Tuesday, April 29, 2014
David Edward Spenard (Assistant Attorney General in the Kentucky Office of the Attorney General) recently published an article entitled, The Cycle of Innovation and Regulation: The Development of a State Charity Regulatory Dialectic for Charitable Investment in Social Enterprise Activity Through a Limited Liability Company Structure, 9 N.Y.U. J. L. & Bus. 603 (2013). Provided below is his introduction:
The limited liability company (LLC) is a fairly recent innovation. Legislative authorization of a variation on the LLC framework allowing the creation of a so-called low-profit limited liability company framework via one specific form, an L3C, is even more recent. Whatever the claims that may surround the L3C framework at present, its principal purpose as manifest in the language of its design is to facilitate program-related investment, a specific type of high-risk investment permissible for a private foundation under the Internal Revenue Code (IRC).
Thus, the L3C creates a specific mechanism for aggregating charitable investment with non-charitable investment. As a charitable hybrid, the L3C can allow a charitable mission to exist alongside financial margin in the same enterprise. Nonetheless, through the IRC as well as the corresponding Treasury Regulations, there are significant restrictions applicable for such an arrangement, and there are penalties for a breach of the IRC or the Treasury Regulations with regard to investment in such an enterprise.
Vermont was the first state to enact legislation creating an L3C platform. Rather than each remaining state neatly falling in line behind Vermont, there have been variations on the Vermont theme. As Mr. Tyler notes in his article, Illinois “seems to have eliminated the ambiguity in its L3C statute by expressly subjecting L3C's in Illinois and their managers to the [[Illinois] charitable trust regime . . . .” Therefore, at least one state legislature has chosen to signal that the creation of an L3C or the operation of an L3C within the borders of its jurisdiction carries with it an additional level of supervision for the purpose of protecting the jurisdiction's interests in assets dedicated to a charitable or public purpose.
While the indication of additional supervision by state charity officials may not be a particularly favorable result for L3C advocates, it was predictable. As importantly, it is entirely necessary. In terms of the regulatory cycle, whenever there is innovation regulation will follow. Likewise, when there is regulation there will be innovation. As described by Edward J. Kane, “Introducing political power into economic affairs initiates a dialectical process of adjustments and counteradjustments.” The use of charitable assets in a venture or the claim of a charitable purpose for a venture will, unremarkably enough, trigger the interest of the state charity official. The creation of a new framework for aggregating capital that can include the investment or contribution of charitable capital will result in a regulatory counteradjustment. Thus, with regard to the use of charitable assets for social enterprise activity, the regulatory dialectic between L3C advocates and state charity officials is underway.
There is a very strong argument that L3C advocates will best serve their own cause by assisting in the development of tailored, reasonable regulation of charitable assets in charitable hybrid enterprises rather than by denying the need for incremental regulation of the enterprise through state charity official supervision. The first step that advocates could take is through establishing a duty of care for the proper use of the charitable assets that applies to each non-charitable participant having the ability to manage or control a charitable hybrid enterprise.