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The Flexible Purpose corporation and the Business of Doing Good

Posted by Nicole Liotine | Feb 21, 2014 | 0 Comments

By D. Ken Brock –

A couple years ago, California became the first state in the Union to allow for the formation of a new business entity, known as the Flexible Purpose Corporation (“FPC”).  Initially heralded by some legal experts as the next stage in corporate evolution, the FPC represents a new corporate form which was intended to allow businesses to integrate the for-profit orientation of a traditional business corporation with the charitable purpose of a non-profit, public benefit corporation.

The justification for this new creation was that, with the traditional for-profit model, the fiduciary duty owed to the shareholders requires that board decisions be based solely upon whether the proposed course of action will maximize shareholder value – and nothing else.  Although for-profit business corporations can – and often do – make charitable contributions and engage in other activities which result in a broader public benefit, they are only permitted to do so if those actions were pursued for the benefit of shareholder returns.  While social welfare activities may not maximize shareholder value directly, they're typically justified by the proposition that they improve the company's overall public image or provide a convenient tax deduction.

Under the Business Judgment Rule, directors are only protected from liability for good-faith business decisions made during the course of furthering the purpose for which the corporation was formed.  Consequently, directors of a traditional business corporation who pursue social welfare objectives at the expense of shareholder wealth can ultimately be subject to significant liability for doing so.

Under the Corporate Flexibility Act, those wishing to engage in charitable or public-welfare activities traditionally accomplished by a nonprofit public benefit corporation may now do so through an FPC.  Unlike the public benefit corporation, the FPC is actually a for-profit stock corporation, which allows for the payment of shareholder dividends.

Here's how it works:

To qualify as an FPC, the corporation's formation documents must identify at least one qualifying special purpose, such as public educational activities or serving the underprivileged, that would ordinarily be fulfilled by a nonprofit public benefit corporation.  In exchange, the FPC's board members and officers are generally provided with a “safe harbor” from shareholder liability whenever they weigh the FPC's special purpose against overall shareholder value.

Since the qualifying special purpose is actually specified in the FPC's charter, it ultimately represents a legally-binding contract among the FPC's shareholders and its management.  FPC directors and officers are also covered by the Business Judgment Rule provided that the decision in question was consistent with the FPC's twin goals of generating shareholder value and fulfilling the special (ie. “charitable”) purpose.

By interjecting the profit motive into the social welfare mission of a public benefit corporation, the FPC was intended to represent a hybrid entity which could supplement much of the social welfare work performed by today's cash-strapped charities.  Provided the activity in question were consistent with the FPC's special purpose, funding for public welfare activities, such as recreational youth programs and homeless shelters, could theoretically be generated by selling shares of stock in the same way that any other for-profit business corporation would raise operating capital.

So far, however, the IRS has yet to figure out how to deal with California's “next big thing” and, to be sure, social welfare organizations haven't exactly been leaping at the opportunity to structure their operations around the FPC corporate model given the uncertainties.  Even so, socially-conscious investors could someday find that the FPC represents a practical, market-based mechanism which allows them to do well by doing good.

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