order to maximize profit even though management would prefer to use or sell a more expensive product that is environmentally friendly. The owners of a financial institution may wish to open a branch in a community that has historically not produced a good return even though conducting business there would promote economic opportunity for the residents. Stockholders may be critical of such a move because it could represent less of a return on investment.
A new era of business
In recent years, a number of for-profit businesses have been formed or transformed for the purpose of making a profit and at the same time giving something back to the community. Because such noble endeavors would likely reduce profit or return on investment, a decision to take on a civic or charitable project may be a violation of their duty to maximize profit.
In order to address this dual purpose, Maryland enacted legislation in 2010 authorizing “social entrepreneurship” by creating two new forms of business entities – the Maryland Benefit Corporation and the Maryland Limited Liability Corporation. Maryland was the first state to do this. By adopting the public benefit corporation model, businesses can make decisions based on benefit as well as return. They are not incompatible or mutually exclusive goals.
“B-Corps,” as benefit corporations and limited liability companies are sometimes called, may be large and global corporations or small closely held businesses. Patagonia, a California corporation, is an example of the former. Among other societal and environmental contributions, it portions 1% of earnings to environmental causes and allows employees to take paid time to work on environmental projects. It also uses more expensive recycled materials in the manufacture of some products. An example of a smaller business may be a small community bank that opens a branch in a depressed area to foster economic development yet at a cost to profit. Another common theme in Benefit companies is the purchasing of inventory locally at a high cost to support the community instead of purchasing a cheaper product from overseas or using higher cost recycled materials.
Benefit corporations and limited liability companies (LLC’s) allow businesses to identify and serve a public benefit without the risk of being sued by their stockholders for failure to maximize returns. While these new business forms may not be the right fit for every enterprise, they do offer a platform for businesses whose product or services dovetail with environmental, public health, economic development and other areas of public benefit. Numerous states have followed Maryland. While there are less than forty benefit companies in Maryland, they are a new idea and will undoubtedly gain popularity in time.
“B Corps”: Here is how they work
Under Maryland law, a public benefit corporation must identify the public benefit that it intends to serve. It then must employ an outside auditor to establish the standards and the reporting mechanisms to measure its success in serving that public benefit. It is not enough for the business to decide that it wants to “do good.” The officers, directors and owners must develop a consistent, long-term public benefit mission that is wholly integrated into the business model and culture. The business must also be willing to submit to an outside auditor and be accountable for achieving the success of its altruistic endeavors. This requirement is designed to assure investors that the business meets its dual purposes, profit and the identified public benefit. While for-profit companies that are not public benefit may be sued by their owners for failure to maximize profits, a public benefit company may be answerable to its investors for failure to uphold its commitment to serve its identified public benefit.
The Maryland law can be found in the Maryland Annotated Code, Corporations and Associations Article, Section 6-C-01-08. Statutory provisions for Benefit Limited Liability Companies are found in the same article at Sections 4A-1201 to 4A-1303. They are very similar. A Benefit Corporation must elect to be a Benefit Corporation and continue to maintain that status. The law defines the term “general public benefit” as “… a material positive impact on society and the environment, as measured by a third-party standard, through activities that promote a combination of specific public benefits.” Section 5-6C-101. In the same section, “specific public benefit is defined as including”: (1) providing 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 or (7) the accomplishment of any other particular benefit for society or the environment.
The law requires a “third-party standard” which is also defined in the same Article of the Maryland Code. The third-party standard should be credible and transparent. It should also be comprehensive in that it considers its objective on the workplace, suppliers, local community and environment. The third-party must be independent and unbiased and cannot be attached to a particular business or industry for which standards are to be developed. The third- party must have access to the expertise to develop and assess the implementation. To be transparent, the standard should be available to the public. Criteria for measuring performance should be disclosed as well as information about the make-up of the third-party
The charter of the corporation must state that it is a Benefit Corporation. This can be done in the original Articles or by amendment approved in accordance with Maryland’s corporate law requirements and the governing documents of the corporation. Conversely, a corporation may terminate being a Benefit Corporation by amending its charter. The reference to public benefit must appear prominently in the charter, each amendment to the charter, and the stock certificates.
Directors of Benefit Corporations have certain duties in addition to the duties of a director of a for-profit corporation. In making decisions, the director must consider its impact on stockholders, employees, consumers, the community or society in which it operates, and the local and global environment. It is important to note, that a director has no duty to a person that is a beneficiary of the public benefit. So long as the director performs his or her duties in good faith, in a manner that “he [or she] reasonably believes to be in the best interest of the corporation …”, with care that would be used by an ordinarily prudent person in a similar situation, and is acting “in the reasonable performance of duties” as required by the Benefit Corporation in accordance with the standard provided in the Benefit Corporation statute, he or she is shielded from liability. Stockholders, in the case of a corporation or members in the case of a limited liability company are the only ones with “standing” to bring an action against the business for failure to meet the benefit standard. The public or targets of the benefit do not have standing to sue.
Benefit companies are required to report their civic activities to their stockholders or members on an annual basis. The report must be issued within 120 days from the end of the company’s fiscal year and posted on its website. If it does not have a website, the report must be available at the request of any person, without charge. The contents of the report are broad and somewhat subjective. It must include a description of steps taken during the year to achieve general and specific public benefits and its successes. It must also include a description of any circumstances that have negatively impacted the achievement of the benefits. In addition it must include an assessment of the “societal and environmental performance” weighed against a third-party standard consistent with the standards used in previous years.
Benefit Limited Liability Companies are regulated in much the same way, substituting the term “members” for “stockholders” and “managers” for “directors”. See Maryland Annotated Code, Corporations and Associations Article, 4A-1201 through 1208. In fact, most benefit companies registered in Maryland are limited liability companies.
What incentive is there for becoming a benefit corporation or benefit limited liability company?
For larger corporations that are publically traded or have a large number of stockholders, transitioning to a B Corp can eliminate complaints from the stockholders about the dilution of profit if the cause is attributed to the intended societal or environmental benefit. This is a valuable against the threat of litigation. Generally, protection from lawsuits is not as important to the founders and members of smaller limited liability companies who are usually of one mind when it comes to the company’s mission to provide a societal or environmental benefit as well as make a profit.
Being labeled and certified as a benefit company can also have a very positive effect on a company’s brand and marketing. It sends a positive message to consumers and the public. Like minded customers are more willing to pay a premium if there is a societal or environmental benefit that they support.
As an example, the company B Labs is a non-profit organization that encourages, supports and assists in the formation, development of standards and evaluating performance. Through its affiliate B Labs, it certifies benefit companies. The certification can be a valuable moniker for public relations, much like the LEEDS for builders, architects and engineers and the Organic designation for the agriculture community. Although Maryland is not among them, some states are considering tax benefits as an incentive.
However, there are some downsides as well. Benefit companies will incur extra costs. They must engage the third-party to develop standards and in some states to review progress and assist in the annual report. The costs will depend on the size of the business and the complexity of the stated goals.
Benefit Corporation legislation is just over three years old. There are between thirty and forty registered in Maryland. The vast majority are limited liability companies. While the Maryland legislation follows a model established by B-Corps, other states have gone their own way. However the common theme espoused by founders is the societal perception and branding that appeals to consumers. Some states offer more assistance and incentives than Maryland, and some have more enforcement tools. For instance, in at least one state, a company’s certification and license can be revoked for failure to carry out its benefit mission for a certain period of time. As previously mentioned, some states offer tax incentives. Others offer support services in the way of consultants and lists of resources. Benefit companies are in their nascent years and the legislation and regulations are sure to develop as experience uncovers areas of improvement and those who operate them spread the word. While the shield from liability and consumer appeal is important, incentives such as tax credits and state support services may encourage a growth in their numbers.