BILL ANALYSIS �
SENATE JUDICIARY COMMITTEE
Senator Noreen Evans, Chair
2011-2012 Regular Session
SB 201 (DeSaulnier)
As Amended March 14, 2011
Hearing Date: April 12, 2011
Fiscal: Yes
Urgency: No
TW:rm
SUBJECT
Flexible Purpose Corporations
DESCRIPTION
This bill would provide requirements for the formation and
operation of a new form of corporate entity called the Flexible
Purpose Corporation. This bill would allow for-profit and
not-for-profit corporate activities to be stated in the
corporation's articles of incorporation, giving the corporate
directors the ability to take corporate actions to support these
activities. This bill would provide for corporate director
liability to shareholders for acts taken in contravention of the
stated activities.
BACKGROUND
Increasingly, businesses are interested in finding ways to be
profitable while taking care of their employees, communities,
and environment. However, corporations organized under
traditional corporate forms must be mindful of shareholder
interests in the profits of the corporations. As such,
directors are subject to the "business judgment rule" which
requires directors to utilize good faith in taking actions for
the best interests of the corporation and the shareholders.
Accordingly, directors are currently liable to shareholders in
the event shareholders disagree with not-for-profit activities
engaged in by the corporation. Such activities could include
donations of corporate property or money to employees and the
community.
Several states have adopted statutes authorizing benefit
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corporations (B Corps), which allow corporations to engage in
activities that benefit non-profit interests. In California,
several bills have been introduced in recent years to provide
directors with explicit legal authority to consider other
factors which the authors and their sponsors believed would give
corporations and directors more flexibility to adopt socially
responsible policies without fear of lawsuits from shareholders.
SB 1528 (Alarcon, 2004) would have provided that in carrying out
his or her duty to the best interests of the corporation, a
director may take into account any or all of the following: (1)
the corporation's employees, customers, suppliers, or creditors;
(2) the economy of the region, state, and nation; (3) the impact
on the community; (4) the environment; and (5) the long- and
short-term interests of the company and its shareholders. SB
1528 was heard in this committee and passed 5-2, voted out of
the Senate 26-13, but died in the Assembly Banking, Finance and
Insurance Committee.
SB 917 (Alarcon, 2003) would have created a new private right of
action, effective in the year 2017, against California
corporations and directors for causing material damage to the
environment, human rights, public health and safety, the welfare
of the communities in which the corporation operates, or the
rights of the corporation's employees. Under that bill, any
person damaged by the corporate action would have standing to
sue, but no director would be liable if: 1) the director voted
against the action which led to the harm; or 2) the damage
occurred due to an action approved by the corporation prior to
the director becoming a board member. SB 917 was referred to
this committee and testimony was taken, but no vote was held.
AB 2944 (Leno, 2008), among other things, 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." The veto message encouraged legislators to find
and study alternative business models that would adequately
protect shareholder interests.
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SB 1463 (DeSaulnier, 2010) was introduced as a new business
model that would protect shareholder interests while providing
corporate directors the ability to designate for-profit and
not-for-profit activities in which the corporation would
participate. SB 1463 was referred to this committee, but was
not heard. SB 201 is substantially similar to SB 1463.
This bill would create a new corporate business model called the
Flexible Purpose Corporation in order to authorize corporations
to participate in designated for-profit and not-for-profit
activities. This bill would maintain shareholder protections
regarding corporate profits.
CHANGES TO EXISTING LAW
Existing law provides for the formation and regulation of
corporations. (Corp. Code Sec. 100 et seq.)
Existing law provides for the formation and regulation of
non-profit entities. (Corp. Code Sec. 5000 et seq.)
Existing law provides a standard of care that a director must
use in discharging his or her duties. 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." (Corp. Code. Secs. 309(a) and
5231.) The liability of directors for negligence is extremely
limited. When the act or omission involves a question of policy
or business judgment, 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. This is usually referred to as
the "business judgment rule" for director liability. (9 Witkin,
Summary of California Law 10th Ed. Sec. 102.)
This bill would provide for the formation and regulation of a
new corporate entity called the Flexible Purpose Corporation,
which would authorize corporations to specify in their articles
of incorporation, in addition to for-profit purposes, a Special
Purpose, which would include not-for-profit activities in which
the corporation would engage.
This bill would provide the same standard of care and
shareholder liability required of a director under the
corporation and non-profit corporation models.
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COMMENT
1. Stated need for the bill
The author writes:
The existing General Corporation Law ("GCL") provides for the
formation of traditional corporations and limited liability
companies ("LLCs"). . . . Although the fundamental
characteristic difference between these two options remains
tax treatment, two other differences make both forms difficult
for the entrepreneur seeking to meld profitability with a
special corporate purpose.
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.
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
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traditional corporation formed under the GCL, which . . . is
typically favored over LLCs by institutional investors.
The sponsor of this bill, the California Legal Working Group for
New Corporate Forms (the Group), a group of individual corporate
attorneys with diverse and extensive experience in creating
hybrid organizations, writes:
Over the past decade, many organizations in both the
non-profit and the for-profit worlds have been "bending the
arcs" of their respective corporate forms to achieve multiple
or blended objectives or values. This drive towards mixing
money and mission has often come at increased risk of
potential liability either with shareholders (in the case of
for-profits) or the IRS (in the case of non-profits).
Individually, the separate forms available to social
entrepreneurs have been limiting, at best.
SB 201 creates a new corporate form in California. . . . The
FPC �Flexible Purpose Corporation] integrates the for-profit
orientation of the traditional corporation, with its statutory
certainty and standardization, with a Special Purpose mission,
by encouraging and expressly permitting companies formed or
converted to pursue one or more purposes in addition to
creating economic value for shareholders.
2. Creation of a new corporate form
This bill would create a new corporate form called the Flexible
Purpose Corporation, in order to allow corporations to engage in
for-profit and not-for-profit activities. Existing law provides
that corporations may engage in specified purposes according to
the purposes listed in their articles of corporation. (Corp.
Code Sec. 202.) Non-profit corporations must state in the
articles of incorporation that they are not for profit. (Corp.
Code Sec. 5130.) As such, a non-profit corporation is not
entitled to operate for the gain of any person. The Group
argues that social entrepreneurs may not qualify for the
non-profit corporation status due to the strict requirements of
tax-exempt activities. Additionally, traditional corporate
forms are typically unsuitable for social entrepreneurs because
these forms create potential risk for directors making decisions
on the basis of a special purpose if done at the expense of
maximizing financial returns and shareholder value.
The Business Law Section of the State Bar of California, a
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supporter of this bill, states that "some business owners desire
their businesses to achieve some higher good, in addition to
doing well. We think it is important that California law
provide business owners and organizers flexibility to achieve
their goals, provided that shareholders are adequately protected
by procedural safeguards." This bill would allow business
owners to achieve their for-profit and not-for-profit goals
while protecting shareholder interests.
3. Director liability
This bill would provide that directors are liable for acts taken
in contravention of the specified purposes of the corporation.
This bill would require these corporate purposes, for-profit and
not-for-profit, to be specified in the articles of
incorporation. Existing law provides that directors are liable
for acts taken in contravention of the corporate or charitable
purpose. (Corp. Code Secs. 309 and 5231.) The author argues
that "SB 201 requires that the Articles �of Incorporation]
specifically identify at least one such Special Purpose in
addition to the general authorization to engage in any lawful
business under the �general corporation law]." Shareholders
would know up front in which non-profit activities the
corporation is engaged. Further, this bill would provide
director liability for acts taken in contravention of the
specified purposes, which would provide the same shareholder
protections found in the corporation and non-profit corporation
statutes.
4. Conversion of existing corporations into Flexible Purpose
Corporations
This bill would provide a mechanism whereby existing
corporations could convert into a Flexible Purpose Corporation.
Existing law authorizes 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.
(Corp. Code Sec. 1152.) The Business Law Section of the State
Bar of California argues that this bill also would require a
two-thirds vote for conversion and "�a] two-thirds or greater
vote, which is a high threshold, provides appropriate notice and
protection to shareholders to make a decision about whether to
convert to a Flexible Purpose Corporation. . . . For
shareholders that do dissent from a vote in favor of converting
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to a Flexible Purpose Corporation, the regime �under SB 201]
provides dissenters' rights . . . �which will] afford those
shareholders who disagree with the change the right to receive
fair value for their shares." This bill would conform to the
standards set for other corporations and would require either a
two-thirds vote for conversion or a simple majority vote if
authorized under the corporation's articles of incorporation.
Accordingly, this bill strikes a balance between flexibility of
corporate special purposes and shareholder protections.
5. Opposition's concerns
The California Association of Nonprofits (CAN), an opponent of
the bill, argues that "SB 201 has great - but unknown -
potential to do harm or good. On the one hand it could expand
California's capacity to deal with major problems impacting our
people and our environment. On the other hand, it could siphon
off much-needed resources from effective existing nonprofits by
redirecting donor dollars from charitable contributions to
flexible purpose corporation investments." In response, the
author argues that the Flexible Purpose Corporation is not a
replacement for a non-profit entity; these two business forms
will continue to serve two different purposes. In addition, the
non-profit corporation can benefit from the Flexible Purpose
Business model when the non-profit engages in unrelated business
activities for which it needs to form a for-profit subsidiary.
California Church Impact, an opponent of this bill, argues that
"there is almost nothing that can be created that cannot be
abused. 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 Flexible Corporate status would not permit diversion of
money into questionable actions, we must remain in opposition."
In response, the author argues that "�t]o offset and compliment
the expanded scope of directors' and officers' protected
decision-making and actions, expanded requirements of
transparency and shareholder communication (in particular as to
Special Purposes) are included. The Flexible Purpose
Corporation will be required to disclose publicly information
regarding objectives, goals, measurement and reporting of the
impact or 'returns' of actions vis-�-vis such Flexible Purpose
Corporation's Special Purposes."
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Support : Brightpath Capital Partners, LP; Business Law Section
of the State Bar of California; iVeridis Corporation; Omidyar
Network; One Sun; Sierra Business Council; Source Trace Systems,
Inc.
Opposition : California Association of Nonprofits; California
Church Impact; California Society of Association Executives
HISTORY
Source : California Legal Working Group for New Corporate Forms
Related Pending Legislation : AB 361 (Huffman) would authorize
and regulate a new corporate entity called the Benefit
Corporation, which would allow corporations to form in ways
similar to this bill. AB 361 has been referred to the Assembly
Judiciary Committee.
Prior Legislation : See Background.
Prior Vote :
Senate Committee on Banking and Financial Institutions (Ayes 7,
Noes 0)
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