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