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October 18, 2011 11:55 AM

Creating a New Corporate Structure, and Maybe a New Practice Niche to Boot

Posted by Sara Randazzo

Susan Mac Cormac—cochair of both Morrison & Foerster's business department and the firm's cleantech group—calls it "the mission of my life": promoting the cause of environmental sustainability amid what she sees as rapidly dwindling and drastically mispriced natural resources.

It's a mission that has consumed many of Mac Cormac's rare free moments since 2001, and it hasn't been hers alone. With Jones Day energy partner R. Todd Johnson and Silicon Valley attorney Derrick Britt, she has served for the past several years as cochair of a ten-lawyer working group that turned a desire to work for the greater good into action by drafting, and then advocating on behalf of, legislation that allows for the creation of so-called flexible purpose corporations.

The group's efforts to have California embrace the for-profit/nonprofit hybrids paid off last week when Governor Jerry Brown signed into law a bill that provides a regulatory framework for such corporations as of January 1. 

For Mac Cormac, who says she got behind the push to create the new corporate structure as a result of "believing what I believe, combined with the only thing I know—the corporate form," last week's bill signing was a signficant step. That doesn't mean she considers her mission accomplished.

"My goal is to have every company required to be this form," she says.

Whether she reaches that goal remains to be seen. But any new or existing company that wants to define itself as a flexible purpose corporation will soon be able to by writing its articles of incorporation in a way that gives ample weight to supporting a specific social mission alongside seeking profits.

Companies adopting the new corporate structure must file regular public reports about the status of their stated missions in the same way that publicly held corporations file regular financial reports with the Securities and Exchange Commission. Those entities considering a move to the hybrid structure—or, later, considering a change in their mission—need two-thirds of their shareholders to approve a switch and must allow shareholders that want to cash out their holdings. (For now, flexible purpose corporations will be taxed the same as for-profit corporations, though Mac Cormac and her colleagues hope to ask the Internal Revenue Service to consider tax breaks for the hybrids in the future.)

While California's flexible purpose corporation statute is the first of its kind, six states—including California—have also passed laws approving so-called benefit corporations, which are similar in concept but require companies to be certified as upholding a set of social and environmental values while offering less flexibility in terms of choosing of a mission. Eight states also offer a third type of corporate hybrid known as a low-profit limited liability company, or L3C, which allows organizations pursuing a charitable purpose to be eligible for program-related investments from foundations.

Why would a corporation want to bake social activism into its bylaws? One key benefit, according to Thomas Kelley, a professor of nonprofit law at University of North Carolina School of Law, is that doing so serves "to assuage entrepreneurs' fears that they'll be sued by their own shareholders for failing to maximize profits and paying too much attention to a social and environmental mission."

Given that many of the companies initially interested in flexible purpose status are small or originate as nonprofit spin-offs, the lawyers who pushed the California legislation say they don't see the new entity creating a boom in new corporate business just yet. At the same time, these lawyers say they do hope that over time a business sector does take hold, one that comprises companies of all sizes that need sophisticated legal help.

Mac Cormac and Johnson are already helping businesses incorporate under the new form on a pro bono basis or at heavily discounted rates. Mac Cormac also plans to work with the Stanford and University of California, Berkeley, law schools to establish clinics to help launch flexible purpose corporations. 

"Most can’t afford me," Mac Cormac says, pointing to the $750-an-hour rate she usually bills for advising on corporate and finance matters, mostly to private companies in the clean technology and sustainable energy industries. "I'm fine for Goldman or Intel, not for the small mom-and-pop shop that wants to be sustainable that has just as much of a right to have good legal counsel to get this done well." In the wake of the bill's signing, Mac Cormac says she has already been contacted by ten new or existing clients interested in adopting the new form.

One client, a nonprofit called Global Integrity that tracks governance and corruption occurring around the world, has expressed an interest in using the flexible purpose structure to spin off a project called FogLamp that sells local intelligence to clients. Mac Cormac says she hopes some of her larger clients—those that can actually afford her services—will be interested in making the switch as well.

UNC professor Kelley sees the hybrid corporate structures quickly gaining fans among companies and lawyers themselves.

"My guess is, it will turn into a new revenue stream that's not only a lucrative sub-area of law practice, but one that's a lot of fun," he says. "There's a lot of satisfaction to be had for a lawyer in helping an organization with a potentially transformative social mission."

Adds Keith Bishop, a Allen Matkins Leck Gamble Mallory & Natsis corporate partner and a member of the California working group: "For the general business lawyer, this is an opportunity to have a foot in what would be historically the nonprofit world."

The hybrid concept does have its critics. In California, a dividing line formed in the legal and business communities between proponents of the flexible purpose bill and a competing bill aimed at legalizing benefit corporations.

The latter bill—backed by B Lab, a nonprofit that bestows something akin to the Good Housekeeping Seal of Approval on companies operating in the sustainable industry for a fee ranging from $500 to $25,000—was opposed by the California Department of Corporation and the business law section of the corporations committee of the state bar. Benefit corporation foes argue that requiring a minimum standard of social and environmental impact is more difficult to regulate, and encourages more potential shareholder lawsuits, than allowing a corporation to choose and maintain its own mission. 

Bishop says he also spoke out against the benefit corporation bill because he felt it would create confusion to have two hybrid structures to choose from. Johnson, who served on B Lab board, stepped down once the nonprofit began actively backing the benefit corporation bill. Brown signed both into law late on October 9, the last day of the year during which he could take action on legislation.

UNC's Kelley says he has heard critics say the hybrid corporate structures are little more than slick exercises in marketing and that existing laws offer plenty of options for would-be social entrepreneurs. Among those options: writing a special mission into a limited liability company's operating agreement; creating dual classes of stock that give some directors a "super vote" on business decisions related to a social mission; and launching nonprofit arms to segregate charitable work.

The trouble with those alternatives, Kelley says, is that they require costly legal work by advanced practitioners with expertise in such work-arounds. By being simpler and more predictable, he argues, the new hybrid structures will prove to be cheaper to set up, operate, and shield against derivative suits from unhappy shareholders.

For his part, Jones Day's Johnson says he has little patience for those he has heard decry the hybrid corporate models by citing economist Milton Friedman's famous quote: "There is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game."

Counters Johnson: "What this does, it's creating a new set of rules for those who want to play by them."

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Still not convinced using the words "corporate" and "hybrid" when describing the L3C are accurate. The L3C is not a corporation and the L3C is not a hybrid legal business structure. The L3C is a for-profit, LLC business entity. Agreed, this may all be semantics...but using these terms in the same sentence with L3C is still causing a fair amount of confusion amongst those trying to better understand the L3C.

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