BILL ANALYSIS �
SENATE BANKING & FINANCIAL INSTITUTIONS COMMITTEE
Senator Juan Vargas, Chair
SB 201 (DeSaulnier) Hearing Date: April 6, 2011
As Amended: March 14, 2011
Fiscal: Yes
Urgency: No
SUMMARY Would authorize the creation of a new corporate form
called a flexible purpose corporation, and would provide for all
of the rules that must be followed by these types of entities
and by other types of entities wishing to become flexible
purpose corporations.
DESCRIPTION
1. Would establish a new corporate form called a flexible
purpose corporation (FPC), and would provide that one or
more natural persons, partnerships, associations, FPCs, or
corporations, domestic or foreign, may form an FPC under the
California Corporations Code, by executing and filing
articles of incorporation with the California Secretary of
State. Would enact a significant number of conforming
changes to the Corporations Code, to recognize the existence
of this new corporate form.
2. In its articles of incorporation, each FPC would have to
list its flexible purposes, which could be any of the
following:
a. One or more charitable or public purpose activities
that a nonprofit public benefit corporation is authorized
to carry out;
b. Promoting positive short-term or long-term effects of,
or minimizing adverse short-term or long-term effects of
the FPC's activities on the FPC's employees, suppliers,
customers, and creditors; the community and society;
and/or the environment.
3. Each FPC's articles of incorporation could also provide
for, but are not required to include the following: a
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provision limiting the duration of the FPC's existence to a
specified date; a provision limiting or restricting the
business in which the FPC may engage or the powers that the
FPC may exercise, or both, provided these restrictions are
consistent with the purpose(s) of the FPC; and a provision
requiring shareholder approval for any corporate action.
4. Each existing company wishing to become an FPC through
conversion or reorganization of an existing corporate entity
would require an affirmative vote of at least two-thirds of
each of its classes of shareholders, or a higher vote
threshold, if required in its articles of incorporation.
The same vote threshold would be required to amend an FPC's
articles of incorporation, or to create or dissolve an FPC
through merger or acquisition. The only type of action
involving the formation or dissolution of an FPC, which
would not require a 2/3rds or higher vote, is the merger of
one FPC into another FPC with a similar special purpose.
5. Shareholders of an existing corporation that decided to
convert to an FPC would be entitled to dissenter's rights,
which are spelled out in existing law (Corporations Code
Section 1300). Dissenters' rights generally entitle
dissenting shareholders to be cashed out for their shares at
the shares' fair market value, as of the day before the
first announcement of the terms of the proposed
reorganization or merger, adjusted for any stock split,
reverse stock split, or share dividend which becomes
effective after that date.
6. Each FPC must prepare an annual report, which must be sent
to its shareholders no later than 120 days after the close
of the FPC's fiscal year, and at least 15 days prior to the
shareholders annual meeting (35 days prior if sent via bulk
mail). In addition to a balance sheet, income statement,
and a statement of cashflows for that fiscal year, the
annual report must also include a management discussion and
analysis (MD&A) regarding the FPC's stated purpose or
purposes, as set forth in its articles of incorporation,
and, to the extent consistent with reasonable
confidentiality requirements, must post the MD&A on its web
site. Each FPC's MD&A is required to include the following
information, at a minimum:
a. An identification and discussion of the short-and
long-term objectives of the FPC that relate to its special
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purpose(s), and an identification and explanation of any
changes made to these special purpose objectives during
the fiscal year;
b. An identification and discussion of material actions
taken by the FPC during the fiscal year to achieve its
special purpose objectives, the impact of those actions,
including the causal relationships between the actions and
the reported outcomes, and the extent to which those
actions achieved the special purpose objectives for the
fiscal year.
c. An identification of material actions, together with
the intended impact of those actions, which the FPC
expects to take in the short- and long-term to achieve its
special purpose objectives.
d. A description of the process for selecting, and an
identification and description of the financial,
operating, and other measures used by the FPC during the
fiscal year for evaluating its performance in achieving
its special purpose objectives, including an explanation
of why the FPC selected those measures and an
identification and discussion of the nature and rationale
for any material changes in those measures made during the
fiscal year.
e. An identification and discussion of any material
operating and capital expenditures incurred by the FPC
during the fiscal year in furtherance of achieving its
special purpose objectives, a good faith estimate of any
additional material operating or capital expenditures the
FPC expects to incur over the next three fiscal years in
order to achieve its special purpose objectives, and other
material expenditures of resources incurred by the FPC
during the fiscal year, including employee time, in
furtherance of achieving its special purpose objectives,
including a discussion of the extent to which that capital
or use of other resources served purposes other than, and
in addition to, furthering the achievement of the special
purpose objectives.
7. In addition to the annual report described above, each FPC
would have to prepare and distribute a special purpose
current report to its shareholders within 45 days of an
expenditure, which was made in furtherance of its special
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purpose objectives, and which had or is believed likely to
have a material adverse impact on the FPC's results of
operations or financial condition for a quarterly or annual
fiscal period. This special purpose current report would
have to identify the expenditure or group of related or
planned expenditures, which had or was likely to have a
material adverse impact on the FPC's financial condition.
EXISTING LAW authorizes the creation of several corporate forms,
including corporations, partnerships, limited partnerships,
limited liability partnerships, and limited liability companies,
each with its own set of allowable and prohibited acts.
COMMENTS
1. Background and Discussion:
Achieving the Double-Bottom Line: Doing Well while Doing Good
This bill is the product of a working group of corporate law
attorneys, which was organized in 2008, to facilitate the
creation of a new corporate form, to give companies in
California greater flexibility to combine profitability with
broader social or environmental purposes. Members of the
working group come from a diverse background, including
academia, non-profit law firms, organizations that foster
social entrepreneurship, and both large and small corporate
law firms. The proposal contained in SB 201 represents the
consensus developed by the working group, as modified to
address review comments received by the working group from
interested parties.
Why Do We Need An Alternative To Traditional Corporations or
LLCs? Over the past decade, it has become increasingly
common for corporations to integrate social and/or
environmental goals within their profit-driven business
models and focus on pursuing returns for investors. Yet,
many organizations that do so are forced to take on
potential risk and liability, in order to achieve multiple
or blended objectives.
These risks are most often borne by corporate directors trying
to weigh the trade-offs between profitability and their
organization's special purpose. According to the working
group, courts have traditionally weighed fiduciary duties of
care and loyalty by corporate directors using the so-called
"business judgment rule," which typically permits some
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flexibility to consider social and environmental factors
when pursuing the long-term best interests of the
corporation and its shareholders. However, the business
judgment rule may not afford boards of directors and other
corporate managers sufficient protection and flexibility to
consider blended value in all operating decisions. Further,
this rule does not come into play in change-of-control
situations, when boards and management generally have a
fiduciary duty to act solely in the interest of maximizing
shareholder value.
The traditional corporate form also presents risks for companies
seeking to maintain a special purpose mission during their
early stages. In the early years, before profitability has
been attained, or when profitability is tenuous at best,
there is a strong possibility that early-stage investors may
shift the company away from its original special purpose, in
order to attain profitability.
This difficulty in what the working group calls "anchoring the
mission" also represents a significant issue for
entrepreneurs who try to use a traditional, mature
corporation to implement a blended value model. The working
group notes that traditional corporate attempts to anchor
the mission either tend towards being overly broad (e.g.,
super-voting stock such as used in Google, which places
investors at risk of decisions made only by the founders) or
overly narrow (where they may either be ignored if they
conflict with a director's fiduciary duty, or diluted or
deleted by amendment).
Finally, the working group notes, even if the risk of director
liability could be eliminated and an equitable means for
anchoring the special purpose mission were possible,
traditional corporation statutes do not provide the
transparency necessary for shareholders to evaluate how, nor
the extent to which, the corporation is achieving its
special purposes.
Why not use an LLC? In short, it is hard to attract equity
capital. The pass-through status of LLCs creates tax
implications for potential investors. LLCs are also
disfavored as an entity choice for widely held companies,
because markets favor the standardization of entities formed
by statute. According to the working group, the cost and
effort of understanding the nuanced differences of operating
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agreements, and the cost and risk of drafting a prospectus
that captures those nuances and fully discloses the risk
factors to be considered by potential investors, each
represent a difficult and time-consuming effort that
companies and investment bankers would be required to
undertake on behalf of each individual LLC seeking equity
capital. Investors vastly prefer the standardization in
statutory approach and the standard set of articles of
incorporation common to most corporations.
Data provided by the working group support its claim that LLCs
have in raising equity capital. Between 1998 and the first
half of 2009, only two, out of over 2,700 initial public
offerings, were made by LLCs.
The working group believes that FPCs will attract equity capital
(something LLCs cannot readily do), while mitigating the
liability issues and other challenges posed by corporations
which seek to do well while doing good.
What Are the Key Elements of an FPC? As summarized above in the
description of the bill, FPCs will be required to set forth
their special purpose(s) in their articles of incorporation.
That special purpose mission will be anchored, unless and
until two thirds of each class of voting shares decides
otherwise (or a greater threshold, if so specified in the
articles of incorporation). The directors of an FPC will be
protected for decision-making involving trade-offs between
profitability and the special purpose(s). Any merger or
reorganization materially altering or eliminating an
existing FPC's special purpose, and any decision by any
other business entity to become an FPC, will require the
same supermajority vote. Each FPC will be required to
provide annual reports on its impact toward achieving its
special purpose(s), and an estimate of future anticipated
expenditures.
Shareholders of an FPC who object to an action requiring a
shareholder vote in connection with a conversion,
reorganization, or merger will have dissenter's rights,
which will allow them to cash out their shares in the FPC.
Dissenters' rights will not be available for shareholders
who object to a material change in an FPC's special purpose.
Would California be the first? If SB 201 is enacted, California
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would be the first state in the country to authorize
flexible purpose corporations. To date, a handful of other
states have authorized the creation of corporations that
allow a special purpose mission to be paired with a
profitability objective. Illinois, Michigan, Utah, Vermont,
and Wyoming have enacted so-called L3C statutes, while
Arkansas, Colorado, Georgia, Louisiana, Maryland, Missouri,
New York, North Carolina, Oregon, and Tennessee have
considered or are considering such statutes. However, the
working group notes that there is a clear difference between
the FPC being proposed and the L3C option, and states that
the L3C option would not achieve the purposes sought through
creation of an FPC statute. According to the working group,
the L3C is primarily designed to be used by for-profit
companies, for which a charitable purpose is primary, and
that wish to obtain program-related investments from
foundations. This distinguishes them from FPCs, which are
primarily intended to be used by for-profit companies
seeking traditional capital market investments.
2. Summary of Arguments in Support:
The California Legal Working Group for New Corporate Forms
drafted the bill and requests support for its passage.
Members of this group include a diverse collection of
individual corporate lawyers in California, with experience
in academia, law firms serving non-profit organizations,
organizations fostering social entrepreneurship, and large
and small law firms serving corporate and financial
institution clients. Most of the arguments justifying the
creation of a new type of business model like the one
proposed by this bill were provided by this group.
In its letter of support, the group observes that non-profit
corporations often prove unsuitable for social
entrepreneurs, as the IRS places strict requirements on the
nature of tax-exempt activities, and the process of seeking
tax-exempt status is prohibitively lengthy for some
organizations. For-profit entrepreneurs seeking to raise
traditional investment capital have been limited to two
corporate forms (the corporation and the limited liability
company), both of which have downsides for entrepreneurs who
wish to seek out multiple or blended objectives. The
working group believes that SB 201 offers a workable
alternative, which can be used by firms that are constrained
by existing alternatives available to them.
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The Sierra Business Council, writing in support, observes,
"Today's business leaders have a deeply embedded sense of
commitment to their community. They believe that 21st
Century companies can be in the business of doing well and
doing good at the same time; advancing strategies and
products that create prosperity and act as catalysts to
solve some of our most vexing social and environmental
problems...SB 201 will help us engage shareholders who share
our sense of social entrepreneurship, access capital that
understands the concept, and demonstrate to the Internal
Revenue Service that non-profits can act entrepreneurially
while fulfilling their mission."
Omidyar Network, a firm that invests in market-based efforts to
catalyze economic, social, and political change states that
it frequently considers investing in organization that would
benefit tremendously through use of the Flexible Purpose
Corporation corporate form. Using a Flexible Purpose
Corporation model, these companies can achieve much greater
scale, and eventually much greater positive social impact.
3. Summary of Arguments in Opposition: The California
Association of Nonprofits (CAN) describes its mission as
follows: "to expand and strengthen the influence,
professionalism and effectiveness of nonprofit organizations
in a manner that builds their capacity to accomplish their
missions and preserves the idealism and value of nonprofit
organizations in California." CAN's concerns are centered
on four issues (capacity, sustainability, efficiency, and
oversight), and are reflected in the following questions,
taken from CAN's letter of opposition.
"Will flexible purpose corporations reduce demands on the
capacity of already over-extended existing nonprofit and
public entities to meet social, educational, cultural, and
environmental needs, resulting in net gain in 'social good'?
Or will they simply dilute the pool of funds available to
meet community needs?"
"Will flexible purpose corporations be independently
self-sustaining or will they compete in the philanthropic
and financial marketplace with existing nonprofit entities?"
"Will the addition of flexible purpose corporations as potential
competitors with nonprofits result in more innovative, more
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efficient, and more effective use of public, private, and
charitable resources?"
CAN also observes that SB 201 does not provide for external
independent review, which would enable individuals
interested in a given special purpose to make informed
decisions about whether to invest in a flexible purpose
corporation or contribute to a nonprofit public benefit
corporation.
4. Prior and Related Legislation:
a. AB 361 (Huffman): Substantially similar to this
bill, but names the new corporation a "benefit
corporation" rather than a flexible purpose corporation.
Pending a hearing in the Assembly Judiciary Committee.
b. SB 1463 (DeSaulnier), 2009-10 Legislative Session:
Substantially similar to SB 201. Never taken up by the
author.
c. AB 2944 (Leno), 2007-08 Legislative Session: Until
January 1, 2015, would have specified that, in
considering the best interests of a corporation and its
shareholders, a corporation's board of directors and
other specified individuals with responsibility for
running a corporation could, in considering the best
interests of the corporation and its shareholders,
consider the effect of the corporation's actions on the
state and national economy, and on the environment, and
could incorporate community and societal considerations,
among other factors, into its evaluation. Vetoed by the
Governor.
LIST OF REGISTERED SUPPORT/OPPOSITION
Support
California Legal Working Group for New Corporate Forms
OneSun LLC
Omidyar Network
Sierra Business Council
SourceTrace Systems
Opposition
SB 201 (deSaulnier), Page 10
California Association of Nonprofits
Consultant: Eileen Newhall (916) 651-4102