New alternative legal structures for businesses engaged in nonprofit or charitable activities
There has been a recent proliferation of alternative legal structures for entities engaged in some manner of historically nonprofit or even charitable activity. The basic purpose of these structures is to allow governing boards to consider social and environmental concerns in exercising their corporate purposes, rather than focusing solely on the shareholders’ bottom line. The most recent iteration of these structures is the New York “benefit corporation,” effective on December 31, 2011. Although not yet available in New York, the “low-profit limited liability company” (or “L3C”) is also chief among these developing business entities.
Benefit corporations represent a new class of business entity required to create benefit for society, as well as for shareholders. In addition to New York, other states that have enacted legislation allowing for their creation include California, Hawaii, Virginia, Maryland, Vermont, and New Jersey.
Some confusion may exist over the difference between “benefit corporations” and “Certified B Corporations” (or “B Corporations”).
The benefit corporation is a legal structure that allows a board to consider social and environmental concerns in its decision-making processes. Requiring the governing board to consider employees, community, and the environment—in addition to shareholder value—when it makes operating and liquidity decisions was considered antithetical to the requirements of state corporate law. At most stages in the life of a corporation, it can be argued that considering other stakeholders adds to the “long-term” value to the shareholders. However, at the time of the breakup or sale of a corporation, there is no longer a “long-term” view and absent other enabling legislation, the so-called Revlon duties limit a Board’s ability to consider matters other than maximization of shareholder value. The B Corporation, by building in consideration of stakeholders other than shareholders into the by-laws, is intended to allow a Board to take matters other than shareholder value into account in determining the consideration to be received by shareholders upon the sale of the corporation. So now the duality of business goals and social mission can comfortably co-exist in a variant of a business corporation. The benefit corporation is not nonprofit, nor is it tax-exempt.
To the uninitiated, it may seem that business corporations in the United States have been taking these broader considerations into account for decades. Firms are rightfully lauded in the business and popular press for their attention to issues beyond the company’s “bottom line.” In the nonprofit world, as well, there is new-found recognition that the impact of charities as investors is more complex than just seeking higher returns. Witness the conundrum of the trustees of the Hershey Trust, who were prevented by court injunction from selling the Trust’s interests in Hershey Foods Corporation because of possible negative impact on the local community. Consider also the inclusion in the law of charitable investing of a requirement that boards take into account an asset’s “special relationship or special value” to the purposes of the institution.
In contrast, the trademarked “Certified B Corporation®” refers to a corporation that has been certified by B Lab, the nongovernmental, nonprofit promoter behind the growth of benefit corporations and B Corporations, to meet certain social and environmental criteria. Such certification is one way of meeting the annual reporting requirements discussed below as a matter of state law for benefit corporations. But the B Corporation label is just that—a certification more similar to The Better Business Bureau’s “Accredited Business,” or a green business certification than to a corporate or tax status.
Currently, classification as a Certified B Corporation does not entitle the entity or its owners to any special benefit, subsidy, or exemption . . . with one exception at the time of this writing. Businesses located in the city of Philadelphia can be classified as “certified sustainable businesses” once they are certified (not just incorporated) as B Corporations. Once so certified, a business shall remain eligible to receive Sustainable Business Tax Credits each year that such tax credits are available. For tax years 2012 through 2017, an eligible business may receive a tax credit of $4,000, which may only be used against the tax based upon annual receipts. No more than twenty-five (25) businesses will be certified as Sustainable Businesses in any one tax year. The concept is an interesting one, in that the Commonwealth of Pennsylvania does not yet even allow for the creation of benefit corporations (the Pennsylvania bill relating to benefit corporations (S433) was laid on the table as of December 7, 2011). Watch for other jurisdictions to try to reward the relevance of these B Corporations with some form of subsidies.
Like other states, the legislature in New York passed this legislation (S79-a/A4692-a) with almost complete unanimity. The salient aspects of the New York model follow the pattern of other states and feature the elements promoted by B Lab. A “benefit corporation” is otherwise a business corporation created for one or more of the following purposes:
- Providing low-income or underserved individuals or communities with beneficial products or services;
- Promoting economic opportunity for individuals or communities beyond the creation of jobs in the normal course of business;
- Preserving the environment;
- Improving human health;
- Promoting the arts, sciences, or advancement of knowledge;
- Increasing the flow of capital to entities with a public benefit purpose; and
- Accomplishing any other particular benefit for society or the environment.
The standard of conduct for directors and officers requires consideration of the ability of the corporation to accomplish its public benefit purposes, and the effect of its activities on not only its shareholders, but also its employees, subsidiaries, and suppliers, the interests of its customers, along with community and societal considerations. The interests of any particular person or group need not be given priority unless the corporation has stated its intention to do so.
The entity must deliver to each shareholder annually a benefit report including a narrative description of:
- The process and rationale for selecting the third-party standard used to prepare the benefit report;
- The ways in which the benefit corporation pursued general public benefit during the year and the extent to which general public benefit was created;
- The ways in which the benefit corporation pursued any specific public benefit set forth in its certificate of incorporation and the extent to which that specific public benefit was created; and
- Any circumstances that have hindered the creation by the corporation of general or specific public benefit.
The report must provide an assessment of the performance of the benefit corporation against a third-party standard—such as that of the Certified B Corporation—applied consistently with any application of that standard in prior benefit reports or accompanied by an explanation of the reasons for any inconsistent application and, if applicable, assessment of the performance of the benefit corporation relative to its specific public benefit purpose or purposes.
The report must also provide the compensation paid by the benefit corporation during the year to each director in that capacity, and the name of each person who owns beneficially, or of record, five percent or more of the outstanding shares of the benefit corporation. The report must be posted on the public portion of the company website, although compensation paid to directors and any financial or proprietary information included in the benefit report may be omitted.
Low profit limited liability company
Governor Cuomo has not yet signed legislation allowing for the creation of L3Cs in New York, but practitioners should be familiar with the form and its uses because they can be created in other jurisdictions. The intended benefit of the L3C is to ease the process by which private foundations can make program-related investments (known as “PRIs”) in these entities, using charitable assets to advance what might otherwise be business purposes.
This past spring A6116-2011/S3011-2011 were introduced into the NYS legislature. They are still in committee as of this writing. The proposals would amend the limited liability company law to allow an LLC to include specific provisions in its articles of organization to the effect that:
- The LLC significantly furthers the accomplishment of one or more charitable or educational purposes within the meaning of Internal Revenue Code (the “Code”) Section 170(c)(2)(B), and would not have been formed but for its relationship to the accomplishment of charitable or educational purposes;
- No significant purpose of the LLC is the production of income or the appreciation of property, although the fact that the LLC produces significant income is not necessarily conclusive evidence to the contrary; and
- No purpose of the LLC is to accomplish one or more political or legislative purpose under Code Section 170(c)(2)(D).
These limitations may look familiar; they are some of the aspects of what a private foundation funder would need to assure in making a loan or equity contribution to a business entity and still have it qualify as a PRI under Treas. Reg. § 53.4943-3(a), for example. To date, there is no indication from the IRS that the classification of an entity as an L3C would obviate the need for a private foundation (and the funded entity) to comply with the PRI rules.
The L3C has been touted as an opportunity for expanded jobs and employment for citizens, a unique niche between the for-profit and charitable sectors, and a way to leverage resources to achieve socially beneficial results. Yet as a L3C is not tax-exempt, it actually affords little more than a well-drafted governing document or funding agreement. The concept is not without its detractors.
Understanding the impact of benefit corporations and L3Cs
While both have been announced with great fanfare—and have attracted a good deal of attention and even support from state legislatures—for some, these vehicles represent a potential erosion of the sometimes precarious balance between nonprofit benefits and burdens. Just as the advance (and periodic decline) of for-profit health care and education businesses has challenged the premise of those pursuits as charitable activities in the United States, the creation of these options requires a re-examination of what it means to be charitable, tax-exempt, or nonprofit.
To understand these alternatives, one needs to appreciate the distinction between the corporate (or business) form and tax status. A nonprofit corporation can be taxable. It is also possible to have a business entity (such as a physician’s professional corporation) recognized as tax-exempt. Generally, however, the demands of tax-exempt status—especially charitable status—require a form that reflects the lack of business purpose and absence of pecuniary interests. It is important to recognize that the corporate (or trust) law and federal tax law have a number of different “crosswalks” which allow satisfaction of one statute to suffice for the other (i.e., N-PCL Section 406 attributes as a matter of state law a number of the provisions of the Internal Revenue Code (the “Code”) to entities classified as private foundations under Code Section 509(a)). There is nothing new or unique about this.
Practitioners owe it to their clients to be familiar with all the possible forms of activity in support of the nonprofit enterprise. The benefit corporation and the low-profit limited liability company pose interesting new options in structuring, but to date have not presented demonstrable benefits that argue for their widespread use. The willingness of state governments to support alternative business entities, however, indicates that these options are likely here to stay. As such, it is important to watch them closely as benefits and burdens are ascribed to them.