Legislative Initiatives Encourage Corporate Social Responsibility

By Jeffrey C. Wolfstone and Kimberly Pray

In 2009, University of Oregon School of Law Assistant Professor Judd Sneirson predicted that the transition to the green economy will trigger a new race among states to attract corporate charters—not to the bottom or to the top but rather to the left.[1] Now in 2010, legislative initiatives to encourage corporate social responsibility are underway in several states.  This article will review three quite different approaches embodied in those initiatives.[2]

The Benefit Corporation

In April 2010, Maryland passed the first “benefit corporation” legislation in the nation[3] followed in May by similar legislation enacted in Vermont and introduced in the New York legislature.[4]  In New York, the proponents state that socially minded companies are increasingly choosing to organize in states with this new corporate form and reason that the bill would give New York a competitive advantage by accelerating development of a new sector of the economy.[5]

Although benefit corporation legislation is not uniform among the states, there are common elements:

  • Benefit corporation legislation is set out in a separate statute or chapter, rather than being embedded in the state’s existing business corporation act.  In each case, corporations can opt in to the new legislative construct, meaning that the new legislation does not automatically affect existing and future corporations governed by the state’s business corporation act.
  • The corporate charter must include a statement that the corporation will pursue a “general public benefit.”  For example, Vermont and Maryland law define this as “a material positive impact on society and the environment, as measured by a third-party standard, through activities that promote some combination of specific public benefits.[6]
  • The corporation may identify one or more specific public benefits in addition to the general public benefit.[7]
  • The process followed in pursuing public benefits must meet a “third-party standard.”  Although not specified by name, B-Lab, a nonprofit corporation promoting benefit corporation legislation, has developed criteria that would meet the third-party standard.  B-Lab has organizational and financial interests in the passage of benefit corporation legislation.[8]

In addition to the common elements noted above, the Vermont law contains a unique enforcement mechanism, called a “Benefit Enforcement Proceeding.”[9]  This new state court proceeding affords the right to bring a claim or action against a director or officer for failure to pursue any general or specific public benefit purpose set forth in the benefit corporation’s articles of incorporation or for violation of a duty or standard of conduct under the applicable statutory chapter.  A benefit enforcement proceeding may be commenced or maintained only by:  (1) a shareholder that would otherwise be entitled to commence or maintain a proceeding in the right of the benefit corporation on any basis; (2) a director of the corporation; (3) a person or group of persons that owns beneficially or of record 10 percent or more of the equity interests in an entity of which the benefit corporation is a subsidiary; or (4) other persons as specified in the articles of incorporation of the benefit corporation.[10]

The benefit corporation legislation raises interesting questions, including the appropriate criteria for satisfying the third-party standard, how courts will assess whether “a material positive impact” has occurred, and to what extent deference will be given to directors’ considerations of an array of nonfinancial interests.

The California Flexible Purpose Corporation

In California, a group of corporate lawyers spent a year drafting a very detailed proposed statute known as the Corporate Flexibility Act of 2010, which creates the Flexible Purpose Corporation (FPC). As in the case of the benefit corporation legislation outlined above, this new law would be a stand-alone chapter under Title 1 of the California Corporations Code.[11]  But the proposed statute differs significantly from benefit corporation legislation.  For example, the bill outlines a broad definition of “special purpose,” which includes both charitable and public-purpose activities permitted by the IRS for nonprofit corporations seeking tax-exempt status as well as short- and long-term benefits of the FPC’s activities for (1) employees, suppliers, customers, and creditors, (2) the community and society, and (3) the environment.

The proposed California legislation requires the board of directors of the FPC to publish an annual report on its impact in accomplishing its special purposes and an assessment of anticipated future expenditures, but does not impose third-party criteria.  The bill also requires the FPC to send a “Special Purpose Current Report” to board members within 45 days of “any expenditures, excluding compensation for officers and directors made in furtherance of special purpose objectives, whether operating, capital, or other expenditure of corporate resources where the expenditure has or is likely to have a material adverse impact on the flexible purpose corporation’s results of operations or financial condition for a quarterly or annual fiscal period.”[12]  This requirement could be onerous in practice.

Amendments to Existing Constituency Statutes

In Oregon, two recent legislative proposals by corporate lawyers addressed corporate governance within the Oregon Business Corporation Act.  In 2007, the Oregon legislature passed HB 2826, which amended Or. Rev. Stat. § 60.047, the section of the Oregon Business Corporation Act that addresses the required and permissive content of articles of incorporation.  The revised law explicitly permits a “provision authorizing or directing the corporation to conduct the business of the corporation in a manner that is environmentally and socially responsible.”[13] 

Because this statute is permissive, and requires a special provision in the articles of incorporation, the drafters viewed the legislation as a modest but important initial step.  And it was viewed in academic literature as a “useful stepping stone, serving to highlight the possibility that corporate charters can serve as a means to begin encouraging sustainable corporate behavior . . . .”[14]

Building on HB 2826, members of the corporate bar assisted in introducing HB 2829 in 2009, to amend the so-called “other constituency” provision of the Oregon Business Corporation Act.[15]  A total of 32 states have enacted other-constituency provisions to provide broad discretion to the board of directors in considering a range of factors (in addition to the interests of the shareholders) in its decision-making function, including “provisions [that] expressly permit decisions that elevate other non-shareholder considerations—such as labor and local communities—over shareholder wealth.”[16]  Oregon is one of ten states in which the other-constituency provision applies only in the context of a hostile takeover of a business corporation, a limitation that HB 2829 would have eliminated.[17] 

Proponents of HB 2829 sought to accomplish two objectives.  First, the legislation would have broadened the applicability of the other-constituency provision to cover all board decision-making, both in the hostile-takeover arena and generally in all other matters.  Second, the new provision would have added unique language making explicit what is commonly understood as implicit in the existing authority of directors.  Under the bill, directors would be expressly authorized to consider “the economic, environmental, social, or ethical considerations that are reasonably regarded as appropriate to the responsible conduct of the corporation’s business” in their decision-making.[18]

HB 2829 would have applied to all Oregon corporations, including those in existence at the time of adoption as well as new corporations formed in the future.  The proposal stalled in committee in 2009, and is expected to be reintroduced in the 2011 session of the Oregon legislature.

Conclusion

As Justice Brandeis wrote:  “It is one of the happy incidents of the federal system that a single courageous state may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country.”[19]  Here, several states have begun to address a common question—namely, the role of the corporation in modern society—by taking significantly different approaches.

At the heart of these different approaches is the question whether it is best to create a new type of corporate entity or to modify the existing business corporation act (on either an opt-in or a generally operative basis).  There is a wide spectrum of competing views, running the gamut from proponents of broadly defined social responsibility as an overlay for all chartered entities to proponents of strict adherence to economic market-based shareholder primacy.[20]  There are also interesting questions relating to the ability of special constituents, shareholders, or others to enforce accountability to general or specific charter provisions related to social responsibility.  And there are yet further questions about the long-range prospects of different types of corporations (e.g., benefit corporations, FPCs, and business corporations) as well as their ability to coexist as useful business models.

We will continue to witness the unfolding of this “happy incident” of democracy relating to the role of the corporation in addressing matters of social responsibility.  As Oregonians, we will also have the opportunity to assist in defining our own unique approach.            

Mr. Wolfstone is a shareholder in the Portland office of Lane Powell PC, and Ms. Pray is the Assistant Director of the Green Business Initiative at the University of Oregon School of Law in Portland and General Counsel & Consultant at Blue Tree Strategies, Inc.
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[1] Judd Sneirson, Race to the Left: A Legislator’s Guide to Greening a Corporate Code, 88 Or. L. Rev. 491, 492 (2009).
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[2] Another alternative approach not addressed in this article is the Low-Profit Limited Liability Company (L3C), a statutory type of limited liability company proposed in about 14 states and so far adopted in about 5 states.  The L3C is primarily designed for a for-profit entrepreneur with primarily a charitable purpose wishing to attract program-related investments from charitable foundations (as opposed to a for-profit entrepreneur seeking access to traditional capital markets).
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[3] Md. Code Ann., Corps. & Ass’ns, §§ 5-6C-01 to -08 (2010).
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[4] Vt. Stat. Ann. tit. 11, § 21 (2010); S. 7855, 2009 Leg., 233rd Sess. (N.Y. 2010).
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[5] S.B. 7855, 2009 Leg., 233rd Sess., Summary (N.Y. 2010).
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[6] Md. Code Ann., Corps. & Ass’ns, § 5-6C-01(C) (2010); Vt. Stat. Ann. tit. 11, § 21.03(a)(4) (2010).
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[7] Md. Code Ann., Corps. & Ass’ns, § 5-6C-01(D) (2010); Vt. Stat. Ann. tit. 11, § 21.03(a)(6) (2010).
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[8] http://www.bcorporation.net.
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[9] Vt. Stat. Ann. tit. 11, § 21.13 (2010).
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[10] Vt. Stat. Ann. tit. 11, § 21.13(b) (2010).
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[11] S.B. 1463, 2009-10 Leg. (Cal. 2010).
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[12] Id. § 3501.
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[13] Or. Rev. Stat. § 60.047(2) (e) (2007).
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[14] Susan L. Smith, Chartering Sustainable Transnational Corporations, (Jan. 29, 2009), available at Social Science Research Network, http://ssrn.com/abstract=1335035.
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[15] H.B. 2829, 75th Leg. Assem., Reg. Sess. (Or. 2009).
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[16] Id.
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[17] Judd Sneirson, Green Is Good:  Sustainability, Profitability, and a New Paradigm for Corporate Governance, 94 Iowa L. Rev. 987, 998 (2009).
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[18] Or. H.B. 2829.
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[19] New State Ice Co. v. Liebmann, 285 U.S. 262, 311 (1932) (Brandeis, J., dissenting).
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[20] See, e.g., Aneel Karnani, The Case Against Corporate Social Responsibility, Wall St. J., Aug. 23, 2010 (“Can companies do well by doing good? Yes—sometimes.  But the idea that companies have a responsibility to act in the public interest and will profit from doing so is fundamentally flawed.”).
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