White and Williams LLP

My colleague, John McCarrick, an expert on director and officer responsibility, recently gave a talk about emerging issues in D&O liability and discussed the impact of the ESG movement. ESG is an acronym for Environmental, Social and (Corporate) Governance. The movement asks business enterprises to extend their purview beyond financial success to address issues of public concern, such as global warming or racial injustice. John was asked by a program participant whether the ESG movement might force more companies to reorganize as public benefit corporations (PBCs).

I last wrote about PBCs with my colleague Marc Casarino in 2013 when Delaware became the 19th state to permit the formation of PBCs. Today PBCs are permitted in 37 states, plus the District of Columbia. Unlike the regular business corporation which is governed by its directors to serve the best interest of its shareholders, a PBC is a for-profit entity organized to produce a public benefit and to operate in a responsible and sustainable manner. Using as example the Delaware law, public benefit means a positive effect (or reduced negative effect) on persons, entities, communities or interests (other than stockholders) of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific, technological or similar nature. The PBC is required to be managed in a manner that balances the stockholders’ pecuniary interests, the best interests of those materially affected by the corporation’s conduct and the public benefit for which it has been formed.

The PBC format has attracted a few poster children, such as Patagonia and Kickstarter. There are three PBCs that are publicly traded: Laureate Education, Lemonade and Vital Farms. One publicly-traded company, Veeva Systems, a cloud solutions enterprise, has recently announced that it is exploring converting to a PBC. There are now several thousand PBC structured companies according to B Lab, a non-profit which advocates for the model and also provides a “B Corp” certification. Still, by comparison, the State of Delaware alone formed 225,000 business enterprises just in 2019. PBC’s unicorn status is still safe.

If the ESG movement has legs, then the push to the PBC may be coming. Years of legal precedent obligate the directors of a business enterprise to base their decisions solely on the interests of the stockholders. There have been some narrow exceptions, such as when a business is on the edge of insolvency, but the exceptions are rare. A fossil fuels energy company that moves toward renewable sources of energy can claim for publicity purposes that the move is an effort to counter global warming. But the board decision has to be based upon profit (e.g., the fossil fuel markets will shrink over time and renewables are the where the company will find growth and profits). Similarly, a consumer-facing company can boast that racial justice is at the forefront of its thinking, but in the board room the conversation has to be more cynical. Perhaps supported by an argument that the effort for social justice will attract customers and sell more products.

The PBC structure brings ESG issues into the daylight of board consideration. The business is organized with the stated objective of balancing both business issues and public benefit issues. The status of the PBC is publicly declared in the company charter, in its notices to shareholders and even on its stock certificates (although this requirement is less meaningful in a digital age). Since financial statements will not show how a PBC is doing at achieving its public interest goals, some states such as Delaware impose a separate reporting requirement.

At least every other year, the corporation must provide its stockholders with a statement of the objectives the board of directors has adopted to promote the public benefit, the standards the board has adopted to measure progress, objective factual information based upon those standards regarding the corporation’s success and an assessment of that success by the board. There is also some thought that the PBC may prove an antidote to the compulsive quest for quarterly results exhibited by reporting companies. If earnings per share are not the only corporate objective perhaps they would diminish in importance.

I recall that when the first few limited liability companies (LLC) were formed, and only one state had authorized them, I along with thousands of other attorneys looked on in amazement. How would this work? How would the IRS treat them for tax purposes? We wondered if this new concept would ever take hold. Gradually more jurisdictions recognized them and the LLC found its place in the Internal Revenue Code. Last year, in fact, 73% of the business entities formed in Delaware were LLCs. I also remember a time when it was common to ask if someone had a fax machine (an interim technology between parchment and email) until that question changed to “What is your fax number?” Similarly, at first we were asked if we had email…until that shifted to “What is your email address?”

Perhaps we are at a turning point in the evolution of business enterprise. A transition point after which the notion that business should only be concerned about wealth creation for its shareholders will seem old fashioned and limiting. Maybe at some time in the future, the PBC will be the preferred form of business enterprise and what we call the business corporation will be relegated to smaller closely-held companies.

When Marc and I wrote about PBCs in 2013 we concluded with these questions: Will this new form of business entity capture a tide of cause-related capital? Will a significant number of investors be willing to support an enterprise that is managed to achieve something in addition to return on investment? Will investors value doing good as much as doing well? Seven years later the questions remain, but the answers appear to be closer.

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