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California Hybrid Corporations 2017-10-02T19:37:25+00:00

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California Hybrid Corporations San Diego

California Hybrid Corporation San Diego Summary

Benefit Corporation (B-Corp) and Flexible Purpose Corporation

On January 1, 2012, the Corporate Flexibility Act of 2011 (California Corporations Code §§ 2500–3503 and California Corporations Code §§ 14600–14631), brought flexible purpose corporation and the benefit corporation, respectively, into existence in California as two new stock corporations.

These hybrid corporations combine the for-profit shareholder structure of a traditional corporation with the social-benefit purposes of a non-profit corporation, allowing entrepreneurs and investors to take advantage of the corporate structure as a means to promote both economic and socially beneficial ends.

Low-profit Limited Liability Company (L3C)

Another type of hybrid entity that has been gaining attention is the low-profit limited liability company, or L3C, that, at the time of this writing, is allowed in nine states (Illinois, Louisiana, Maine, Michigan, North Carolina, Rhode Island, Utah, Vermont, and Wyoming), but not California. The L3C form must be organized primarily for furthering a charitable purpose and may not significantly pursue financial return; in many ways it is similar to the hybrid corporations of California, which makes the L3C worth mentioning here. However, since the L3C is not currently available in California, it is only mentioned here for reference.

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California Hybrid Corporation San Diego Details

Hybrid Corporations Versus Conventional For-Profit Corporations

A conventional, for-profit California corporation may only include a general statement of its purpose in its articles of incorporation, and while such general statement may contain additional text to limit the purpose of the corporation, no further purpose or additional purpose is permitted. California Corporations Code § 202. Additionally, a director of a conventional, for-profit California corporation is required to perform his or her duties in the manner he or she believes to be in the best interests of the corporation and its shareholders, which is generally interpreted to mean the maximization of shareholder profits. California Corporations Code § 309(a).

California hybrid corporations were designed for entrepreneurs and investors seeking to accomplish a social objective as a corporate purpose in addition to creating shareholder profits. California hybrid corporations:

May (flexible purpose corporations must) state the social purpose of the corporation in the articles of incorporation and state that the purpose of the corporation is not exclusive to generation of financial return. California Corporations Code §§ 2602(b)(2), 14610.

May authorize directors to take noneconomic factors such as employees, the community, and the environment into consideration, in addition to the maximization of shareholder profits, when making business decisions and offer directors legal protection for those considerations that otherwise might violate the fiduciary duties of a director to the shareholders of a company. California Corporations Code §§ 2602(b)(2)(B), 14620(b).

Require a supermajority vote in order to change the corporation’s social mission, making it more difficult for investors to divert the corporation from its social mission. California Corporations Code §§ 3000(b), 14601(d), 14610(d).

Require annual reports on the social benefit of corporate activities to increase transparency for investors concerned about social goals. California Corporations Code §§3500, 14630.

Tax Treatment of California Hybrid Corporations

California hybrid corporations are treated the same as conventional, for-profit corporations for purposes of federal or California tax law. California hybrid corporations may be C corporations or elect to be treated as S-corporations, as permitted under federal tax law. California hybrid corporations are not eligible for federal or state income tax-exemption and cannot offer charitable tax deductions in exchange for contributions as may be done with a non-profit corporation.

However, states and municipalities may offer tax or other benefits to hybrid corporations in preference to other business entities. An example of this is the California Benefit Corporation Discount Ordinance that provides preferential treatment for benefit corporations that bid on city contracts. San Francisco Admin C chap 14C, §§ 14C.1–14C.3.

Comparing the Hybrid Corporations

While the underlying premise of both hybrid corporate forms is to promote social purposes in a corporate form and allow directors to consider more than just the maximization of profits when making business decisions without incurring liability to shareholders, California flexible purpose corporations and California benefit corporations each use a different approach toward accommodating social purposes.

Material Public Benefit Versus Special Purpose.

Benefit corporations are required to create “a material positive impact on society and the environment,” while a flexible purpose corporation must only consider the special purpose in its articles of incorporation rather than generate a general public benefit. California Corporations Code § 14601(c).

Benefit corporations do not permit incremental changes in social objectives; either a company meets the general public benefit test or it does not. The general public benefit is measured against a third party standard, but there is no government role in determining the acceptability of a third party standard, the qualification of the third party setting a standard, or which particular set of third party standards is adopted by a particular benefit corporation. Also, there is no audit or certification required to be conducted by any third party standards organization.

California flexible purpose corporations are permitted to adopt a special purpose and to focus only on meeting such special purpose, as opposed to providing a general public benefit; this permits even small corporations to meet flexible purpose requirements.

Standard for Assessment

The general public benefit derived from operation of a California benefit corporation must be measured on an annual basis by a third party standard. California law does not establish such third party standards, so it is up to the directors of each California benefit corporation to find a third party to set the general public benefit standard. California flexible purpose corporations require no third party standards and rely solely on reporting to investors regarding how well the California flexible purpose corporation is meeting the special purpose stated in its articles of incorporation.

Director Fiduciary Duties

The directors of a California benefit corporation must consider the impacts of any action or proposed action on its employees, the environment, and the community, as well as other constituents, when deciding which suppliers to use, which contracts to accept, and what services to provide. California Corporations Code § 14620(b). There is not yet any guidance from the law regarding how factors should be weighed, what priority should be given to factors, or how the factors should be documented in the board of directors meeting minutes. California flexible purpose corporations do not require directors to take these factors into account, although directors are permitted to do so. Directors of a California flexible purpose corporation must consider how actions or proposed actions will impact the special purpose or purposes listed in its articles of incorporation, but may also consider other factors. California Corporations Code § 2700(c).

Reporting

California benefit corporations must report on the overall public benefit of the corporation, not just on one or more special purpose of the California benefit corporation. California flexible purpose corporations are allowed to only report with regard to the special purpose or purposes listed in articles of incorporation and are not required to provide report overall impacts of the business.

Enforcement

California law includes a right of action for enforcement of the benefit to be provided by a California benefit corporation. California law provides shareholders of California benefit corporations the right to hold directors accountable for failure to create a material positive impact on society or to consider the impact of decisions on employees, the community, and the environment, and the board of directors of a California benefit corporation must certify compliance with the public benefit criteria. California Corporations Code § 14601(g).

California law relies on accountability to investors for enforcement of the special purpose or purposes of California flexible purpose corporations. California flexible purpose corporations do not provide any means for enforcing a special purpose that might create liability for directors because the goal of the flexible purpose corporation is to permit innovation and an unfettered application of directors’ business judgment in balancing a special purpose and maximizing shareholder value.

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