Benefit Enforcement Proceedings for the Benefit Corporation– What are they and How will they work?

As more and more states enact legislation authorizing Benefit Corporations, more questions will be asked about the form and function of these hybrid entities.  Nowhere are these questions more evident than when examining the dispute resolution process set forth in the various state statutes.

A quick primer.  Benefit Corporations are designed to allow a corporation to create a general or specific public benefit.  In so doing, the Board of Directors for a Benefit Corporation takes alternative factors, such as ‘community and societal consideration,’ and the ‘interests of the customers of the benefit corporation,’[1] into consideration when making decisions for running the company.  This expansion of the Board’s responsibilities serves to break the mold from the “fiduciary duty” model that governs traditional for profit entities.

So the intent seems clear.  The question, however, may be this – what happens when a Benefit Corporation fails in its mission to create a general or specific benefit?  The legislation sets forth that in the event that this happens, the appropriate recourse is what’s called  “Benefit Enforcement Proceeding,” (“BEP” for short).

Where Can You Bring a BEP?

Most likely, a BEP will be brought in the state courts where the Benefit Corporation in question is domiciled and or doing business.  Different states will have different identifiers for their court systems, but in most instances BEPs will likely be properly brought in a District Court, Superior Court, or if the state in question has a Business Court system (similar to Delaware’s court of Chancery), in that forum.

Who has Standing to Bring a BEP?

A BEP can only be brought by a discrete group of individuals – the shareholders/ stakeholders, directors, or anyone else identified in the bylaws of the Benefit Corporation as having standing to pursue a BEP.  This is important as it substantially limits the scope of potential BEP actions that a Benefit Corporation may face.  Further, it eliminates the possibility that businesses will shy away from becoming a Benefit Corporation for fear of opening themselves up to a myriad of BEPs from unknown third parties.  For example, if your business is focused on addressing problems related to homelessness, you could be deterred from becoming a Benefit Corporation if any third party advocated for the homeless would have standing to bring a BEP against your company when  they didn’t agree with how you were implementing your social mission.

By limiting those parties who have standing to bring a BEP to the Directors,  shareholders, and third parties identified in the company’s bylaws, BEPs will function largely as an internal means for dispute resolution within Benefit Corporations and, in theory, should not be a deterrent for any company seeking to incorporate as a benefit corporation.

What Can be Resolved Through a BEP?

So – assuming that a Benefit Corporation faces a BEP from a party with standing to bring such an action, in a court that properly has jurisdiction to decide the dispute, the next question becomes – what is the remedy that can be sought through a BEP?  In other words, if a director or shareholder of a benefit corporation files a BEP action, what relief are they entitled to ask for from the court?

The answer to this question is, unfortunately, largely unknown.   The various statutes offer precious little in terms of detail when it comes to BEPs.  It appears that the questions as to form and function of BEPs will largely be answered through the court systems.

One more reassuring point, made clear through Benefit Corporation legislation, is that a BEP cannot be used as a vehicle to seek money damages from a Benefit Corporation.  While a prevailing party in a BEP is entitled to costs under certain circumstances, there are no other financial damages authorized under BEPs.   What this means in practice, is that BEPs should be used largely as a means to compel some sort of action from a Benefit Corporation.   In other words, a party bringing a BEP against a Benefit Corporation will likely be seeking to compel the Benefit Corporation to take (or refrain from taking) some form of action.

In furtherance of trying to determine what kind of action may be brought through a BEP, Apex Law reached out to B Labs, the non-profit responsible for the creation of the Benefit Corporation, and who is responsible for most of the Benefit Corporation legislation, for a discussion on this issue.  Through this conversation, 3 potential BEP actions were identified[2].

  1. Transparency – the Annual Benefit Report

A party with standing could file a BEP seeking a judgment directing the creation and publication of the annual benefit report.  Benefit Corporations are required by statute to create an annual benefit report, and to include in that report information regarding the general or specific benefit that the Corporation is seeking to create.

Theoretically, a director or shareholder in a Benefit Corporation who is unconvinced that the company is taking its obligations to create a thorough and transparent annual report seriously, could institute a BEP to force the company to increase clarity and timeliness in the creation of this report.   For instance, a BEP plaintiff could challenge the third party standard upon which the company is measuring its social impact, or seek an order requiring the company to post its annual report to its website (as is required by statute – see section 14630 of the California Benefit Corporation Statute for the information required in a California Annual Benefit Report).

If there is one major question about seeking greater clarification and transparency through a BEP, it is this – would it be worth the time and cost?  In certain instances maybe, but it is hard to imagine there being too many directors and/or stakeholders in a benefit corporation that are willing to expend the energy to tweak the annual report process.  Only in instances of blatant disregard for the annual report requirement would this cause of action be practical.

     2.        Shareholder Consideration

One of the unique aspects of Benefit Corporations is the requirement that the Board of Directors take the shareholders’ interests into account when making decisions.  Thus if a Benefit Corporation has shareholders who are socially motivated, and have invested in that Benefit Corporation in part because of the company’s general or specific benefit, then the BOD for that company must take that into consideration when running the company.

If, for any reason, a shareholder of a Benefit Corporation believes that the BOD is not considering his/her interests when making decisions, then that individual could potentially bring a BEP to force the BOD to identify and substantiate its decision making process.

If this sounds like a fairly ambiguous and somewhat confusing cause of action – it is.  There are several issues that immediately come to light regarding how a cause of action for “failure to consider the stakeholders/shareholders,” would work.  To begin with, how would such a cause of action be proven?  What standard would the BOD be held to when defending against such a cause of action?  How could they rebut such a charge?

Second, let’s remember that when it comes to BEPs, monetary damages are not permitted , so any BEP that is brought for failure to consider shareholder action would have to bring with it a specifically crafted remedy that could be enforced against the Corporation to right the perceived wrong.  It is one thing to show that the BOD has not properly considered the stakeholders of a Benefit Corporation when taking action, but the question immediately becomes after making such a showing – what’s next?   Is the BOD divested of power?  Are the Directors compelled to evidence how they consider their shareholders when taking action (above and beyond what appears in the corporate minutes)?  What if they consider the shareholders but take the same actions as before?  These questions, and more, will likely be answered as courts start dealing with BEPs.

        3.    Failure to Create General or Specific Public Benefit

The final potential cause of action from a BEP (although to be candid there is not an exhaustive list of potential BEP claims), would be a BEP accusing a Benefit Corporation of failing in its mission to create a general or specific public benefit.    Much the same with the identified cause of action for “failing to consider stakeholder interests,” how this BEP would be evaluated and handled by a court is entirely speculation, as is the potential remedy for such a cause of action.

Conceivably, any party bringing a BEP accusing the corporation of failing to create a general or specific public benefit would be seeking either (1) to have the Corporation re-structured as a classic ‘for profit’ corporation (ie no longer being a Benefit Corporation); or (2) to have those in charge of running the Benefit Corporation replaced with those better able to achieve the social mission of the company.

Under the first scenario, a stakeholder and/or board member could seek a court order affirmatively reclassifying the company from a “Benefit Corporation,” to a classic “for profit” corporation.  What this would mean is that the BOD would no longer enjoy the protection of the Benefit Corporation legislation, and would likely revert back to the classic “fiduciary duty,” model of corporate governance (duty of loyalty, duty of care, focus on the bottom line).  The BOD’s responsibilities would, therefore, cease to include creating a general or specific public benefit (as the BEP would likely argue they were failing to do anyhow), and refocus the purpose of the Corporation on financial performance metrics.

While this sounds draconian, this cause of action could potentially arise in instances where investors have provided funds with an agreement for reduced financial returns because of the general or specific public benefit being created by the corporation.  In the absence of such public benefit, those investors may very well want to change the game and realign their investment to increase their returns.  If a Benefit Corporation is failing at its mission – the social investment dollars could find themselves in a position of wanting to recoup as much as possible, in order to redeploy those funds to other more successful social ventures.

Under the second potential remedy, stakeholders in a Benefit Corporation that has failed to create its general or specific public benefit, could potentially seek to replace members of the BOD with individuals better suited to accomplish the social mission (assuming such individuals are available).  This BEP would likely be governed to some extent by the bylaws of a Benefit Corporation and the internal procedures set up for the replacement of Board Members. However, a BEP Plaintiff could also ask a court for affirmative relief and, upon a showing that the Benefit Corporation had not accomplished its goals, seek a court order replacing those responsible.  Whether or not a judge would be willing to take such a step is questionable, but in all truthfulness, it is difficult to speculate what kind of remedy for this cause of action would adequately address the damages raised in the BEP.

Ultimately the process and procedure for these BEPs is yet to be determined.    For the time being there are many more questions than answers.  The legislation is sparse on the mechanics of a BEP, and unless and until a few BEPs are brought in states where Benefit Corporations are authorized, much of what is written or discussed about BEPs will be largely speculation.  It is interesting, however, to postulate on what a BEP may look like, and to examine possible outcomes for BEPs.  Such discussion can assist with educating clients on the issues that they may face as a Benefit Corporation.

Also – despite the risk of the unknown, there are rewards for those willing to become one of the first Benefit Corporations, and prove themselves as leaders in the space.  In examining these issues I do not want to suggest that becoming a Benefit Corporation (or other form of hybrid entity) is not a worthy endeavor.  Given the relative youth of the legislation, however, it is a good idea to have an open and direct conversation about those issues that may arise as Benefit Corporations become more prevalent.

The next post on the blog will look at ways that a company could insulate itself from some of the unknown involved with these BEPs.

If you have any questions about this article, or wish to discuss the matter further, feel free to contact Eric Camm at Eric@apexlg.com.

 


[1] §14620 of California Benefit Corporation Legislation.

[2] Note:  The opinions and views expressed in this article are only those of Apex Law.  B Labs has not endorsed this article nor have they adopted the views of this article as their own in any way shape or form.  I only note the conversation with B-Labs in attempt to acknowledge their participation in the discussion and to properly credit them for their efforts in helping myself and the other members of Apex Law develop our knowledge base of Benefit Corporations.

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