California Creates New Corporate Structures Enabling For-Profit Corporations To Consider the Public Benefit
November 22nd, 2013
In January 2012, California created two new state corporate structures: (1) flexible purpose corporations, and (2) benefit corporations. Unlike traditional for-profit corporations, these new corporate structures are required to provide for benefit to the public. Unlike traditional non-profit corporations, these new corporate entities are not tax exempt. These new entities seek to straddle some of the rigid distinctions that existed under the previously permitted corporate structures.
Flexible Purpose Corporations
California was one of the first states to enact legislation permitting flexible purpose corporations. Corporations Code section 2500 et seq. sets out the legal parameters for California flexible purpose corporations. The articles of incorporation for a flexible purpose corporation must include a specific statement that:
“a purpose of the flexible purpose corporation is to engage in one or more of the following purposes…:
(A) One or more charitable or public purpose activities …
(B) The purpose of promoting positive short-term or long-term effects of, or minimizing adverse short-term or long-term effects of, the flexible purpose corporation’s activities upon any of the following: (i) the flexible purpose corporation’s employees, suppliers, customers, and creditors; (ii) the community and society; (iii) the environment.” Corp. Code § 2602.
The board of a flexible purpose corporation is required to annually prepare a report to shareholders containing, among other things, a discussion of the short term and long term objectives of the corporation; the material actions taken to achieve its special purpose objectives; the impact of those actions; and the extent to which the actions achieved the special purpose objectives for that year. Corp. Code § 3500(b)
As of the writing of this article, over 30 states have passed or have pending legislation creating the legal framework for benefit corporations. California Corporations Code section 14600 et seq. sets out the legal requirements for California benefit corporations.
In California, a benefit corporation “shall have the purpose of creating general public benefit.” Corp. Code § 14610(a). And, the benefit corporation “may identify one or more specific public benefits that shall be the purpose or purposes of the benefit corporation.” Corp. Code § 14610(b).
Like flexible purpose corporations, benefit corporations have specific accountability requirements. Benefit corporations are required to prepare a public benefit report, assessing the public benefit as measured by an unrelated third-party. In California, benefit corporations must prepare an annual report to shareholders explaining the standard used to measure the public benefit, the process for choosing the third-party evaluator, and the extent of public benefit created. Corp. Code § 14630(a).
B Corporations are a subset of benefit corporations. A corporation designated a “B Corporation” is a benefit corporation that uses a particular third-party, B Labs, as the evaluator. If a benefit corporation receives its third-party evaluation from B Labs, it is a B Corporation.
Thus, all B Corporation are benefit corporations, but not all benefit corporations are B Corporations.
Case Study: Ben & Jerry’s
The sale of Ben & Jerry’s to Unilever is often discussed in the context of Benefit Corporations. The facts show that Ben & Jerry’s stock was initially profitable. However, during the 1990s, it languished, and the stock was trading around $20 per share. Third parties, including Dreyer’s and Unilever, offered to pay substantially more per share to acquire all outstanding stock. Although the owners preferred not to sell, in 2000 Ben & Jerry’s accepted Unilever’s offer, and the corporation was sold.
Since that time, there has been debate among lawyers and others as to whether the company was required by corporate law to accept this offer. But, the fact is that Ben & Jerry’s was a for-profit corporation, bound by for-profit corporate law.
Leo E. Strine, Jr., Chancellor of the Delaware Court of Chancery, stated in “Our Continuing Struggle with the Idea that For-Profit Corporations Seek Profit”:
“[A]s a matter of corporate law, the object of the corporation is to produce profits for the stockholders and that the social beliefs of the managers, no more than their own financial interests, cannot be their end in managing the corporation.”
This is not new law — as is shown in Dodge v. Ford Motor Co., 170 N.W. 668 (Mich. 1919), where shareholders receiving a regular 60% annual dividend brought suit, and won, against Ford Motor Co. for failing to distribute the maximum wealth to shareholders in the form of a special dividend.
As demonstrated in Dodge v. Ford, corporate law requires maximizing profits to shareholders. This exposes the corporate leadership (and the corporation itself) to potential litigation when some shareholders disagree with decisions made by the corporate leadership. Henry Ford, and the Board of Directors at Ford Motor Co., had a plan to accumulate capital in order to expand production capacity. The higher production of cars would in turn lead to higher profits down the road.
Mr. Ford had good business sense, and Ford Motor Company accumulated capital according to the plan. However, the successful execution of the plan and resultant accumulation of cash proved to be a basis for the court to step in and alter the business plans of the corporation.
The court recognized that Mr. Ford personally was responsible for the phenomenal growth of the business. The court stated:
“Mr. Henry Ford is the dominant force in the business of the Ford Motor Company… A business, one of the largest in the world, and one of the most profitable, has been built up. It employs many men, at good pay.”
Despite Mr. Ford’s successful history in running the business, the court apparently believed it was better able to determine the future business plans of Ford Motor Company. The court reviewed the production plans, including the projected number of car sales and projected price for the cars, and determined that Ford Motor Company should not accumulate cash to increase production capacity. Instead, the court decided that the company should distribute the accumulated cash to the shareholders as a special dividend. This court decision remains good law, and is frequently referenced as a clear example that the primary purpose of a for-profit corporation.
Dodge v. Ford makes clear that the purpose of for-profit corporations is to maximize short-term wealth to its shareholders. Socially responsible purposes are not a relevant consideration when a board of directors makes decisions regarding the future actions of a for-profit corporation.
Returning to Ben & Jerry’s — after the third-party offers, Ben & Jerry’s stock price rose significantly and the company faced a decision: to accept one of the offers, or to refuse all offers, keep control of the company, and face potential litigation from shareholders claiming that the Board failed to maximize shareholder wealth. In the end, the board of Ben & Jerry’s apparently decided the prudent course of action was to sell.
Note however, that if Ben & Jerry’s had been a benefit corporation or a flexible purpose corporation, other factors related to the special purposes of the corporation could have legally been considered by the board of directors, and perhaps Ben & Jerry’s would not have been sold at that time.
Interestingly, in Oct 2012, Ben & Jerry’s became the first wholly-owned subsidiary of a publicly traded company to become a certified B Corporation.
The newly-formed B corporation now may legally state that one of its purposes is: “To make, distribute and sell the finest quality all natural ice cream and … promoting business practices that respect the Earth and the Environment.”
The primary purpose of a for-profit corporation is as stated in the name — it is for profit. Case law is clear that a corporate board of directors must make corporate decisions that ensure the primacy of this purpose. Consideration of other purposes, including purposes that benefit the public or the environment, is not permissible in for-profit corporate decision-making.
The sale of Ben & Jerry’s to Unilever illustrates some reasons why a business may prefer to organize as one of these new corporate forms. At the time of the Unilever offer Ben & Jerry’s was organized as a for-profit corporation and it took the prudent course of action — it accepted the offer from Unilever and distributed the wealth to its shareholders. Now, Ben & Jerry’s, as a subsidiary of Unilever, has re-organized as a benefit corporation and may legally consider environmental factors as part of its business model.
Other business entities may wish to form as a flexible purpose corporation or benefit corporation, to obtain the benefits of corporate law while also pursuing public benefit purposes.
We are delighted to announce and welcome Sharon Adams as Of Counsel at Bay Oak Law Firm, APLC
November 22nd, 2013
One of the major justifications small business owners have for not protecting their information more carefully is “who would want our information? We’re just a small firm that doesn’t handle anything important for anybody.” A recent security breach reveals the risks. A small software service that provides back-end software solutions for car-hire services had its data hijacked . The data included credit card numbers, pick-up and drop-off information, and client names. While actor Tom Hanks is described as a “VVIP” client (hardly surprising), others had data about their preferences, included those who smoked marijuana or had sex in the car. If you are a flower shop, it may not seem important, but if a nearby resident is repeatedly sending flowers to someone not his or her spouse, or sending “Sorry, I screwed up” bouquets to the spouse, that may become sought-after information if the resident becomes notorious later.
Starting next year, companies that have had compromised data relating to consumer user names and passwords will have to inform all its California customers of the data compromise. Senate Bill 46 was signed by Governor Brown in September, and will be effective as of January 1, 2014. Designed to minimize the effects of identity theft, the new notification requirements will give California consumers the chance to minimize the effects of the data compromise – and thereby reduce the potential liability for the website. However, there are real dangers lurking for the companies charged with protecting the information. Enacted as amendments to California Civil Code §1798.29, it will require that every California resident whose data is subject to a security breach be notified “in the most expedient time possible and without unreasonable delay.” Written in plain English, the notice of the security breach is supposed to inform the California resident:
- • of the type of the personal information that was subject to the breach,
- • when the breach occurred and similar information,
- • of the contact information for the leading credit reporting agencies,
- • if a social security or driver’s license number were subject to the breach, as well as
- • other possible ways of protecting from the consequences of the breach.
Data protected is far more than user names and passwords; they also include medical and insurance information, account numbers, and credit or debit card numbers. Notice also that while California residents are protected, it does not limit those required to give notice to California companies. Every website is covered, regardless of its location.
What to Do. If your company suffers a data security breach, avoid the temptation to hide it unless law enforcement specifically asks you to do so (there is a law enforcement exemption to the notice requirements). As soon as reasonably possible, notify everyone involved as soon as possible in a way that complies with the law (electronic notice is allowed). Do so for everyone, both California and non-California residents. The stick here is that failure to provide timely notification can make the company liable for millions of dollars in damages. This law is a true Trojan horse that requires the strictest care. If customers suffer an identity theft and did not get timely notice, this statute will likely allow them to seek damages against you. This could get very expensive, very quickly. Check with your insurance agent to see whether your general liability insurance can provide any protection. If (or when) it does, make sure there is sufficient protection – a $10,000 limit may not cover much. In the meantime, check with your IT people to make sure there are several layers of security for information that could cost you. It took a lot of trickery, and a wooden horse, to conquer the riches of Troy. To steal a fantastical amount of money 50 years ago meant burrowing into a bank vault. These days, untold riches can result from letting computers tap into accounts, while the felon is playing Angry Birds or Candy Crush Saga. Companies are now on the hook for the consequences of a successful data breach.
November 11th, 2013
Bay Oak Law’s own Daniel Gwozdz was recognized by the Bar Association of San Francisco on Veteran’s Day for his service in the US Army between 2000 and 2005. Dan was a scout for the legendary 10th Mountain Division, and served during operations in Operation Joint Guardian in Kosovo, and Operation Iraqi Freedom.
October 1st, 2013
Despite the federal economic shutdown, the federal courts will remain open, for now. They’ll reassess around October 15th — about the time when the debt ceiling is reached.
September 16th, 2013
by: Daniel E Gwozdz
Daniel E Gwozdz is a 2012 graduate of Gonzaga School of Law and the newest attorney at Bay Oak Law.
If the title above grabbed your attention, chances are that you are either a member of an Limited Liability Company or are interested in forming one. Limited Liability Companies, or LLCs, are a relatively new form of hybrid business entity that provide limited liability protection and a great deal of a flexibility to the owners, called members. The most important benefit that an LLC provides is limited liability. When set up properly, limited liability protects the LLC’s members from being personally responsible for the contractual debts and obligations of the LLC – including court judgments – other than the members’ personal investment into the business. (If a member personally participates in tortious wrongdoing, then the member can still be liable.)
Before LLCs, limited liability could only be established, in most cases, by incorporating a business or by forming a limited partnership in which certain owners, called limited partners, have an ownership interest in the business but lose their limited liability protection if they engage in the management of day-to-day operations. Another advantage of an LLC is that it provides greater flexibility in structuring the business and requires fewer mandatory formalities than a corporation. California LLCs also provide their members with federal passthrough taxation – meaning, the income of the LLC is only taxed once when it passed on to its members whereas corporations pay taxes on their income and this income is taxed again when it is distributed to its shareholders. For LLCs organized in California, however, there is a yearly franchise fee imposed on the LLC ranging from $800 to $11,790 depending on the LLC’s income.
On January 1, 2014, the California Revised Uniform Limited Liability Company Act, or RULLCA goes into effect, replacing the Beverly-Killea Act which established LLCs in California in 1996. New and existing LLCs will automatically be subject to the new law beginning January 1, 2014. While many of current LLC provisions will be carried over to the new law and it is unlikely that new law will have a major impact on the day-to-day operations of most LLCs, it is still a good idea to be familiar with the new law and how it may affect your business. Some of the important changes and provisions of the new LLC law include:
• Operating Agreement: The new law heightens the importance of an LLC’s operating agreement. Under the previous law, in the event of a conflict between the provisions of the Articles of Organization and the Operating Agreement, the Articles prevailed. Under RULLCA, the Operating Agreement takes precedence unless the disagreement over the terms of the documents involves a 3rd party that reasonable relies on the Articles. In addition, LLC members are bound by the Operating Agreement even if they did not sign it. Transfers of an interest in the LLC are ineffective as to any person with notice of the restriction at the time of transfer. So, if you are an LLC member or are about to become one, it is in your best interest to carefully review your LLC’s Operating Agreement.
• Non-Economic Members: The new laws allow a person to have some of the rights of members, such as voting rights, without requiring or obligating the person to make a contribution to the LLC and without giving the person a transferable interest in the LLC. Since a non-economic member does not have a transferable interest, that member is not a “partner” for tax purposes. A full member may transfer his economic interest in the LLC while maintaining his voting rights. A well drafted Operating Agreement should address whether non-economic members are allowed and what rights they have.
• Fiduciary Duties: Under the old law, it was unclear as to whether the LLCs members owed a duty to each other. Under RULLCA, if the LLC is manager managed; only the manager owes the duty of loyalty and the duty of care to the members. All members owe a duty of good faith and fair dealing to each other.
• Indemnification: Under the new law, the LLC must indemnify any member of a member-managed LLC or manager of a manager-managed LLC who complies with his duties outlined in the new law. The new law, however, often allows the Operating Agreement to alter or eliminate the indemnification requirement. In addition, the new law allows the operating agreement to alter or eliminate a member or manager’s liability to the LLC and other members except with respect to: breaches of the duty of loyalty; excess distributions; intentional infliction of harm; or criminal conduct.
• Dissociation: The new law introduces the term dissociation to describe an event that terminates membership status providing consistency among business entities (a dissociation was referred to as a withdrawal under the old law). While the events triggering a dissociation remain largely the same, under the new law, a judicial order may be used to remove a member – currently, the entire LLC needs to be dissolved, if the majority of members want to remove a member who will not voluntarily withdraw.
• Death of a Sole Member: The new law clarifies what happens if the sole member of an LLC dies. Typically an LLC with no members is automatically dissolved. Under the new law, if the sole member of an LLC dies, his heirs may admitted as substitute members.
It is important to remember that many of the provisions in RULLCA are default rules and can be modified or eliminated in the Operating Agreement. If you would like additional information regarding RULLCA or assistance reviewing or drafting new or existing LLC agreements, please contact Bay Oak Law, ‘Your Consigliere.’
Photo by Coolcaesar, from Wikipedia Commons.
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September 16th, 2013
And so it begins. By October 1st, employers are to give notice to employees about health insurance options by giving the employees the following form. It only takes a few minutes to fill it out and print it for your employees. Only the first two pages are mandatory; the last page is optional. The best time to fill it out is now, before it is too late. Make sure you keep a copy with the employee’s records.
June 4th, 2013
In 1989, I was listening to this song while following the news from Beijing. Someday, tomorrow will come for the people of China.
March 28th, 2013
The USCIS has introduced a new I-9 form that will have to be used for new employees. While use is currently voluntary, it will be required from May onward. No need to panic, however — it does not have to be used for current employees, only those who are new, or return to the company after being away.
The form has more up-to-date formatting, although the information required is largely the same. The form comes with six pages of instructions, so it should be largely self-explanatory. If you need questions answered, though, give Bay Oak Law a call, or send an email to firstname.lastname@example.org.
March 26th, 2013
The New York Times has an excellent article on a lawsuit in which a law firm is accused of running up the fees. Smaller firms can’t afford to do this.
Picture: By Marcel Jirina (Museum of butter, Maslovice, Czech Republic), GFDL or CC-BY-3.0, via Wikimedia Commons
March 18th, 2013
When is a fictional character copyrightable? Certainly main characters are. But what about lesser characters – even ones that do not have even a single line?
Judge Ronald S.W. Lew faced this question in DC Comics v. Towle in February 2013 regarding the Batmobile. Defendant Mark Towle runs Gotham Garage a custom car business. He has been selling kits that allow people to customize their vehicles into the Batmobile. DC Comics sued for copyright and trademark infringement.
Like most of Batman’s fights, the outcome was not in much doubt. Batman wiped the floor with Towle. Judge Lew found that Towle violated DC Comics’ copyright and trademark rights in the Batmobile. Judge Lew found that the public is likely to be deceived by Towle’s product, and also that the Batmobile had enough “artistic features” to be protected under copyright law.
Batmobile certainly a unique image that justifies protection, if only because there is a demand for kits to fit out a car as a Batmobile. However, the line delineating what is protectable intellectual property starts getting very fuzzy as characters get less distinctive. Supporting characters and henchmen are almost always anonymous, or nearly so, and have little intellectual property protection. In Nichols v. Universal Pictures, 45 F.2d 119 (2d Cir. 1930), the legendary judge Learned Hand found that “the less developed the characters, the less they can be copyrighted; that is the penalty an author must bear for marking them too indistinctly” in ruling that two plays featuring a Jewish person marrying a Catholic person in New York were not so similar as to constitute copyright infringement. Copyright protects expression, not ideas. Luckily, “Holy _____” is not long enough to constitute protected expression.
Photo By Joy Acharjee (Flickr) CC-BY-2.0, via Wikimedia Commons