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Alternative business organizations and social enterprise
Dana Brakman Reiser*
Despite Milton Friedman’s famous quip that “the social responsibility of business is to increase its profits” (Friedman 1970), many businesses seek to improve society, help the less fortunate, and be responsible corporate citizens (CECP 2014; Brakman Reiser 2009). These efforts have a long history; the earliest corporations were chartered with social or community-oriented goals at their center (Rana 2013). Some foundations created with wealth generated by large companies have become household names, like the Ford, Rockefeller and Gates Foundations. But corporate charitable activity is not limited to these legendary scions.
Businesses pursue social and environmental goals in different ways, depending on their size, orientation and public exposure. Philanthropy is often an important part of these efforts (Brakman Reiser 2009). Cash and in-kind donations to local, national and international charities from 272 companies surveyed, including 62 of the top 100 companies in the Fortune 500, totaled over $24 billion in 2015 (CECP, Giving in Numbers 2016). Some rely on separately-incorporated nonprofit foundations, which have their own boards of directors and can make grants out of income on their endowment on an extended time horizon. Many, including even very small businesses, simply contribute funds or in-kind donations to charities directly.
Depending on a company’s goals for its philanthropic activity, it may focus on local charities or ones that complement its business model in some way. Employee-matching programs and cause-related marketing campaigns even endeavor to align a company’s philanthropy with the charitable interests of its employees or customers, respectively. In whatever way a business structures its philanthropy, these efforts are generally tax-favored and offer additional public relations and marketing benefits.
In addition to philanthropy, many large and especially multinational companies devote significant resources to corporate social responsibility (CSR). Corporate social responsibility is a company’s efforts to integrate social and environmental concerns into its business operations (Schwab 2008). Corporate social responsibility programs may spur innovation within a company to make it a more positive force in society. These programs have initiated changes in companies’ supply chains, manufacturing processes, employee relations and a variety of other activities (Brakman Reiser 2009). Although sometimes expensive, these efforts can provide both short-term public relations value and long-term savings for the companies that undertake them.
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Philanthropic contributions and corporate social responsibility efforts are sufficient to meet the desires of many businesses to pursue social or environmental goals along with their profit objectives. A growing number of entrepreneurs, business managers, and investors, however, want to create businesses with even greater social and environmental commitments (Brakman Reiser and Dean 2017). Many names are used to describe these businesses, including “for-benefit companies,” “blended enterprises,” and “mission-driven businesses.” This chapter refers to these firms as “social enterprises,” defined here as businesses that integrate profit-making goals and a social mission in a single for-profit entity.
An entire chapter could have been devoted to exploring the term “social mission” or indeed the word “social” itself. Some would argue all businesses have a social mission, as they produce goods and services that benefit society, provide opportunities for gainful employment and contribute to the tax base. Other views of what is social and what is a truly social mission will be far narrower, focused on each person’s conception of the good—which conceptions can conflict with each other. Rather than wade too deeply into this philosophical quandary, this chapter takes its definition of “social mission” as serving interests and constituencies beyond those of investors in the enterprise.1 Such groups include, but are not limited to, employees, customers, a local community, the environment, and society at large. Social enterprise, thus defined, has grown substantially across the globe in recent years (Defourny and Nyssens 2010; Kerlin 2006). Early on, this growth was fueled by the success of microfinance, pioneered by Grameen Bank and others in Asia and Latin America (Defourny and Nyssens 2010). Today, entrepreneurs spanning many continents and myriad industries helm businesses that include a social mission as a key component of their business models.
This chapter is devoted to a particular development that has accompanied this growth of social enterprise in the United States and Europe: the creation of alternative organizational forms intended to be more hospitable to their dual aims than traditional for-profit or nonprofit ones. It begins by situating these efforts in the legal context of US and European law. With this background in place, the chapter will describe, compare and contrast several quite different new organizational forms launched in a variety of jurisdictions. Finally, it will assess how much support forms like these can provide to social enterprises and offer suggestions for reform.
Nonprofits
In the United States, organizations pursuing a social mission are frequently established as nonprofits. For US nonprofits of any substantial size, the most common legal form is the nonprofit corporation, though nonprofits can and do form as charitable trusts and many small and new nonprofits are unincorporated nonprofit associations (Fremont-Smith 2004). Nonprofit corporations share many features of their for-profit counterparts, and are governed by a board of directors subject to a charter and bylaws.
Despite these similarities, however, and even though social goals are part of what impels founders to create social enterprises, nonprofit forms will be unsuitable for these for-profit businesses. Perhaps most importantly, nonprofit organizations may not distribute their net earnings to those who control them (RMNCA 1987; I.R.C. § 501(c)(3)). This limitation has been styled the “nondistribution constraint” (Hansmann 1996). The nondistribution constraint prohibits equity share issuance; thus, nonprofit corporations must be financed through donations, earned revenue, and borrowing. This check on capital formation is a serious drawback to organizing a social enterprise as a nonprofit.
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Of course, there are potential benefits of nonprofit forms. In particular, US nonprofits can qualify to receive substantial tax benefits, such as federal income, estate and gift tax exemptions, state property tax exemption, and the ability to receive tax-deductible contributions from individuals and entities. In exchange for these benefits, however, comes a significant regulatory burden.
To be eligible for these tax benefits, a nonprofit must pursue charitable purposes. Permissible charitable purposes vary somewhat by jurisdiction, but most are similar to the federal tax system’s requirement of a “religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition . . . or for the prevention of cruelty to animals” (IRC § 501(c)(3)). Again, depending on the relevant tax benefit regime, pursuing non-charitable purposes is prohibited, limited, or otherwise triggers a loss of tax benefits. Entities found to be overly commercial may be ineligible for tax exemption, and even if entity-level exemption is maintained, income from unrelated business activities is taxed at regular rates (IRC § 511). Similarly, property owned by a nonprofit must be used for charitable purposes to be exempt from state property taxation (Brody 2002). In addition, federal and state tax benefits are accompanied by public reporting obligations and limitations on commercial and political activity (IRC § 501(c)(3); Fremont-Smith 2004). Unless a social enterprise will be financed largely through tax-deductible donations and will engage in few activities that stray beyond tax regulators’ notions of charity, nonprofit forms will be more hindrance than help.
For those developing social enterprises, defined again as businesses that integrate profit-making goals and a social mission in a single entity, for-profit choices in the US have until recently been limited to corporations, various kinds of partnerships, and limited liability companies. In the past several years, however, a number of new legal forms have been developed intended to house these social enterprises. These forms are in their infancy, and contain many features that will need improvement if they are to serve the needs of social enterprises better than existing ones.
Specialized forms for social enterprise
The first specialized form for social enterprise developed in the United States was the low-profit limited liability company, or L3C (Brakman Reiser 2010; Murray and Hwang 2011; Tyler et al. 2015). This form is a twist on the limited liability company (LLC), a for-profit form available across the US that offers adopters both limited personal liability and pass-through tax treatment (Tyler et al. 2015). Mandatory rules for LLCs’ governance are few, and adopting entities use an operating agreement to set ownership terms by contract (Tyler et al. 2015).
Legislation adopting the L3C form sits atop existing LLC legislation, but adds four special components. In the words of the first L3C statute, adopted in Vermont in 2008, an adopting entity “significantly further[s] the accomplishment of one or more charitable or educational purposes,” and “would not have been formed but for the company’s relationship to the accomplishment of charitable or educational purposes” (11 VSA § 3001 (27)(A)). In addition,
[n]o significant purpose of the company is the production of income or the appreciation of property; provided, however, that the fact that a person produces significant income or capital appreciation shall not, in the absence of other factors, be conclusive evidence of a significant purpose involving the production of income or the appreciation of property.
(11 VSA § 3001 (27)(B))
Finally, political and legislative purposes are barred (11 VSA § 3001 (27)(C)). If an existing L3C stops complying with the additional L3C components, however, it simply transforms into an ordinary LLC (11 VSA § 3001 (27)(D)). Moreover, L3Cs must self-monitor and enforce these mandates; no compliance regime is included in L3C legislation.2
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The components of L3C statutes in large part derive from another regime, US tax law’s regulation of “program-related investments (PRIs).” Program-related investments are a special category of expenditures available to private foundations, a subcategory of tax-exempt nonprofit organizations subject to a range of special rules (Internal Revenue Code (IRC) § 509). Principal among these is the requirement that private foundations make “qualifying distributions” equal to five percent of the fair market value of their net assets each year (IRC § 4942). Most qualifying distributions are grants to nonprofit, tax-exempt public charities. In contrast, PRIs may be loans, purchases of equity or other types of investments and may be made to for-profit entities, but also count toward the five percent floor (Brewer et al. 2014; Tyler 2010).
Of course, not just any investment in a for-profit is a PRI—only an investment meeting requirements almost precisely aligned with the four components of L3C law (US Treas. Reg. §53.4944-3)—and investing foundations are required to exercise additional oversight on such investments. In addition to counting toward the annual spending requirement private foundations must meet, PRIs are exempt from possible treatment as “jeopardy investments,” risky investments of the foundation’s assets that can lead to penalty excise taxes (IRC § 4944(c)). Incorrect PRI classification by a private foundation, however, runs the risk of very serious penalties. Thus, many private foundations have been hesitant to employ them (Murray and Hwang 2011), and some advisors caution doing so without obtaining a private letter ruling through lengthy and expensive Internal Revenue Service process (Bishop 2010).
The overlap of the L3C statute’s core components and the requirements for PRI treatment is deliberate. The creators of the L3C concept intended it to be an organizational form ready-made to receive PRIs. They hoped the IRS would bless investments in L3Cs as PRIs per se and thereby encourage the expansion of their use by foundations (Brewer et al. 2014; Lang 2014). Perhaps unsurprisingly, given the absence of any enforcement apparatus to ensure L3Cs comply with the PRI requirements, the IRS has not provided a blanket ruling or other assurance that investments in L3Cs will meet the PRI standards.
Although the IRS has not blessed the L3C as a PRI vehicle, the form enjoyed some success with state legislatures. Between 2008 and 2011 nine states adopted L3C legislation, following a pattern very similar to the initial Vermont statute (Americans for Community Development 2012). Since 2011, however, no new adoptions have appeared and North Carolina repealed its L3C statute (Brewer et al. 2014; Tyler et al. 2015).
This waning of the L3C’s popularity coincided with the arrival of another specialized form of legislation on the scene: the benefit corporation (Brakman Reiser 2013; Brakman Reiser 2011a). The benefit corporation, as its name suggests, is an incorporated legal form. While incorporated entities are also taxable as a matter of default under US law, they can qualify for pass-through treatment under Subchapter S (Eustice and Kuntz 2015). Many social enterprises, the lion’s share of which are small and have few owners, will have no difficulty doing so. Corporate shareholders enjoy limited liability, and corporate statutes set a few important mandatory rules and a somewhat sticky default framework for matters of governance. The benefit corporation statutes follow these patterns, but vary certain aspects of standard for-profit corporate law to suit the needs of social enterprises.3
Firstly, benefit corporation statutes require adopting entities to pursue a “general public benefit” in addition to their profit-making purposes (Model Benefit Corporation Legislation (MBCL); § 201(a)). General public benefit is defined as “[a] material positive impact on society and the environment, taken as a whole, assessed against a third-party standard, from the business and operations of a benefit corporation.” Benefit corporations may elect to identify a specific public benefit, such as protecting the environment or supporting the arts, that they plan to pursue, but need not do so (MBCL § 201(b)).
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Secondly, benefit corporation statutes impose different obligations on fiduciaries. They instruct directors that they
shall consider the effects of any action or inaction upon (i) the shareholders of the benefit corporation, (ii) the employees and work force of the benefit corporation, its subsidiaries, and its suppliers, (iii) the interests of customers as beneficiaries of the general public benefit or specific public benefit purposes of the benefit corporation, (iv) community and societal factors, including those of each community in which offices or facilities of the benefit corporation, its subsidiaries, or its suppliers are located, (v) the local and global environment, (vi) the short-term and long-term interests of the benefit corporation, including benefits that may accrue to the benefit corporation from its long-term plans and the possibility that these interests may be best served by the continued independence of the benefit corporation; and (vii) the ability of the benefit corporation to accomplish its general public benefit purpose and any specific benefit purpose.
(MBCL § 301(a)(1))
Importantly, benefit corporation statutes do not instruct directors to prioritize any of these considerations over others. The legislation guarantees benefit corporation directors significant discretion to pursue the social mission of their enterprises if they so choose, but do not require them to do so. So long as directors consider the needs of employees, the community, etc., they may then decide to act instead to maximize shareholder value. Consideration, not action, is the mandate. Further, directors are not personally liable for a benefit corporation’s failure “to pursue or create general public benefit or specific public benefit” (MBCL § 301(c)).
These social purpose and fiduciary duty requirements expressly reject the shareholder value maximization paradigm many identify with US for-profit corporations. Yet, it is worth noting that ordinary for-profit corporate statutes do not explicitly limit the objectives of adopting entities to maximizing shareholder value, and do not instruct fiduciaries to pursue this shareholder wealth maximization exclusively or otherwise. Indeed, many corporate scholars argue for-profits need not single-mindedly pursue shareholder value maximization, pointing to the breadth of fiduciaries’ discretion (Elhauge 2005) and the unique facts involved in the few cases where courts have rebuked them for failing to do so (Stout 2012). Still, the trope of shareholder value maximization runs strongly through for-profit law and lore (Brakman Reiser 2013; Strine 2012). Further, the values of the marketplace undergird it, as for-profit corporate fiduciaries who fail to maximize shareholder value may watch share prices fall and find their companies subject to a takeover motivated by extracting greater value. For all of these reasons, social enterprise founders worry the force of shareholder value maximization will push them to abandon their social goals (Page and Katz 2010). By their foundational purpose and fiduciary duty requirements, benefit corporation statutes attempt to cast off this burden.
Some benefit corporation statutes also add new content to standard for-profit law to address enforcement. They often, but not always, include a new right of action: the benefit enforcement proceeding (MBCL § 305).4 When such a provision exists, benefit enforcement proceedings are the exclusive means by which directors may be challenged for their failures to pursue general or specific public benefits (MBCL § 305(a)), though personal liability remains unavailable. The benefit corporation itself, directors, shareholders and others designated in the benefit corporation’s charter or bylaws may bring an action making such a challenge, but are limited to obtaining injunctive relief (MBCL § 305)(b), (c)).
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Although this limited additional right of action is often included in benefit corporation statutes, their primary model for enforcement is disclosure (Brakman Reiser 2011a). Benefit corporations are required to issue annual benefit reports to shareholders, and to post these reports on any organizational website (MBCL §§ 401, 402). The report must describe the benefit corporation’s efforts to pursue general public benefit, along with the extent of its success in doing so. Although this assessment is made by the benefit corporation itself, it must be made with reference to a “third-party standard”: “[a] recognized standard for defining, reporting, and assessing corporate social and environmental performance” (MBCL § 102). Under the Model Act, this standard must be created by an entity independent of the benefit corporation that uses it (i.e., not a controlled subsidiary or, say, a company run by the CEO’s sister), and must be made transparent to the public (MBCL § 102).5
Information-forcing is also the hallmark of an important precursor of the benefit corporation idea—the similarly-named “B Corp” (Brakman Reiser 2013). In fact, a B Corp is not a legal form at all, but a trademarked name available to businesses with a social mission through a certification and licensing process run by B Lab. B Lab is a nonprofit organization dedicated to “us[ing] the power of business to solve social and environmental problems” (B Corp website 2017). The certification process requires at least two steps. Aspiring B corporations must revise their articles of incorporation to require directors to consider a range of impacts and constituencies when acting in their fiduciary roles (B Corp website 2017). Applicants must also complete a B Assessment and achieve a score of 80 out of a possible 200 points. This detailed survey asks questions ranging from recycling policies to employment conditions to governance, and varies depending on an applicant’s size and industry (B Corp website 2017). Applicants who make the required changes and score highly enough on the B Assessment may license the B Corp mark for a sliding-scale fee based on annual sales, promote themselves as B Corps, and access a number of benefits available to the B Corp community (B Corp website 2017). Successful applicants may keep the certification for two years, and 10 percent of entities are subject to a random audit by B Lab. (B Corp website 2017).
The similarity between the names “benefit corporation,” a state legal form, and “B Corp,” a private trademark available for use as a certification, has led to much confusion. The overlapping names and some of their overlapping content, however, is easily explained. B Lab has been heavily involved with developing and promoting the benefit corporation form (B Corp website 2017). Further, the B Assessment is one tool benefit corporations formed under state law can use as the third-party standard against which they must assess themselves. Importantly, though, none of these state forms require B Lab to certify an entity in order for it to qualify as a benefit corporation (Brakman Reiser 2013). Benefit corporations must only use a third-party standard to assess themselves. At the time of this writing, over 2,100 B corporations exist around the world (B Corp website 2017).
Benefit corporation statutes have been widely adopted since Maryland’s first-in-the-nation legislation was enacted in 2010. In the US, entity formation laws are enacted at the state rather than the federal level, so state legislatures are the site of the action. At the time of writing, 31 states have benefit corporation legislation on the books and more are considering adopting a statute (Benefit Corp Information Center 2015). In 2013 a key development in the march through US state legislatures occurred when Delaware adopted legislation enabling the “public benefit corporation” (Plerhoples 2014). This variation on the benefit corporation form is important because Delaware is the state of incorporation of choice for major and publicly-traded US corporations (Delaware Department of State 2015). When Delaware joined this party, it was viewed by some as powerful evidence of the importance and legitimacy of specialized forms for social enterprise (Murray 2014; Plerhoples 2014).
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Like L3Cs and benefit corporations, the Delaware public benefit corporation is a state legal form of organization that permits an adopting entity to have a dual purpose. A Delaware public benefit corporation pursues profits, but also identifies a “public benefit” to pursue in its corporate charter (8 Delaware Code § 362). The statute also gives a tripartite instruction to public benefit corporation directors. As they manage their corporations, they must “balance” the financial interests of shareholders, the interests of other stakeholders impacted by the firm’s conduct, and the public benefit the firm identifies in its charter (8 Delaware Code § 365). Delaware’s new form does not include any special enforcement proceedings, but does require shareholders to be sent a report on the company’s public benefit progress every two years (8 Delaware Code § 366).
It remains to be seen how popular the public benefit corporation will become in Delaware or elsewhere. (In the US, entities can form under any state’s law, so a social enterprise in Utah that finds the Delaware public benefit form attractive can form under it from afar.) Indeed, despite the popularity of the various specialized legal forms among state legislatures, the adoption of these forms by actual social enterprises has been slow (Brakman Reiser and Dean 2017). The most recent figures available show that at most only about 4,500 organizations have adopted any of these specialized forms since the inception of the first one in 2008 (Murray 2016). These low figures could be explained as the very gradual uptake of a new and untested legal concept, and time will tell. An alternative explanation, however, suggests that while these forms are an attractive legislative product, they do not sufficiently resolve the concerns social entrepreneurs have identified with using standard for-profit forms to house social enterprise. Primary among these are corporate objectives and capital access.
A critique of US specialized forms
The “two masters” problem
One of the main arguments for the development of specialized forms has been the need to permit fiduciaries to pursue a dual mission, both profit and social purpose. With a purely nonprofit or for-profit enterprise, the argument goes, purity of mission is also necessary. Of course, this view is somewhat overstated. Nonprofits certainly may earn profits; in fact, fully 50 percent of the income of US public charities in 2012 came from earned revenues from tuition payments, ticket sales, patient revenue, etc. (McKeever and Pettijohn 2014). For-profits may make charitable contributions, engage in corporate responsibility and, as discussed earlier, are not legally bound to a strict requirement to maximize profits for shareholders. Yet, there are legal and practical limits that a social enterprise pursuing dual missions of profit and social purpose might encounter. Nonprofits cannot have shareholders or distribute the profits they earn to members or others in control. Also, ultimately, for-profits who dismiss the profit concerns of their investors do so at their peril. The market will punish such actions, even if the law is unlikely to do so.
The US hybrid forms thus explicitly permit the expression of these dual objectives and fiduciaries’ pursuit of them in an attempt to develop an organizational form more suited to social enterprise. Solving this one problem, however, has generated another. Having two goals, especially goals that will often conflict, complicates the role of managers and the discipline of fiduciaries. When faced with a decision, like where to locate production facilities for the growing product of a promising social enterprise, should managers choose more expensive local production to generate jobs for their community? Or, should they opt for production off-shore that would increase profits and generate a complex mix of benefits and problems in the off-shore location? Depending on the production process employed, this choice may also have environmental implications.
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Managers, even those managers who are directors or officers with a legal obligation as fiduciaries, typically have great discretion in such operational decisions (Elhauge 2005). But, in an environment with a primarily profit-making objective, this single bottom line can focus the mind and improve decision-making confidence. For nonprofit fiduciaries, the single bottom line of serving organizational mission plays a similar function, but is significantly more difficult to identify and evaluate. They must determine their mission, a contested process to which multiple constituencies have appropriate contributions to make, and then measure their progress toward it, a daunting task (Brakman Reiser 2011b).
For a dual purpose social enterprise, combining the goals of profit and purpose complicates fiduciaries’ jobs even further. This challenge of the “two masters” problem has been recognized at least since biblical times.6 But US hybrid forms do nothing to mitigate it. The L3C statutes say nothing explicit regarding fiduciary duties (11 VSA § 3001 (27)); benefit and public benefit corporation statutes instruct fiduciaries to “consider” or “balance” these concerns, with no guide star or prioritization to set the course (MBCL § 301(a); 8 Del. Code § 365). Moreover, these forms offer little or nothing in the way of remedies, relying heavily on self-directed and non-monitored reporting to shareholders and (sometimes) the public, and locating any ability to challenge fiduciaries’ management of the enterprise solely in shareholder suits for non-monetary relief (Brakman Reiser 2013). This discretion may be sufficient to placate fiduciaries’ concerns about a lack of guidance, as it essentially removes any concern that failures to pursue profit or purpose will be subject to legal remediation. In fact, this even greater freedom of decision may make these forms particularly attractive to managers seeking to further reduce the already quite limited exposure they face for accountability for poor decision-making. The almost complete lack of accountability, however, should trouble another important constituency—investors.
The capital access problem
Another major motivation behind the development of social enterprises in general and the specialized legal forms that house them in particular, is capital formation. The essential argument here is that nonprofits, due to their reliance on donations, debt and surpluses from earned revenue, are insufficiently capitalized to respond effectively to the serious problems facing society—from education, to climate change, to the many consequences of the ever-widening gaps in wealth and income. For-profit entities keen to marry profit for investors with social value suggest that we might harness vast pools of investment capital to address these vital societal issues. This promise will be realized only, however, if investors controlling this capital are also persuaded that social enterprises can effectively produce both profit and social value—and are willing to bet their money on it (Tyler et al. 2015).
Assuming dual purpose investors, often called “impact investors,” exist in large numbers, they face great uncertainty when considering a specific investment. They are asked to hand over their money (perhaps for a rate of return lower than that pure for-profits would offer) to an entrepreneur set on pursuing both profit to share with them and also a social purpose—an aim difficult to achieve and perhaps even harder to evaluate. To do so, significant trust is required (Brakman Reiser and Dean 2017). Indeed, there are questions of trust on both sides, as entrepreneurs dedicated to dual mission may find the thought of investment, and particularly equity investment, bittersweet. The addition of new investors carries its own risks. They may fail to share in, or even abandon, the entrepreneur’s commitment to mission if it begins to cut too much into profits, thereby pushing the entrepreneur away from the social goals she holds dear (Brakman Reiser and Dean 2017).
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Both entrepreneur and investor need trust and assurances, but these needs are not addressed by the current American forms of social enterprise. Because there is no prioritization of social good required at the entity or fiduciary level and precious little enforcement in any event (Brakman Reiser 2013, Brakman Reiser and Dean 2017), investors must find some other route to assure themselves they can trust managers. Moreover, either managers (in the L3C) or investors (in benefit and public benefit corporations) can remove the mission component from the entity unilaterally (Brakman Reiser 2013; Brakman Reiser and Dean 2017). While these forms were developed with the aim of aiding capital formation, they do little to solve the trust problems that inhibit the key actors in the capitalization process (Brakman Reiser and Dean 2017).
Unless specialized forms prove effective at resolving the two-masters problem and providing assurances needed for capital formation, they will also have a difficult time fulfilling the final desire behind these forms: branding (Brakman Reiser 2013, Brakman Reiser & Dean 2017). With every business seeking to paint itself as “one of the good guys,” the marketplace of self-proclaimed social enterprises could become quite crowded with poseurs. Certainly one goal of these forms is to serve as a signal for consumers, investors, employees and others to identify trustworthy dual-purpose enterprises. Such a brand, if effective, would be extremely valuable for all involved. But, without prioritization and enforcement, it is hard to imagine any of these specialized organizational forms serving as an effective brand.
Indeed, a single brand may be a mirage. These various constituencies are often looking for different kinds of information, and the appropriate standards may vary not only on the dimensions addressed here but also further by industry or geography. Ironically, for this branding purpose, private certification may be a superior solution, bringing us back to the world of B Lab and the B Corp certification, as well as some of the many other entities seeking to measure, mark and brand social enterprises.
The European environment explored
European nations each have an extensive list and a long tradition of standard nonprofit and for-profit legal forms. Nonprofit forms include all manner of associations and foundations, as well as companies limited by guarantee and various others (Hopt and von Hippel 2010). Each of these forms, however, comes with the familiar and problematic limitation for social entrepreneurs that profits may not be distributed to owners (Defourny and Nyssens 2013). In addition, some European countries limit commercial or “trading” activities by nonprofit entities (Framjee 2009; Coates and Van Opstal 2009; Kerlin 2006; Hopt and von Hippel 2010). For-profit forms are myriad too. Although European Union (EU) company forms have been slow to launch (Kirshner 2010; Bratton et al. 2009),7 each member state offers its own version of a private and public company and various types of partnerships (Bratton et al. 2009). Despite this plethora of legal options available to house social enterprises, European nations experienced pressure similar to that in the US to develop specialized forms. Nearly all of the forms that have emerged, however, are meaningfully distinct from those seen Stateside.8
Cooperatives
The effort to develop specialized forms to house social enterprises has earlier roots on the Continent than possibly anywhere else, especially in Italy. Social enterprise organizations began taking on the cooperative form there as early as the 1970s and 1980s, due to its inherently attractive combination of the ability to engage in commercial activity and pursue community aims, while offering owners limited liability and a role in governance (Borzaga and Santuari 2001). This activity culminated, however, in the passing of landmark 1991 legislation recognizing the “social cooperative” as a new and distinct Italian legal form (Law 8 November 1991, No. 381).
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Social cooperatives under this law were required to operate “for the general benefit of the community and for the social integration of citizens” (Borzaga and Santuari 2001). This law also breaks down the class of social cooperatives into two types. Type A social cooperatives deliver social services, typically healthcare or education, and may take on outside, non-member, investors. Type B social cooperatives engage in “work integration,” providing training and work opportunities for individuals, at least thirty percent of whom must be disadvantaged (Borzaga and Santuari 2001; Cafaggi and Iamiceli 2008).
Social cooperatives formed under the 1991 law may make distributions of profits to owners, albeit limited ones.
[T]he Act states that the amount of profits to be divided must not exceed 80 percent of the total; that the rate of profits for each share cannot be higher than 2 percent of the rate applicable to the bonds issued by the Italian Post Service; and that no assets can be distributed should the co-op be wound up.
(Borzaga and Santuari 2001: 171)
Cooperatives are also required to disclose information regarding their activities to members and to report financial information to the Enterprises’ Register Office (Cafaggi and Iamiceli 2008). As of 2008, there were 13,938 active social cooperatives in Italy (Carini et al. 2012).
Decision-making power in social cooperatives is decentralized. Originally, all cooperatives were required to conform to a so-called “tripartite” system of administration and control, which contemplated three governing bodies: the member assembly, the board of directors and the board of supervisors (Fici 2006). This multistakeholder approach represents the interests of different classes of stakeholders, though the power of cooperative members predominates. Cooperative members must make up at least a majority of the board, whereas the roles played by financing members and voluntary working members are specifically limited. Since a 2003 reform, social cooperatives may choose among three different governance models in which members have differing degrees of authority to monitor directors and enforce compliance. In addition to the original tripartite model, dualistic and monistic models are available, but external auditing is required for cooperatives adopting the new models (Cafaggi and Iamiceli 2008).
The 1991 Italian social cooperative law was highly influential across Europe (Defourny and Nyssens 2013). Forms like France’s “collective interest cooperative society,” Greece’s “social cooperative with limited liability,” and Poland’s “social cooperative” share with the Italian law the commitments to mission primacy, limitations on distributions, and a multistakeholder approach to governance (Defourny and Nyssens 2013; Kerlin 2006). In these countries and others, social entrepreneurs are using social cooperatives to deliver on dual goals of social good and profit.9
Despite the influence its 1991 social cooperatives law commanded across Europe, in 2006 Italy enacted a new piece of social enterprise legislation to pursue quite different purposes. This law enacts a nationwide definition of “social enterprise,” which is not dependent upon the form taken by a particular entity. Instead, the new social enterprise definition includes
any kind of private organisation (e.g., associations, foundations, co-operatives, non-co-operative companies) which permanently and principally operates an economic activity aimed at the production and distribution of social benefit goods and services while pursuing general interest goals.
(Cafaggi and Iamiceli 2008: 24)10
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For economic activity to be the enterprise’s principal operation, this activity must generate 70 percent of the organization’s revenues (Cafaggi and Iamiceli 2008). Importantly here, although social cooperatives that qualify may still make limited distributions, the social enterprise category is otherwise asset-locked. Profits and surplus must be used to benefit mission, not distributed to owners (Cafaggi and Iamiceli 2008). This sets the Italian national definition of social enterprise somewhat at odds with its use by many American commentators, and with the definition in this chapter. The Italian social enterprise legislation also has only limited requirements related to stakeholders and governance (Cafaggi and Iamiceli 2008).
Company forms
Belgium and the United Kingdom have diverged from the cooperative path and instead utilized a company model. Belgium’s social purpose company (Société à Finalité Sociale (“SFS”)) designation was enacted in 1995 (Doeringer 2010; Defourny and Nyssens 2013). Adopting the SFS designation allows socially-minded organizations including nonprofits to engage in unlimited commercial activity (Coates and Van Opstal 2009); such activities by non-SFS Belgian nonprofits are legally restricted (Doeringer 2010).
As a designation only, when a company registers as an SFS, it does not change its underlying legal form. Instead, it simply accepts limits on its ability to distribute profits and additional reporting requirements. An SFS-designated entity must state in its articles that its members seek limited or no profit, and that any profit distributions will not exceed an annual return of six percent on an investor’s principal (Doeringer 2010). In addition, upon dissolution, residual assets must be transferred to a company or charity that furthers the SFS’s social purpose (Doeringer 2010). Disclosure requirements mandate production of an annual report indicating how the SFS furthered its social goals. Yet the report is not required to contain any specific content and no regulator polices such reports or whether an organization’s activities align with its social purposes more generally (Coates and Van Opstal 2009). By the mid-2000s, only about 400 SFS registrations had been filed with the Belgian government (Defourny and Nyssens 2008).
The UK’s Community Interest Company (CIC), in contrast, is a specialized legal form subject to oversight by a dedicated regulator. The CIC was established by amendments to UK company law adopted in 2004 (Companies Act 2004) and, to date, over 15,000 CICs have been created (CIC Regulator 2014/2015). The CIC form relies on company law as its basic framework, adding requirements that the adopting entity pursue a “community benefit,” observe an asset lock on some of its capital and caps dividends, as well as mandated stakeholder involvement. The CIC status does not confer any tax benefits on companies that adopt it, whether formed as companies limited by shares or limited by guarantee, and they are subject to entity-level tax (UK CIC Regulator Guidance 2016: Ch. 2; Companies Act 2004 § 36).11
In 2014, however, the UK did begin to provide tax benefits to investors in CICs, among other types of social ventures, through a new scheme of tax relief for social investments (Finance Act 2014, Schedule 11, ¶257J). Thereby, eligible investors are permitted to deduct thirty percent of the cost of their investment in a CIC or other eligible entity (HMRC Guidance 2015). In addition, investors may defer paying tax on capital gains on such investments or even avoid paying capital gains tax on the investment entirely (HMRC Guidance 2015).
The CICs, like other UK companies, are governed by a board of directors and all directors are fiduciaries. Like other company directors, CIC directors must exercise their management and supervisory duties with “reasonable care, skill and diligence,” and avoid conflicts of interest or other situations of potential disloyalty (Companies Act 2006). The role of CIC directors is unique, however, because they are also responsible for preserving the CIC’s ability to meet the community interest test (UK CIC Regulator Guidance 2016: Ch. 9). This test, necessary to form as a CIC, requires that “a reasonable person might consider that its activities (or proposed activities) are being carried on for the benefit of the community” (UK CIC Regulator Guidance 2016: Ch. 4). The CICs must report on their community interest achievements to the Regulator annually (UK CIC Regulator Guidance 2016: Ch. 8).
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The CIC Regulator directs adopting entities to include stakeholders in its governance (UK CIC Regulator Guidance 2013: Ch. 9). The specific form of stakeholder involvement is not mandated, with the idea that CICs of various types and sizes will flourish using diverse techniques to involve stakeholders in governance. Yet, the CIC Regulator has offered suggestions on how stakeholder governance roles might be articulated. Its Guidance suggests that adequate information may be provided:
by simple methods such as circulating news letters and holding stakeholder meetings or more sophisticated methods such as setting up a web site with dialogue facilities or issuing formal consultation documents before taking a major policy decision. Alternatively, stakeholder groups can be given official standing under a company’s constitution (for example, by requiring that they are consulted before the directors or members make certain types of decisions).
Other stakeholders could be included with the members in the circulation of the company annual report and accounts and invited to attend an open forum linked to the company’s annual general meeting.
In many organisations the setting up of user and advisory groups or a club committee separate from the board of directors can be an effective way of bringing stakeholders into the running of the organisation.
A wide view should be taken of who may be affected by your activities and should include not only those who currently benefit but also potential beneficiaries. You should also consider those indirectly affected such as the other residents of the area of your operations.
(UK CIC Regulator Guidance 2016: Ch. 9)
Information on a CIC’s efforts to include stakeholders in governance must be provided in its annual community interest report to the Regulator for review (UK CIC Regulator Guidance 2016: Ch. 8).
Perhaps the most potent components of the CIC structure relate to financing. The CICs’ assets are subject to an “asset lock,” prohibiting a CIC from disposing of assets for less than fair market value consideration, except in pursuit of the community benefits the CIC is designed to pursue or in a transfer to a charity or another CIC (UK CIC Regulator Guidance 2016: Ch. 6). This “fundamental” feature means that even beyond dissolution, a CIC’s assets are perpetually devoted to community benefit (UK CIC Regulator Guidance 2016: Ch. 6).
In addition, dividends paid to members of a CIC limited by shares are permissible only to the extent the Regulator so authorizes (Companies Act 2004 § 30). The Regulator has issued a number of regulations limiting dividends, most recently in October 2014. Although the Regulator initially applied per-share dividend caps, and then increased these caps after consultation in 2010, the most recent changes removed the per-share dividend cap entirely. Now, the only cap on dividends mandates the total dividend declared for all shares must not exceed thirty-five percent of distributable profits in any given year (UK CIC Regulator Guidance 2016: Ch. 6). A cap on performance-related debt payments was also increased (UK CIC Regulator Guidance 2016: Ch. 6). The various caps and changes to them represent the Regulator’s attempt to balance the competing desires to incentivize investments in CICs and to maintain their focus on producing benefits for the community.
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Evaluating European social enterprise forms
The European experience with social enterprise is diverse, with a range of cooperative forms, company forms, and designations that layer over legal forms taken by individual entities. Many of these forms emphasize a multistakeholder approach to governance not found in American forms and all place restraints on profit distribution, while US forms do not. These differences also affect the type of work European social enterprises perform, the capital they can raise, and the branding they are able to offer.
European social cooperatives tend to be focused on traditional charitable work rather than innovating new business ideas (Esposito 2013; Defouny and Nyssens 2013; Defourny and Nyssens 2008). Of course, the mission primacy embedded in these forms makes some business activities unrealistic. However, the founding statutes also often encourage the view that social cooperatives are essentially charitable in nature, such as in Italy’s direction to social cooperatives to engage in social service or work integration activities or the even more extreme Portuguese social solidarity cooperative’s prohibition on all distributions (Cafaggi and Iamiceli 2008). Additionally, the strong norm of multistakeholder governance in European social cooperatives may be perceived as an obstacle to effective operation of a business.
The European experience also showcases the tension between maintaining a social purpose and raising capital. The UK CIC Regulator’s decade-long struggle to identify dividend limitations for CICs that will focus adopting entities on pursuing community benefit without turning off investors is, perhaps, the most dramatic example. The financial limitations on CICs mean they offer investors something quite different from ordinary equity. Investors can buy these shares and participate in profits, but only to the extent of capped dividends—not the full amount of a CIC’s profits its directors might choose to distribute; and share ownership entitles investors to no residual claim. CICs’ inclusion in the new social investment tax regime suggests that even with increased dividend caps, stimulating investment in these social enterprises remains difficult. Some authors likewise attribute the lack of uptake of Belgian SFS designations to the challenges these organizations will face in raising capital (Esposito 2013; Doeringer 2010).12
Finally, with so much diversity of form and meanings, it is difficult to imagine social enterprise branding emerging at the European level. Instead, branding effects, if any, will need to occur country by country. It will be interesting, in this regard, to track the development of the new Italian social enterprise designation. Its attempt to bring under one umbrella the many forms being taken by organizations using economic activity to pursue social good is unique. Italy has long been at the vanguard of European legal innovation for social enterprises, so the space is well worth watching.
Concluding remarks
Businesses have long deployed corporate philanthropy to pursue social goals along with their profit-making objectives, and in recent decades many have adopted corporate social responsibility programs to include social and environmental considerations as part of their business decision-making. Businesses, entrepreneurs, and investors who seek to more fully integrate these dual goals, or prioritize social missions, are now forming social enterprises.
States throughout the US and countries across Europe have responded with a range of dual purpose entity forms. Social cooperatives common across Europe can be used in this vein, but until these break free from their traditionally-limited social service and work-integration emphases, business entrepreneurs will make little use of them. The UK’s community interest company was developed precisely for this purpose, and has seen significant adoption on the ground. It is still, however, much more commonly used by companies limited by guarantee, and the effort to attract capital to CICs limited by shares remains a work in progress.13
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Hybrid forms have been a great legislative success story in the United States, with at least some form being adopted by over half the states in less than a decade. However, the acceptance by entrepreneurs has not been nearly as fulsome or fast. Unless the legislation enabling these forms is revised to require prioritization of social good and to provide a reliable enforcement mechanism, these forms will continue to have little to offer social enterprise founders and investors. More targeted reforms, like financing arrangements that reassure entrepreneurs and investors of their mutual commitments, show greater promise (Brakman Reiser and Dean 2017). Likewise, in the absence of an enforcement regime that establishes government forms of social entrepreneurship as a reliable sorting mechanism, private certification systems will likely grow to brand social enterprises for a range of audiences.
Essential works
The essential works on US social enterprise law include Dana Brakman Reiser and Steven Dean, Social Enterprise Law: Trust, Public Benefit, and Capital Markets (2017), Cass Brewer, Elizabeth Minnigh, and Robert Wexler, Social Enterprise by Nonprofits and Hybrid Organizations (2014), and materials found on the websites of B Lab and the Benefit Corporation Information Center. For comprehensive comparative analysis of social enterprise in the US and Europe, see Jacques Defourny and Marthe Nyssens, “Conceptions of Social Enterprise and Social Entrepreneurship in Europe and the United States: Convergences and Divergences” (2010), Janelle A. Kerlin, “Social Enterprise in the United States and Europe: Understanding and Learning from the Differences” (2006), and Carlo Borzaga and Jacques Defourny. The Emergence of Social Enterprise (2001). Extensive guidance on the UK community interest company form is provided at the CIC Regulator website.
For further reading in this volume on the legal frameworks of corporations, see Chapter 14, The corporation: genesis, identity, agency. On the idea of the “social” and “social responsibility” see Chapter 10, Social responsibility. On the responsibilities of fiduciaries, see Chapter 24, Corporate governance. On the question of the nature of business, especially in relation to the “two masters” problem, see Chapter 13, What is business?
Notes
* I am grateful for the support of the Brooklyn Law School Dean’s Summer Research Program and for the dedicated research assistance of Susan Miller.
1 For a more thorough investigation of the social mission concept and its relationship to ethical questions, consult Chell et al. (2014), Fayolle and Matlay (2010), Praszkier and Nowak (2012), and Spence (2014).
2 The Illinois L3C regime is an interesting outlier. It deems L3C fiduciaries “trustees” required to register and report under its Charitable Trust Act and subject to enforcement by the state attorney general (Ill. Comp. Stat. 180/1-26(d); Lane 2011; Tyler 2010).
3 Benefit corporation statutes currently exist in over half the states, and vary somewhat in their particulars. To describe the basic features of these statutes, references to the Model Benefit Corporation Legislation will suffice. When adoptions by particular states are relevant, those state statutes will be referenced.
4 Some states, like Maryland, do not include enforcement proceedings (Maryland Code 2013).
5 The Model Act also requires the standard to comprehensively address the various considerations directors must consider in their decision-making and to be developed by an entity with appropriate expertise and which uses a “multistakeholder approach” (MBCL § 102). A number of state benefit corporation statutes, especially those earlier adopted in time, do not contain these additional requirements (Colorado Revised Statutes § 7-101-501; Maryland Code, Corporations and Associations, § 5-6C-01 et seq.; McKinney’s New York Business Corporation Law § 1701 et seq.).
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6 “No one can serve two masters. Either you will hate the one and love the other, or you will be devoted to the one and despise the other. You cannot serve both God and money” (Luke 16:13).
7 The European Union has not created any EU-wide social enterprise forms or designations (Esposito 2013), as it has done for public limited liability companies and standard cooperatives (Fici 2013). The EU has left the development of specialized forms to member countries and has instead offered support for the emerging social enterprise trend in Europe by funding research (Defouny and Nyssens 2013) and supporting activities such as the construction of databases and formation of expert panels (European Commission Website 2015).
8 One recent exception is Italy, which enacted a provision allowing for a new corporate form closely aligned with a benefit corporation or social purpose corporation model in late 2015, see Law 28 December 2015 (Stability Law), n. 208, article 1, par. 376–384. According to the legislation, it aim[s] to promote the establishment and encourage the spread of companies, hereinafter referred to as “Società Benefit,” which, by performing an economic activity, pursue one or more objectives of common benefit besides sharing profits, and which operate in a responsible, sustainable and transparent manner toward people, communities, territories and the environment, cultural heritage and social activities, entities and associations and other stakeholders.
9 In 2012, France had 190 organizations registered as collective interest cooperative societies and Greece had 113 limited liability social cooperatives (European Commission Report 2012).
10 As of 2011, 769 organizations were registered as “social enterprise” in Italy (Borzaga and Galera 2012).
11 Notably, even if formed as a company limited by guarantee, a CIC is expressly prohibited from being deemed a charity under UK tax law (Companies Act 2004 § 26(3)(a)).
12 Of course, other factors also may be at work in the lack of adoption of the SFS designation (Coates and Van Opstal 2009; Defourny and Nyssens 2008).
13 As of 2016, 9,987 CICs still on the public register were companies limited by guarantee; only 3,068 were companies limited by shares (CIC Regulator 2016/2017).
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