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L ANGUAGES FOR COMMUNICATION IN INTERNATIONAL ENTERPRISES AND ORGANIZATIONS

THE BIRTH AND DEVELOPMENT OF BENEFIT

CORPORATIONS IN THE UNITED STATES: THE PATAGONIA CASE .

Prova finale di:

Nicolas Mazzotti Relatore:

Prof.ssa Livia Ventura

Correlatore

Prof.ssa Marina Bondi

Anno Accademico 2018-2019

Abstract

The following thesis is about the birth and development of the Benefit Corporation in the United States, with a particular case study on Patagonia, Inc.

The purpose of this work is to study how the Benefit Corporations were born and their development though time. Notably, in the first part of this work, we are going to make an overview on the traditional corporations. This is a fundamental step since it allows to highlight the business background against which the benefit corporation have been created. In fact, starting from the first historical debates about what final objective the traditional corporations should have had, we are going to delve into the U.S Corporate Law, underlining also the key elements of the Model Business Corporation Act. The last part of this chapter will be about the shareholders’ primacy, which helps us to create a link with the following chapter. In the second part of the work, it is important to stress the rising of the increasing concern about sustainability and environmental safeguard: it is this process, in fact, that leads progressively to the creation of, at a first moment, the B Corp Movement and then of the Benefit Corporations. A deeper analysis will be carried out on these new business ventures, digging into their main passages concerning the historical development, their features, their mission and, last but not least, the Model Benefit Corporation Legislation.

The rest of the thesis presents the case study on Patagonia Inc. Here, after having discussed the main provisions of the California Benefit Corporation Law, we will see the historical development of the firm, focusing mainly on its mission and environmental – social commitment, in terms both of B Lab Certification and acquisition of the legal model. Only at the very end, some real data will be taken into account, with the study of the two most recent Annual Benefit Report, dated 2017 and 2018.

All things considered, it is possible to affirm that the final result of the present work of thesis is a better understanding of the mechanisms that led to the rising of the Benefit Corporations, including their main features and their modus operandi, applying then all this to the real case of Patagonia Inc.

Riassunto

Il seguente lavoro di tesi verterà sulla nascita e sullo sviluppo delle Benefit Corporation negli Stati Uniti, con un’analisi riguardante l’azienda Patagonia, Inc.

Lo scopo è quello di studiare come sono nate le Benefit Corporations e il loro sviluppo nel tempo.

Più nello specifico, nella prima parte del lavoro, verrà svolto un quadro generale sulle corporations tradizionali. Questo passaggio è fondamentale perché evidenzia il contesto societario nel quale sono sorte le Benefit Corporations. Infatti, partendo dai primi dibattiti storici su quale dovesse essere l’obiettivo finale delle normali corporations, ci si

immergerà nel diritto societario americano, sottolineando anche gli elementi chiave del Model Business Corporation Act. L’ultima parte di questo capitolo riguarderà la shareholders’ primacy, la quale creerà il link con il capitolo successivo.

La seconda parte della tesi verterà, invece, sul crescente interesse nei confronti della sostenibilità e della salvaguardia ambientale: è questo processo, infatti, che conduce progressivamente alla creazione, in un primo momento, del movimento B Corp e, in un secondo momento, delle Benefit Corporations. Un’analisi più approfondita verrà affrontata su questa nuova tipologia di business, scoprendo i passaggi che hanno caratterizzato il suo sviluppo, analizzando anche le sue caratteristiche, la sua missione e, ultima ma non per importanza, la legislazione sulle Benefit Corporation.

Si giunge, poi, alla parte riguardante l’azienda di outdoor wearing Patagonia Inc. Dopo aver discusso le previsioni di legge più significative previste dalla California Benefit Corporation Law, si procederà con lo studio dello sviluppo storico dell’azienda,

concentrandosi principalmente sulla sua missione e sul suo impegno sociale ed ambientale, sia per quanto riguarda la Certificazione B Lab, sia per quanto riguarda l’acquisizione del modello legale. Solo nella parte finale, verranno presi in considerazione i dati provenienti dai due Annual Benefit Report, del 2017 e del 2018.

Concludendo, si può dire che, come risultato finale, si è giunti ad una maggior comprensione dei diversi meccanismi che hanno portato alla nascita delle Benefit Corporations e del loro modus operandi. Si è poi applicato tutto ciò a un caso reale, la Patagonia Inc.

Résumé

Le travail de thèse suivant portera sur la naissance et le développement de la Benefit Corporation aux États-Unis, avec une analyse de la société Patagonia, Inc.

L'objectif est d'étudier comment les Benefit Corporations ont été créées et leur évolution dans le temps.

Plus spécifiquement, dans la première partie du travail, on fera un survol des sociétés commerciales. Cette étape est fondamentale parce qu'elle met en lumière le contexte dans lequel les Benefit Corporations ont vu le jour. En fait, dès les premiers débats historiques sur ce que devrait être le but ultime des sociétés normales, nous nous plongerons dans le droit américain des sociétés, en mettant également en lumière les éléments clés du Model Business Corporation Act. La dernière partie de ce chapitre portera sur la primauté des actionnaires (shareholders’ primacy), ce qui créera le lien avec le chapitre suivant.

La deuxième partie de la thèse concerne l'intérêt croissant pour la durabilité et la

protection de l'environnement : c'est en effet ce processus qui conduit progressivement à la création, dans un premier temps, du mouvement B Corp et, ensuite, des Benefit

Corporations. Une analyse plus approfondie sera effectuée sur ce nouveau type

d'entreprise, en découvrant les étapes qui ont caractérisé son développement, en analysant également ses caractéristiques, sa mission et la législation sur la Benefit Corporation.

Ensuite, on viendra à la partie concernant l'entreprise de vêtements de plein air Patagonia Inc. Après avoir discuté des dispositions légales les plus importantes de la loi californienne sur la Benefit Corporation, nous procéderons à l'étude de l'évolution historique de

l'entreprise, en nous concentrant principalement sur sa mission et son engagement social et environnemental, tant en ce qui concerne la certification B Lab que l'acquisition du modèle juridique. Dans la dernière partie, les données des deux rapports annuels, 2017 et 2018, seront prises en compte.

En conclusion, nous pouvons dire qu'en fin de compte, nous sommes parvenus à une meilleure compréhension des différents mécanismes qui ont mené à la naissance des Benefit Corporations et de leur modus operandi. Cela a ensuite été appliqué à un cas réel, celui de Patagonia Inc.

THE BIRTH AND DEVELOPMENT OF BENEFIT CORPORATIONS IN THE UNITED STATES:

THE PATAGONIA CASE

Introduction

Chapter 1: General Overview of US Corporation.

1.2 Main features of corporate internal structure……….8

1.3 An overview of corporations in the U.S.A……….…………..………....9

1.3.1 First historical debates…...…………..………..9

1.3.2 Us Corporate Law………...……….………..11

1.3.3 Model Business Corporation Act…………...………….…………..…….13

1.3.3.1 History……….………...……….13

1.3.3.2 Structure....……...………..14

1.3.3.3 Purpose.………...……….………..14

1.3.3.4 Content and Enactment……….………...15

1.3.3.5 General Provisions – Chapter 1………,,,………...15

1.3.3.6 Incorporation – Chapter 2.………,,,,,,,……….16

1.3.3.7 Purpose and powers – Chapter 3….…,,…….….……….…...17

1.3.3.8 Directors and officers – Chapter 8 (fiduciary duties)…….……...…18

1.3.3.9 Appraisal Rights - Chapter 13……….…,,,,,….…………22

1.3.3.10 Reports and records – Chapter 16…….…………..……,,…………23

1.3.4. Business Corporation and Shareholders’ primacy model: between success

and criticism………...………23

1.3.5 The Director primacy model of Bainbridge……...…….……….………..25

1.3.6 The team production theory by Blair and Stout………..…………...27

1.3.7 The stakeholder primacy by Freeman………..………..……29

1.3.8 Shareholder primacy by Friedman………....………....31

Chapter 2: Birth and Development of Benefit Corporation in the U.S.A

2.2 B Corp Movement………….…………..….………..44

2.3 Benefit Corporation: birth and development ……….……….…………..49

2.3.1 Historical development………...………..49

2.3.2. Benefit Corporations: main features and mission………….………...50

2.3.3 Differences and similarities between B Corps and Benefit Corporation...…54

2.3.4 Why to create a Benefit Corporation? Advantages and disadvantages...…...56

2.4. Model Benefit Corporation Legislation………...……….57

2.4.1 Subchapter 1 – Preliminary Provisions………....………57

2.4.2 Subchapter 2 – Corporate Purposes………..………...……….59

2.4.3 Subchapter 3 – Accountability………60

2.4.4 Subchapter 4 – Transparency……….63

Chapter 3: The Patagonia Case.

3.1.1 Chapter 1 - Preliminary Provisions………...…….……….………..65

3.1.2 Chapter 2 – Corporate Purposes……….………..….………….….………...66

3.1.3 Chapter 3 – Accountability……..…….……….66

3.1.4 Chapter 4 – Transparency……..……….………..67

3.2. Patagonia Inc.,………..……….68

3.2.1. History and development………..……...…….………68

3.2.2. Mission and products……….……...……..….……….71

3.2.3 Environmental and Social Commitment…………...…...……….………..73

3.2.4 B Lab Certification……….……...………...………..77

3.2.5. Acquisition of the legal model of Benefit Corporation according to the California law……….79

3.3 Annual Benefit Report………80

3.3.1 Analysis of 2017 Report……….…….….………..…....80

3.3.2 Analysis of 2018 report……….……….84

3.3.3 Comparisons……...……….………….……….………..88

3.3.4 Final considerations………...…...……….92

Conclusions……….……….……….95

Bibliography……….………99

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Introduction

We are living an era of great changes.

Everything, on this world, is in a perpetual cycle of evolution, in a bad or in a positive way. Unfortunately, in the last decades, humanity is witnessing more negative changes, mainly linked to the environment and to the society. What is happening?

Environmentally speaking, affirming that we are destroying our home is not an overestimation. In fact, almost in every location on this planet, even in the remotest ones, there is at least a human being who does not care about the context he is living in.

Billions and billions of people conduct their existence without considering the effects that even their simplest actions can have on the natural world surrounding them. This is, obviously, proven by lots of data. As the World Resource Forum underlines, if we consider the ecological footprint, which is a tool for measuring in hectares the amount of lands and water used to support domestic consumption, the situation is worrying: in fact, considering that Planet Earth has 13.4 billion of global hectares of productive land and water, in 2007 the world-average footprint was of 2.7 global hectares per person.¹ In more recent years, the situation has deteriorated, reaching the level of 2.8 global hectares in 2014. This is not good if we consider that each person should have a 1.7 global hectares of available biocapacity.² The idea is that, with this trend, by 2030, two Earths will be needed. More than 80% of world population lives in countries where they consume more than what the local ecosystems can produce.

For instance, lots of mineral are disappearing: oil will last only for 40 years, natural gas for 60 years, coal for 250 years.³ With this trend, the day will soon come when no more natural resources will be available: this can be avoided with the implementation of renewable resources, otherwise everything will be lost. There are tons of evidences proving world destruction by humans. Taking the problem of deforestation, in Southeast Asia, the average area deforested every year covered more than 1 million hectares from 2005 to 2015.

1 https://www.wrforum.org/opinion/planet‐earth‐limits‐natural‐resources/

2https://www.footprintnetwork.org/

3 https://www.wrforum.org/

In Latin America, the growing of urbanization, energy consumption, economic growth and other similar factors has led to increment the greenhouse ga emissions. In Monterrey, Mexico, the particulate matter (PM) reached the high level of 85.9, which is higher than the limit of 20 stated by the World Health Organisation. In the Artic, since 1980, warming has kept increasing causing the endless glacier ice loss. This was mainly due to climate change and, thus, by human activities. The melting of sea ice contributes to destroying the marine food chain, altering the normal life conditions for the inhabitants of the oceans.⁴

It seems that we are blinded by the desire to enrich only ourselves, to maximize our well-being in the present, without taking into account any future perspective. And even worse, it is that we are not understanding the fact that all the efforts made for the maximization of our personal welfare are senseless, since with this trend there will not be a bright future, or maybe, any future at all. It is like a child trying to catch money for buying sweets that he cannot eat. This is exactly what we are doing.

Obviously enough, everyone is involved in this process, businesses included. As a matter of fact, the number of companies that are conducting their affairs not- caring about possible consequences about the environment and society is not small.

From the smallest firm to the worldwide multinational groups, managers are taking decisions with the sole final goal of making money. Consequently, no matter if hundreds of tons of CO2 are reversed into the atmosphere each day, no matter if the most important rivers in the world are polluted, if the amount of plastic in the oceans is outnumbering the quantity of fishes in the oceans, no matter if poor children are overexploited in gold mines or in the textile factories with a paltry pay, or if they have to suffer miserable working conditions: what matters is only money. Money are the only responsible factor for all these changes.

Therefore, it is time to act. It is time to make something before it is too late. This is exactly the idea that has led to a sort of sensitizing in the business world. Notably, there has been like a flash in the dark: thanks to the brilliant work of few individuals, new hybrid form of businesses started to come out, with the aim of addressing also environmental causes, and not only profit.

4 https://www.un.org/sustainabledevelopment/blog/2016/05/rate‐of‐environmental‐damage‐

increasing‐across‐planet‐but‐still‐time‐to‐reverse‐worst‐impacts/

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Starting from 2006, precious in this sense was the role of the nonprofit B Lab, which, as we will see in this work, developed and promoted the introduction of the Benefit Corporation in the United States at first, followed then by other countries.

These type of corporation began to distinguish itself from the others because of its fundamental double goal: on one side, they still have the goal of profit maximization as the traditional corporation, on the other side, they are legally required to consider the impact of their actions and business decisions on the environment and society.

This is exactly what is needed by the business world. In fact, even though they are not well diffused as the traditional corporations, the new Benefit Corporations are just the first important step towards a project of environmental safeguard. The idea, thus, is to induce a kind of chain effect that might, during the years to come, induce the creation of always more Benefit Corporations, leading to the astonishing result of creating working opportunities for people and, meanwhile, protecting the environment and society where these businesses will operate.

The aim of the present work is to study the main features and elements that characterize the Benefit Corporation. More in particular, in the first part we are going to deal with the traditional corporations, studying how they were born and the main debates about their objectives and governance. Then, in the second chapter, we are going to deal with the birth and development of the Benefit Corporation in the U.S.A, learning the pivotal role of B Lab and its certification system, and of the Model Benefit Corporation Legislation.

To conclude the work, we want to analyze a real Benefit Corporation, to see how it works and the real efforts dedicated to the implementations of good initiatives.

Having said this, it is now important to dig deeper into the world of corporations.

CHAPTER 1

General overview of US Corporation.

1.1. The panorama of the traditional business corporation from a comparative law perspective.

Notwithstanding the fact that the main aim of the present work will be the analysis of the Benefit Corporation legal model born in the US, it is necessary to take a step back, in order to analyze what are the essential features that characterized the

“classical” type of corporations. Only after, we will take into consideration the development of the Benefit Corporation. In more practical words, what should be studied are the main issues of the corporations in the United States and, once accomplished this first task, why the first Benefit Corporations were born.

The law governing corporations is the Corporate Law. According to the thesis proposed by Hansmann and Kraakman and based on the economic analysis of law approach, the principal aim of corporate law is the creation of the aggregate welfare of all the stakeholders of a firm, including employees, customers and suppliers. However, usually scholars argue that the goals of the corporate law is not widely extended, but it should be more focused on the best interests of its shareholder, or, better, on the maximization of their financial returns.⁵

Having said this, it is now time to get a closer look to the main features of corporations. A corporation is to be considered as group of people acting as a single entity. From a comparative law perspective, corporations are characterized by five different features, as it is clearly indicated in the famous work of Hansmann and Kraakman et altri, “The Anatomy of Corporate Law: A Comparative and Functional Approach”. This feature is very important for companies. In fact, with legal personality, a firm can achieve a sort of independent status: it works as a single contracting party separated from the members, coordinating all the productive activities.

5 Reinier Kraakman, Henry Hansmaan and al., The Anatomy of Corporate Law, A Comparative and Functional Approach, Oxford University Press, p.25, 2004.

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Furthermore, it allows a firm to own a “separate patrimony” and, thus, to own its own assets. So doing, the firm assets are completely detached from the shareholder’s personal assets and they can be sold or bought by the firm at will and they can also be pledged to firm’s creditors (Affirmative Asset Partitioning).

In addition to that, two further rules are worthy of mention when analyzing legal personality, notably the “priority rule” and the “liquidation protection rule”. The priority rule assumes that the firm’s creditors have a first claim on the firm’s assets, also prior to any possible claim made by shareholders’ personal creditors. Nowadays, this rule is applied by every organizational forms and its importance derives from the fact that it enhances the credibility of the firm in the market.

For what concerns the liquidation protection rule, instead, the shareholders of the company can not decide to withdraw their personal assets whenever they want and the shareholders’ personal creditors can not foreclose on the firm’s assets. The rationale of this rule is very straight-forward: avoiding any damages and destruction of the firm caused by shareholders or creditors. The second is limited liability. With limited liability, the shareholders’ personal assets are separated from the business assets and debts. The shareholders’ personal assets cannot be claimed by the business creditors for the corporation’s debts. Flexibility in the allocation of risk, facilitating delegated management, shifting business risk from shareholders to creditors and allowing creditors to monitor the managers are the most important advantages of the limited liability. These two first different features permit a sort of division of the assets: in fact, legal personality allows a company to hold, own, and sell its personal assets. On the other hand, with limited liability, the shareholders can protect their personal assets against potential debts of the firm. In addition to that, thanks to juridical personality, the business creditors can have a first claim on the firm assets, allowing to reduce the cost of monitoring on those assets. The same thing is true for shareholders’ personal creditors, who can have a first claim on the shareholders’ personal assets, thus limiting the monitoring cost on those assets.

Then, we have the transferability of shares. Transferability of shares allows a company to conduct business uninterruptedly, even in case of a possible change of the firm’s owners. It is necessary, however, to distinguish the transferability of shares from free tradability of shares. In fact, the former assumes that the shares of a firm can be transferable between two different groups of owners but they cannot be tradable on the financial market.

The latter, on the other hand, allows the assets of the firm to be tradable on the financial market, where they can be sold and bought. Basically, all types of legal systems have at least one type of organizational form with free tradability of shares, that is to say the open corporation.

The fourth is the centralized management under a board structure. This permits a company to separate the owners from the managers. With this, a business has the centralization of management. There can be: one tier corporate governance model and two tier corporate governance model. In the first case, the Board of Directors, which is elected by the shareholders, has the ultimate decision-making authority on what concerns the main issues and problems of the company, such as setting the company’s policy, objectives and direction, naming the audit, hire and monitoring the managing director and other executives. All the members are liable for their actions and decisions towards the company. This board is composed by: executives directors, non-executives directors and chairman of the board. This latter is, in very simple word, the head of the firm and, from here, his responsibility to run the business smoothly and at his best. He has also the duty of promoting and creating a good channel of communication with the Chief Executive Officer (CEO) and the other officers. Overall, its duty is to maintain the company in good shape.

As far as the executive directors are concerned, they usually are employees and other figures linked to the company. Among these internal directors, we find the Chief Executive Officer (CEO) and also the Chief Financial Officer (CFO). Their main aim is to control and run the day-to-day operations, reporting everything to the Board of the Directors. All the ideas, projects and new formulas promoted and created by the Board are subject to the approval or refusal of the executive directors. For what concerns, instead, the Non-executive directors, they are all external directors and they are usually paid a fee for the work done. They attend monthly board meetings and they take part to the process of planning and also monitoring the executive directors. On the other hand, in the two- tier corporate governance model, things are quite different. In fact, the board is composed by two groups: the Management Board and the Supervisory Board. The Management Board is composed by members-directors that are all executive directors whose decisions, only in specific cases, need the approval of the Supervisory Board. The management board’s members are all elected by the Supervisory Board,

7

which is also responsible for guiding and controlling the Management Board. In Germany, (but very rarely in other countries) thanks to the “principle of Codetermination”, employees can become part of this second board.

Another important element is the investor ownership. Mainly, the two key- elements in the ownerships are: 1. The right to control the firm 2. The right to receive the firm’s net earnings. The business corporation statutes universally provide as a default rule that the above mentioned rights are proportional to the amount of capital contributed to the firm. The diffusion of this kind of ownership is due to its high level of advantages: in fact, not only the investors are usually very difficult to protect, but since investors usually share homogenous interests, this can also reduce the risk of conflicts between the shareholders. However, in particular in Germany, it could happen that sometimes investor ownership is not always followed by corporation, which, on the contrary, thanks to the already mentioned principle of Codetermination, is able to include in the control of the firm and in the receiving of the net earnings also members (e. g: employees) that are not investors. Finally, it should be highlighted that in non- profit corporations, the investors are allowed to participate only to one of the two rights, not both.⁶

6 Ivi, p. 6‐15

1.2 Main features of corporate internal structure.

These being the most important features for a corporation, we need to introduce now what is the classic and basic corporate structure.

To begin with, each company is composed by the Board of Directors, which aims at protecting the shareholders’ interests and informing them about the business actions and status. The shareholders, who are the owners, are also responsible for the appointment of the directors. The officers are the management team. Then, the biggest part of the firm: the employees, the core of the production of the firm, without who the company can not exist

After this brief but important overview of the principal actors of a business, it is interesting to study what are the characteristic elements of the board of directors. First of all, the board and the officers are two distinct entities: as a consequence, all the decisions that do not require any approval from the owners are divided into those depending on the board and those under the control of the officers. This distinction is very useful because it enables the board to check and control the decisions of the officers. In two-tier corporate governance, the officers can be part of the Management Board, but not of the Supervisory one. On the opposite, in the one-tier board, the officers are completely free to be part of the board. Secondly, the board is fully separated from the shareholders. The main advantages are the avoidance of a possible opportunistic behavior by the shareholders but also the reduction of the costs linked to the decision-making process, since they eliminate the need to inform and to receive the consensus from all the owners about all the decisions made. Thirdly, the board is elected by the shareholders: this important element assures the owners that the board remains faithful to their interests and it distinguishes the corporation from other type of organizational form, such as the non-profit firms, where the presence of the board is mandatory but it is not elected by the shareholders/members. The last element characterizing the board is the fact that it is composed by multiple members, thus facilitating a mutual monitoring on decisions. However, it should be highlighted that not all the companies have the same board composition: this is the case of close corporations (GMBH in Germany, SARL in France, SRL in Italy) where there is only one director.⁷

7Ivi.

9

All things considered, as Kaufman suggests, the corporate organizational form is one of the most relevant innovation of the modern era. Basically, the corporation is based on a specific legal contract, called business charter, which is created between the sovereign state and the business promoter. This business charter has the objective to establish duties and benefits, acting as a “legal shield” protecting, for example, investors form insiders’ and outsiders’ appropriation of firm-specific resources. ⁸

1.3 An overview of corporations in the U.S.A.

1.3.1 First historical debates.

From an historical point of view, the first business corporations that were created in USA were very few entities. In particular, in the Thirteen Colonies there were only seven business entities, then increased to 28 up to 1790. From 1790 to 1860, U.S state legislatures chartered more than 22,000 corporations by individual acts of their legislatures and from 1840 there were 7,000 entities under general incorporation laws.

By 1910, 270,000 of the overall 450,000 business corporations existing in the world were American. In more recent years, the United States counts almost 6 million corporations:

a huge data that gives them the name of “corporation nation”. ⁹

The largest early corporations were mainly insurance companies and banks, and only later railroad and manufacturing industries. Notably, the two Banks of the United States (BUS) chartered by Congress that differed from the other smaller companies because of a large size. The first BUS, founded by Alexander Hamilton in 1790 was influential because many features of its charter were a source of imitation for later bank and non-bank charters.¹⁰

At the end of the nineteenth century, there was a huge presence of large scale business organization in the manufacturing sectors, created from the merger of small firms.

8 Alexander Styhre, What we talk about when we talk about fiduciary duties: the changing role of a legal theory concept in corporate governance studies, Management & Organizational History, 2018, p. 116

9 Richard Sylla, How the American Corporation Evolved Over Two Centuries, Proceedings of the American Philosophy Society, Vol.15, American Philosophical Society, p. 355.

10 Ivi, p. 356.

However, the opponents to this process were not missing: farmers were against the high rail road rates and the small retailers were crushed by bigger competitors.

Another important concern which was linked to the development of these huge enterprises was the increasing number of shareholders. This was mainly due to the mergers and acquisitions, since the former owners of the “acquired company” were added to the already existing owners of the “acquiring company”. Between 1900 and 1917, the three largest American corporations tripled their stockholders, as Harwell Wells pointed out.

In the 1920, some ideas started to come out about how these companies should have been ruled and governed. In other words, what scholars and thinkers discussed about was the organization of the corporation: how can the huge number of small shareholders with little power influence the management of their company? By having a diffused ownership and thus no control by the shareholders on the management, the interests of directors and managers can no longer be the same. The solution was the separation of ownership and control.

A first important debate about the corporation and their separation of ownership and control was between the following two important writers: Louis D.

Brandeis, an activist lawyer and the journalist Walter Lippman. Brandeis, in his book

“Other People’s Money, believed that this separation was the fundamental problem of the modern corporation. In particular, due to this division, it was not possible for managers of giant corporations to manage responsibly and to know what was happening in all the divisions of the company. This separation could have led to an efficient and unwieldy corporation.¹¹

Completely different was the idea of Lippman. According to him, the division of control and ownership was a positive process for society. By giving power to the appointed managers with a salary, the profit – seeking approach of owners was transcended: these new managers were, in fact, free from the rules of the “profit system”

and they would run the corporations in the interest of society as well. ¹²Also worthy of mention in the debates concerning questions and perplexities about the above – mentioned issues are other two scholars, Berle and Means. For them, the control of a giant corporation depended on the ability to elect its managers, which can be made by the majority shareholder or by minority shareholders. In addition to that, they also

11 Harwell Wells, The Birth of Corporate Governance, Seattle University Law Review, Vol.33, No.4, 2010, p.1247 - 1257

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strongly advocate the fact that shareholders should have judicial protection: not only inside the corporation but also in the courtroom. However, their most important thought about the corporations and their development was the belief these business entities were crucial for the modern life and their impact on society was similar to that of medieval churches in the past: generally speaking, the growth of corporate concentration would lead to accumulate wealth together at an increasing size, as clearly demonstrated by the 200 biggest U.S corporations that at their time controlled half of the nation corporate wealth.¹³

After having discovered some of the various thoughts and perplexities animating the first debates about the birth and development of corporations, it’s now time to make some consideration about the US Corporate Law.

1.3.2 US Corporate Law.

The United States of America is a common law country characterized by the federalism. Generally speaking, there are two broad levels of law: federal law and state law. The attribution of legislative power is contained in the written Constitution, which is the most important in the world. The Congress has the power to create federal laws, which are limited in scope: in fact, according to Article 1 of the Constitution, it has legal competence only on certain subjects such as currency, taxation, defense, copyright, maritime law, antitrust and trademarks. The federal statutes are grouped in the United States Code.

The other level is the State law. Basically, each of the fifty American states has legal competence all over the rest: family law, tort law, contract law, criminal law, private and business law and so on. Each state has its own state constitutions, courts and governments. If this was a brief overview of the legal system, we are going to shift now to the Corporate Law, both from the federal and state perspective.

At the federal level, central are e.g the Security and Exchange Act of 1934 and the Sarbanes-Oxley Act of 2002, and Dodd-Frank Act of 2010. These statutes govern the trading of securities in the financial market at a federal level. Then, a more recently act was made for the public company boards, management and public accounting firm: it covers the board of directors’ responsibilities of a public company

13 Ivi, p. 1289‐1290

and enacts penalties in case of misconduct. It forces also the Securities and Exchange Commission to regulate public corporations. In addition to that, other initiatives have to be taken into account.

For example, since in USA the legal competence in terms of corporate law is very jagges due to the high number of states, several organizations have worked at the creation of model laws. These laws can, then, receipted by the states in order to uniform the corporate law. Between these organizations, there is the American Bar Association, which has created the Model Business Corporation Act, one of the most important model for business laws.

As a matter of fact, the majority of corporate laws was born at the state level.

The state statutes differ from each other across countries, even though there are many states that mainly follow the Model Business Corporation Act since they have not developed their own statutes. California, for example, has its own set of laws. In general, the primary role played by the state statutory corporate law is to promote and facilitate corporate transactions and conduct and, as Eisenberg points out, state legislation is good at this. Instead, it is weak in the regulation of conflicts of interest between shareholders and top managers, because of different reasons. One of these motives is, for example, the asymmetric expertise: in other words, what lacks is the legislative expertise and also neutrality in the corporate law. In fact, it can happen that certain laws predictably work for or against the interests of a group of people. On the contrary, the state judge-made law is good at regulating conflict of interests. This statement is confirmed by the fact that the courts have implemented good laws related to the fiduciary duties of directors, as we will see in the following pages.¹⁴

U.S corporate law admits the existence of different types of corporations. Generally speaking, they can be macro-divided into for-profit corporations and non-profit corporations. At it is quite easy to understand already from their name, the first category is centered only on the maximization of the profit of the firm and, therefore, of its owners.

Additionally, U.S corporate law admits also the existence of the so called Not-for-profit corporations, whose main purpose is not the making of a profit but, usually, is the pursuit of social, benevolent, charitable or educational goals.

14 Melvin Aron Eisenberg, The Architecture of American Corporate Law: Facilitation and Regulation, Berkeley Business Law Journal, Volume 2, Issue 1. 2005, p. 176‐181.

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For what concerns the first type, which is to say the for profit corporations, very common is the Closely Held Corporations, which has only few stockholders and its shares are not traded on the public market. Another possible type is the C Corporation, a business entity which is allowed to have an unlimited number of shareholders (also foreign ones);

differently from the S Corporation, the C Corporation must not have more than 100 shareholders who must be natural persons (even though some trusts and estates corporations can be shareholders). Here, profit and losses are distributed to the shareholders according to their interests. Then, the Professional Corporation is composed by professionals such as doctors and lawyers, who decide to create a corporation only for the advantages they can have such as centralized management, limited liability of shareholders and others. The Publicly Held Corporation, instead, is the most used in the business word: its shares are publicly traded on a public stock exchange, as The New York Stock Exchange or Nasdaq). As already underlined above, it is possible to say that all these corporations are basically Profit or Business Corporations. In fact, their main goal is to transact business in order to maximize their profit.

However, this work will be focused on the category of Profit corporation.

Notably, we will consider the Benefit Corporation, a recent evolution of the traditional for profit enterprise introduced for the first time in Maryland in 2010.

1.3.3 Model Business Corporation Act.

1.3.3.1 History

The Model Business Corporation Act (from now on the MBCA) is a set of laws aiming at regulating corporate issues in a uniform way across the different states of U.S.A.

The Model Business Corporation Act was made by the Committee on Business Corporations of the American Bar Association. This last is a completely voluntary association of lawyers and law students: its main goal is the promotion of the administration of justice and of the uniformity of the legislation across the different countries. Everything started when after the creation of the Federal Act, the Committee was asked to create an act which should have been used for state use. In 1946, an initial draft was made reporting the title of “Model for State Business Corporation Acts”.

To cite some of the scholars who contributed, there were Professor William E.

Britton, Frederick W. Brune, Professor Dodd, George C. Seward, Greenberry Simmons and others. Due to the fact that the initial draft was judged to be incomplete, the Committee decided to improve the Act in terms of coordination, language, style and arrangement. In 1950 it was, then, published. Another revision was made in 1984 and then, more recently, in 2016.¹⁵

1.3.3.2 Structure

It is formed by 17 chapters, which are then subdivided in different sub-chapters. It starts with the General Provisions (Chapter 1) and it ends with Transition Provisions (Chapter 17). Totally, there are 145 Sections. The first 46 sections are related to substantive provisions, as for example definitions, purposes, powers, name, authorizes shares and others. Then, the following 52 sections are about the procedures for incorporation, amendment, merger, voluntary dissolution, liquidation, involuntary dissolution. The next 19 sections are centered on status, admission, withdrawal. Laws concerning annual reports, fees, franchise taxes are contained on the following 10 sections. The last 18 sections concern administrative authority, penalties and miscellaneous issues.¹⁶

1.3.3.3 Purpose

The first purpose of the Act is to furnish state commissions a useful tool that can be used for the modernization of their corporate laws. The Committee believed that thanks to this tool, the local commissions can avoid a lot of labor and research. In fact, not only the Act is able to bring uniformity in the corporate laws, but it also promotes the same terminology across the different states, promoting an easier interpretation.

15 Ray Garret, History, Purpose and Summary of the Model Business Corporation Act, from the Buiness Lawyer, Vol. 6, No.1, published by the American Bar Association, 1950, p.1.

16 Ivi, p. 2

15 1.3.3.4 Content and Enactment

As already said, the Act is about business laws for corporations. There are a multitude of topics (process of incorporation, limited liability, corporate management structure and so on). In addition to that, what is important to highlight is the fact that certain MBCA’s laws are default laws and, thus, they are applied only in those fields where the corporation is lacking its bylaws.

As far as the application is concerned, the Act is voluntary and the states can apply modified versions according to their needs. There are some states which apply it only partially. ¹⁷

Now, we are going to concentrate on what the act prescribes in terms of general provisions, incorporation, purpose, dissenter rights, fiduciary duties and reports. In fact, it is important to underline these points in order to understand what the main changes are in the Benefit Corporation legislation that will be introduced in the next chapter.

1.3.3.5 General Provisions – Chapter 1

To begin with, the General Provisions are contained in Chapter 1.

Here, worthy of mention is surely the Subchapter B stating that the legislature of each state has the power of amend or repeal part or all of this Act whenever it wants.

The purpose of section 1.02 is, basically, to avoid the belief that a corporation can have specific rights in a specific statutory provision and the possibility of the state to modify corporation statutes as it considers appropriate. Completely different is subchapter 1.20, where the requirements for documents are explicated. In other words, this section aims at standardizing the filing requirements for all documents, in order to reduce the number of documents that have to be processed by the secretary of state.

Furthermore, in Subchapter C, the Act grants the secretary of state the authority necessary for the performance of its duties, but at the same time underlines that the secretary of state has not the power to establish public authority. Subchapter D is about definitions of items which can be found in the document. Subchapter E concerns instead the Ratification of Defective Corporate Actions, which are those actions that, even though they are within

17 From www.upcounsel.com and info.legalzoom.com

the power of the corporation are void or voidable due to a lack of authorization to act in compliance with the provisions of the Act or the bylaws. For example, the failure of the incorporator to appoint the initial board of directors and the failure to obtain the shareholder approval about a corporate action are considered as defective actions. ¹⁸

1.3.3.6 Incorporation – Chapter 2

On the other hand, Chapter 2 – INCORPORATION takes into consideration basically the fundamental steps for the formation of the company.

For example, it concerns the corporate name, the number of shares authorized and the street address of the initial office. It provides that the existence of the company is accepted once the articles of the incorporation are filed, as clearly shown in the extract below taken from the Model Act (see note 15). ¹⁹

18 From the Model Business Corporation Act (2016 Revision), Chapter 1.

19 Ivi, chapter 2, p.55.

2.02. Articles of Incorporation.

(a) The articles of incorporation must set forth:

(1) a corporate name for the corporation that satisfies the requirements of § 4.01;

(2) the number of shares the corporation is authorized to issue;

(3) the street address of the corporation’s initial registered office and the name of its initial registered agent at that office; and

(4) the name and address of each incorporator.

(b) The articles of incorporation may set forth:

(1) the names and addresses of the individuals who are to serve as the initial directors;

(2) provisions not inconsistent with law regarding:

(i) the purpose or purposes for which the corporation is organized;

(ii) managing the business and regulating the affairs of the corporation;

(iii) defining, limiting, and regulating the powers of the corporation, its board of directors, and shareholders;

(iv) a par value for authorized shares or classes of shares;

(v) the imposition of personal liability on shareholders for the debts of the corporation to a specified extent and upon specified conditions;

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In addition to that, this chapter focuses also on the alternative methods that can be used for the organization of the corporation (and not just the usual ways as the bylaws, appointment of officers and agents,raising of equity capital etc..). It says that if the initial directors are elected in the articles of incorporations, they have to induce a meeting, with the final aim of appointing officers, creating bylaws and addressing all the other themes at stake. Otherwise, if the articles of incorporation do not elect the directors, the meeting is to be hold by the incorporators, who according to the majority, have to elected the directors or the board. In case a board is elected, then this last has the duty to complete the process of the organization of the incorporation (see note 16 for the complete article). ²⁰

1.3.3.7 Purpose and powers – Chapter 3

This chapter of the Act deals with the purposes and powers of a corporation.

The first paragraph (§3.01) says that every corporation has the freedom to engage in any lawful business, except the presence of a more limited purpose contained in the article of

20Ibidem.

§ 2.05. Organization of Corporation.

(a) After incorporation:

(1) if initial directors are named in the articles of incorporation, the initial directors shall hold an organizational meeting, at the call of a majority of the directors, to complete the organization of the corporation by appointing officers, adopting bylaws, and carrying on any other business brought before the meeting;

(2) if initial directors are not named in the articles, the incorporator or incorporators shall hold an organizational meeting at the call of a majority of the incorporators:

(i) to elect directors and complete the organization of the corporation; or

(ii) to elect a board of directors who shall complete the organization of the corporation.

(b) Action required or permitted by this Act to be taken by incorporators at an organizational meeting may be taken without a meeting if the action taken is evidenced by one or more written consents describing the action taken and signed by each incorporator.

(c) An organizational meeting may be held in or out of this state.

incorporation. Additionally, it also provides that there can be certain state statutes that limit the purpose of some types of businesses. The second paragraph (§3.02), instead, is about the powers of the corporation. Here, what is stated is that the corporation has automatically all the powers of the individuals; in particular, a corporation has all the powers independently from the magnitude of its purpose. ²¹

1.3.3.8 Directors and officers – Chapter 8 (fiduciary duties).

First of all, it is important to say that the term fiduciary duty comes from the latin fiducia (trust), underlining how the main aim of a fiduciary individual is that of acting in the best interest for the beneficiary. With a fiduciary duty, managers are prevented from self- interested behavior that can be a damage for the beneficiary. This term is very common in the legal word, mainly in courts decisions concerning trustee- beneficiary, employee- employer, director-shareholder, attorney-client relationships.

Having said this, it is also important to highlight that what distinguishes fiduciary duties from contract is, basically, the “self-interest”. In fact, fiduciary law encourages to avoid self-interested behavior that damages the beneficiary, while in contracts, the parties are allowed to behave in a self- interested manner (no party has the duty to take care of the other). Thus, the directors of the firm should protect the interests of the different human-beings that participate to the so called “team production effort”. In this way, the directors and managers have to occupy the “trustee-like position”, which gives them the duty to act, in the process of the decision-making, in the best interests of shareholders.²²

After having made a short introduction about the fiduciary duties of directors, we are going now to what states the MBCA about this important subject. In fact, this is a key point to understand the topic that will be addressed in the next pages, the shareholder primacy value.

21 Ivi, chapter 3. P.62.

22 Alexander Styhre, What we talk about when we talk about fiduciary duties: the changing role of a legal theory concept in corporate governance studies, Management & Organizational History, 2018 p. 119‐120

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Section 8.30 of Subchapter C is about the standards of conduct for directors, which are the same of those provided by the courts in evaluating the conduct of directors: the duty of loyalty and the duty of care.

Each member of the board of directors, when discharging the duties of a director, shall act: (i) in good faith, and (ii) in a manner the director reasonably believes to be in the best interests of the corporation.²³

These above are the basic standards of conduct for all the directors of a corporation. In more detailed words, it provides that directors, in good faith, should act in a way that they subjectively think to be the best way – and not what an objective analysis would judge as the best way. Also “best interests of the corporation” play a pivotal role in understanding the director’s duties. In fact, this implies that each director has the possibility of choosing between “near-term opportunities” and “long-term benefits” and also taking decisions that can have different effect across different groups of shareholders.

(b) The members of the board of directors or a board committee, when becoming informed in connection with their decision-making function or devoting attention to their oversight function, shall discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances.

In the above sub-paragraph of Section 8.30 it is expressed the standard of care for the directors. Here, what is stated is two-fold trust: on the one hand, it provides a standard of conduct for individual action and on the other hand, it provides the obligation concerning the degree of care to be used collectively by the directors when it comes to perform their functions. What it is meant for standard is what a normal person in the same position would believe to be appropriate.

Another element that is worthy of mention is the fact that the “oversight function” is characterized by a continuum and the attention of the directors is related to a performance over a period of time. This is completely different from the decision–

making function, which requires informed action at a point in time.

(c) In discharging board or board committee duties, a director shall disclose, or cause to be disclosed, to the other board or committee members information not already known by them but known by the director to be material to the discharge of their decision-making or oversight functions, except that disclosure is not required to the extent that the director reasonably believes that doing so would violate a duty imposed under law, a legally enforceable obligation of confidentiality, or a professional ethics rule.

Subchapter (c) expresses the duty of each director to disclose information that he knows also to the rest of the board, whose information might be useful for decision- making processes. This disclosure can be made in two ways: through direct communication in meetings of the board or by any other means available (e.g:

informing the chairman of the board or the chairman of the committee).²⁴If these were the main laws given by the MBCA, we also found interesting to report what a prominent professor such as Bernard S. Black presented on the Third Asian Roundtable on Corporate Governance, held in Singapore in 2001. In fact, according to him, in addition to traditional duty of loyalty, duty of care, duty of disclosure, a further duty can be added:

the duty of extra care. Let’s see what he believed to be the main implications of each, paying particular attention to the duty of extra – care.

First of all, the duty of loyalty. Basically, this is the most important one. It provides the fact that decision makers should make the interest of the company, and not their own one.

This can easily be avoided by not entering in the so called “self-dealing transactions”, that-is to-say those transactions involving a conflict of interest. However, since that cannot be easily put into practice, it would be a good alternative to make self-dealing transactions approved by a non-interested decision maker (non-interested directors or non-interested shareholders).

Public companies, for example, rely always on non-interested directors when it comes to approve a transaction characterized by a conflict of interests. In the United States, if this kind of transaction is made by non-interested directors, it is valid unless the shareholders proves that that transaction was not accomplished in a fair way for the company. On the contrary, there is an invalidity of the transaction when the directors are not able to prove it was fair for the company. However, what should be stressed is

24 From the Model Business Corporation Act, p. 179‐184.

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the fact that the board of directors is not only actor playing a role in the protection against self-dealing, since also good institutions have to be taken into account.²⁵

Secondly, the duty of care. In this case, directors and managers are also requested to pay attention and try to make good decisions. Some people may argue that this duty is not so demanding, and in fact this is true. What is important is just to take decisions and initiatives that are not irrational. The idea is also that the American courts do not consider the directors liable for their decisions, except for those cases where a completely irrationality characterizes the decision. This approach of non-interference is the so called business judgment rule. One possible justification of this rule is that bad management decisions are only one of the reasons for the failure of an investment and, thus, it would be difficult for courts to judge on the operations of managers. According to Bernard Black, it is fair that the judges do not penalize directors when they are responsible for honest mistakes.

Thirdly, the duty of disclosure. This third fiduciary duty has emerged in the American companies in the 1980’s and its focus is the provision of disclosure for shareholders. In particular, it applies in two cases: when shareholders have to vote and when the company is engaged in a conflict-of-interest transaction. For what concerns the first case, it is obvious that having access to all the necessary information is fundamental for a good vote. For what concerns, instead, the second case, disclosure enables the shareholders to claim a violation of the duty of loyalty and, in addition to that, it can discourage these conflict-of-interest transactions.

An important issue which is worthy of mention is the remedy for the violation of this duty. It is clear that if the missing of disclosure is promptly founded, corrective disclosure is possible. But what happens if the breach of this duty is discovered only after some time? The designation of the right remedy is not clear in these cases. In fact, for instance, it is hard to affirm whether having had a better disclosure could have changed the vote or not. In the United States, a good approach is to ask the plaintiff, whenever he claims the breach of this duty, to give evidence of the fact that having had more information could have changed the votes.

25 Bernard S.Black, The Principal Fiduciary Duties of Boards of Directors, Presentation at Third Asian Roundtable on Corporate Governance, Singapore, 4 April 2001, p 1-4.

Finally, the duty of extra-care which is added, as previously said, by Black.

This duty lacks a proper name and it is not well-defined. Basically, it refers to the scrutiny that the judges make towards managers’ decisions when it comes to take-overs, since the directors of the target company could be involved in a loss of position and, as a consequence, they could be against some take-overs only for their own personal interest.²⁶

1.3.3.9 Chapter 13 – Appraisal Rights

In this chapter, the Act provides the basic rules for the appraisal rights, that is to say the rights to dissent from corporate decisions and obtain payment of the value of the own shares.

Paragraph §13.02 states that a shareholder has appraisal rights, and he is entitled to receive payment of the “fair value” of his shares; this can happen in case of a merger in which the corporation becomes a party, in case of an exchange of share which involves directly the corporation, in case of an amendment of the articles of incorporation. Then, another case which entitles to the withdrawal of shares is the conversion of the corporation to a nonprofit corporation or to an unincorporated entity. In other words, when there is a change in the mission and purpose of the company.

Paragraph §13.24 is about the Payment of shares. The corporation in obliged to pay the shares within 30 days after the request in the amount equal to the fair value of shares plus interest. The payment should be accompanied by the financial statements of the company, by a statement of the corporation estimates of the fair value of the shares and a statement that shareholders requiring appraisal rights has the right to demand additional payment within a specified time.

Furthermore, in paragraph § 13.26 a shareholder, who is not satisfied with payment received, has to give notice to the corporation by demanding the “self – estimated” fair value of the shares plus the interest. ²⁷

26 Ivi, p. 5‐11.

27 From the Model Business Corporation Act, chapter 13, p. 306‐326.

23 1.3.3.10 Reports and records – Chapter 16

This chapter 16 treats the questions of records and reports that a company has to maintain. The Subchapter A provides a list of all the necessary corporate records:

principally, they are the articles of incorporation, notices to the shareholders, bylaws, records of the meetings and the annual report. The Subchapter B, instead, underlines the necessity for the corporation to file the Financial statement for shareholders and the Annual report for the Secretary of State. The Financial statement is to be delivered to the shareholder through the website or trough any other mean and it is about the recent fiscal year, upon request of the shareholders. This document should be delivered by the listed corporations in line with the rules of the United States Securities and Exchange Commission. According to the Act, this kind of document is not prepared by the small companies unless it is required by the bank, suppliers or other parties.

The Annual Report for the Secretary of State should contain several types of information, such as the name of the corporation, the street of the registered office, the names and business addresses of the directors, the total number of authorized and outstanding shares. In case the annual report does not contain the information required, it is the duty of the Secretary of State to ask for correction. Then, also the foreign corporation who conduct business in the state are required to file the annual report.

If a company fails to file the annual report, it will be subject to administrative dissolution (for domestic companies) or to termination of registration (for foreign corporation).

1.3.4 Business Corporation and Shareholders’ primacy model: between success and criticisms.

One of the most important debates in the U.S corporate law was the debate about what the proper purpose of the business corporation should be. Mainly, there was uncertainty between the idea of maximizing the shareholder wealth (the so-called shareholder primacy) and the possibility of running a corporation in a sort of stakeholders friendly - way, considering, thus, also the interests of society at large.