This article is a summary based primarily on a chapter in Hybrid Ventures: Advances in Entrepreneurship, Firm Emergence and Growth, Volume 19 titled “Purposes, Priorities, and Accountability Under Social Business Structures: Resolving Ambiguities and Enhancing Adoption”, written by John Tyler III, Evan Absher, Kathleen Garman, and Anthony Luppino.
Table of Contents
Introduction
One of the main criticisms of social enterprises is that there is a lack of substantive accountability for prioritizing social mission over other purposes, especially profits. Prioritizing and imposing meaningful accountability for social mission, however, is vital for the proliferation of, and engagement with, social enterprises. There are certain business forms and strategies entrepreneurs can utilize to compel their social mission, although this article explains that no existing framework ensures prioritization of social mission for the longevity of the enterprise.
To better understand social enterprises, an exploration is needed into prioritization of purposes and accountability to those purposes. These two elements are what distinguish a social enterprise, and the thought process of its decision makers, from traditional businesses. Proper prioritization of purposes and the appropriate legal form to hold decision makers accountable to those priorities are essential to the success of a social enterprise from a social impact lens. This article seeks to explore the gaps in social enterprises’ abilities to effectively prioritize their purposes and utilize form in a way that solidifies accountability to social and environmental impact. As a way of illustrating the gaps and a means to address them, this article suggests consideration of a new form: the “social primacy company.”
Priorities
- What are the underlying purposes?
- How are they prioritized, especially when they collide?
- How do they withstand changed minds and circumstances or new people with different priorities?
These are questions that founders must answer and clearly provide for in their founding documents because it will shape the thought process of decision makers for the lifetime of the company. Every company has priorities, and they provide a degree of consistency when directors and managers are inevitably faced with a choice among the entity’s purposes.
Let’s take a look at priorities of purpose in existing business forms:
Traditional Businesses (C corporations, LLCs)
On one end of the spectrum are businesses that prioritize maximizing shareholder value, i.e., traditional for-profit businesses. It is debated whether prioritizing shareholder value is a fiduciary mandate; Morrison & Foerster partner Susan Mac Cormac would argue that it is not via the Business Judgment Rule which protects decision makers from liability if considering social and environmental factors in good faith.1 However, in practice, managers and directors of traditional businesses rarely elevate social mission over shareholder value for a variety of reasons, including pressure to have strong numbers for quarterly reporting, stock option compensation, public perception of stock price as the ultimate measure of success, and the risk of being sued for breaching fiduciary duty. Hence, even when traditional businesses operate to produce public benefits, it tends to remain within the constraints of pursuing financial gains for their shareholders. When a conflict emerges between competing purposes, the view is that the law supports the primacy of enhancing shareholder value.
Traditional businesses can, however, embed social mission into their corporate form by explicitly changing the order of priorities to uphold social good over shareholder value through shareholder/voting agreements and charter provisions. The downside to this approach is that those contractual agreements are permissive rather than mandatory, they can be renegotiated, and are dissolved when ownership change occurs. Additionally, the ability to hold decision makers accountable to social good via these contractual agreements is negligible, which will be discussed in the accountability section.
Charitable Organizations – 501(c)(3)
Charitable organizations are on the other end of the spectrum, and to obtain and maintain tax exempt status they must be organized and operated exclusively for charitable purposes and with no more than incidental private benefit (I.R.C. §§ 501(c)(3) and 170(b)). Charitable organizations have a statutory obligation to certain priorities under state and federal law that allow for tax exemption and deductible charitable contributions. Charitable organizations cannot contract around priority of purposes, and therefore decision makers are bound to upholding charitable purposes.
L3C
A still fairly new social business form in the United States, the L3C (low-profit limited liability company), is mandated by its authorizing statutes to significantly further one or more charitable purposes within the meaning of Sec. 170(c)(2)(b) of the US Internal Revenue Code and does not permit production of income or the appreciation of property as a significant purpose.2 Thus, although the L3C is tolerant of multiple purposes, it legally prioritizes the furthering of charitable purposes over owner value.
Social Business Corporate Forms – Benefit Corporation and Social Purpose Corporation
A benefit corporation is legally required to have the purpose of creating general public benefit, i.e. “material positive impact on society and the environment, taken as a whole, as reported against a third-party standard” (Model Benefit Corporation Legislation, § 102). Directors of benefit corporations must consider how their decisions affect shareholders, employees, subsidiaries, suppliers, customers, community, and environment in the short and long term (Model Benefit Corporation Legislation, § 301). However, directors need not give priority to a particular interest.
Social Purpose Corporation statutes require that directors consider identified social and environmental effects in addition to, or together with, the financial interest of the shareholders (Cal. Corp. Code § 2602). This ensures that directors have flexibility to choose between purposes given different circumstances, so social mission may not be prioritized.
These two corporate forms promote flexibility more than anything else; nowhere in the statutes is a mandate to prioritize social mission or shareholder value. Rather, directors can prioritize or dismiss social good or owner value as long as the impact of a decision on other stakeholders is considered.
Owners in any of the traditional or social business corporate business forms can agree to modify director duties and allow interests beyond shareholder value to be considered or prioritized. Utilizing contracts to prioritize social good relies on owner agreement to pursue non-owner interest. However, depending on contracts to promote social good has significant limitations, which will be discussed in the next section. Ultimately, decision-makers in businesses will at some point or another have to choose between shareholder value and social good, and accountability to those purposes is fundamental in giving purposes actionable priority.
Accountability
- How are enterprises and their decision makers held accountable for staying true to those priorities?
- Who can enforce accountability?
- To what end is accountability enforced: outcomes or process?
The answers to these questions vary among available organizational business forms, differentiate accountability to priorities, and influence how owners, investors, employees, directors, and regulators consider decisions to fulfill their respective responsibilities. There are three main forms of accountability: public, practical, and legal, all of which vary in who can invoke the accountability and the effectiveness of enforcing consequences on accountable persons and entities.
Public Accountability
Public accountability exists to some extent for all business forms and has become a more powerful mechanism as social media has developed the ability to reach large numbers of people very quickly. Anyone can invoke public accountability by undertaking a campaign that influences some aspect of a business, but its effectiveness in delivering consequences relies on persuading enough people to act. Benefit corporations and social purpose corporations, through their requirements to report purpose and performance to the public, are predisposed to public accountability. Their reports are generated internally, and therefore the information may not always be reliable. There are degrees to which certified B corporation status facilitates public accountability as well. The media, arguably, has the most pivotal role in empowering public accountability, highlighting the importance of media understanding priorities of purpose and accountability to those purposes.
Practical Accountability
Practical accountability refers to the power of owners to remove and replace directors and managers. All the business forms previously discussed, except 501(c)(3) organizations which cannot have owners, suppose that a certain number of owners, normally a majority, have the authority to hold decision-makers accountable for decisions, outcomes, and efforts related to the priority of purposes. Only owners can invoke practical accountability, and the ease of doing so correlates with the number of owners with fewer owners being easier (fewer people to convince to take action) and increasing difficulty as the number of owners increases.
Benefit corporations circumvent dependence on owner accountability by including statutes that allow designation of a public benefit director (MCBL, § 302(a)(1)) or a delegated authority to a third party to enforce its purposes (MCBL, § 305(c)(iv)). Benefit corporations are not required to do either of these things, and even so, usually a majority of owners can overturn those appointments and delegations thereby returning to practical owner liability. There is also a statute that allows for benefit enforcement proceedings, a proceeding for failure to create general public benefit or violation of duty (MCBL, § 102). However, these proceedings are voluntary, and any imposed consequences are prospective rather than punitive, and therefore may not be an effective deterrent of acting against social mission.
Practical owner accountability is vital, however it is important to keep in mind the limitations of imposing consequences. It may be difficult to gather enough votes to remove a director or manager, or the prioritization of flexibility may inhibit the ability to pursue legal action.
Legal Accountability
The last approach to accountability, legal accountability, is exercised through contracts, fiduciary duties, and regulatory mechanisms.
Contract
Utilizing contracts to allow consideration or prioritization of social mission has been used in practice for some time now, and it can be effective, especially for enterprises that are simply socially tolerant. However, for those that wish to prioritize social mission, relying on contracts comes with certain difficulties that may prove to make those contracts ineffective at enforcing social mission as a priority. The first difficulty is that the parties bound by a contract can change their minds. The contract can be amended or dissolved, or all parties can breach the contract in agreement. What once was a commitment to social good can change to something completely different as the preferences of owner changes.
Two additional difficulties that diminish the reliability of contract law to enforce commitment to social good is proving damages and causation. Enforcing a contract requires that the plaintiff prove financial, economic damages. If the plaintiff made money from the contract breach, proving damages will be extremely difficult. Even if the plaintiff suffered financial loss from a breach of contract, contract law requires proof of causation, and a defendant can blame the business model for financial losses rather than the breach of contract.
Legal accountability through contracts can and does work in some scenarios, especially as a moral matter, but it is not reliable as a mechanism for legal enforcement for the reasons mentioned above.
Fiduciary
Fiduciary accountability allows anyone who is owed fiduciary duty to pursue claims. Although damage still must be proven, damages need not be only monetary. If a manager of an enterprise that prioritizes a particular social benefit over owner value prioritizes profits for owners anyway, anyone to whom a fiduciary duty is owed may pursue claims. This, however, can be problematic when plaintiffs seek financial remedies, which would be hypocritical in the event of a financial windfall. Ideally, recovery should benefit the prioritized social benefit or the social enterprise as a whole without punishing the plaintiff for seeking to enforce the duty.
Fiduciary duty, when purposes are appropriately prioritized, can be a powerful mechanism to ensure the prioritization of social good, however it is not clear when fiduciary duties apply to social good in existing business structures. Decision makers have a fiduciary duty, perceived or actual, to owner value in traditional businesses, and to charitable purposes in 501(c)(3) organizations. Traditional businesses that modify priorities with contracts seem to displace fiduciary duties with contractual duties. Since benefit and social purpose corporations prioritize flexibility, a breach of fiduciary duty would be difficult to prove unless certain interests or stakeholder were not considered in the decision-making process. Fiduciary accountability exists more prominently in L3C entities which explicitly prioritize charitable purposes over shareholder value. Given these observations, fiduciary duty through existing legal forms does little to provide legal accountability, except for in charitable organizations and arguably in L3C entities. Even then, the fiduciary duty is to specific charitable purposes rather than broader social good more generally.
Regulatory
Social enterprises still have to adhere to the myriad of laws that apply to traditional businesses such as consumer protection, IP, employment discrimination, environmental, securities, tax, etc. Regulators may be able to enforce future actions, undo previous actions, dissolve the entity, and/or hold owners personally responsible for the enterprise’s liabilities if a breach is egregious enough. Unfortunately, when flexibility is prioritized, when purposes are prioritized through contracts, or when fiduciary duties have room for interpretation, which is normally the case in social enterprises, regulators will likely not be able to enforce social good as a priority unless there is an intentional misleading of others or a pursuit of personal interests over others who are owed a fiduciary duty.
Accountability with Regard to Process vs. Outcomes
Legal accountability, in all business forms previously mentioned, is only enforceable to decision-making processes, and not to particular outcomes. This is justified given that if it was the other way around there would be a disincentive for people to participate in organizations that prioritize social good. Legal liability can be enforced if an outcome provides evidence for a decision maker wrongfully prioritizing purposes, but poor outcomes themselves are not grounds for legal accountability.
Outcomes do, however, matter for public and practical owner accountability. Owners expect certain outcomes, and the people they entrust to deliver those outcomes are held to account accordingly. A majority of owners can replace decision makers that do not meet expected outcomes or impacts. Public perception of an entity is affected greatly by outcomes and impact. The behavior of employees, customers, contractors, the media, suppliers, etc. can all be shaped by outcomes.
Conclusion
Different business forms prioritize purposes in different ways, and accountability, whether public, practical, and legal, applies to each form in unique ways. If the ultimate goal is to ensure that an enterprise is committed to social good over owner value, it is not clear that any existing business form and accompanying strategy is sufficient. The emergence of new social business forms that prioritize flexibility of purposes have provided an alternative to shareholder value maximization, however there is still no business form that formally prioritizes social good over owner value with consistent, meaningful accountability to that priority. The “social primacy company” discussed in the article could be one way of addressing that gap, in part by statutorily imposing a fiduciary duty to prioritize social good over shareholder value when they come into conflict.
References & Additional Resources
- Susan Mac Cormac. “Corporate Forms for Social Enterprises.” Morrison & Foerster. https://www.mofo.com/resources/video-audio/161019-corporate-forms-for-social-enterprises.html.
- For an in-depth summary of the positions pro and con regarding profit maximization, see John Tyler, Evan Absher, Kathleen Garman, and Anthony Luppino, “Producing Better Mileage: Advancing the Design and Usefulness of Hybrid Vehicles for Social Business Ventures,” 33 Quinnipiac Law Review 235, 274-278 (2015) https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2585755.
- Feldman, Sandra. “What Is an L3C (Low-Profit Limited Liability Company): An Entity for Entrepreneurs Who Value Purpose and Profits”, Wolters Kluwer. March 3, 2020. https://ct.wolterskluwer.com/resource-center/articles/what-is-l3c-low-profit-limited-liability-company
- “Model Benefit Corporation Legislation”, BenefitCorp.net, April 17, 2017. https://benefitcorp.net/sites/default/files/Model%20benefit%20corp%20legislation%20_4_17_17.pdf
- Corporate Codes, California Law, California Legislative Information. https://leginfo.legislature.ca.gov/faces/codesTOCSelected.xhtml?tocCode=CORP&tocTitle=+Corporations+Code+-+CORP
Related Resources on ImpactTerms.org
- Social Enterprise
- Including Mission in the Statement of Corporate Purpose
- Balancing Purpose and Profit