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The New ABC's of California Corporations

There is a brand new corporation on the block — two new ones, actually — and they have the potential to be kind of cool. Standing alongside the “C,” “S” and 501(c)(3) corporations, not to mention the limited liability company (“LLC”), there are now the “B Corporation” and the “Flexible Purpose Corporation.”

As a brief recap, the “C Corp.” is your standard stock company; the “S Corp.” has a limited number of shareholders and permits certain favorable tax and corporate governance practices; the 501(c)(3) is the non-profit company; and an LLC offers the advantage of limited liability while keeping the company formalities relatively simple. There are several other types of companies under California law, but it is not necessary they be discussed for the purposes of this writing.

So with all these options already available, why the new types of corporations? And what exactly are they, anyway?

The B Corp., more properly known as a “Benefit Corporation,” changes the primary focus of corporations. Currently a corporation’s sole mandate is to maximize shareholder value: make maximum profit for its “shareholders” (those holding shares of stock in the corporation). Under old law, if a corporation takes so-called “stakeholders” (the environment, community employees, vendors) into account, the shareholders may file a lawsuit against the directors of the company for failing to maximize shareholder value. And they may win. Furthermore, you don’t need a plurality of shareholders to file an action. A single shareholder, one holding a very small number of shares, an infinitesimal percentage of the outstanding stock, is all that is required to bring suit.

There are two important features to the Benefit Corporation. First, it requires that in addition to shareholders’ interest, the board of directors take the environment, community, employees and suppliers into account when they make decisions. This shifts the corporate purpose from maximizing shareholder value to maximizing stakeholder value.

It also establishes a high level of transparency and accountability. Under the new California law, within 120 days of the end of the fiscal year, a B Corporation must publish for public review and inspection a Benefit Report. That report must detail its performance over the past year in reaching its mission on both environmental and social dimensions.

Similarly, a Flexible Purpose Corporation, or “FlexC” (pronounced “fleks-see”), allows a company to identify in its corporate documents an additional purpose for which it is formed. In essence, it allows the company to identify its own special purpose. The company must clearly state that purpose, outline goals to achieve that purpose and, like a B Corp., publish an annual report disclosing how well it has achieved that purpose.

The new FlexC laws allow the company to choose a purpose that generally benefits society, such as a charitable or public purpose (a 501(c)(3) purpose), promoting some positive effect on it stakeholders, environment or community (such as shoes for the poor, e.g. Tom’s Shoes) or minimizing adverse effect of the company’s activities (such as reducing the company’s carbon footprint).

There are many such companies that could serve as examples, except that until now they either risked (or suffered) a shareholder suit. For example: Ben & Jerry’s (which was legally forced to abandon its philanthropic orientation), Whole Foods Market and, paradoxically, the Ford Motor Company when in 1914 it made the conscious decision to pay its employees a generous salary thereby allowing them to purchase a family (Ford) car. With this new law, there is recognition of an additional, more encompassing, rationale for corporate activity.

To distinguish clearly between these two new types of corporations, the B Corp provides that the companies consider the environment, community, employees and suppliers when making decisions. The FlexC allows the corporation to identify for itself a legitimate corporate purpose beyond maximizing shareholder value.

Be cautioned, however, before electing to go the route of a B Corp., the company must be firmly committed to that path. It is not an artificial, for-the-moment Going Green Marketing Scheme. Public accountability is a major element of the new laws.

The primary advantages of these new structures are, first that they grant the company the power to make decisions that are in the best interest of all stakeholders without the risk of a shareholder lawsuit. Second it allows a company to differentiate itself from any competing company that is simply marketing itself in some form of green washing.

Of course, there is the additional benefit that an investor can direct their money to companies that are serious about running a socially conscious company committed to making the community, other stakeholders and perhaps even the world a better place.

Other states have seen the wisdom of providing for this type of company. New Jersey, Virginia, Hawaii, Vermont and Maryland also have laws that allow Benefit Corporations. Similar legislation has been proposed in New York and Michigan. There currently are no plans for Delaware, the king of corporate formation states, to adopt this new structure in the near future. California is the first state to adopt the FlexC organization.

Existing companies can elect to change into these new forms of companies; though I suspect new companies will be the ones primarily to take advantage. At the same time, it remains to be seen whether having these forms of corporations available will embolden courts to more strictly apply the shareholder value maxim for traditional corporations. There are, of course, other ambiguities that will be explored by the courts and need to be monitored as the law is put into practice.

Obviously, these new corporate structures are not appropriate for every company. There are a number of complex considerations to balance and take into account, both in terms of the near and long term. We would be pleased to discuss these new laws with you and your other representatives in order to assist you in making the best decision for your particular organization.

The new law takes effect January 1, 2012.

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