It has been a little over three years since Vermont became the first state in the country to recognize the low-profit limited liability company (L3C) as an official legal structure on April 30, 2008. Since then, other legal forms such as the Benefit Corporation and the Flexible Purpose Corporation (proposed in California) have started to share the growing spotlight on new hybrid entities. Benefit Corporation legislation, first passed in Maryland on April 12, 2010, has now been passed in 5 states, and California’s Flexible Purpose Corporation legislation is expected by many to pass this year.
In some respects, the L3C movement continues to have significant momentum. For example, as of July 29, 2011, interSector Partners, L3C estimated approximately 427 L3Cs have been organized nationwide.
Additionally, the number of state legislatures enacting L3C laws continues to increase (though at a slower rate than some had anticipated). Currently, L3C legislation has been adopted in 9 states and 2 federal jurisdictions:
- Vermont – effective April 2008 (H.0775)
- Michigan – effective January 2009 (SB 1445)
- Wyoming – effective February 2009 (HB 0182)
- Utah – effective March 2009 (SB 148)
- Illinois – effective January 2010 (SB 0239)
- North Carolina – effective August 2010 (SB 308)
- Louisiana – effective August 2010 (HB 1421)
- Maine – effective July 2011 (LD 1265)
- Rhode Island – effective starting July 2012 (HB 5279)
- Oglala Sioux Tribe – effective July 2009 (Ordinance 09-23)
- Crow Indian Nation of Montana – effective January 2009 (CLB 09-02)
According to a table compiled by Carter G. Bishop, Professor at Suffolk University Law School, L3C legislation is also pending in an additional 15 states* as of May 26, 2011:
- Alabama – SB517
- Arkansas – SB5
- Arizona – SB1503
- California – SB 323
- Georgia – HB 594
- Hawaii – SB674
- Iowa – SF158
- Indiana – SB 0501
- Kentucky – HB 110
- Maryland – HB 552, crossfiled with SB 209
- Massachusetts – H.1868
- Montana – HB 415
- New York – S 3011, crossfiled with A 116
- Oklahoma – HB 1088
- Oregon – HB 2745
* The 16th state bill listed in the table, Rhode Island HB 5279, was signed into law in June of this year.
In other respects, the L3C movement continues to hit snags that have presented obstacles for its proponents since the beginning. For example, L3C initiatives at the federal level have been relatively stagnant since our last post on the topic in May 2009. There, we discussed that program-related investments (PRIs) are historically underutilized and the practice of many private foundations that make PRIs is to seek private letter rulings (PLRs) for assurance that such investments qualify as a PRI. Such PLRs can only be relied upon by the taxpayer that requested it. Thus, many proponents of the L3C were hoping to secure a blanket-PLR or some guidance with broader applicability from the IRS or Congress specifically on the L3C as a qualifying PRI. However, this proposal as it was initially presented in the Program-Related Investment Promotion Act of 2008 was not successful in producing new federal legislation or IRS rulings. The most recent attempt, the Philanthropic Facilitation Act of 2010, has similarly not resulted in any federal action.
Additionally, proposed L3C legislation on the state level has faced opposition by some groups. For example, three committees of the American Bar Association indicated an intent to lobby state legislators to oppose any new L3C authorizing legislation. This prompted the release of a recent letter to the chairs of those committees (with a copy to well-known L3C critic, Daniel S. Kleinberger, Professor at William Mitchell College of Law) in which attorneys Marcus S. Owens, William M. Klimon, Diara M. Holmes, and Sharon Weinberg Nokes of Caplin & Drysdale, Robert A. Wexler, Betsy Buchalter Adler, and Rosemary E. Fei of Adler & Colvin, and Richard Schmalbeck of Simpson Thatcher & Bartlett responded to certain criticisms by those committees, namely the concern over its necessity as a new business structure, potential for private benefit, and the significant charitable purpose but “low-profit” relationship. The authoring attorneys responded with four main points, summarized, in part, here:
- While the L3C is not necessary for a private foundation to make a PRI to a limited liability company (LLC), the “L3C” designation is an identifier signifying certain legal restrictions that will make it easier for private foundations to conduct due diligence.
- The concern about private benefit is not specific to an L3C as any PRI made to an organization other than a charity always involves some level of private benefit. An analysis of private benefit must look at all of the facts and circumstances to determine whether the private benefit is a disqualifying private benefit (i.e., impermissible) or incidental to the accomplishment of charitable purposes (i.e., permissible). Tranched financing does not in and of itself result in a disqualifying private benefit and furthermore is neither required by nor part of L3C legislation.
- There is no contradiction in prohibiting the production of income to be a significant purpose while also labeling the company as “low-profit” and allowing the involvement of for-profit investors. Profit as a result does not alone equate with profit as a significant purpose; other factors must exist to conclude the production of income is a significant purpose of the company.
- While new legal structures are not “necessary” for businesses to pursue social motives, there are benefits for adopting a standard structure (e.g., signifying brand or purpose to the public) and it is entirely appropriate for states to adopt such legislation.
Many of the current debates surrounding the L3C, while raising important considerations, are heavily academic discussions based on hypothetical situations or theoretical applications of the law because the L3C is a relatively new legal concept. These answers might only come with time as L3Cs actually test the applicability of current laws, thereby resulting in a body of regulations and judicial interpretations that may help answer these questions more definitively and comprehensively.
There have already been, however, case studies on the L3C such as the August 2010 research paper “Vermont's Social Hybrid Pioneers: Early Observation and Questions to Ponder” by Elizabeth Schmidt, Associate Professor at Vermont Law School, in which she surveyed some of early adopters of the L3C in Vermont. Interestingly, Professor Schmidt observed that although the hope of receiving PRIs was the most commonly listed reason by these entrepreneurs for pursuing an L3C form, the need to create a “for profit with a nonprofit soul” was the most important factor in their decisions to form L3Cs among the reasons they had listed. Thus, while the utility of the PRI for an L3C is often a main focal point for academic debates among lawmakers, regulators, and other practitioners, it is still unclear how much this will affect L3C entrepreneurs in practice, or whether other motivators such as flexibility, control, halo effect, mission fit, and the cutting edge factor will translate into healthy, viable, mixed-motive L3C operations despite lacking a formally issued stance by the IRS or Congress.
Accordingly, three years later, it cannot be said with certainty what will become of the L3C. Similar to other new hybrid entities, there is still a need for greater awareness, education, and understanding about the L3C before it can reach its potential, but the conversations certainly become richer and more abundant with each year.
For a short explanation of the L3C, please read our post, “L3C – Low-profit Limited Liability Company.” Our brief summary on L3C developments and resources (updated as of May 5, 2009) is available here.
The Citizen Media Law Project also provides resources on forming an L3C in various states here.
Some of Professor Kleinberger's articles on the L3C are available for download here.