California Benefit and Flexible Purpose Corporations: Small- and Mid-Size Corporations vs. Large Corporations

California recently enacted two new forms of business entities: benefit corporations and flexible purpose corporations. While arguments are made that the two forms are redundant and unnecessary, one relevant difference between the two forms may be their target companies.

As mentioned in an article by Aman Singh on Forbes Corporate Social Responsibility Blog, benefit corporations have largely been limited to small- and mid-size corporations. One explanation for this may be the mandate for benefit corporations to consider certain other constituencies and use a third-party standard to assess the benefits to these other stakeholders. Such a mandate may scare off large corporations, either for implementation purposes or because large corporations cannot get all its shareholders on board.

Flexible purpose corporations, however, offer a slightly more tenable solution to large corporations. Flexible purpose corporations allow a corporation to specify one or more charitable or public purposes. Directors are then enabled to consider and weigh the short- and long-term prospects of such purposes in performing their duties. As the name entails, flexible purpose corporations provide flexibility in pursuing specific charitable or public purposes, allowing corporations to put one toe in the untested waters of for-profit social enterprises rather than diving head first in considering the numerous stakeholders required under benefit corporations.

While both benefit and flexible purpose corporations require a two-thirds vote of each class of shares in order to amend their articles to adopt a certain purpose, large corporations may find it easier to obtain the necessary shareholder approval for a single purpose rather than the mutli-stakeholder approach of benefit corporations. Moreover, flexible purpose corporations can pursue those charitable or public purposes that shareholders themselves are demanding without bringing in other considerations into the mix.

Expanded and Rigidified Duty of Reasonable Care for Directors of California Benefit Corporations

As codified in section 309 of California’s General Corporation Law, which applies to benefit corporations, directors of California corporations are protected by a business judgment rule. This broad protection of directors in performing their duties, however, is subject to certain limitations, including the duty of reasonable inquiry. The duty of reasonable inquiry requires directors to “not close their eyes to what is going on about them in corporate business, and must in appropriate circumstances make such reasonable inquiry as an ordinarily prudent person under similar circumstances.” Gaillard v. Natomas Co., 208 Cal. App. 3d 1250, 1265 (Cal. Ct. App. 1989). As the court in Gaillard noted, “[t] he term ‘under similar circumstances’ requires a court to consider the nature and extent of a director's alleged oversight or mistake in judgment in the context of such factors as the size, complexity and location of activities involved, and to limit the critical assessment of a director's performance to the time of the action or nonaction and thereby avoid harsher judgments which can be made with benefit of hindsight.” Id.

Despite the facts and circumstances application of section 309, the duty of reasonable inquiry appears to have been expanded and rigidified for directors of benefit corporations. In order to pursue a general public benefit, directors of benefit corporations are required to “consider the impacts of any action or proposed action upon all of the following:

1. The shareholders of the benefit corporation.
2. The employees and workforce of the benefit corporation and its subsidiaries and suppliers.
3. The interests of customers of the benefit corporation as beneficiaries of the general or specific public benefit purposes of the benefit corporation.
4. Community and societal considerations, including those of any community in which offices or facilities of the benefit corporation or its subsidiaries or suppliers are located.
5. The local and global environment.
6. 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 retaining control of the benefit corporation rather than selling or transferring control to another entity.
7. The ability of the benefit corporation to accomplish its general, and any specific, public benefit purpose.” Cal. Corp. Code § 14620 (emphasis added).

Although subsection (d) explains that directors do not need to give priority to any particular stakeholder, section 14620 presumably requires a reasonable inquiry into the impact to each stakeholder for each and every decision made by directors. By not considering all listed stakeholders, directors may face potential liability. And while the statute is not clear as to what consideration directors should give to each stakeholder, the bar would probably be set rather low, especially given that directors cannot be held liable for the failure to create a general public benefit. Directors seeking to avoid potential liability, however, will want to, at the very least, document their consideration of each of these stakeholders, whether through their own investigation or by relying on certain other persons allowed by subsection (e) of section 14620. 

Ultimately, section 14620 makes directors accountable for at least considering the broader impact of their decisions on stakeholders, which is what was intended by the statute. Directors, however, should be aware of the practical consequences of section 14620’s language, and should take the necessary steps to satisfy their new duties in order to avoid messy litigation over whether consideration was given to the listed stakeholders.