Dispute Resolution Planning for Social or Hybrid Entities

With the uncertainty surrounding new corporate entities such as the Benefit Corporation, Flexible Purpose Corporation, and Low Profit Limited Liability Company, it is important for these businesses to contractually control the dispute resolution process.

Legislation acknowledging  new forms of business entities called “Benefit Corporations” (enacted in six states California, Maryland, Virginia, Vermont, Hawaii and New Jersey), “Flexible Purpose Corporations” (authorized in California), and the “low profit limited liability company”, or L3C (authorized in Illinois, Louisiana, Maine, Michigan, North Carolina, Utah, Vermont, and Wyoming) has recently come into law.  With these statutes, certain states have allowed for businesses to expand the traditional definition of a corporation’s intent, to include the purpose of serving a general or specific public benefit.  Meant to bridge the “for profit” and “nonprofit” worlds, these hybrid entities remain in their infancy in terms of existence and application.  Frankly, there just isn’t that much, if any, caselaw or other guidance out there examining benefit corporations, flexible purpose corporations, or L3Cs.

So even though the legislation adopting these hybrid entities identifies how certain legal concepts should apply,  (namely an expansion of the concept of an officer or director’s fiduciary responsibility to include a beneficial social impact), the parameters of these concepts are unknown.  For any business or individual out there contemplating incorporating a hybrid entity, this unknown creates uncertainty and can be unsettling.

To deal with this issue of not knowing how exactly a court is going to view and interpret these hybrid entities, it is imperative that anyone forming a Benefit Corporation, Flexible Purpose Corporation, or L3C take control over what it can when it comes to contracting with third parties. One way to take control is to establish solid dispute resolution provisions in any contract a hybrid entity enters into.  Such provisions include (1) Choice of Law; (2) Jurisdiction; and (3) Methods of Dispute Resolution.  By having these contractual provisions in place, a hybrid entity can utilize the legislation authorizing their formation, ensure that the venue for any dispute is close to their business, and control costs and timing by providing for alternative methods of dispute resolution beyond civil litigation.

Choice of Law

First, a hybrid entity that is formed and operating in a state that has legislation authorizing that entity would be wise to include a “choice of law” provision in its contracts requiring that the laws of the state in which that company is domiciled shall govern any dispute between the parties.  For any company doing business in a state without any legislation authorizing hybrid entities, it could be wise to again insert “choice of law” provisions selecting a state that has such legislation (such as the state in which the hybrid entity was formed).

By insisting on “choice of law” provisions in a state that recognizes the hybrid business entity, a company can avail itself of the specific legislation authorizing its chosen form of existence, and reduce the risk of a court in a different state looking skeptically at the company (ie, refusing to consider an identified social benefit as a legitimate use of corporate resources), without the benefit of the legislation authorizing the existence of the hybrid entity.

(Courts in every state must recognize the laws of other states, of course, and cannot completely disregard a hybrid entity formed in a different state under valid authority, but nonetheless, hybrid entities should take steps to avail themselves to the laws of the state in which they were incorporated, just to be safe).

Jurisdiction

Of equal importance, any hybrid corporation or company should always include “jurisdiction” provisions in its contracts that provides for exclusive jurisdiction for dispute resolution in the city or county in which that business is located.  This will not only help control costs, but will also make sure that the court or alternative dispute resolution method chosen (such as mediation or arbitration) is relatively close to the business, increasing the chances that it will be familiar with the company and/or its socially beneficial purpose.   While there is no guarantee this will provide an advantage for a hybrid entity, it’s generally more beneficial and efficient for a company to resolve disputes close to where it is located, rather than waste valuable resources dealing with litigation in a jurisdiction farther from the business.  Accordingly, any hybrid entity that is contracting with third parties should always insist on a jurisdiction provision in any contract that is executed.

Alternative Dispute Resolution (Mediation and Arbitration)

Yet another consideration for hybrid entities is what form of dispute resolution to favor.  The classic form for resolving disputes is, of course, litigation.  Most civil litigation takes months, if not years, to resolve and is often extremely expensive.  Generally litigation is not an efficient way to resolve any dispute.  Alternative forms of dispute resolution can be bargained for in any contract by providing a provision where the parties agree to resolve any dispute through the use mediation or arbitration, in lieu of litigation.

Mediation is a non-binding form of resolution, and is largely a structured negotiation between the parties, overseen by a mediator who is familiar with the subject matter of the dispute and whose job is to attempt to facilitate a final resolution.  Mediation can be a gamble as it is generally nonbinding, so the parties are under no obligation to settle their differences.  It can be a good way, however, to get a dispute resolved and salvage a relationship between two parties, as the outcome of a successful mediation is a mutually agreed upon resolution.

Arbitration is best described as a private form of litigation.  Arbitration is generally binding and any award from an arbitrator can be entered into a court of jurisdiction as a final judgment.  An arbitrator has the power to set discovery schedules, hear motions, allow or disallow witness testimony, and ultimately preside over the arbitration between the parties, rendering a ruling at the conclusion.  A benefit of arbitration over litigation is that arbitration is generally conducted much faster than any civil litigation could be.

Because mediation and arbitration are private remedies, the parties are responsible for bearing the upfront costs of the proceedings.  Oftentimes a fee or costs provision in a contract can allow for the prevailing party to recover the costs they have incurred in dispute resolution, but at the outset, each party to a mediation or arbitration must be prepared to shoulder approximately one half of the upfront costs.

Ultimately, alternative dispute resolution methods could prove to be very effective for hybrid entities to quickly get in front of a mediator or arbitrator contracted to devote time and attention to their matter.  When dealing with civil litigation it must always be remembered that the court systems are under tremendous strain with their case load. The chance that a judge will have the time to sit down and truly learn about hybrid entity formation and existence is small.  Accordingly, to increase the possibility that the individual hearing a dispute involving a hybrid entity has had the time to internalize the legislation authorizing hybrid entities, as well as the its intent,  new hybrid entities should include mandatory mediation and/or arbitration provisions in their contracts.

The bottom line is that the Benefit Corporation, Flexible Purpose Corporation, and L3C are corporate structures that are in their infancy.  Until such time that the court systems have begun providing precedent to help govern the parameters of these entities, and the appropriate boundaries of their officers and directors, a level of uncertainty is going to be the reality of running these businesses.

In the meantime, those running hybrid entities should contractually take control where they can, starting with contractual provisions governing (1) Choice of Law; (2) Jurisdiction; and (3) Methods of Alternative Dispute Resolution mentioned above. While these by no means determine the outcome of any dispute between two parties, these provisions can help a hybrid entity avail itself to the laws of the state in which it is incorporated, keep jurisdiction for any dispute close to the business, and allow for faster and more efficient dispute resolution through the use of mediation and arbitration.

The article provided above is for general information purposes only and should not be relied on as specific legal advice. This article does not form an attorney-client relationship. If you have any questions about this article, or wish to discuss examples of quality dispute resolution language for contracts, please feel free to contact Eric J. Camm at Eric@apexlg.com

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