Flexible Purpose Corporation: California’s New Corporate Form

Beginning January 1, 2012, California will be the first state in the country to authorize Flexible Purpose Corporations (FPC)— a new corporate form that will allow a corporation to integrate the for-profit philosophy of the traditional corporation with a special purpose mission that is similar to a charitable purpose.  As authorized through the Corporate Flexibility Act of 2011 (SB 201), California companies will have greater flexibility to combine profitability with a broader social or environmental purpose.  Entrepreneurs and investors will have the opportunity to organize a company to pursue both economic and social objectives, allowing investors to have multiple or blended objectives.

Under the traditional for-profit corporate form, directors have the fiduciary duty to shareholders to maximize profits and promote the long-term value growth for shareholders.  A company could engage in actions that resulted in societal or environmental benefits so long as those actions were pursued for the benefit of shareholder returns.  However, the traditional model portends potential risk for directors if the actions pursued by the board are not aligned with the corporation’s purpose or objective to maximize shareholder value. Decisions by directors are often afforded the business judgment protection—a legal presumption that a corporate fiduciary has endeavored in good faith to exercise care in pursuing the corporation’s interest.  The business judgment presumption gives directors discretion in deciding how to pursue a corporate objective; however, the board could still face liability if there is no rational basis for the action in light of the corporation’s purpose.  To avoid the potential liability risks, directors under the traditional corporate form tend to pursue risk-averse actions and forgo decisions that could result in mixed benefits to society and shareholders.

In response to the need for a new corporate form, the California Working Group for New Corporate Forms (the “Working Group”) drafted and sponsored legislation to amend the California Corporations Code to include the FPC.  The legislation that created the new form, SB 201, was introduced by Senator DeSaulnier in 2011, approved by the legislature, and signed into law by Governor Jerry Brown on October 9, 2011.

“In the mainstream corporate world, traditional corporations are becoming more engaged on social and environmental issues.   While companies are moving towards embracing a more sustainable mission, the natural evolution of corporations is not occurring fast enough,” said Susan Mac Cormac, partner in the Corporate Group of Morrison & Foerster and member of the Working Group.  “California’s new FPC is a major development that supports and encourages the convergence of business profitability and sustainability, allowing corporations to positively impact society and the environment while providing returns to both impact and mainstream investors.”

The Corporate Flexibility Act of 2011

The Corporate Flexibility Act of 2011 will allow companies to be formed or converted into a FPC in order to pursue one or more purposes.  Specifically, the new corporate form will allow companies to engage in one or more of the following purposes:

1. One or more charitable or public purpose activities that a nonprofit public benefit corporation is authorized to carry out.

2. The purpose of promoting positive short-term or long-term effects of, or minimizing adverse short-term or long-term effects of, the FPC’s activities upon any of the following: the FPC’s employees, suppliers, customers, and creditors; the community and society; or the environment.

As specified in the Act, the articles of incorporation and share certificates must include the “special purpose” and must state that the company is taking the FPC corporate form.  Included in the articles, directors can specify the duration of the FPC’s existence and can limit or restrict the business of the FPC so long as those limitations are aligned with the stated special purpose.

Existing corporations can merge or convert from an existing traditional corporate form to FPC.  However, such merger or conversion will require approval by an affirmative supermajority two-thirds vote of shareholders, except in the case of a merger from one FPC into another FPC with a similar special purpose.  Any merger or reorganization that significantly alters or eliminates an existing FPC’s special purpose, and any decision by another business entity to convert into an FPC would also require a supermajority two-thirds vote.  In other words, the FPC is not permitted to change its stated special purpose without a two-thirds vote of each class of voting shares.

Under the new corporate form, directors of a FPC may consider the short-term and long-term prospects of the FPC, the best interest of the FPC and its shareholders, and the purposes of the FPC as stated in the articles of incorporation.  Directors who perform their duties according to the provisions in the Act will not be liable for any alleged breach of fiduciary duties.

“The FPC is fully integrated with the existing California Corporate Code and is primarily intended for use by small and large (private and public) for-profits companies seeking access to traditional capital markets.  The enhanced protection under the FPC seeks to unlock creative opportunities by eliminating blended value risks, yet also remaining consistent with other aspects of traditional corporate law,” said Ms. Mac Cormac.  “The FPC not only allows existing large for-profit corporations to convert in order to better accomplish their goals, but also allows entrepreneurs seeking traditional investment capital to benefit from statutory certainty when creating their start-up.”

California is the first state in the country to authorize the creation of a FPC, but other states such as Illinois, Michigan, Utah, Vermont, and Wyoming have enacted statutes allowing for the creation of for-profit corporations with a primary charitable purpose.  California also enacted legislation allowing for the creation of a Benefit Corporation (AB 361)—a corporation formed for the purpose of creating a general public benefit as assessed against a third-party standard.   The two new corporate forms will be available in California starting January 1, 2012.