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A New Kind of Corporation

November 13, 2011

by Racquel Palmese

You worked pro bono to help write AB 361, the Benefit Corporation bill, to create this new entity. What is the background of your work on this?

I’m a lawyer, and before that I was an environmental activist. As a lawyer in private practice, I would try to focus on direct environmental action and direct environmental law, getting involved in protecting natural resources. I came to realize about 12 years ago that all the work I and many others were doing, despite it being necessary and good, was not having a real impact. It was not going to turn the tide, because we were basically fighting against business. You don’t win when you fight business.

I had an epiphany in 1999, when I realized that business is not setting out to damage the environment. They’re just trying to make a buck, and if you can devise a system whereby they can make a buck doing the right thing, then business will do that. I pretty much shifted my career over towards trying to help develop the framework that would facilitate green business being possible. I focused my energy initially on green building, because construction is the most resource-consumptive industry on the planet, and of all human endeavors it’s number one in environmental harm. I put a lot of energy into kick starting the green building movement for a large number of years, along with solar and natural products.

What happened to make your work shift?

Over the years, especially in California, we’ve seen the notion of providing environmentally preferable business services take root. Customers and investors, all other things being equal, would rather do business with companies that are actually doing good things rather than those that are doing harm.

That’s where you see the real proliferation of green businesses and green business certification programs, where companies are now seeking to burnish their environmental credentials. They believe, and evidence supports, that it makes them more profitable and more attractive to the marketplace, to consumers and investors.

Notwithstanding all these efforts over the years by many folks and by industry to really get involved in sustainability, our corporate law has not kept up. Corporate law creates a dynamic where the only purpose of a corporation is to make a profit. Period. There’s nothing in any of the statues on the books that allows a corporation to consider its impact on the community, larger society, the environment or even its employees.

That is a problem, because any time a company steps out and puts things like environmental considerations ahead of profit – such as a bottled water company choosing to replace regular plastic water bottles with biodegradable plastics that cost more, creating a short-term hit on profits – the shareholders can hold the company accountable. That’s what California corporate law requires you to do.

Here we have corporate law that basically requires companies to put profits ahead of everything else, working against companies that are actually trying to be responsible citizens and operate their businesses in such a way as if the rest of the world really does matter.

The Benefit Corporation Bill changes that and allows the business to prioritize environmental or social criteria on an equal footing with, or even ahead of, profits if they so choose. It gives them the freedom and the flexibility to do that, whereas the traditional corporation does not have that flexibility.

Many companies advertise themselves as environmentally friendly. Does this designation help separate fact from PR spin?

The notion of being green and socially responsible is catching on. Suddenly every company, if you listen to their marketing and PR, sounds like God’s gift to the planet. We know that’s not always true, so there’s a lot of greenwashing out there.

To the extent that consumers prefer companies that have environmental values at heart, that preference gets eroded by companies that claim to be green but really are nothing more than business as usual. We needed a way to set the true sustainability leaders apart from the pack.

It’s tough for consumers. Let’s say a consumer cares and is really keeping an eye out for greenwashing – how do you really know?  How do you get access to enough data to really discern whether or not a business that’s claiming to be green and truly is? Who’s got time to do that?

We’ve all got lives, and you can’t get access to that information anyway. Those problems are also what we sought to solve with the Benefit Corporation Bill.

How does the Benefit Corporation control greenwashing?

Here’s how we did it. We changed the fiduciary duties of the corporation so that a company now has the flexibility to prioritize environmental and social criteria as they so choose. The Benefit Corporation Bill does not change corporate law for anybody except for those that choose to organize as a benefit corporation. Everybody else that wants a traditional corporation, more power to you, we don’t touch you whatsoever. But for those who want to opt into this higher threshold of governance and environmental and social responsibility, they can choose to become a benefit corporation. By doing so, they can help stand apart from the pack to consumers and investors, both of whom have said throughout the process of legislative hearings that they’re clamoring for this – investors included.

Investors want to invest in companies that meet their investment profile of being socially and environmentally responsible, because they’ve seen the data from Wall Street that shows that positive environmental and social players are more profitable than the status quo. There are lots of investors out there that want to invest in these companies, but like consumers, they have a very difficult time identifying marketing fiction from true environmental and socially responsible commitments.

The option of organizing as a benefit corporation provides an opportunity for true leaders to stand out from the pack and be recognized.

How does it accomplish this?

The Benefit Corporation Bill has three functions. The first one we already discussed, which is purpose. These companies now have a purpose of promoting general public benefit, and it changes fiduciary duties so that they are free to do so.

The second aspect is transparency. As I mentioned, it’s tough for consumers and tough for investors to differentiate fact from marketing fiction, so a benefit corporation each year has to produce what’s called an Annual Benefit Report. That document gets posted on the company’s website and distributed to its shareholders. It includes information from the board of directors that says what they did to promote general benefit, what stood in their way and where they are headed with it.

How is the report validated?

There’s a requirement that each year a benefit corporation assess its performance on environmental and social issues against a third-party standard. The legislation doesn’t identify one particular standard or another, because there’s a great proliferation of standards each year. Hopefully, this bill will help this trend to continue, but it does define what a qualifying standard must do.

It’s common sense stuff. The standard has to be comprehensive. It has to look at everything. It has to evaluate environmental and social issues at all levels, and it has to be independent and it has to be legitimate. The company assesses its performance using that third-party standard and then it includes the results of that assessment in its Annual Benefit Report.

What’s an example of a third party standard?

A comprehensive third-party standard looks at all aspects of a company’s operations. An example would be the B Corp Certification program. There’s also a business certification program that’s been developed by Underwriter’s Laboratory called UL Environment. When we did the analysis, we saw that there were over six programs that met the criteria. We weren’t trying to lock in one particular standard or another, because there are all kinds of businesses and it’s tough to take a standard that works for a law firm like mine that also works for a trucking company.

Our hope is that the Benefits Corporation Bill and the growth of benefit corporations will spur the market to create more and more relevant third party standards that can be used by these companies to produce ever relevant results. That’s the transparency element.

If you’re a customer or an investor, you may be really focused on social equity issues and you’ll want to make sure that in an age of the 99% that a company isn’t paying its CEO more than 100 times its lowest paid employee. I may be more focused on environmental issues, so I can then look at the company’s annual benefit report and see how they did on these issues and make decisions accordingly.

Knowledge is power, and the purpose of this is to provide greater knowledge and transparency to the marketplace and investors so that people can get more of what they want and so that companies can be recognized for what it is they are doing.

You mentioned that there are three aspects to benefit corporations. What is the third leg of the stool?

The third leg is accountability. Right now in a traditional corporation, if the company decides to be a rapacious pig and just pollute the planet, they’ve got liability if they break the law, but their shareholders don’t have the ability to hold the company responsible to be a good citizen. A benefit corporation, by voluntarily taking on these responsibilities, subjects itself to accountability to its shareholders who are given an express right to hold the company accountable if it fails to do the things it has promised to do.

If the company fails to be transparent and provide the annual report, if it fails to assess its performance against a third party standard, a shareholder of that company can take the company to court and get a court order requiring that it does so. Likewise, the company can also adopt a specific public benefit purpose in addition to promoting general public benefit.

What is a public benefit purpose?

Here’s an example: One of my clients is very committed to a theme of “one percent for the planet,” whereby they give one percent of their sales to environmental nonprofits. The Benefit Corporation Bill provides a vehicle for them to do that by adding that specific public benefit purpose to their governing corporate documents. If the company fails to do that, a shareholder could hold it accountable. The three legs on the stool are purpose, transparency and accountability.

Is California the first state to pass a benefit corporation bill?

Prior to California signing on, the bill had been adopted in five other states, on the east coast mainly. It started there because its original champion, the nonprofit called B Lab, created the B Corp certification. It was the first national green and corporate social responsibility certification program for business. There has also been a local program in the Bay Area, but B Lab was the first to create a national standard that companies could use to get certified and validated for their environmental and corporate social responsibility efforts.

For example, our firm is a certified B Corp. There are hundreds of certified B Corps in California, and those are the companies that are real market leaders. B Lab got an initial benefit corporation bill passed in several New England states, and we’ve obviously known them for quite a while. They wanted to try and get something passed in California.

Myself and two other attorneys took what they had done in other states, tweaked it for California, improved it, wrote the bill for California and championed it through the legislative process. Jonathan Storper at HansonBridgett in San Francisco and John Montgomery in Palo Alto at Montgomery & Hansen. We were the Three Musketeers who did the pro bono work to write this and get it across the finish line. The author of the bill in the legislature was Jared Huffman (D) from San Rafael. He was a rock star.

What are a few examples of companies that have become Benefit Corporations?

The law was signed last year and just came into effect. To convert from another type of corporation, or to become a benefit corporation, you have to file paperwork with the California Secretary of State. The first day they were open for business in 2012 was January 3, and we had a whole entourage of companies we got set up to do that. On that first day at 9:30 in the morning, 18 companies filed their paperwork to become the first benefit corporations in California.

At the head of the pack was Patagonia, a well known outdoor clothing and gear manufacturer based in Southern California. They’re one of the first green businesses on the planet, and their founders were the first in line. Some of the other companies were Sun Light & Power, one of the oldest solar energy contractors in California, in business since 1976. Environmental and social responsibility have been key aspects of their operation since day one. Some of the other companies included Give Something Back, an Oakland-based office supply company. They were founded 15 or 20 years ago with an interesting business model. They donate the lion’s share of their profits to charities. Their customers have a say in choosing who gets their money.

We also had a number of startups – Big Shift Communications is a marketing and PR firm based out of San Francisco. Terrassureis a sustainable development company based out of Mill Valley and they are focused around green building and urban planning. A new startup clothing company called DopeHut  is an online clothing store. Another one who was noteworthy was Scientific Certification Systems. Not a startup, they’ve been in the East Bay for years. They are one of the world’s leading certifiers of environmental claims by companies. They have been real leaders in the green building movement and in everything dealing from recycled content clients, organic certification, you name it.

If you have an existing company and want it to become a benefit corporation, can you simply switch it over?

If you’re an existing corporation, or LLC, partnership or sole proprietorship, you can convert to a benefit corporation, and that is indeed what a majority of those companies who I mentioned before did. Most were regular corporations and converted over to become benefit corporations. You could also open an additional arm of your company and spin it off to a benefit corporation.

What if you are a non-profit corporation?

Some nonprofits that have a product or service that they want to actually spin off as a for-profit so they can bring in investors will see this as a real tool. Non-profits are prime examples of organizations that might want to create a subsidiary benefit corporation. When you’re a non-profit, you don’t have shares to sell, so you can’t bring in investors, you can’t  bring in equity partners, because there’s no equity to give them. So, when a non-profit develops a great solution that’s going to revolutionize the world, it can’t bring in the money it will need to scale it up.

If this solution were developed in a for-profit business, shares can be issued to investors who will be given a share of the company. If a non-profit sets up a traditional corporation to market its idea, it would like a large percentage of the profits to flow back to itself. That’s tough to do in a traditional corporation because of all the reasons I have mentioned. Now a non-profit can set up a subsidiary benefit corporation and structure it so that whatever percentage, including all of the profits, go straight back to the non-profit.

This sounds like a great solution for businesses that want to focus on social equity and the environment as part of their bottom line.

Absolutely!

Thank you.

Donald Simon is a partner in the law firm Wendel Rosen Black & Dean LLP. He will be presenting on Benefit Corporations at the Green California Summit.  

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