Lessons from the U.K. and U.S. on Hybrid Legal Models for Social Enterprise

Written By Kristina Roberts, JD 2018

Disclaimer: The information provided in this blog article is NOT LEGAL ADVICE. This information has been provided by a recent law school graduate, not a student-at-law registered with the Law Society of Alberta or a lawyer. If you need advice with respect to a specific legal matter, contact a lawyer. In Alberta, you can contact a lawyer by calling the Lawyer Referral Service at: 1-800-661-1095.

Hybrid legal structures, designed specifically for social enterprises, have begun to pop up all over the world. These models uniquely allow for the creation of profit-seeking enterprises that have purpose, fairness, and sustainability embedded into their core. Two of the countries that have had the most success with these hybrid legal structures are the U.K. and the U.S.; the experiences of these jurisdictions provide great lessons for Canadian policy makers. Legislators in B.C. and Nova Scotia, as well as several individuals and groups in the Canadian business community, have already been inspired by many of the features of these models, which are highlighted in this blog article.

The United Kingdom: Community Interest Corporations

The Community Interest Corporation (CIC) was introduced in the U.K. in 2005. The primary benefit of the CIC is that it offers legal protection of an organization’s social mission while allowing it to operate like a for-profit corporation. In other words, the social mission is embedded into the organization’s founding documents, and therefore decision makers cannot choose to forego pursuing the social mission in light of changing economic conditions and the like. This means that the social mission is more likely to outlive a specific leadership team or the founding shareholders of an organization. CICs must satisfy a ‘community interest test’ in order to retain their special status (test à whether a reasonable person might consider that the company’s activities are being carried out for the benefit of the community). Whether an organization satisfies the community interest test is determined by the Office of the Regulator of Community Interest Companies.

The Office of the Regulator of Community Interest Companies is a specific regulator that oversees CICs in the UK.  The Office decides whether an organization is eligible to become a CIC and provides guidance and assistance to entrepreneurs setting up CICs. It also has the power to investigate complaints and decide whether an organization can continue to benefit from the CIC designation (i.e. whether it is meeting the community interest test).

During its first few years of its existence, the CIC model seemed to be benefitting enterprises in terms of legal security and branding, but it was proving to be difficult for CICs to secure the financing they needed to succeed. This was attributed to a couple of different factors. Firstly, the dividends payable to investors were originally limited to 20% per share, which was considered by many to be too low. Secondly, CICs were not permitted to offer any tax incentives to donors or investors. In October 2014, the dividend cap was raised to 35% and the Social Investment Tax Relief was launched. The Social Investment Tax Relief provides individuals who invest risk capital in CICs with a 30% tax deduction. These reforms have proven to be beneficial, as we have seen a growth in investment in CICs in recent years. To date there are over 13,000 CICs operating in the U.K. and approximately £290 million is invested in these enterprises annually.

The United States: Low-Profit Limited Liability Corporations

In the United States, a variation of the Limited Liability Corporation (LLC) was created to accommodate business models prioritizing a mandate other than profit maximization — the Low-Profit Limited Liability Company (L3C). The L3C model originated in Vermont in 2008, and similar legislation has since been passed in ten states. An L3C is defined as a company that:

  • Significantly furthers the accomplishment of one or more charitable or educational purposes;
  • Would not have been formed except for the company’s relationship to the accomplishment of its charitable or educational purposes;
  • Does not have a “significant purpose” of producing income or appreciating property (though both are allowed); and
  • Does not exist to accomplish one or more political or legislative purposes.

The primary benefit of the L3C model is that it allows companies to retain all the benefits of incorporating as an LLC, while also being able to access “Program Related Investments” from private foundations. LC3s are not tax exempt under the Internal Revenue Code. As of July 2014, there were 1051 L3Cs accounted for across the United States. The LC3 model has not experienced as much uptake and popularity as another alternate model that was introduced for C-corps in the U.S. – the benefit corporation.

The United States: Benefit Corporations

The benefit corporation first appeared in Maryland in 2010. To date, benefit corporation legislation has been passed in 34 states, and there are six more states working on their own legislation, according to the benefit corporation website.

The benefit corporation is an alternative to the shareholder-primacy model of corporate governance in the United States. In order to become a benefit corporation, a company must embed a “public benefit” purpose into its articles of incorporation, and require corporate directors to consider the interests of all of the stakeholders affected by the operation of the business. While it is a positive addition to American corporate law, the requirement for directors to consider or balance the interests of various stakeholders is similar to what is contemplated by Canadian corporate law already. The benefit corporation model does not impose a dividend cap, or alter the tax status of a corporation.

The uptake of benefit corporation legislation and the number of benefit corporations across the U.S. continues to grow (~5000), whereas the passage of L3C legislation has stagnated. Perhaps this can be explained, in part, by the branding and marketing power of the non-profit B Lab, which oversees benefit corporations in the United States and administers the certification process where benefit corporation legislation does not exist (e.g. in Canada).

While the process of B-corp certification is very similar to what is required under American Benefit Corporation legislation, the legislation was required in the United States because a regular corporation would not be able to legally obtain certification. In Delaware, the state that sets the tone for corporate law for the United States, corporate directors owe a duty of loyalty directly to shareholders. This means that profit-seeking activities need to be primary or else directors could face liability. The legal model of the Benefit Corporation was created in order to allow directors to take the needs of other stakeholders into account. In Canada, corporate law is a bit different in that the Supreme Court has made it clear that corporate directors are allowed to take the interests of stakeholders other than shareholders into consideration. Whether directors are required to take these interests into consideration remains unclear. However, due to the influence of securities regulators in Canada, B-corp certification is best suited to closely-held private companies.

Incorporating as a benefit corporation, or obtaining the B-corp certification, has allowed companies like Patagonia to benefit from branding advantages, and has allowed them to more easily attract conscious consumers. Additionally, the support of the benefit corporation/B Corp community as a whole is likely a valuable asset for these companies.

Critics of the benefit corporation model point out that there is a lack of regulatory oversight of these organizations, when compared to the CIC in the U.K. As a result of this lack of government monitoring and enforcement, the third-party B Lab is relied upon to hold benefit corporations accountable, and to maintain the integrity of the model as a whole.

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