California Social Purpose Corporation: An Overview

Published on: by Michele Berger Category:CALIFORNIA LAW, SOCIAL ENTERPRISE 2 Comments

The social purpose corporation is one of two “hybrid” corporate forms in California that provide alternative business entity options to entrepreneurs who want to combine profitability with broader social and environmental objectives (the other is the benefit corporation). Formerly known as the flexible purpose corporation, the social purpose corporation requires directors to consider socially responsible purposes, in addition to shareholder interests, when making business decisions.

Special Purposes

In addition to engaging in any lawful business purpose, the social purpose corporation must set out one of the following special purposes in its articles of incorporation:

  • One or more charitable or public purpose activities that a nonprofit public benefit corporation is authorized to carry out.
  • The purpose of promoting positive effects of, or minimizing adverse effects of, the social purpose corporation’s activities upon any of the following, provided that the corporation consider the purpose in addition to or together with the financial interests of the shareholders and compliance with legal obligations, and take action consistent with that purpose:
    • The social purpose corporation’s employees, suppliers, customers, and creditors.
    • The community and society.
    • The environment.

Fiduciary Duties

While directors of any corporation must fulfill their fiduciary duties of care and loyalty to the corporation, directors of the social purpose corporation must also consider and give weight to additional factors, as they deem relevant, including the overall prospects of the corporation, the best interests of the corporation and its shareholders, and the purposes of the corporation, as set forth in its articles of incorporation.

Reports

Annual Report – The board must produce and send to its shareholders an annual report, containing a management discussion and analysis (the “special purpose MD&A”), along with standard corporate financial statements. The special purpose MD&A must, among other things, identify and discuss (1) material actions taken to achieve the corporation’s special purpose throughout the fiscal year, (2) the impact of such actions, including the causal relationships between the actions and the reported outcomes, and (3) the extent to which those actions achieved the special purpose objectives for the fiscal year. It must be made publicly available on the corporation’s website.

Current Report – In addition to the annual report with the special purpose MD&A, shareholders of a social purpose corporation must receive a special purpose current report within 45 days of any (1) significant expenditure in furtherance of the corporation’s special purposes, (2) withholding of expenditures in furtherance of the corporation’s special purposes, or (3) a determination that a special purpose has been satisfied or should no longer be pursued. Such reports must also be made publicly available on the corporation’s website.

Major Changes

Amendment to Articles– Any amendment that changes the special purposes of the corporation can only be approved with an affirmative vote of at least two-thirds of the outstanding shares of each class, or a greater vote if required by the articles.

Conversion/Merger– Similar to the requirements for an amendment, any reorganization that materially alters or eliminates the corporation’s special purposes requires the vote of at least two thirds of each class of outstanding shares, or more if required by the articles. These supermajority voting rights function as substantial control for even minority shareholder groups.

Derivative Actions – Any shareholders of the social purpose corporation may maintain a derivative lawsuit to enforce the duties required of the directors of the corporation.

Why Would You Form a Social Purpose Corporation?

Instead of a Nonprofit Corporation – If you are seeking investors and equity capital and/or have a plan that is inconsistent with tax exemption under IRC Section 501(c)(3).  In order to establish and maintain tax exemption under 501(c)(3), a nonprofit corporation must be primarily operated for a  charitable or other exempt purpose. If an organization plans to engage in activities that are in direct competition with for-profits, or operate in a manner that is too commercial with respect to pricing, marketing methods, sources of revenue, staffing, and use of surpluses, then a social purpose corporation may be a better choice of form. Additionally, in contrast to a nonprofit corporation, a social purpose corporation is not subject to prohibitions on private inurement or private benefit; self-dealing rules; restrictions on lobbying or political campaign activities; or 501(c)(3)-like public disclosure requirements.

Instead of a Regular (For-profit) Corporation – If you want to market the corporation’s goods and services as a social business, attract capital from social investors (including foundations), and anchor your social mission even after you exit from the ownership. For-profit corporations traditionally are organized to pursue the interests of their shareholders above all other interests. While the business judgment rule may provide broad flexibility for board members to consider other interests, this may not be true in the event of a sale of the corporation. In such event, the Revlon Rule generally provides that the board must approve a sale to the highest bidder without consideration of other factors.

Instead of a Benefit Corporation – If you want more flexibility than is provided by a California benefit corporation. A benefit corporation’s directors must advance a “general public benefit,” and must also consider a number of stakeholders, including shareholders, employees, subsidiaries, suppliers, customers, and the community, as well as the local and global environment. A social purpose corporation must only take into account its shareholders and its special purposes, as stated in its articles of incorporation. Accordingly, board members of a social purpose corporation may have fewer considerations when making decisions and less risk of liability for failure to consider required factors.

Concluding Thoughts

Although the social purpose corporation may be an attractive option for entrepreneurs who want to emphasize social impact as one of the core missions of their business, the adoption rate of the social purpose corporation has been slow. According to the California Secretary of State’s Office, since its introduction in 2012, there have been only 68 flexible purpose corporations and 9 social purpose corporations formed (as of 10/16/15).