December 10, 2019

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Becoming a B: An Examination of the Delaware Benefit Corporation Legislation

The Delaware case illustrates how to more safely structure a corporate for benefit creation.

Dirk_sampselle

By Dirk Sampselle

Part of the Becoming a B series

Part 1: How the Fiduciary Duties of Traditional Corporations May Preclude Directors and Officers of Traditional Corporations from Pursuing Publicly Beneficial Activities

When an enterprise seeks to maximize both profit and social and environmental impact, it is essential that its leaders and attorneys consider the risks and opportunities afforded by its choice of entity in legal formation.

What follows is a discussion of the law of fiduciary duties for Delaware corporations, so that readers may better understand the risks associated with proceeding under a traditional corporate form without the assistance of an attorney in structuring provisions that may allow the corporation to operate towards an end other than that of strict shareholder value creation.

Overview of Business Judgment Rule and Director Liability

When reviewing decisions by directors in the day-to-day context, courts apply the business judgment rule, absent bad faith or self-dealing. In essence, the business judgment rule is a rebuttable presumption by courts that, in making business decisions, the directors of a corporation act “on an informed basis, in good faith and in the honest belief that the action taken [is] in the best interests of the company.”

If director liability follows from a board decision that results in a loss because that decision was ill advised or “negligent,” compliance with a director's duty of care can never appropriately be judicially determinedPEANUTS by Charles M. Schulz by reference to the content of the board decision that leads to a corporate loss, apart from consideration of the good faith or rationality of the process employed.

Whether a court considering the matter after the fact believes a decision substantively wrong, or “stupid” or “irrational,” provides no ground for director liability, so long as the court determines that the decision-making process employed was either rational or employed in a good faith effort to advance corporate interests. “To employ a different rule – one that permitted an 'objective' evaluation of the decision – would expose directors to substantive second guessing by ill-equipped judges or juries. This would, in the long-run, be injurious to investor interests. Thus, the business judgment rule is process oriented and informed by a deep respect for all good faith board decisions.”

The End of Rational Directorial Decision-Making: Shareholder Value Maximization

While Delaware courts do not second-guess the substance of director and officer decisions, case analysis of Delaware court decisions illuminates a court doctrine that implies that the decision-making process directors and officers implement must seek shareholder value maximization if it is to be considered rational. To do otherwise would be to implement an irrational decision-making process.

In eBay Domestic Holdings, Inc. v. Newmark, 16 A.3d 1, 33 (Del. Ch. 2010), the Delaware Court of Chancery wrote:

“When director decisions are reviewed under the business judgment rule, this Court will not question rational judgments about how promoting nonstockholder interests – be it through making a charitable contribution, paying employees higher salaries and benefits, or more general norms like promoting a particular corporate culture – ultimately promote stockholder value.”

Stockholder vs. Non-stockholder Interests

That is to say, a Delaware corporation may indeed promote non-stockholder interests by, e.g., donating a portion of its profits to a charity. But it may do so only so long as its profit donation strategy is rationally calculated to promote shareholder value. The rationality of the decision is defined by whether the ultimate purpose and end sought by the decision is the promotion of stockholder value.

In other words, the director-protective business judgment rule can be overturned if a plaintiff can show “that the decision of the Board was so irrational that it could not have been the reasonable exercise of the business judgment of the Board.” Under this test, as long as the board can show that the judgment was rationally related to the interests of the company, the court will defer to the board‘s business judgment.

For example, directors seeking to pay employees higher salaries can do so, if doing so is rational-decision-makingrationally related to the long-term best interests of the corporation, i.e., because it promotes retention. But, the directors and officers may not pay employees higher salaries merely to benefit the employees, e.g., because the directors and officers would like the employees to be able to take care of themselves and their families.

The corporation cannot openly espouse the pursuit of intrinsic good; directors and officers must rationalize any moral-good-oriented decision back to a rational relationship between intrinsic good and the interests of the company.

It is true that when that relationship rationally exists, courts do give officers and directors broad leeway to define and pursue innovative, alternative paths to profitability, but when decisions do not rationally relate to profitability, a directoral decision amounts to a waste of corporate assets.

In Walt Disney, the Delaware Supreme Court held that a claim of waste will only arise in the “rare, unconscionable case where directors irrationally squander or give away corporate assets.” But when “rationality” is defined by relating back to the company’s economic wellbeing, it may well be considered waste to give away a substantial portion of corporate proceeds for giving’s sake.

Indeed, “waste” entails any “exchange of corporate assets for consideration so disproportionately small as to lie beyond range at which any reasonable person might be willing to trade.” Most often, the claim is associated with “a transfer of corporate assets that serves no corporate purpose; or for which no consideration at all is received. Such a transfer is in effect a gift.”[1]

Conclusion: Altruism For Inspiration and Profit

If a business’s strategy is to present itself to consumers as giving for the sake of giving, and giving without proportion or even regard to the brand equity and consumer popularity to be gained by the strategy – if its strategy is to present itself as innocently benevolent, and be truly benevolent – then it is almost axiomatic that such altruistic actions would constitute “waste;” they do so by their very design and intent.

And yet to do so would be righteous: it is giving for giving’s sake that inspires and elicits attention in the corporation’s target market, not “giving” in exchange for brand loyalty or recognition, and certainly not “giving”B Corps only insofar as it improves corporate profitability and promotes shareholder wealth. It is the altruism of the call to action, not the narrow-minded strategic outcomes, which inspires.

The paradox is that, in being freed to do the right thing for the right reasons, corporations may free their collective imaginations to explore opportunities for even greater long-run profitability: from attacking mission-aligned new market opportunities, to enhancing employee wellbeing and motivation, to enhancing product quality through improved supplier oversight, to simply getting ahead of the game in resource conservation in anticipation of the impending real-world and regulatory resource constraints.

The fact that benefit corporation decision-making may subordinate profit to purpose does not in itself necessitate that these entities be less profitable than those which consistently and especially in the short-term prioritize profit over purpose.

At B Revolution, we call the benefit corporation legal form and B Corporation certification the corporate governance architecture of the 21st century; in an era when resources are becoming more scarce, consumers are becoming more conscientious and demanding of transparency, economies are becoming more interconnected and interdependent, the corporate world does not need governance policies that are simply smarter and more rational in the economic sense: it needs ones that are wiser and more conducive to collective wellbeing.


[1] Id. at 336.

The opinions, beliefs and viewpoints expressed by CSRwire contributors do not necessarily reflect the opinions, beliefs and viewpoints of CSRwire.

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