BILL ANALYSIS                                                                                                                                                                                                    



                                                                  SB 1301
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          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  








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          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.








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          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  








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               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  








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            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  








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               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  








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          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  








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          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;








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               (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  








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             "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  








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          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 











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