Wednesday, September 24, 2014
March of the Benefit Corporation: So Why Bother? Isn’t the Business Judgment Rule Alive and Well? (Part III)
(Note: This is a cross-posted multiple part series from WVU Law Prof. Josh Fershee from the Business Law Prof Blog and Prof. Elaine Waterhouse Wilson from the Nonprofit Law Prof Blog, who combined forces to evaluate benefit corporations from both the nonprofit and the for-profit sides. The previous installments can be found here and here (NLPB) and here and here (BLPB).)
In prior posts we talked about what a benefit corporation is and is not. In this post, we’ll cover whether the benefit corporation is really necessary at all.
Under the Delaware General Corporation Code § 101(b), “[a] corporation may be incorporated or organized under this chapter to conduct or promote any lawful business or purposes . . . .” Certainly there is nothing there that indicates a company must maximize profits or take risks or “monetize” anything. (Delaware law warrants inclusion in any discussion of corporate law because the state's law is so influential, even where it is not binding.)
Back in 2010, Josh Fershee wrote a post questioning the need for such legislation shortly after Maryland passed the first benefit corporation legislation:
I am not sure what think about this benefit corporation legislation. I can understand how expressly stating such public benefits goals might have value and provide both guidance and cover for a board of directors. However, I am skeptical it was necessary.
Not to overstate its binding effects today, but we learned from Dodge v. Ford that if you have a traditional corporation, formed under a traditional certificate of incorporation and bylaws, you are restricted in your ability to “share the wealth” with the general public for purposes of “philanthropic and altruistic” goals. But that doesn't mean current law doesn't permit such actions in any situation, does it?
The idea that a corporation could choose to adopt any of a wide range of corporate philosophies is supported by multiple concepts, such as director primacy in carrying out shareholder wealth maximization, the business judgment rule, and the mandate that directors be the ones to lead the entity. Is it not reasonable for a group of directors to determine that the best way to create a long-term and profitable business is to build customer loyalty to the company via reasonable prices, high wages to employees, generous giving to charity, and thoughtful environmental stewardship? Suppose that directors even stated in their certificate that the board of directors, in carrying out their duties, must consider the corporate purpose as part of exercising their business judgment.
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There is no requirement under Delaware law that says a company must seek to maximize daily profits (and, as it should be, there is no law that says they can’t). If a company is not trying to make a profit, of course, we have long had the option of nonprofit associations. How they pursue profit, though, should be up to the directors.
Since 2010, though, there are some reasons to question whether the above is an accurate characterization of Delaware law. In eBay v. Newmark, Chancellor Chandler determined that a for-profit entity was the right vehicle for craigslist’s service-based mission, even though the company was both profitable and a market leader in its sector. He explained:
The corporate form in which craigslist operates, however, is not an appropriate vehicle for purely philanthropic ends, at least not when there are other stockholders interested in realizing a return on their investment. Having chosen a for-profit corporate form, the craigslist directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders. The “Inc.” after the company name has to mean at least that. Thus, I cannot accept as valid for the purposes of implementing the Rights Plan a corporate policy that specifically, clearly, and admittedly seeks not to maximize the economic value of a for-profit Delaware corporation for the benefit of its stockholders—no matter whether those stockholders are individuals of modest means106 or a corporate titan of online commerce.
eBay Domestic Holdings, Inc. v. Newmark, 16 A.3d 1, 34 (Del. Ch., 2010)
Josh has written multiple times that he thinks this analysis goes too far, but even under Chancellor Chandler’s description, it appears that we don’t need a benefit corporation for instances when the shareholders agree on the corporate mission. (Chancellor Chandler seems to concedes as much when he notes that it is at least conceivable that a philanthropic company may be okay when there are no “other stockholders interested in realizing a return on their investment.”) That is, no objection? No problem.
Chancellor Strine, too, though, in a Wake Forest Law Review article, Our Continuing Struggle with the Idea that For-Profit Corporations Seek Profit, has indicated his problem with directors not focusing on profits, too. (Cf. Haskell Murray on Delaware judges writing for law reviews here.) Strine says, “I simply indicate that the corporate law requires directors, as a matter of their duty of loyalty, to pursue a good faith strategy to maximize profits for the stockholders.” He notes, though, that absent Revlon duties (which require a board to seek the best price in a change in control): “The directors, of course, retain substantial discretion, outside the context of a change of control, to decide how best to achieve that goal and the appropriate time frame for delivering those returns.”
There are examples out there that suggest other states, even if Delaware does not, will allow companies to have a broader and more benefit-focused purpose. There are examples out there (that have not yet been questioned) that completely ignore profit seeking as a stated purpose. As an example, the corporate purpose for Chick-fil-A is stated to be
[t]o glorify God by being a faithful steward of all that is entrusted to us. To have a positive influence on all who come in contact with Chick-fil-A.
I assume Chick-fil-A is a Georgia corporation, but run through the eBay filter, a disgruntled shareholder should be able to get some traction under Delaware law, as note the there is no mention of profit seeking (though it is clearly a profit-making entity). But so far, no problem there.
Furthermore, even if the craiglist example (or, Chick-fil-A, for that matter) were not permissible, as Chancellor Chandler says, that problem should be able to be rectified by adding community-service as one of the entity’s chosen methods for pursuing profit, and stating so. Imagine Craig Newmark had always said,
We wish to pursue as much profit as we can, and we adopted our community-service mission as part of the profit-seeking model. It’s why we’re the industry leader, and we seek to stay the leader. We have considered monetizing craiglist, but we have not yet found a way that can do so consistent with our community-service mission, which got us to where we are today. We have determined that changing course now to pursue short-term profit would lead to long-term demise, and we’re not willing to risk this company in that manner. If new information changes our minds, we’ll revisit the option as appropriate.
Of course, the business judgment rule should protect against the need for such an explanation. Absent self-dealing, it’s hard to see how such as statement could be refuted without a judge substituting his or her business judgment for that of the directors. (Framed this way, self-dealing or pet charity claims are not especially compelling.)
In many states, adding a more specific corporate purpose to the articles of incorporation could create such a foundation for directors so their charge would always be clear. For example, in West Virginia, by adding the corporate philosophy to the corporate purpose, business decisions would need to be run through such a filter as part of the directors’ mandate. West Virginia’s articles of incorporation form provides:
9. a. The purpose for which this corporation is formed is as follows:
(Describe the type(s) of business activity which will be conducted, for example, “agricultural production of grain and poultry”, “construction of residential and commercial buildings”, “manufacturing of food products”, “commercial painting”, “retail grocery and sale of beer and wine.” Purpose may conclude with words “…including the transaction of any or all lawful business for which corporations may be incorporated in West Virginia.”)
Thus, a corporation could consider something like this for its purpose:
This corporation will conduct the business of an online sales community that will seek profit and sustainability by creating a public benefit through service to the community, philanthropic giving, and caring for customers, including the transaction of any or all lawful business for which corporations may be incorporated in West Virginia.
Such a statement would also be a way to protect the entity (and directors) from a shareholder who changes his or her mind and decides that community commitment is no longer a good goal in pursuit of profit. Thus, as long as the corporate mission is stated clearly in the articles/charter/certificate, that mission should insulate directors from shareholders later changing their mind to object to stakeholder considerations. Why not hold shareholders to the deal they signed up for? In addition to being consistent with statutes like the West Virginia law, freedom of contract would also suggest we should, especially in the context of a company that has stated a belief that long-term financial well-being is linked to community-based goals.
Consider also Pennsylvania, which has a benefit corporation act. The benefit corporation ideas seems especially unnecessary there given the following provision in the traditional corporations statute (“Subpart A: Corporations Generally”):
15 Pa. Consol. Stat. § 515. Exercise of powers generally.
(a) General rule.--In discharging the duties of their respective positions, the board of directors, committees of the board and individual directors of a domestic corporation may, in considering the best interests of the corporation, consider to the extent they deem appropriate:
(1) The effects of any action upon any or all groups affected by such action, including shareholders, members, employees, suppliers, customers and creditors of the corporation, and upon communities in which offices or other establishments of the corporation are located.
(2) The short-term and long-term interests of the corporation, including benefits that may accrue to the corporation from its long-term plans and the possibility that these interests may be best served by the continued independence of the corporation.
(3) The resources, intent and conduct (past, stated and potential) of any person seeking to acquire control of the corporation.
(4) All other pertinent factors.
Still, even in Delaware, it would seem that a stated corporate policy, as part of the bylaws or the certificate, that a corporation is a profit-seeking venture that will use community-service and philanthropic considerations as part of the business model to obtain and maintain profit would be a permissible exercise of “a good faith strategy to maximize profits for the stockholders” that would not run afoul of the duty of loyalty. Josh Fershee would argue that Delaware law, as written, seems to permit any board to apply such a corporate philosophy, but the writings of Chancellors Chandler and Strine noted above suggest that could be a risky analysis in practice.
Where does all this lead? It seems that benefit corporations have a clearer role in the Delaware landscape than in many other states. (It's worth noting that Delaware has a public benefit corporation law, here, that requires a "specific public benefit" in the certificate of incorporation.)
Regardless of jurisdiction, there may be value in having an entity that plainly states the entity’s benefit purpose, but in most instances, it does not seem necessary (and is perhaps even redundant). Furthermore, the existence of the benefit corporation opens the door to further scrutiny of the decisions of corporate directors who take into account public benefit as part of their business planning, which erodes director primacy, which limits director options, which can, ultimately, harm businesses by stifling innovation and creativity. In other words, this raises the question: does the existence of the benefit corporation as an alternative entity mean that traditional business corporations will be held to an even stricter, profit-maximization standard?
Perhaps the benefit corporation serves the purpose of forcing companies to be clear about their public benefit purpose, and maybe it even encourages more companies to seek such a purpose. Both of those can be good things, but it still seems that, for most circumstances, the benefit corporation is (or at least should be) a solution in search of a problem.
Next up: Part IV - So Why Bother, Redux? Maybe It’s a Tax Thing?
JPF and EWW