BILL ANALYSIS Ó
SB 1301
Page 1
Date of Hearing: June 24, 2014
ASSEMBLY COMMITTEE ON JUDICIARY
Bob Wieckowski, Chair
SB 1301 (DeSaulnier) - As Amended: June 11, 2014
As Proposed to Be Amended
SENATE VOTE : 36-0
SUBJECT : CORPORATE FLEXIBILITY ACT OF 2011: SOCIAL PURPOSE
CORPORATIONS ACT
KEY ISSUES :
1)SHOULD VARIOUS CHANGES BE MADE TO STRENGTHEN AND IMPROVE THE
2011 LAW ENABLING COMPANIES TO ORGANIZE AS "FLEXIBLE PURPOSE
CORPORATIONS" TO ACHIEVE GREATER FLEXIBILITY TO COMBINE
SHAREHOLDER PROFITABILITY WITH ONE OR MORE ADDITIONAL SPECIAL
PURPOSES?
2)UPON RE-EVALUATION OF THE STATUTE AND PROPOSED CHANGES TO IT,
SHOULD THE "FLEXIBLE PURPOSE CORPORATION" BE RENAMED INSTEAD
TO "SOCIAL PURPOSE CORPORATION"?
SYNOPSIS
In 2011, the Legislature passed and the Governor signed the
Corporate Flexibility Act of 2011 which authorized companies to
organize as a new type of corporate entity known as a "flexible
purpose corporation." The Act was intended to give such
entities greater flexibility to combine profitability with
broader special purposes, including benefiting the corporation's
employees, suppliers, and customers, or seeking some benefit
social or environmental in nature. This bill is follow-up
legislation by the author of the 2011 Act and proposes to make
various clarifying and technical changes to improve and build
upon the framework of the existing FPC statute. First, the bill
would rename FPC's into "social purpose corporations" (SPC), and
change dozens of corresponding references in the law to reflect
the name change. Currently, the Act permits but does not
actually require the corporate directors to make decisions that
result in furthering the corporation's special purpose. This
bill strengthens the Act to require, rather than merely
authorize, the directors of a SPC to consider and exercise
SB 1301
Page 2
discretion to further the corporation's special "social
purpose." According to the author, this change is intended to
more closely align the actions of the directors with the special
mission of the SPC by requiring them to consider the special
mission in carrying out their duties. Among other things, the
bill also clarifies provisions relating to dissenter's rights
and the conversion of domestic corporations into SPCs. The bill
is opposed by the California Association of Nonprofits and a
former member of the working group of attorneys who originally
drafted the FPC statute, on the sole basis that the corporate
entity should not be renamed as "social purpose corporations"
when the original term FPC is more appropriate and descriptive
of the corporate entity, all things considered. This bill was
previously approved by the Assembly Banking & Finance Committee
by a 10-2 vote.
SUMMARY : Makes various clarifying and technical changes to the
law governing entities currently organized as "flexible purpose
corporations" (FPC) and changes the name of such entities to
"social purpose corporations" (SPC). Specifically, this bill :
1)Provides that any flexible purpose corporation (FPC) formed
before January 1, 2015 shall continue its existence on and
after January 1, 2015 as a social purpose corporation (SPC),
but does not also require any FPC to formally change its name
or articles of incorporation to reflect the change to a social
purpose corporation.
2)Clarifies that a SPC may state in its articles of
incorporation that one of its purposes is to promote positive
effects or minimize adverse effects of the SPC's activities
upon (a) its employees, suppliers, customers, and creditors;
(b) the community and society; or (c) the environment, but in
any case so long as the corporation considers the purpose in
addition to, or together with, the financial interests of the
shareholders and compliance with legal obligations, and takes
action consistent with that purpose.
3)Requires, rather than authorizes, the directors of a SPC to
consider and give weight to those factors the director deems
relevant, including the overall prospects of the corporation,
the best interests of the corporation and its shareholders,
and the purposes of the corporation as set forth in its
articles of incorporation.
SB 1301
Page 3
4)Requires existing business associations formed as trusts and
wishing to convert to SPCs, and SPCs wishing to convert to
domestic other business entities, to obtain votes of at least
two-thirds of their shareholders.
5)Provides dissenters' rights to the shareholders of a SPC whose
shareholders vote to convert to a domestic corporation or
other business entity, or which is the disappearing
corporation in a corporate merger with an entity that is not a
SPC.
6)Changes the approval threshold for a social purpose
corporation to abandon a proposed transaction to sell, lease,
convey, exchange, transfer, or otherwise dispose of all or
substantially all of the assets of the corporation to
two-thirds of the outstanding shares rather than to all of the
outstanding shares.
7)Clarifies that the principal terms of a reorganization must be
approved by at least two-thirds of each class, or a greater
vote if required in the articles of incorporation, of the
outstanding shares of any class of a SPC that is a party to a
merger or sale-of-assets reorganization, if holders of shares
of that class receive shares of the surviving or acquiring SPC
having different rights, preferences, privileges, or
restrictions than those surrendered.
8)Makes other technical changes to ensure the use of proper
terminology when referring to the act of conversion to or from
a social purpose corporation.
EXISTING LAW :
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. (Corporations Code Section 2600. All
further references are to this code unless otherwise stated.)
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
SB 1301
Page 4
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
of these. (Section 2602(b).)
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.
(Section 3000(b).)
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. (Sections 3301 and 3401.)
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. (Section 3401(g).)
6)Provides that a director shall perform his or her 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. (Section 2700(a).)
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. (Section 2700(c).)
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
SB 1301
Page 5
of the FPC, as provided. (Section 2700(d).)
9)Requires the board to prepare, for inclusion with the FPC's
annual report to shareholders, a specified management
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. (Section 3500(b).)
FISCAL EFFECT : As currently in print this bill is keyed
non-fiscal.
COMMENTS : In 2011, the Legislature passed and the Governor
signed the Corporate Flexibility Act of 2011 which authorized
companies to organize as a new type of corporate entity known as
a "flexible purpose corporation," which was intended to give
such entities greater flexibility to combine profitability with
broader special purposes, often social or environmental in
nature. According to the Secretary of State, a total of 62 FPCs
have been formed since January 1, 2012, when the new law went
into effect. This bill, by the same author of SB 201, is
follow-up legislation that proposes to make various clarifying
and technical changes to improve and build upon the framework of
the existing FPC statute. Among other things, the bill would
change the name of the corporate entity to "social purpose
corporation", and change dozens of corresponding references in
the law to reflect the name change.
Author's statement. According to the author:
SB 1301 renames "flexible purpose corporations" as
"social purpose corporations" to more accurately
reflect the spirit of the law, and clarifies that any
corporation formed as a "flexible purpose corporation"
before January 1, 2015, continues its existence as a
social purpose corporation. In addition, SB 1301
clarifies that social purpose corporations are
required, and not just encouraged, to consider a
special purpose in the long-term, and bolsters the
requirement of disclosure and reporting to shareholders
on such purpose. SB 1301 makes it easier for companies
from outside the state to incorporate or reincorporate
as a "social purpose corporation" in California. This
bill also cleans up California code to better conform
to other states' guidelines and new corporate laws that
have proven successful in encouraging companies to
SB 1301
Page 6
incorporate with a special mission.
Background on existing flexible purpose corporations (FPC) . 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. SB 201 (DeSaulnier), Ch. 740.
Stats. 2011, authorized the formation of a new 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.
Under existing law, FPCs do not generally 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 in addition to the general purpose of shareholder
profit. Unlike other types of corporations, FPCs are organized
to allow the directors to pursue one or more "special purposes"
in addition to the purpose of 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. 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. 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
SB 1301
Page 7
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 employees, suppliers, customers,
and creditors; the community and society; the environment; or
any combination of these.
This bill seeks to strengthen the corporation's core commitment
to its special purpose, while renaming the entity a "social
purpose corporation." Existing law provides a standard of care
that a director of a corporation must use in 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.
Under the existing FPC law, enacted by SB 201, the same standard
of care applies to FPC directors-although the law falls short of
actually requiring the director to make decisions that result in
furthering the FPC's special purpose. Instead, the FPC law only
provides that the director "may consider . . . and give weight
to" the special purpose while discharging his or her duties.
(Corp. Code Section 2700(c).)
To strengthen this standard for directors, the bill would
require, rather than simply permit, the directors and management
of a social purpose corporation to consider and give weight to
appropriate factors to further the corporation's special "social
purpose." These factors include the overall prospects of the
social purpose corporation, the best interests of the social
purpose corporation and its shareholders, and the purposes of
the social purpose corporation as set forth in its articles.
According to the author, this change is intended to "more
closely align the actions of the directors with the special
mission of the corporation by requiring them to consider the
special mission in carrying out their duties." Proponents of
the bill contend this important distinction between now-existing
"flexible purpose corporations" and companies to be formed as
"social purpose corporations" is one reason why the proposed
name change is not inappropriate. They state that the proposed
SB 1301
Page 8
new name "better captures the essence of the corporate form and
reflects the fact that the corporation is at its core devoted to
the special mission."
Author's Amendment: In order to reinforce the importance for
SPCs to further the special "social purpose" that helps to brand
these companies and distinguish them from other for-profit
corporations that lack any additional purpose, the author
proposes to make several clarifying amendments, specified below.
As proposed to be amended, the bill seeks to clarify that the
social purpose stated in the SPC's articles of incorporation is
a purpose that is distinct from the corporation's general
purposes, and therefore any special purpose stated in the
articles must be considered by the corporation "in addition to,
or together with, the financial interests of the shareholders
and compliance with legal obligations," and moreover that the
actions taken by the corporation shall be "consistent with that
purpose." The proposed amendments are:
On page 33, delete lines 12 through 23, and insert:
(2) A statement that a purpose of the social purpose
corporation, in addition to the purpose stated pursuant to
paragraph (1) , is to engage in one or more of the following
enumerated purposes, in addition to the purpose stated
pursuant to paragraph (1), as also specified in the
statement set forth pursuant to paragraph (1) :
(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 effects of, or
minimizing adverse effects of, the social purpose
corporation's activities upon any of the following, provided
that the corporation consider the purpose in addition to or
together with the financial interests of the shareholders
and compliance with legal obligations, and take action
consistent with that purpose:
(i) The social purpose corporation's employees, suppliers,
customers, and creditors;
(ii) The community and society;
SB 1301
Page 9
(iii) The environment.
Dissenter's rights. Existing FPC law 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 or
her 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. Among other things,
this bill would provide dissenters' rights to the shareholders
of a SPC whose shareholders vote to convert to a domestic
corporation or other business entity, or which is the
disappearing corporation in a corporate merger with an entity
that is not a SPC.
Shareholder approval for proposed conversions. 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. With respect to the conversion, merger, or
reorganization of a legal entity into a new SPC, or from a SPC
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. The two-thirds
threshold is intended to provide appropriate notice and
protection to shareholders before making any decision to convert
into (or out of) a flexible purpose corporation. Among other
things, this bill requires existing business associations formed
as trusts and wishing to convert to SPCs, and SPCs wishing to
convert to domestic other business entities, to obtain votes of
at least two-thirds of their shareholders.
Additional technical amendments: The author also proposes to
make the following technical amendments, which are intended to
ensure the use of proper terminology when referring to the act
of conversion to or from a social purpose corporation.
On page 6, line 18, strike "change" and replace with
"conversion"
On page 6, line 24, strike "change" and replace with
SB 1301
Page 10
"conversion"
On page 7, line 17, strike "change" and replace with
"conversion"
On page 7, line 12, strike "changed" and replace with
"converted"
On page 49, line 23, strike "change" and replace with
"conversion"
On page 50, line 1, strike "change" and replace with
"conversion"
On page 50, line 8, after "change" insert "status"
On page 50, line 31, strike "change" and replace with
"conversion"
On page 66, line 20, strike "Section 1155" and replace with
"Section 3304"
On page 78, line 38, after "corporation," insert "business
corporation,"
ARGUMENTS IN OPPOSITION : The California Association of
Nonprofits (CAN) is opposed only to the provisions of the bill
that change the name of the corporate entity from "flexible
purpose corporation" to "social purpose corporation." If the
bill did not rename the corporate entity, they explain, they
would not be in opposition. CAN states:
While we welcome the ability of for-profit corporations
to form as flexible purpose corporations, we are
strongly opposed to the provision that changes the name
of such entities from "flexible purpose corporations"
to "social purpose corporations" or any similar name.
The term "flexible purpose" was chosen after much
consideration by the authors of SB 201 in 2011, and it
is an accurate description of these corporations. The
proposed term "social purpose corporation" will mislead
the public into confusing such corporations with
nonprofit organizations, leading to them mistakenly to
think that these corporations are tax-exempt
nonprofits. As a result they may make donations of
good and/or investments of cash in the mistaken belief
that they are donating to a nonprofit. The conflation
of nonprofit and for-profit corporations has already
proven to be a source of confusion for Californians.
Steven Hazen, a corporate law attorney who was a member of the
working group that drafted the text which was ultimately enacted
as SB 201 in 2011, also expresses opposition to the bill unless
SB 1301
Page 11
it is amended to retain the name "flexible purpose corporation."
Hazen contends that the choice of name for the new entity
envisioned by the working group was a matter of significant
deliberation within the group, and that the term "FPC" has
several advantages:
(1) "FPC" gives notice of the new law's intent - namely
to enable a corporation to have a purpose that goes
beyond the economic interests of its shareholders, and
to give those shareholders the power to determine what
that purpose would be, rather than to dictate to them
what it had to be.
(2) "FPC" avoids an implication that, by virtue of
holding such status, the entity was morally superior to
any other entity created under the Corporations Code.
(3) "FPC" avoids any implication that entities formed
under other divisions of the Corporations Code were
somehow institutionally unable to accomplish specific
goals.
(4) "FPC" avoids any implication that the State of
California was taking a position in the nature of
endorsement of one set of values adopted by
shareholders of a corporation over a different set of
values adopted by shareholders of another corporation.
REGISTERED SUPPORT / OPPOSITION :
Support
Morrison and Foerster, LLP
Opposition
California Association of Nonprofits (CAN)
Steven K. Hazen, Esq.
Analysis Prepared by : Anthony Lew / JUD. / (916) 319-2334
SB 1301
Page 12