On July 16, 2020, the State of Delaware adopted amendments to the Delaware General Corporation Law (DGCL) that will have a meaningful impact on the factors being weighed by companies considering conversion to a public benefit corporation (PBC).
What is a PBC?
A PBC is incorporated under the DGCL like any other for-profit corporation organized under Delaware law. The primary difference is that the charter of a PBC specifies one or more public benefits that the corporation intends to pursue alongside its mission to act in the best interests of its stockholders. Public benefits may include artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific or technological objectives.
Directors and officers at a traditional corporation have duties to make determinations in the best interests of the stockholders and the corporation. In contrast, the directors and officers of a PBC have duties to engage in a good faith balancing of the interests of (a) the stockholders, (b) those constituencies materially affected by the corporation’s conduct, and (c) the public benefit(s) identified in the company’s charter. On its face, this duty to engage in a “tripartite balancing” of these three sets of interests gives directors greater flexibility. But, until the new amendments, there were concerns among practitioners and boards about some of the costs of going the PBC route.
What’s changed?
Elimination of super majority approval requirement and appraisal rights risks
Prior to these amendments, the approval of two thirds of a company’s outstanding stock entitled to vote was required to amend its charter to become a PBC. And, in the case of private companies, the decision to convert to a PBC triggered an opportunity for dissenting holders to exercise appraisal rights and thereby monetize their unlisted shares at the expense of the issuer. Both of these requirements were procedurally onerous and a deterrent to conversion. The amendments will remove both the supermajority requirement and the right to appraisal. Companies may now convert to PBCs through a simple majority vote of their stockholders (plus whatever additional approvals are required under their organizational documents).
Stockholder directors qualify for insulation
Although PBC directors have a duty to consider all three elements of the tripartite balancing described above, the DGCL makes clear that non-stockholder stakeholders may not sue PBC directors even if these non-stockholders represent constituencies referenced in the PBC’s charter as potential beneficiaries of the tripartite balancing. Moreover, PBC directors may benefit from the presumption of a statutorily enshrined business judgment rule so long as their decisions are both informed and disinterested. Similarly, the charter of a PBC may broadly exculpate directors from liability in connection with their tripartite balancing so long as they are disinterested. However, the original PBC statute left it unclear whether a director’s ownership of stock in the PBC created a conflict of interest on the part of the director (in favor of the “interests of the stockholders” prong) when it comes to the tripartite balancing. The amendment will make clear that a PBC director’s ownership of stock in the PBC does not disqualify the director from being “disinterested” so that the director can benefit from the protection of the business judgment rule and the broad PBC exculpatory provisions when engaging in the tripartite balancing.
More broadly limiting stockholder litigation
From a litigation perspective, the amendments will provide further clarity that any action by a stockholder to challenge or enforce the tripartite balancing, whether through a derivative action or otherwise, may be brought only by plaintiffs that own at least 2% of the company’s outstanding stock for a private company, or the lesser of 2% or $2,000,000 of a company’s outstanding stock for a publicly traded company.
What’s next?
Courts have taken a broad view of the scope of the “best interests of the corporation and its stockholders” for purposes of permitting directors of non-PBCs to protect non-stockholder constituencies at the same time as acting in the best interests of the stockholders and the corporation. However, as directors are increasingly called upon to consider the interests of many different non-stockholder constituencies, directors will find it increasingly difficult to squeeze the square peg of benefiting “other constituencies” into the round hole of a duty to maximize stockholder value at every turn. The PBC statute can be a source of refreshing latitude for directors.
Revisiting the benefits, risks and uncertainties
The following summarizes some of the practical benefits of converting to a PBC:
- The process for converting to a PBC is simple. Once the amendments are effective, the process for conversion will be harmonized with the process for any other charter amendment.
- Non-stockholder constituencies are not permitted to bring claims for a breach of a PBC director’s duties despite the attractiveness of PBCs to these constituencies.
- Although stockholders of a PBC may bring suits for breaches of fiduciary duties, only stockholders that own a minimum amount of stock (as described above) are eligible to bring such suits.
- A statutory business judgment rule and broad exculpatory provisions will protect disinterested PBC directors when it comes to their informed and good faith tripartite balancing.
- Ultimately, the flexibility that a PBC affords directors and officers can be broader than that afforded to directors and officers of non-PBC corporations.
Even with these favorable amendments, some uncertainties and risks still remain:
- There have been few examples of PBCs that have conducted initial public offerings so far. Following Laureate Education, an international community of universities that went public as a PBC in January 2017, Lemonade, an online insurance company, recently completed its IPO as a PBC in July 2020. Currently, another PBC, Vital Farms, which is an ethical food company, has also filed its IPO registration statement with the Securities and Exchange Commission. Although the data is limited, we expect the PBC status of a company with a compelling social mission to help attract impact investment funds looking to identify companies for their portfolios that satisfy their social impact investment criteria and meet the growing demand of their own investors.
- PBCs are not immune from activism or proxy contests. However, for private companies, coupling a conversion to a PBC with the implementation of a dual class structure can help protect the mission of the company. When a company’s narrative is framed by detailed environmental and social impact disclosure and the adoption of a PBC’s alternative fiduciary duty paradigm, the protection of this narrative through structural features such as high-vote shares for the pre-IPO stockholders arguably becomes justifiable rather than a source of controversy. When a company converts to a PBC, the purposes of a dual class capital structure pivots from protection of the autonomy of founders to the protection and promotion of a mission to serve a broader purpose than only stockholder value.
This piece reflects an updated version of the original blog published on June 25th 2020.
