Benefit corporations are business corporations that are designed and intended to benefit society and make a profit for their shareholders. Growing in popularity as part of the backlash against “profit-at-all-cost” capitalism, these companies offer the promise of an economy that gives priority to human and environmental needs as well as economic needs. Because of the dual nature of benefit corporations, their directors and managers of these companies have the unenviable task of balancing the private interests of the owners, the creation of a public benefit, and the interests of stakeholders (parties who are important to the company and impacted by its operations, but are not its owners). This balancing act is the essence of governing and managing benefit corporations, since, as a legal matter, benefit corporation directors have an affirmative obligation to balance these interests – they aren’t allowed to prioritize one over the other. Furthermore, like all corporate directors, benefit corporation directors are legally accountable for this balancing act. But what are the accountability mechanisms? How are directors of benefit corporations held legally accountable and to whom? The answer is two-fold: benefit reports and benefit-enforcement proceedings.
Benefit Reports
A “benefit report” is an annual report that describes the benefit corporation’s goals for creating general or specific public benefit and how successful the corporation was in achieving its goals over the past year. Every benefit corporation is required to prepare and distribute a benefit report, but the specifics vary from state to state. These reports typically explain how the benefit corporation pursued its public benefit goals, circumstances that hindered the corporation in achieving desired social outcomes, and – where applicable – the process and rationale for selecting or changing the third-party standard used to prepare the benefit report (in many states, a benefit corporation must measure and report on its performance using an independent third party standard.) In some states, these reports must be filed with the Secretary of State so they can be made publicly available (although anecdotal evidence suggests that few states collect them). In most states, benefit corporations must distribute their benefit reports to shareholders and/or post them online.
Benefit reports are essential elements in benefit company accountability for several reasons. First, in creating the report, a company’s leadership is expected to review itself and its performance and to revisit its goals and strategies. It gathers data, articulates its efforts toward accomplishing its goals, and looks at the year ahead to anticipate next steps – and possibly modify its approach. If the benefit report lacks these qualities, that will be apparent, and the savvy customer or investor will notice.
On the other hand, a well-written benefit report that honestly describes the company’s efforts and is forward-looking will help insulate the company from challenges related to its social impact goals. A strong report is evidence that the board is fulfilling its duties and is taking its responsibilities seriously.
Benefit Enforcement Proceedings
A “benefit enforcement proceeding” is a specific proceeding, usually authorized in the state’s benefit corporation statute, that allows a claim to be made against the corporation or its directors for:
failing to pursue the general public benefit purpose of the benefit corporation or any specific public benefit purpose set forth in the corporation’s articles of incorporation;
violating a duty or standard of conduct imposed on a director or officer of a benefit corporation pursuant to the benefit corporation law; or
failing to distribute or post the annual benefit report as required by law.
Of the 37 states that have authorized benefit corporations, 22 of them include benefit enforcement proceedings in their statutes: AK, CA, CT, DC, FL, ID, IL, IN, MA, MT, NE, NH, NJ, NV, OK, PA, RI, SC, UT, VT, VA, WV. The states that don’t have such proceedings (DE, NY, CO, HI, KS, KY, LA, MD, MN, NM, OR, TX, WI) still allow suits against benefit corporations, typically by the same parties for the same reasons, but traditional corporate enforcement procedures are used.
However, standing to bring these actions is very limited. The rules vary from state to state, but as a general matter, a benefit enforcement proceeding can only be brought in the name of the corporation (as a derivative action), the board, or shareholders owning at least 2% of the corporation’s voting shares (or in some states $2 million of equity).
Another bar to these actions is the business judgment rule. The business judgment rule creates a legal presumption that – absent evidence to the contrary -- directors act in good faith when making business decisions, giving priority to the interests of the corporation above all other considerations as they are bound to do by law. This rule extends to the decisions made by benefit corporation directors when balancing the interests of the shareholders against the corporation’s pursuit of its social mission. In practice, the rule makes it very difficult to challenge the decisions of directors, including (or especially) decisions made by directors of benefit companies, because once a director invokes the business judgment rule, the burden shifts to the plaintiff to prove that the decision was made in bad faith or for an improper purpose, and that the director has violated one of the fiduciary duties of care, loyalty, or obedience.
The Bottom Line
It is perhaps ironic that the unique nature of benefit corporations makes it harder to hold them legally accountable. Because they have a dual, indeed a multifaceted purpose, neither a lack of profits (which would be an obvious problem in a traditional for-profit corporation) nor a failure to accomplish social objectives (which would be an obvious problem in a traditional non-profit corporation) is necessarily indicative of poor governance or management in a benefit corporation. Because it is the balancing of interests that is the board’s essential function in a benefit corporation (and where criticism may most fairly be leveled at benefit corporate boards,) more work is required to evaluate such boards’ performance. At the same time, it is precisely in the balancing of interests where benefit company directors are most protected because of the subjective nature of the judgments they must make. Unless they act in bad faith, or for an improper purpose, it is very difficult to challenge these decisions. To date, there is not a single reported case of a benefit company board being held accountable for misfeasance in this regard. In one notable Virginia case, the board of a benefit corporation was forced to resign for failing to fulfill its obligation to pursue mission. However, that case was resolved by settlement, and the board resignations were negotiated, not ordered by a court. We still don’t have the benefit of judicial guidance on how these issues will ultimately play out.
As a result of the difficulty in using legal process to hold benefit corporate directors accountable, the publicly available benefit report may turn out to be the more potent tool for holding benefit corporations and their boards accountable. Therefore, those who govern and manage benefit corporations should review their reports and make sure they meet the company’s needs – attention must be paid.
Copyright 2021 Allen R. Bromberger, Esq.