BILL ANALYSIS Ó
SB 201
Page 1
Date of Hearing: June 28, 2011
ASSEMBLY COMMITTEE ON JUDICIARY
Mike Feuer, Chair
SB 201 (DeSaulnier) - As Amended: March 14, 2011
SENATE VOTE : 37-1
SUBJECT : FLEXIBLE PURPOSE CORPORATIONS
KEY ISSUE : SHOULD BUSINESSES THAT WISH TO PURSUE CHARITABLE OR
PUBLIC PURPOSES, IN ADDITION TO PRODUCING SHAREHOLDER PROFIT,
HAVE THE ABILITY TO VOLUNTARILY INCORPORATE OR REORGANIZE INTO A
NEW FORM OF CORPORATE ENTITY KNOWN AS A FLEXIBLE PURPOSE
CORPORATION?
FISCAL EFFECT : As currently in print this bill is keyed fiscal.
SYNOPSIS
According to the author, the California Corporations Code lacks
flexibility for corporations seeking to combine the for-profit
philosophy of a traditional corporation with a higher "special
purpose" that is charitable, serves the public, or otherwise
benefits the environment, the community, or society. To address
this need, this bill authorizes in California a new form of
corporate entity known as a flexible purpose corporation (FPC),
the form of which, the author contends, would provide greater
flexibility for the corporation to combine profitability with
broader social or environmental "special purpose." Under this
bill, provisions of the General Corporation Law that govern
other for-profit corporations also apply to FPCs except as
otherwise expressly stated by this bill. The bill would revise
the fiduciary duty of the corporate directors of a FPC to
include consideration of both shareholder profit and
non-financial, special purpose-related interests, but the bill
does not give shareholders any special right of action to
enforce the special purpose. Instead, the bill envisions that
by introducing some flexibility to the fiduciary duty, FPC
directors exercising ordinary business judgment would continue
to be protected from liability by the business judgment rule for
decisions that further the special purpose but do not
necessarily maximize shareholder value. To promote corporate
transparency and ensure that shareholders are able to evaluate
whether the FPC is achieving its special purpose(s), this bill
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requires the FPC to prepare and publish annually on its website
an extensive "management discussion and analysis" report that
details the corporation's special purpose objectives,
activities, and expenditures in the previous year.
The bill is supported by an assortment of businesses, venture
capital firms, non-profits, and advocates for sustainable
business and socially responsible investing, among others.
These proponents assert that benefit corporations offer
entrepreneurs and investors the option to invest in businesses
that meet higher standards of corporate purpose, the result of
which is likely to be the creation of broad social and
environmental benefits for the California public. The bill is
opposed by associations of non-profit groups, who argue that
before any bill authorizing the formation of alternative
corporate entities such as FPCs is passed, the Legislature
should conduct an informational hearing to study the potential
impact such legislation might have on the non-profit community.
Specifically, these opponents express concern that this bill may
result in resources being siphoned off from existing
non-profits, presumably if philanthropy dollars are redirected
from charitable contributions to investment in FPCs.
SUMMARY : Authorizes and regulates the formation and governance
of a new form of corporate entity known as a flexible purpose
corporation (FPC). Specifically, this bill :
1)Authorizes, under a new division of the Corporations Code, one
or more natural persons, partnerships, associations, or
corporations to form a flexible purpose corporation by
executing and filing articles of incorporation with the
Secretary of State.
2)Requires the articles of incorporation of an FPC to state its
flexible purposes, which may be one or more of the following:
a) One or more charitable or public purpose activities that
a nonprofit public benefit corporation is authorized to
carry out.
b) The purpose of promoting positive short-term or
long-term effects of, or minimizing adverse short-term or
long-term effects of, the FPCs activities upon its
employees, suppliers, customers, and creditors, the
community and society, the environment, or any combination
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of the above.
3)Requires that a proposed amendment to the articles shall be
approved by at least two-thirds of the outstanding shares of
each class if the amendment would materially change any
special purpose of the FPC already stated in the articles.
4)Requires that each existing company wishing to become an FPC
through conversion or reorganization to take an affirmative
vote of at least two-thirds of each of its classes of
shareholders, or a higher vote threshold, if required in the
articles of incorporation.
5)Establishes that shareholders of an existing corporation
converting to an FPC would be entitled to dissenter's rights
as specified under Chapter 13 of Division 1 of the
Corporations Code.
6)Provides that a director shall perform his or duties in good
faith, in a manner the director believes to be in the best
interest of the FPC and its shareholders, and with that care,
including reasonable inquiry, as an ordinarily prudent person
in a like position would use under similar circumstances.
7)Permits a director, in discharging his or her duties, to
consider and give weight to, as the director deems relevant,
certain factors including the short-term and long-term
prospects of the FPC, the best interests of the FPC and its
shareholders, and the purpose of the FPC as stated in its
articles.
8)Relieves from liability a person who performs the duties of a
director, in accordance with the above specified provisions,
for any alleged failure to discharge the person's obligations
as a director, and allows the liability of a director for
monetary damages to be eliminated or limited by the articles
of the FPC, as provided.
9)Does not authorize a special right of action for shareholders
to sue for specific enforcement of the FPC's special purpose
or purposes above or beyond those options currently available
to shareholders under the existing General Corporation Law.
10)Requires the board to prepare, for inclusion with the FPC's
annual report to shareholders, a specified management
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discussion and analysis (MD&A) concerning the FPC's stated
special purpose or purposes, and requires the MD&A to be
posted on the FPC's web site. Among other things, the MD&A
must include:
a) An identification and discussion of the short-and
long-term objectives of the FPC that relate to its special
purposes, 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 and discussion of any material
operating and capital expenditures incurred by the FPC
during the fiscal year to achieve its special purpose
objectives, and a good faith estimate of projected costs
FPC expects to incur over the next three fiscal years in
order to achieve its special purpose objectives.
EXISTING LAW :
1)Establishes the General Corporation Law to authorize and
regulate the formation and governance of general corporations,
including the duties and liability of corporate directors, the
rights of shareholders, and amendment of the articles.
(Division 1 of Title 1 of the Corporations Code, commencing
with Section 100. All further references will be to this Code
unless otherwise specified.)
2)Establishes the Nonprofit Corporation Law to authorize and
regulate the formation and governance of nonprofit benefit
corporations, nonprofit mutual benefit corporations, and
nonprofit religious corporations, including the duties and
liability of corporate directors, the rights of shareholders,
and the respective purposes for which those nonprofit
corporations may be lawfully formed. (Division 2 of Title 1,
commencing with Section 5000.)
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3)Authorizes and regulates the formation and governance of
corporations for specific purposes, including but not limited
to consumer cooperative corporations, small business financial
development corporations, and professional corporations, and
specifies the respective purposes for which those corporations
may be lawfully formed. (Division 3 of Title 1, commencing
with Section 12000.)
4)Requires that corporate directors perform their duties 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 under similar
circumstances. (Section 309(a); Section 5231(a).)
5)Limits the liability of directors for negligence pursuant to
the "business judgment rule", which stands for the principle
that 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, when the act or omission involves a
question of policy or business judgment. (See, e.g., 9
Witkin, Summary of California Law 10th Ed., Sec. 102.)
COMMENTS : According to the author, the California Corporations
Code lacks flexibility for corporations seeking to combine the
for-profit philosophy of a traditional corporation with a higher
"special purpose" that is charitable, serves the public, or
otherwise benefits the environment, the community, or society.
To address this need, this bill authorizes in California a new
form of corporate entity known as a flexible purpose corporation
(FPC), the form of which, the author contends, would provide
greater flexibility for the corporation to combine profitability
with broader social or environmental "special purpose."
Stated Need for the Bill : This bill is sponsored by the
California Working Group for New Corporate Forms (the "Working
Group"), who identify themselves as a self-appointed, diverse
collection of corporate lawyers in California who come from
academia, small and large corporate law firms, non-profit law
firms and entrepreneurial organizations. According to the
Working Group, for nearly 18 months its members have been
deliberating and drafting a proposed new division of the
Corporations Code to "facilitate the organization of companies
with greater flexibility for combining profitability with a
broader social or environmental purpose." In explaining the
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objective of the bill, the sponsor and the author state:
The use of a traditional corporation portends potential
risk for directors making decisions on the basis of a
Special Purpose, if done at the expense of maximizing
financial returns for shareholders and outside the
presumption of the business judgment rule. Although case
law does not present a clear picture of exactly when and
how liability arises (based on the facts and circumstances
of each case), prudent counsel, responding to risk-averse
directors, tend to draw conservative lines on how far a
board might take a corporation in pursuit of a Special
Purpose, at the expense of financial returns. Corporations,
as a product of trust law, typically do not permit
entrepreneurs to alter this dynamic through the articles of
incorporation, because the rules are either statutorily
embedded or judicially created as a part of a director's
fiduciary duties to the shareholders and the corporation.
SB 201 creates a Flexible Purpose Corporation in
California, which integrates the for-profit philosophy of
the traditional corporation along with its statutory
certainty and standardization, but seeks to address the
issues noted above so that entrepreneurs and investors can
avoid the difficult work of trying to integrate a Special
Purpose mission within the scope of the business judgment
rule and, instead, can work on building an organization
from the start that integrates achieving profitability and
accomplishing its stated Special Purposes without the
traditional obstacles and considerations. . . . By
authorizing the flexible purpose corporation, SB 201
provides a statutory safe harbor for directors and officers
of companies seeking to meld the traditional goal of
profitability with a Special Purpose of the company's
choosing. This safe harbor does not currently exist for a
traditional corporation formed under the General
Corporation Law, which is typically favored over LLCs by
institutional investors.
Relationship to General Corporation Law . The General
Corporation Law (GCL), Division 1 of Title 1 of the Corporations
Code, authorizes and regulates the formation and governance of
general corporations, including the duties and liability of
corporate directors, the rights of shareholders, and amendment
of the articles. This bill authorizes the formation of a new
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corporate entity known as a flexible purpose corporation (FPC),
in the process adding a new division, Division 1.5, to Title 1
of the Code. Section 2501 of the bill clarifies that the
provisions of the GCL apply to FPCs except as otherwise
expressly stated by this bill. This new division reproduces
numerous sections of the GCL and mirrors many of its provisions,
except where revised to necessarily differentiate FPCs from
general corporations. In addition, this bill amends several
chapters of the GCL to integrate references to FPCs into
statutes authorizing the merger, conversion, or reorganization
of existing entities into or out of another corporate form.
According to the Working Group, FPCs do not differ from
corporations organized under the GCL except in the following
ways: (1) FPC articles must set forth one or more qualifying
special purposes; (2) Two-thirds vote of shareholders is needed
to change or eliminate the special purpose, or to approve a
change of corporate form into or out of an FPC; (3) Directors
are protected from liability for decisions furthering the
special purpose at the expense of profitability; (4)
Shareholders have dissenters' rights in conversions or mergers;
(5) FPCs must comply with expanded disclosure and reporting
requirements with respect to its special purposes.
Flexible Purpose Corporations are distinguished by their special
purpose mission. Unlike other types of corporations, FPCs are
organized to allow the directors to pursue one or more "special
purposes" in addition to creating profit for shareholders. FPCs
must specify the special purpose in their articles of
incorporation, which is designed to put shareholders and
potential shareholders on notice that the FPC's directors may
exercise their business judgment to engage in activities that
take the special purpose into account, even if doing so will not
necessarily maximize profitability for shareholders. The
special purpose may be a "charitable or public purpose activity"
that could be carried out by a nonprofit benefit corporation
(pursuant to Section 5111), the definition of which is largely
left to case law (see, e.g. Younger v. Wisdom Soc. (1981) 175
Cal. Rptr. 542, public purpose was "to contribute to the
intellectual life of the nation"; In re Los Angeles County
Pioneer Soc. (1953) 40 Cal.2d. 852, commemoration of historical
events and collection and preservation of data of historical
interest are charitable purposes.) Alternatively, the special
purpose may be to promote the positive effects of (or mitigate
the negative effects of) the FPC's activities upon its
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employees, suppliers, customers, and creditors, the community
and society, the environment, or any combination of the above.
Under this bill, two-thirds of the shareholders must vote to
approve any proposal to change the special purpose, which can
only be done by amending the articles of incorporation.
Two thirds of shareholders must approve conversion or
reorganization of an existing corporation into or out of an FPC,
but with guaranteed opt-out rights for dissenters. Existing
provisions of the GCL authorize 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. (Section 1152.) With respect to the conversion,
merger, or reorganization of a legal entity into a new FPC, or
from a FPC into a different legal entity, this bill requires a
supermajority vote of two-thirds of each class of voting share
to effectuate the change of corporate form. Proponents contend
that this high threshold is necessary to provide appropriate
notice and protection to shareholders before making any decision
to convert into (or out of) a flexible purpose corporation.
This bill also provides shareholders with dissenters' rights in
the event of any material change in the special purpose, or any
conversion or merger with a non-FPC that may cause the dissenter
to wish to opt out and exercise his appraisal rights.
Dissenters' rights, outlined in Chapter 13 of the GCL
(commencing with Section 1300) are intended to afford those
shareholders who disagree with the change in special purpose, or
any proposed conversion or merger, the right to receive fair
value for their shares. According to the Working Group, any
change or conversion into a FPC that establishes the importance
of the special purpose may substantially alter the expectations
of shareholders or investors with respect to value of shares,
and therefore such a change should require a higher vote
threshold in order to protect these shareholders' interests.
Accordingly, this bill finds a balance between protecting
shareholders and enabling corporations to reorganize as FPCs to
pursue corporate special purposes.
Directors of a FPC have the duty to consider the special purpose
in their decisions, but shareholders are not given any special
right of action to enforce the special purpose. Existing law
provides a standard of care that a director must use in
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discharging his or her duties, namely that 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
under similar circumstances." (Section 309(a).) In addition,
the traditional "business judgment rule" limits the liability of
a director for an erroneous decision or poor choice, in the
absence of a showing of fraud, bad faith, or negligence, when
the act or omission involves a question of policy or business
judgment.
This bill establishes the same standard of care for FPC
directors (Section 2700(a) of the bill) but falls short of
actually requiring the director to make decisions that result in
furthering the special purpose. Instead the bill only provides
that the director "may consider . . . and give weight to" the
special purpose while discharging his or her duties. This
important provision, which has no equivalent in the GCL,
represents one of the central tenets of this bill, namely that
the fiduciary duty of directors should include, not exclude,
consideration of both financial and non-financial interests in
the exercise of ordinary business judgment. According to the
Working Group:
FPC directors and officers are afforded considerable
flexibility in their decisions and actions, both within and
outside of the ordinary course of business, subject to
reasonableness and materiality standards of existing case
law. Such decisions and actions need not necessarily favor
any one purpose (including enhancing shareholder value)
over any other. Rather, existing case law that imposes a
reasonableness and materiality standard will also apply to
the prioritization by directors and managers of one or more
of the stated Special Purposes over others, including, in
appropriate circumstances, favoring the achievement of a
stated Special Purpose over the economic interests of the
shareholders.
This bill does not, however, provide shareholders or other
parties any special right of action for enforcement of the
special purpose. The Working Group contends that providing a
special right of action to enforce the special purpose runs
counter to the larger objective of this bill to provide the
directors of a FPC with greater discretion to pursue actions
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they feel are in the best interests of the FPC and its
shareholders without being subject to increased liability for
decisions that don't necessarily maximize profit. They note
that under the current GCL, shareholders are already permitted
to file suit for a director's breach of fiduciary duties, and
that under this bill, the fiduciary duty of directors includes
the duty to adhere to the special purpose of the FPC.
Therefore, according to the Group, a special right of action is
unnecessary because current law will permit shareholders to
enforce the special purpose by filing suit for breach of
fiduciary duty.
In addition to filing suit for breach of fiduciary, the
Committee notes that FPC shareholders also retain their ability
under the GCL to seek replacement of directors as another
potential method of enforcement, or they could simply vote with
their money and divest from the FPC if they felt the special
purpose was not being adequately furthered by the FPC directors.
To be able to evaluate the corporation's performance with
respect to the special purpose, however, shareholders and
investors must have access to the proper information.
Reporting requirements on special purpose activities. To ensure
access to this information, this bill requires the FPC to
prepare and publish on its website an extensive annual report
("management discussion and analysis" report, or MD&A)
discussing its special purpose objectives, activities, and
expenditures in the previous year. Among other things, the FPC
must discuss the material actions it has taken to achieve its
special purpose objectives, the impact of those actions, and the
extent to which those actions achieved the special purpose
objectives in the previous year. The MD&A report also must
disclose costs and expenditures incurred by the FPC, as well as
projected expenditures to further the special purpose
objectives.
According to the Working Group, these transparency requirements
will ensure that shareholders have information needed to
determine whether the FPC is adequately achieving its special
purposes or not. Such a determination, however, would appear to
necessarily be a subjective one because the directors are
responsible for defining the parameters by which performance is
to be evaluated in the MD&A report. Ultimately, the
shareholders who utilize the information reported in the MD&A
document must make a subjective decision whether the FPC is
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working appropriately to achieve the special purpose, or whether
the answer to that question even matters in relation to the
FPC's return on investment when considered together.
This bill appears complementary with AB 361 (Huffman): AB 361
(Huffman), which this Committee approved on May 3, 2011 by a
vote of 7-2, seeks to create a new form of corporate entity
known as a "benefit corporation" that, like this bill, is
intended to provide new flexibility for the corporation to
combine profitability with broader social or environmental
corporate purpose. While the two bills seek to address the same
problem-lack of flexibility under the current GCL-they propose
two complementary "flavors" of alternate corporate form that
businesses or entrepreneurs, depending on their particular
needs, may elect to adopt if both bills are enacted. To the
extent the bills differ on particular concepts and details,
passage of both bills would actually appear to increase the
available choices to companies and entrepreneurs seeking a more
flexible form than the single rigid option currently authorized
by the GCL for for-profit enterprises. According to the Working
Group, it appears that the bills also complement each other by
appealing to different constituents, stating in correspondence
with the Committee: "Ultimately the Working Group believes that
benefit corporations are primarily designed for use by private
companies focused on sustainability that avail themselves of
socially responsible capital, as opposed to companies seeking
access to traditional capital markets."
ARGUMENTS IN OPPOSITION : This bill is opposed by the California
Association of Nonprofits (CAN), the California Society of
Association Executives (CalSAE), the Blood Centers of
California, and California Church Impact. These opponents all
take the position that more information should be gathered by
the Legislature before it acts to authorize the formation of
this, or any unprecedented hybrid corporate form that may affect
the non-profit sector. As summarized in the letter of
opposition by CAN:
SB 201 and similar measures present historic and difficult
choices that will affect the type, scope, and integrity of
social, educational, cultural, and environmental services
delivered to the people of California for decades to come.
There are significant risks involved that need to be more
closely examined, including opportunities for abuse and
detrimental impacts on quality of life-saving resources,
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such as the blood supply. Those risks as well as
opportunities need to be considered in a detailed and
deliberate fashion simply not possible in the few short
weeks allocated for legislative hearing and floor votes.
(All of the opponents named above) have united around one
simple request: that the Legislature hold all legislation
intended to introduce new corporate forms into the
California code until those measures have been the subject
of a public vetting process, including legislative hearings
that will allow the legislature and the governor-as well as
nonprofits, for-profits, and the public-to make informed
decisions.
The opponents contend that this bill could produce harmful
unintended consequences for the non-profit sector, including
"siphoning off much-needed resources from effective existing
nonprofits by redirecting donor dollars from charitable
contributions to flexible purpose corporation investments." In
response, the author and sponsor assert that the opponent's
concern is misplaced because this bill is intended to provide an
alternative to the standard for-profit corporation, not an
alternative to the nonprofit corporation. They contend that the
bill "will allow for-profit corporations to focus more on social
and charitable impact and permit greater flexibility for those
corporations to contribute to the charitable sector that CAN
represents." They further contend that FPCs "will not divert
resources from non-profits . . . primarily because foundations,
charities or individuals will not be permitted to receive
favorable tax treatment in connection with donations to FPCs,
who instead must avail themselves of the mainstream capital
markets."
California Church Impact argues separately that "we are
supportive of Flexible Purpose Corporate principles, but we also
know from past experience that non-profit status has been
roundly and thoroughly abused by for-profit entities as a means
of diverting profit to fund political and other activities.
Until we can be assured that the FPC status would not permit
diversion of money into questionable actions, we must remain in
opposition." In response, the author asserts that the fear of
potential abuse should be mitigated by the bill's inclusion of
expanded requirements of transparency and public reporting with
respect to the FPC's special purposes.
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PREVIOUS LEGISLATION: AB 2944 (Leno) of 2008 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 who
stated that it "was a package of concepts that could produce
unknown ramifications and the need for which have not been fully
demonstrated."
SB 1463 (DeSaulnier) of 2010 would have created a new form of
corporate entity known as a Flexible Purpose Corporation (FPC)
in order to authorize corporations to participate in designated
for-profit and not-for-profit activities. SB 1463 was referred
to the Senate Judiciary Committee, but was not heard.
PENDING LEGISLATION : AB 361 (Huffman) seeks to create a new
form of corporate entity known as a "benefit corporation" that,
like this bill, is intended to provide new flexibility for the
corporation to pursue a "public benefit", as defined, that does
not necessarily maximize shareholder profit. AB 361 is
currently awaiting hearing in the Senate Banking and Finance
Committee.
REGISTERED SUPPORT / OPPOSITION :
Support
California Legal Working Group for New Corporate Forms (sponsor)
Benetech
Brightpath
Corporations Committee of the State Bar of California
GreenBiz
GreenOrder
iVeridis Corporation
Lawyers' Committee for Civil Rights of the San Francisco Bay
Leapfrog Network
Omidyar Network
OneSun
Pacific Community Ventures
Revolution Foods
Sierra Business Council
Social Profit Network
Source Trace Systems, Inc.
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SPNCO, Inc.
The Troy and Alana Pack Foundation
Opposition
Blood Centers of California
California Association of Nonprofits (CAN)
California Church IMPACT
California Society of Association Executives (CalSAE)
Analysis Prepared by : Anthony Lew / JUD. / (916) 319-2334