Kyle Westaway & Dirk Sampselle, the Benefit Corporation: an Economic Analysis With Recommendations to Courts, Boards, and Legislatures

• Jurisdiction: United States,Federal
• Publication year: 2013
• Citation: Vol. 62 No. 4

THE BENEFIT CORPORATION: AN ECONOMIC ANALYSIS WITH RECOMMENDATIONS TO COURTS, BOARDS, AND LEGISLATURES

Kyle Westaway* Dirk Sampselle**

INTRODUCTION 1001

1. A Brief History of Corporate Governance Theory and Law 1002

   1. Corporate Governance Norms and the Ends of Business .. 1004

   2. The Role of Delaware in Shaping the History of Corporate Governance 1008

2. Why the Benefit Corporation Was Created and Adopted 1010

1. DELAWARE CORPORATION FIDUCIARY DUTIES AND CORPORATE GOVERNANCE 1014

   1. Derivative and Direct Suit Mechanics 1015

      1. Pleading a Direct Claim 1016

      2. Derivative Actions and the Demand Requirement 1018

      3. Pleading a Derivative Action 1020

      4. The Delaware Pleading Standard 1022

   2. Fiduciary Duties: General Principles and “For-Benefit” Contours 1022

      1. The Duty of Loyalty 1023

      2. The Duty to Act in Good Faith 1024

      3. The Duty of Care 1025

      4. The Doctrine of Corporate Waste 1026

         
         

         * Kyle Westaway believes in the power of the market to create a positive social and environmental change. He is a Lecturer at Law on Social Entrepreneurship at Harvard Law School. He is a cofounder of Biographe—a sustainable style brand that employs and empowers survivors of the commercial sex trade in Bangkok. Kyle is the Founding Partner of Westaway Law—an innovative law firm that counsels social entrepreneurs on the leading edge of the movement at every stage of growth from startup to acquisition. Westaway is the author of Profit & Purpose (Wiley) and founder of socentlaw.com—the first blog on social enterprise law.

         ** Dirk Sampselle, JD, MBA, is founder of B Revolution Consulting, a national consulting firm dedicated

         to helping companies earn the B Corporation certification. A nationally recognized expert in the benefit corporation legal entity and business strategy for B Corporations, Dirk is a drafting author of B Lab’s Benefit Corporation White Paper, a legislative memorandum used to educate legislatures on the benefit corporation legal form. He regularly counsels early- and growth-stage companies on how to achieve high performance on the B Corporation certification. He earned his JD and MBA as a Dean’s Scholar at Pepperdine University in Malibu, CA.

      5. The Duty to Be Informed 1028

   3. Fiduciary Duties: Lifecycle Analysis 1029

      1. Day-to-Day Activities 1029

      2. Bidder Activity and Unsolicited Bids 1030

      3. Defensive Measures 1031

2. THE BENEFIT CORPORATION STATUTES 1032

   1. Key Features 1032

      1. Statutory Positioning 1032

      2. General Public Benefit Purpose 1034

      3. Specific Public Benefit Purpose 1034

      4. Purpose Positioning 1035

      5. Annual Reporting and the Third-Party Standard 1037

   2. Pleading a Direct or Derivative Claim for Failure to Consider 1039

      1. Litigation Incentives: Undermotivation 1040

      2. Litigation Incentives: Overmotivation 1041

      3. Stating a Harm 1042

      4. Remedies for Breach of the Duty to Consider 1043

3. RECOMMENDATIONS 1046

   1. Recommendations to Courts 1046

      1. General Public Benefit: Ambiguity 1046

      2. General Public Benefit: Duties 1050

      3. Purpose Structure 1053

      4. Benefit Enforcement Proceeding: Substantial Purpose Analysis 1055

      5. Benefit Enforcement Proceeding: Standard of Scrutiny 1058

      6. Benefit Enforcement Proceeding: Defensive Measures 1062

      7. Benefit Enforcement Proceeding: Pleading Harm and Other Pleading Dilemmas 1063

      8. Evaluating Monetary Damages for Injuries Flowing from

         Boards’ Failure to Consider the Mandated Stakeholder Constituencies 1064

      9. Additional Implications: The Duty of Care 1067

   2. Recommendations to Boards 1071

      1. Maintaining the General Public Benefit Purpose 1071

      2. Specifying Public Benefit Purposes 1073

   3. Recommendations to Legislatures 1073

      1. Do Not Adopt the New York Model of General Public Benefit Primacy 1073

      2. Do Not Adopt the California Model of Choice-of-Law Cannibalization 1075

      3. Strike “As” from the General Public Benefit Language 1077

      4. Eliminate the Public Comment Period Limitation to Require Open Commenting 1078

      5. Adopt the Benefit Corporation 1079

INTRODUCTION

Formal rules can complement and increase the effectiveness of informal constraints. They may lower information, monitoring, and enforcement costs and hence make informal constraints possible solutions to more complex exchange. Formal rules also may be

enacted to modify, revise, or replace informal constraints.1

The benefit corporation legislation can be seen as a system of new formal rules, which at once seeks to complement and increase the effectiveness of the “corporate social responsibility” and “sustainable business” trends, and also disrupt the longstanding, informal constraint of shareholder wealth maximization. This legislation is designed to reduce transaction costs for both consumers and investors who subscribe to the “ethical consumer” and “impact investing” trends, respectively. This Article offers an analysis that describes key challenges of the legislation and prescribes some best-guess answers for how to address such challenges.

In so doing, this Article begins with a brief analysis of the history and norms of corporate governance—the dominant paradigms of thought and theories of corporate existence—and discusses how they gave rise to the benefit corporation. It then analyzes the predominant views on corporate governance today, institutionalized in that venerable State of Delaware’s statutes and precedents. The Article then critically analyzes the benefit corporation’s key elements and poses key questions that create uncertainty for courts to resolve. The Article concludes by describing how courts might optimally resolve these uncertainties and defining some processes and procedures that boards of directors may use to mitigate exposure. It also makes some recommendations to legislatures regarding whether to adopt certain provisions, and it ultimately recommends that legislatures pass this legislation for a litany of reasons, the most important of which is that the legislation

1. DOUGLASS C. NORTH, INSTITUTIONS, INSTITUTIONAL CHANGE AND ECONOMIC PERFORMANCE 46–47

   (1990) (citation omitted).

   creates an opportunity to develop needed changes to the corporate governance architecture in order to reduce transaction costs in the long run, and it facilitates this new form of corporate governance, which addresses the rising demands of today’s markets.

   
   

   A. A Brief History of Corporate Governance Theory and Law

   
   

   Since Ronald Coase penned The Nature of the Firm in 1937,2 legal scholars and economists have debated the theory of the firm and essentially addressed two key questions: (1) what are the means of corporate governance (i.e., who owns the decision-making power); and (2) what are the ends of corporate

   governance (i.e., whose interests should prevail)?3 Formulations of answers to

   the former can be categorized into the following camps: shareholder primacy (stating that shareholders own the corporation and directors and officers are mere fiduciaries of the shareholders’ interests); the contractarian model (stating that shareholders are only one of several factors of production wound together in the contracts of the firm, but directors and officers are contractual agents of the shareholders); and managerialism (stating that a corporation is a bureaucratic hierarchy with autonomous professional managers who may

   pursue whatever interests they choose, and shareholders are nonentities).4

   Formulations of answers to the latter may be categorized into two camps: stakeholderists, who claim that directors and officers ought consider all corporate constituencies in corporate decision making, and shareholder- primacy advocates, who, while claiming that shareholders are the proper owners of the corporation, also claim that shareholders are the proper beneficiaries of director and officer fiduciary duties.5 The director-primacy

   theory of the firm arose within the last decade and posits that boards of directors—not shareholders or managers—control the corporation, and it also asserts that shareholders are the appropriate beneficiaries of director fiduciary duties, and that directors ought to be accountable for maximizing shareholder wealth.6 Proponents of stakeholder interests typically assert that corporate governance should be treated as a subject of public law and that the separation

   of ownership and control requires regulation in order to achieve public

   
   

2. R. H. Coase, The Nature of the Firm, 4 ECONOMICA 386 (1937).

3. Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 NW. U. L. REV. 547, 549–50 (2003).

4 Id. at 547–48.

5 Id. at 547–49.

1. Id. at 550.

   
   

   outcomes unrelated to private profitability.7 Proponents of shareholder wealth maximization, unsurprisingly, view corporate governance as a subject of private law such that the separation of ownership and control does not justify state intervention.8

   
   

   While many corporations are not subject to a separation of ownership from control today,9 the predominance of that separation throughout the development of corporate governance law has greatly influenced its present state.10 Corporations at the time of the American Revolution were almost exclusively public or semi-public in nature (e.g., formed for the purpose of building a public good, like a canal or railroad, not “public” in the “publicly held” sense that public corporation has come to mean today).11 Grants of limited liability for the operators of these businesses came by royal charter or special legislative act, but generally, even these semi-public corporations were subject to English company law, which did not grant limited liability.12 In the eighteenth century, the law of joint stock companies was developed through common law, which denied limited liability to shareholders,13 and the Bubble Act of 1720 made it a criminal offense for an unincorporated company to presume to act as a corporation.14 Around 1844, English corporations law and

   
   

2. Id. at 549.

3. Id.

4. Closely held corporations constitute over 99% of the corporations in the United States. See ROBERT T. SLEE, PRIVATE CAPITAL MARKETS: VALUATION, CAPITALIZATION, AND TRANSFER OF PRIVATE BUSINESS

   INTERESTS 27 (2d ed. 2011). In closely held corporations, shareholders are typically able to exercise a great deal of control over the management team and affairs of the company, and for the...