Transcript New Social Hybrid Legal Forms What Matters to State Regulators? October 1, 2012 Victoria B.

New Social Hybrid Legal Forms
What Matters to State Regulators?
October 1, 2012
Victoria B. Bjorklund, Esq.
Simpson Thacher & Bartlett LLP
New York, NY
Robert Keatinge, Esq.
Holland & Hart LLP
Denver, CO
Agenda
Topics for Discussion
 A Changing Landscape
 Why do social hybrids matter?
 What are the main social hybrid forms?
 Who is advocating these social hybrid forms?
 Low-profit Limited Liability Companies (L3Cs)
 Program-related Investments and the L3C
 Risks and Criticisms
 Theory v. Reality
 Benefit Corporations
 Related forms: B-Corps and Flexible-purpose corporations
 Conclusion
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States Adopting Social Hybrid Legislation
(as of June 2012)
Benefit corporations - 9
Flexible purpose corporations - 2
Low-profit limited liability companies (L3Cs) - 9
Timeline of Social Hybrid Legislation
2008-June 2012
2008
•L3Cs: VT
•L3Cs: IL, NC and LA
•Benefit corps: MD and VT
2009
•L3Cs: MI, UT and WY
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2012 (as of June)
2010
•Benefit corps: LA and SC
•Flex purpose corps: WA
2011
•L3Cs: ME and RI
•Benefit corps: CA, HI,
NJ, NY and VA
•Flex purpose corps: CA
Introduction
Why have this discussion?
Recent legislation
 As of June 2012, 17 states have enacted specific legal forms
for for-profit, non-exempt entities intending to generate
social benefits; legislation is pending in many other states
 Two major forms: Low-profit limited liability companies
(L3Cs) and benefit corporations, each with different aims
and advocates
 There are also flexible purpose or social purpose corporations,
related to benefit corporations, further discussion to follow
 Efforts have come from outside organizations, led by
Americans for Community Development (L3C advocates)
and B Lab (Benefit corporation advocates)
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Introduction
Why have this discussion?
General concerns
 New hybrid forms may be unnecessary; existing for-profit forms
(the LLC and corporate forms) are flexible and can be used by
socially beneficial for-profit organizations
 New hybrid forms may be overly restrictive relative to the
ordinary LLC and corporate forms
 New forms with built-in social benefit requirements may weaken
legal arguments in favor of corporate philanthropy and social
consciousness among ordinary for-profits
 While new forms create obligations on the leadership, most
statutes prescribe no government oversight and few transparency
requirements, and any oversight may burden state regulators
 L3Cs in particular may carry risks for established non-profit
organizations seeking to partner with socially conscious for-profits
without alleviating the burdens associated with such co-ventures
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Introduction
Why have this discussion?
Concerns for state regulators
 New hybrid forms are not monitored by government
entities to ensure compliance with their statutory mandates
 Lack of transparency and accountability may later result in
greater oversight by state regulators
 Abuses of new forms do not have clear methods of resolution,
which may require state regulators to become involved in
resolving disputes in the future
 Inherent restrictions may require creation of new areas of state law
to govern L3C or flex-purpose corporation compliance; benefit
corporations ceding oversight to B Labs may be undesirable
 Potential weakening of legal arguments in favor of corporate
philanthropy and social consciousness among ordinary for-profits
may require state regulators to become involved in corporate law
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Social Hybrid Forms
What are they?
Benefit corporation
Focus on social benefits in organization
and governance
Focus on joint investment by nonprofits
and for-profits
Ensure that organization remains
dedicated to social benefit goals
alongside profit motives
Finance high-risk, low-return socially
beneficial ventures with tranched
investment from foundation PRIs
Approx. 100 nationwide, in California,
Hawai’i, Louisiana, Maryland, New
Jersey, New York, South Carolina,
Vermont and Virginia
Approx. 600 nationwide, in Illinois,
Louisiana, Maine, Michigan, North
Carolina, Rhode Island, Utah, Vermont and
Wyoming
States with benefit
corporation statutes
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L3C
States with L3C statutes
Social Hybrid Forms
Who are the advocates?
L3Cs
 Advocacy led by a non-exempt entity, Americans for Community
Development, and its leader, Robert Lang
Benefit corporations
 Advocacy led by B Labs, a Philadelphia-based § 501(c)(3) public
charity that describes itself as promoting social and environmental
consciousness in business ventures
 Additional projects by B Labs include the B-Corp designation, a
private certification by B Labs of a company’s commitment to
social or environmental goals (similar to Fair Trade USA)
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L3Cs
The Basics
Structure
 Variant on the flexible LLC form; includes LLC requirements
Differences from the LLC
 Entity must further an IRS-recognized charitable purpose
 Mirrors program-related investment (PRI) standards to ostensibly
ease investment from private foundations
Purposes
 Encourage tranched investment by private foundations and forprofit investors by seeking foundation PRIs to generate capital
 “Brand” entities with a social purpose
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L3Cs
PRIs and L3Cs
What is a PRI?
 I.R.C. § 4944(c) allows foundations to make below-market grants
or loans when they are program-related
 Primary purpose must be charitable under § 170
 No significant purpose can be the production of income
 No purpose can be campaign or lobbying activities
 Regulation examples, including new examples, leave grey area
 Foundations without experience in PRIs may be reluctant to make
PRIs; foundations with experience perform significant diligence
prior to making a PRI
How do L3Cs relate to PRIs?
 L3Cs are structured to mirror the three PRI requirements with the
intent to make PRIs to L3Cs simpler than other PRIs
 But L3Cs do not automatically comply with PRI requirements
(especially charitable purpose); thus, IRS has not given blanket
approval of PRIs to L3Cs
 L3C advocates are no longer pushing for blanket IRS approval
 Federal legislation to mandate a process whereby L3Cs seek IRS
endorsement has stalled and is unlikely to be enacted
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L3Cs
Criticisms
State regulation
 In most states, L3Cs lack transparency, and their activities are not
monitored to ensure they further their stated charitable purpose
 Except Illinois, where L3C directors and managers are charitable trustees
by law and subject to monitoring by state charities bureau
 Illinois-type monitoring may become more common in other states, or
alternatively a new monitoring system may develop
 State regulation, to the extent it exists, is dependent on an
understanding of federal rather than state charitable definitions
 Alternative LLC form would require less regulation
Other issues
 L3Cs do not reduce PRI costs to foundations; complacency risks
 Improper private benefit to for-profit investors may result from
tranched investment (significant uncertainty in the area)
 PRI-based structure limits activities to those federal law considers
charitable when other activities may have merit and prevents
lobbying or political activities when they may be appropriate
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L3Cs
Theory v. Practice
L3Cs in practice
 L3Cs have not been used primarily by individuals seeking PRIs,
and we are unaware of any PRIs made by foundations to L3Cs
 May partially result from relative lack of appeal of L3Cs as PRI targets
due to recent vintage, small size and less sophisticated leadership
 According to a study of L3C early adopters in Vermont, leaders
were primarily interested in a for-profit entity with social goals
Connecting theory to practice
 The L3C form in particular has significant problems; however,
appetite exists among some entrepreneurs for “branding”
 PRIs ought not to be the focus of future social hybrid reforms
 State regulators may be concerned by relative inexperience of L3C
operators with charitable forms if called upon to regulate
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Benefit Corporations
The Basics
Structure
 Variant on corporate form; existing corps can elect in
 Certification by B Labs, advocates of benefit corporations
 Provides some oversight as certification must be kept up-to-date
and B Labs publishes some details, though certification is private
and outside of ordinary political regulatory system
Difference from exempt and non-exempt forms
 Unlike non-profit corps, permitted to distribute profits
 Unlike for-profit corps, requirement that Board consider social
and environmental goals is built into legal structure
 Annual report to shareholders based on “a third-party
standard” (typically the B Labs standard) to state social goals
 Shareholders have right of action to enforce social goals
 Must include a Director and an Officer who are oriented
toward benefits
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Benefit Corporation Purposes (Cont.)
Purposes (Model Benefit Corporation Legislation
(“MBCL”) § 201)
 General public benefit purpose. – A benefit corporation
shall have a purpose of creating general public benefit. This
purpose is in addition to its purpose under [cite section of
the business corporation law on the purpose of business
corporations].
 Optional specific public benefit purpose. – The articles of a
benefit corporation may identify one or more specific
public benefits that it is the purpose of the benefit
corporation to create in addition to its purposes under [cite
section of the business corporation law on the purpose of business
corporations] and subsection (a). The identification of a
specific public benefit under this subsection does not limit
the obligation of a benefit corporation under subsection (a).
 Effect of purposes. – The creation of general public benefit
and specific public benefit under subsections (a) and (b) is
in the best interests of the benefit corporation.
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Benefit Corporation Purposes (Cont.)
General Public Benefit (MBCL §§ 102(a), 301(a))
A material positive impact on society and the environment,
taken as a whole, assessed against a third-party standard,
from the business and operations of a benefit corporation.
This involves consideration of:
(i)
the shareholders of the benefit corporation;
(ii) the employees and work force of the benefit corporation,
its subsidiaries and its suppliers;
(iii) the interests of customers as beneficiaries of the general
public benefit or specific public benefit purposes of the
benefit corporation;
(iv) community and societal factors, including those of each
community in which offices or facilities of the benefit
corporation, its subsidiaries or its suppliers are located;
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Benefit Corporation Purposes (Cont.)
General Public Benefit (MBCL §§ 102(a), 301(a)) (Cont.)
(v) the local and global environment;
(vi) the short-term and long-term interests of the benefit
corporation, including benefits that may accrue to the
benefit corporation from its long-term plans and the
possibility that these interests may be best served by the
continued independence of the benefit corporation; and
(vii) the ability of the benefit corporation to accomplish its
general public benefit purpose and any specific public
benefit purpose
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Benefit Corporations
Criticisms
Structural concerns
 Knock-on effects on boards of ordinary for-profit corporations;
may reduce courts’ sympathy towards consideration of social
benefits or corporate philanthropy
 Possibly redundant with charter amendments that can build social
benefits into the corporate purpose
 Less flexible and potentially less favorable tax treatment due to use
of the corporate form over LLC form
Oversight and enforcement concerns
 Only shareholders and third-party standard creators can enforce
in pursuit of social benefits; no government monitoring
 Although, as with L3Cs, state regulators may be called upon to enforce
in the future if legislatures decide mechanisms are insufficient
 Less reporting to state charities bureaus or IRS than non-profits,
thus less transparency to non-shareholders (but also less
burdensome on state regulators)
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Model Charitable Solicitations Act
Is a solicitation for investment in a Social Hybrid
Organization a “Charitable Solicitation”?
MCSA § 1(c) “’Solicit’ and ‘solicitation’ mean the request
directly or indirectly . . . on the plea or representation that
such money, credit, property, financial assistance, or other
thing of any kind or value, or any portion thereof, will be
used for a charitable purpose or benefit a charitable
organization.”
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Model Charitable Solicitations Act
Is a solicitation of a contribution to a Social Hybrid
Organization a solicitation for a “charitable purpose”?
MCSA § 1(d)(2) “Charitable purpose means:
Any benevolent, educational, philanthropic, humane,
scientific, patriotic, social welfare or advocacy, public
health, environmental conservation, civic or other
eleemosynary objective, or an objective that benefits law
enforcement personnel, firefighters, or other persons who
protect the public safety.”
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Model Charitable Solicitations Act
Is a Social Hybrid Organization a “Charitable
Organization”?
MCSA § 1(a)(2) “Charitable Organization means:
Any person who is or holds himself out to be established
for any benevolent, educational, philanthropic, humane,
scientific, patriotic, social welfare or advocacy, public
health, environmental conservation, civic or other
eleemosynary purpose or for the benefit of law
enforcement personnel, firefighters, or other persons who
protect the public safety, or any person who in any manner
employs a charitable appeal as the basis of any solicitation
or an appeal which has a tendency to suggest there is a
charitable purpose to any such solicitation.”
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Model Protection of Charitable Assets Act
Is property of a Social Hybrid a “Charitable Asset”?
MPCAA § 2(1) “Charitable asset” means property that is
given, received, or held for a charitable purpose. The term
does not include property acquired or held for a for-profit
purpose.
MPCAA § 2(2) “Charitable purpose” means the relief of
poverty, the advancement of education or religion, the
promotion of health, the promotion of a governmental
purpose, or any other purpose the achievement of which is
beneficial to the community.
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Benefit Corporations
Related alternatives
Flexible or social purpose
corporation
 Board may consider social
benefits, but no third-party
standard required
 Criticized for potential
“greenwashing” and misleading
of investors due to lack of an
independent standard
 More need for state regulators to
become involved because no
third party standard exists
heightens risk of abuse
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States with flex-purpose
corporation statutes
Conclusion
What can we conclude?
 Some appetite exists for legal forms “branded” as forprofits advancing social benefit goals, and legislators have
quickly enacted social hybrid legislation
 Existing hybrid forms, particularly L3Cs, are ill-suited for
the purposes they purport to advance and may be
redundant with LLCs and corporations
 Although current law affords little oversight or
transparency for social hybrids, state regulatory oversight
may be expanded in ways that may distinguish social
hybrids from standard for-profit forms
 In general, legal structures at the state and federal levels as
well as the socially conscious community are still adapting
to the social hybrid
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NEW YORK
BEIJING
HONG KONG
HOUSTON
LONDON
LOS ANGELES
PALO ALTO
SÃO PAULO
TOKYO
WASHINGTON, D.C.
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