Saturday, July 18, 2020
A few of us have blogged about benefit corporations here from time to time; they’re a controversial business form, in part because there are disputes about whether they actually are materially different from the ordinary corporate form, and in part because of flaws in states’ adopting legislation.
The basic issue here is that, as we all know, the business judgment rule is robust enough that corporate directors are perfectly free, as a practical matter, to pursue a stakeholder-oriented mission without the need of any special form. The reason they do not has little to do with their formal legal obligations, and everything to do with the market for corporate control: If directors do not put shareholders first, their companies may become ripe for a takeover and they may be voted out of office.
In theory, benefit corporations could solve a shareholder collective action problem. Let’s assume, as some theorize, that given the choice, many shareholders would actually prefer not to maximize their own welfare but instead to share those gains with other stakeholders. The problem is, they may experience defection in their own ranks. Over time, some shareholders may change their minds and prefer to keep all excess profits; or, they may fear other shareholders will do so. As a result, at any given time, individual shareholders may sell their shares to a profit maximizer (a hedge fund, etc), who ultimately takes control and abandons the stakeholder-oriented mission.
The benefit corporation form, then, could theoretically precommit shareholders to remaining true to their original purpose. But that only works if there are credible bonding mechanisms.
In Delaware, one bonding mechanism was the statutory requirement that companies could only adopt, or abandon, benefit corporation status by a 2/3 vote of the shareholders (more on that below). This requirement ensured a hedge fund would have to acquire a supermajority stake before abandoning a benefit corporation’s altruistic mission. But locking shareholders into the form wouldn’t have much of an effect unless the form itself offered a meaningful commitment to stakeholderism.
That’s why Delaware has an additional bonding mechanism, namely, that directors are legally required to balance the interests of all stakeholders when managing the corporation. The problem – and this is well discussed in the literature – is that the mechanisms for enforcing this requirement are rather meager. Many states, Delaware included, also require directors of benefit corporations to issue reports on the actions they have taken to advance public benefits, but Haskell Murray has found that many benefit corporations simply don’t issue the reports.
So, if you assume a rapacious hedge fund wanted to take over a benefit corporation and profit by abandoning its social mission, the 2/3 vote requirement might impede the fund from obtaining enough shares to formally convert the company’s status, but the fund could still gain enough votes to steer decisionmaking in a more rapacious direction, with very little to fear in terms of legal reprisal.
As a result, some companies have chosen to obtain certification as a B-Corp. B-Lab is a private organization that certifies that companies have complied with its standards for pursuing a stakeholder oriented mission, i.e., B-Corp certification. This third-party certification does not create legal obligations for directors, but may serve as some kind of assurance to shareholders that a particular company remains committed to its social purpose.
The reason I’m mentioning all of this now is that given the weaknesses inherent in benefit-corporation status, we have not seen many standalone publicly-traded benefit corporations, especially ones organized in the United States. (Or, for that matter, B-Corps – Etsy famously abandoned its B-Corp status not long after going public, exactly as the theory of shareholder defection would predict). Laureate Education is one of the very few publicly-traded benefit corporations, and it maintains its status with dual-class stock that gives control to a single entity, Wengen Alberta (that entity, however, is controlled by several private equity firms and, well … you get the feeling Laureate’s benefit-corp status is less about stockholders deciding to share profits than a recognition that, given Laureate’s business model, publicly doing good really is necessary to do well). There’s also Amalgamated Bank, which – as a bank incorporated in New York – cannot formally adopt benefit-corporation status but recently amended its articles of incorporation to make the same kind of commitment. Amalgamated, like Laureate, is also not depending on its charter to enforce that commitment, though; it’s 40% owned by unions.
And now, two new companies are joining this list.
First up is the insurance company Lemonade, which went public earlier this year. Lemonade is an odd duck; one would not ordinarily think of an insurance company as a natural fit for benefit corporation status, but it describes its public mission thusly:
This corporation’s public benefit purpose is to harness novel business models, technologies and private-nonprofit partnerships to deliver insurance products where charitable giving is a core feature, for the benefit of communities and their common causes.
In short, Lemonade donates some of the premiums it receives to charities designated by policyholders. And how does Lemonade expect to be able to maintain its commitment to this benefit once its shares are freely-tradeable? With a combination of extensive inside ownership and antitakeover devices. The co-founders control more than half the votes, and they’ve reached an agreement with Softbank – which controls another 21% – to decide with Softbank how Softbank’s shares will be voted. There’s a staggered board and various other garden-variety antitakeover provisions (advance notice procedures, no written consent, shareholders can’t call meetings, directors can adopt poison pills, 2/3 vote requirement for shareholders to amend bylaws and various charter provisions). Lemonade also has regulatory protections:
Under applicable state insurance laws and regulations, no person may acquire control of a domestic insurer until written approval is obtained from the state insurance commissioner following a public hearing on the proposed acquisition.
Second, we have Vital Farms, which just unveiled its S-1 last week. Vital Farms is an “ethical food company that is disrupting the U.S. food system,” and is also incorporated as a Delaware public benefit corporation:
The public benefits that we promote, and pursuant to which we manage our company, are: (i) bringing ethically produced food to the table; (ii) bringing joy to our customers through products and services; (iii) allowing crew members to thrive in an empowering, fun environment; (iv) fostering lasting partnerships with our farms and suppliers; (v) forging an enduring profitable business; and (vi) being stewards of our animals, land, air and water, and being supportive of our community
But again, Vital Farms is not relying on PBC status to commit to its purpose; instead, insiders own 61.7% of the company and, like Lemonade, it has a staggered board and similar antitakeover provisions.
My point here is that benefit-corporation status is not, in fact, serving as a commitment device for any of these companies; instead, to remain true to their mission, these companies are relying on more mundane types of insulation from the market for corporate control. But that kind of insulation carries the same risk as any other entrenchment device; the companies will pursue stakeholder interests only so long as their managers feel it in their interests to do so. The benefit-corporation form is not doing much work.
Notably, Delaware is adopting amendments to the DGCL that eliminate benefit corporations’ only real commitment device, namely, the 2/3 vote requirement necessary to shed benefit corporation status. With these amendments – which were, I believe?, only just signed into law – we really may as well just call them “corporations” and be done with it.
One final observation: it’s interesting to compare the risk factors in the prospectuses of Lemonade and Vital Farms – especially since publicly-traded benefit corporations are so rare that there isn’t much of a template. Lemonade notes the dual risks that its pursuit of stakeholder-oriented goals may diminish profits, and the fact that it may fail to achieve those goals may result in reputational harms that diminish profits. As Lemonade puts it, “There is no assurance that we will achieve our public benefit purpose or that the expected positive impact from being a public benefit corporation will be realized, which could have a material adverse effect on our reputation, which in turn may have a material adverse effect on our business, results of operations and financial condition.” Benefit-corp status is thus treated at least in part as a mechanism for pursuing shareholder wealth maximization on the “do well by doing good” theory.
Vital Farms, by contrast, while warning of the risk that it may fail to achieve its stakeholder benefits and suffer related reputational harm, mostly just highlights that benefiting stakeholders may ultimately result in some sacrifice of shareholder welfare: “While we believe our public benefit designation and obligation will benefit our stockholders, in balancing these interests our board of directors may take actions that do not maximize stockholder value.” Vital Farms does not, in other words, treat benefit corp status as itself contributing to shareholder value (via marketing or otherwise).