John Montgomery | Montgomery & Hansen
Interviewee: John Montgomery, Montgomery & Hansen LLP
California Benefit Corporations: Installing a Corporate Conscience
John Montgomery has nearly 30 years of experience in Silicon Valley practicing corporate law. He is the founder of Montgomery & Hansen LLP. John represents clients on corporate matters including venture capital financing, initial public offerings, and mergers and acquisitions.
John was a co-chair of the legal working group behind Assembly Bill 361, which established benefit corporations in California at the start of this year. This new corporate form leads the way in providing a material positive impact on society in addition to optimizing profits for shareholders.
Morgan James Publishing will soon publish his book, Great from the Start: How Conscious Corporations Attract Success, which outlines how to apply the business secrets of Silicon Valley to build conscious corporations designed to attract success in an interdependent economy.
Q: How did you get into corporate law?
A: I was a creative writing minor and studio art major as an undergraduate. So, I got out of undergraduate education a familiarity with the creative process, and I got comfortable creating something out of nothing or out of an idea, which is essentially what entrepreneurs do. I didn’t realize it at the time, but those two disciplines prepared me for working with entrepreneurs. Because basically entrepreneurs come to me and they have a wacky idea for a company. They are looking for people that help support their belief in their idea and help them manifest it in the world through putting that idea in a corporate form for it to set forth in.
The other thing I got exposed to as an undergraduate was team dynamics. I rowed crew. I got exposed to my first collective flow state. In rowing, when an eight-oared shell gets in sync it creates a phenomenon called swing. And it’s a collective flow state much like the state that a choir gets in or an orchestra when everyone is on the same note.
Anyway, long story short, I didn’t get into the MFA program at UC Davis. I wanted to study with Wayne Thiebaud who was on the faculty there. At the time there were very few figurative painters and I was a figurative painter. Davis had one of the very few figurative painting programs in the country. I didn’t get in and I applied to one law school as a backup. I didn’t feel like doing odd jobs and paintings and getting my portfolio more mature, which was what Davis told me to do. So I ended up going to law school. I hated it; hated 1L. I Thought it was the most god awful educational experience on the planet. So, I am delighted to see you guys branching out of the required curriculum and pursuing your interests at such an early stage; it’s great. Anyway, I followed my intuition and ended up working with entrepreneurs.
Q: What issue is the Benefit Corporation designed to address?
A: About 20 years ago, I started seeing a correlation between the words in the legal documents, contracts, corporate codes, articles, bylaws, founding stock purchase agreements, and behavior. What I started wondering was, “Why do individuals, who are generally people of conscience that have an internal moral compass, default to maximizing profits for shareholders at the expense of society and the environment. Why does a corporation lack a collective conscience?” That’s essentially the cosmic question that led me to write my book, get into conscious capitalism, and get involved in the Benefit Corporation movement. What I observed was that the corporation, as Justice Stevens says in Citizens United, has no conscience. And the epilogue of my book talks about how that came to be. Essentially, we’re doing business in corporate entities that are 500 years old that were intentionally lobotomized by the kings of Europe to not pose a political or economic threat to their sovereignty. Europe got rid of the kings but the corporate form carries forward and it lacks an internal conscience mechanism. If you have amoral people leading a corporation, that corporate entity carries the mercantile DNA of kings of Europe, you get behavior like Enron. So the corporation is prone to sociopathic behavior. There is no internal conscience mechanism.
Q: Can you briefly outline how a Benefit Corporation works and the differences from a traditional C corporation?
A: First of all, in putting forward the Benefit Corporation legislation we tried to keep it simple. California has a very well written corporations code. There’s a very established body of common law flowing out of interpretation of that code. So rather than reinvent the wheel, we decided to draft as little supplemental code as possible. C corporations utilize the existing general corporation law and have particular sections that are applicable only to C corporations. We tried to take the same approach with Benefit Corporations.
Basically if you understand three things, you can become an instant expert in Benefit Corporations: Benefit Corporations have a public purpose, transparency, and accountability. If you understand those three concepts and the general California corporation law, you’re an expert in Benefit Corporations. We tried to keep it simple.
The general public purpose is to create a material positive impact on the society and environment from the operations of the business taken as a whole. It takes Google’s original aspiration – “Do no evil”– and takes it to the next level: “Do good.” It makes that a requirement for companies which voluntarily elect to become Benefit Corporations. It starts to create the architecture of an internal social and environmental conscience. That’s step one. Step two is transparency.
A Benefit Corporation is required to report annually to its shareholder[s] about its delivery of a material positive impact on society and the environment. There is an accountability requirement that is two-fold. The Benefit Corporation can either be certified by an independent third party standards body as to its performance providing a material positive impact on society and the environment by such third party's assessment tool or assess itself using such a third party assessment tool.
To the extent that a Benefit Corporation fails to provide a public benefit, the shareholders of said corporation have a cause of action against the corporation to compel it to provide a material positive impact. There are no monetary damages available, only injunctive relief similar to the cause of action that shareholders have compelling a company to hold an annual meeting if it fails to do so. If the failure to provide a material positive benefit is particularly egregious, a court can award costs and attorney’s fees to the shareholders.
That is essentially the essence of what a California Benefit Corporation is.
Q: How does the California Benefit Corporation legislation differ from the national model legislation or legislation that has been passed in other states?
A: Let me give you a little historical context. Four years ago there was a constituency statute that passed both houses of the California legislature. There are thirty-one states that have adopted constituency statutes which expressly authorize the board of directors to consider the interests of other stakeholders in the exercise of their fiduciary duties or business judgment in determining what’s in the interest of the corporation. So California was making noises to follow along in that movement.
The bill passed both houses of the legislature but governor Schwarzenegger vetoed it. There were a number of attorneys who coalesced after that veto to draft an alternative that would be more palatable to California. The original constituency statute would have changed the fiduciary duties of section 309 in the corporation code so that the new constituency statute would have applied to all California corporations. I think Governor Schwarzenegger thought that was too big and too radical a change.
So a committee of lawyers was formed and started working on what was called the Flexible Purpose bill. That bill came up before the legislature for the first time in 2010. It came up and got vetoed. In 2011 they worked on it again. At the end of 2010, the B Lab, which is one of the national sponsors of Benefit Corporation legislation, was asked if it would support the Flexible Purpose Corporation bill. B Lab declined because in B Lab’s view there were serious deficiencies in the Flexible Purpose Corporation legislation vis-à-vis the three objectives that underlie Benefit Corporation legislation (material positive impact on society and the environment, accountability, and transparency). At the last minute, B Lab called lawyers from the three bay area law firms that are certified B corps under B lab’s certification standard and asked us if we would work with them to put Benefit Corporation legislation before the legislature. That gives you a little bit of the context on how it came to be.
I started working on this around December of 2010. At that time five other states had adopted Benefit Corporation legislation. There was a model act (link to Benefitcorp.net). What we tried to do for starters was to take the best of those five states and tweak the language so that it conformed and could ride on top of the existing California general corporations code. In the legislative process we got a lot of comments and opposition from the people behind the Flexible Purpose legislation and there was quite a bit of spirited dialogue between the two groups. The silver lining in that spirited dialogue was that both bills ended up being much better.
Specifically to your question, we put in considerable shareholder protections. For an existing corporation to become Benefit Corporation, it requires a two-thirds vote and you have to comply with dissenter’s rights. If you’re a minority shareholder in an existing California general corporation and there’s a vote to become a Benefit Corporation and you don’t want to go along with it, you can comply with statutory dissenter’s rights and have the company buy your stock out at fair market value. Conversely, if you are a Benefit Corporation and you decide to cease to be one, it takes a two-thirds vote. If you are a minority shareholder in said corporation and don’t want to stop being a Benefit Corporation, you can also elect for dissenter’s rights. There are considerably more protections for shareholders in the California legislation than there are in other states.
Q: Constituency statutes use permissive language to allow directors to consider other factors than profits in making decisions that affect the future of the company. The language in the Benefit Corporation legislation states that a director shall consider the impact of their actions on a variety of factors including society and the environment. How does this difference affect fiduciary duties?
A: Well this is serious business. The California Benefit Corporation legislation is a radical departure from existing fiduciary duty. It’s not a permissive consideration, it’s a mandatory consideration. So essentially what this does is require the directors to exercise the beginnings of a planetary conscience. That’s a big deal. It means that you have to be pretty damned committed to a desire to not only optimize profits for your shareholders but also to provide a material positive impact on society and the environment. I think your generation is going have no problem with this. My generation is squealing like a stuck pig. There is a lot of resistance to this.
It’s a new concept. It’s very foreign to the prevailing paradigm that corporations exist solely to maximize profit for shareholders. It breaks the no longer tenable assumption in the current paradigm which is that the commons are infinite, resources are infinite, and that a corporation can maximize profit while ignoring all of the negative consequences of its behavior. It breaks the assumption that the commons and society can absorb the negative consequences and that there are infinite resources to be exploited. In a massively interdependent global economic system that just doesn’t work. This is a profound shift.
Q: Considering the resistance, what incentives are there to encourage incorporation as a Benefit Corporation?
Well, there are no tax incentives. A Benefit Corporation is taxed at the same corporate rate. But there are two primary benefits. There are preliminary empirical economic data coming out of Harvard that shows that corporations that adopt sustainable practices perform better than their peers. Significantly better. About five points of return per annum. Those findings are substantiated by a couple of books: Firms of Endearment, which profiled a bunch of conscious capitalism based companies against their peer group. Those companies beat the S&P 500 by a factor of nine over a ten year period. After the debacle of 2008, the difference has declined to a factor of two instead of nine but it’s still a significant improvement over peer companies. There’s another book called profits for life which provides similar data. Preliminary indications are that companies that have models of sustainability or conscious capitalism outperform conventional companies.
If you look at the venture capital business, it has provided a negative rate of return as an industry for the last eleven years. So, I’m interested in this out of enlightened self-interest. This puts me in a position where if you extrapolate the returns of the industry upon which I’m dependent for my livelihood, it doesn’t look good. So I’m eager to find better business models. This appears to be a better business model.
The biggest benefit is on the customer and stakeholder side. There are sixty million consumers who are oriented towards lifestyles of health and sustainability. That number is growing daily. Those consumers are increasingly voting with their pocketbook. They would much rather do business with a company that has a conscience. You see that with Patagonia, an iconic brand that is associated with sustainability. Early financial data indicates that these companies are just better businesses.
Q: Can you tell us about the third party assessment standards incorporated in the Benefit Corporation legislation and how these assessment tools are regulated?
A: We’re at the very front end of third party assessments. My prediction is that, in ten years, all of the accounting firms that do audits of public companies will have gotten into the sustainability certification business. My prediction is that the SEC through regulation S-K will probably have promulgated disclosure requirements for companies with respect to sustainable business practices. That’s probably where we’re going. We’re at the very early stages of the accountability process.
One of the things that you’ll notice in the California Benefit Corporation legislation is that we tried to enumerate the characteristics of a third party standards body and its relationship to an entity being certified. We tried to stress that there needs to be independence. There can’t be any material financial obligations. There must be a minimum of interlocking personnel. What we’re hoping to encourage is the creation of a marketplace where third-party standards get adopted, promulgated, and accepted. In the early days of the organic food market, there were a lot of organic food standards. There was a lot of confusion and a lot of conflation between natural and organic. I think the standards have gotten more settled. But we are in the front end of that process here. I’ve done several MCLE programs on this topic. On the Benefit Corp.net website, there are five or six third-party standards bodies that have developed certification standards that we think comply with the California statute. Are those rigorous enough? Probably not. I have a definition in the book that I got from Professor John Sterman at MIT which is basically a definition of sustainability. It says that you must leave the world as you found it. Don’t deplete resources faster than they can replenish. Don’t put pollutants into the biosphere faster than they can be naturally absorbed. These are fairly simple principles. But I think that’s probably where we’re going.
Q: You’re saying that a marketplace for third-party assessment tools will promote more rigorous standards. What is preventing such a marketplace from promoting less rigorous standards by creating a situation where deficient Benefit Corporations will seek out the third-party standard that will pass them?
A: First, with respect to a Benefit Corporation, you have to be pretty damn committed to providing a public benefit to a Benefit Corporation. Second, in the short term, there may be some shopping for the third party standards. I suspect, however, that over the long term a generally accepted third party standard will develop with third parties providing certification or assessment against that standard.
Q: Turning to the issue of remedies, monetary damages are not allowed under the Benefit Corporation legislation but injunctive relief is allowed. What sort of judicial orders would come out of a suit brought under the cause of action available against non-performing Benefit Corporations?
A: Nobody knows yet. But you know that in the corporations code, if you fail to hold an annual meeting and the corporation doesn’t adhere to a request to have one. You can request that the court compel that the company hold an annual meeting. I suspect it will be very similar. The court will basically say, “Look. You committed to being a Benefit Corporation. You are required to provide a material positive impact on society and the environment and you haven’t done anything. You didn’t do your benefit report. The court will instruct you to make an effort.”
Q: Do you see the courts doing anything like changing membership on the boards or installing receivers in order to accomplish these goals?
No we didn’t provide those remedies in the bill.
When I got interviewed by KPFA and I told the interviewer about the bill, she said, “Why shouldn’t every corporation have a conscience?” Well, duh. I fantasize about what would the global economic system look like if every single corporation on the planet had a planetary collective conscience. It’d be a very different ball game.
Q: What do you think the effect would be on global competitiveness if America were to implement such a conscience first? Wouldn’t this give countries operating without a conscience a competitive edge?
Well, here’s where I think things are going. We’re increasingly living in a glass house. Information is becoming more and more ubiquitous and available around the clock. Mobile applications and mobile communications are empowering the consumer. I like to think of the internet as the collective conscience and consciousness of humanity.
If you think of overlaying an eastern chakra system on the internet, what do we have? We have the first chakra: survival. Which is Google: “How do I find the information that I need to survive quickly?” Then you have the second chakra, which is “How do I get laid? How do I manage my relationships?” There’s Facebook. Then you have the third chakra. “How do I manage my power, my career, my professional status?” LinkedIn.
What we’re beginning to see are significant internet companies arising in the heart chakra, the fourth chakra. You have avaaz (link here) which has several million members. They’ll put out petitions to stop the Japanese from killing whales or to try to get Iran to stop from stoning a woman for having an affair, or whatever the issue is. We’re really enabling a planetary flow of information and transparency that was just unimaginable. One of the logical consequences of that is that people are going to know that their iPod and iPad were made in pretty shitty labor conditions in China. And that Apple basically exported 700,000 jobs that could have been in the United States. To its credit Apple says that it created half a million jobs for people who create applications for the iPod and iPad ecosystem. This may be true. But the reason Apple has 30% plus margins is that they outsource labor. Generally speaking, a lot of US corporations sort of look the other way. Practices that would not be permissible in the United States would be permissible abroad. As those kinds of practices become more apparent, there is a good chance that people will start exercising their conscience and voting with their pocketbook.
Q: Is this sort of international effect on the work considered in the third party standard rubric? Or are only domestic effects considered?
A: You’d have to go into the details of the each of the standards. I’ll confess I haven’t done my homework. I’ve looked at the websites of a couple of the standards other than the B Lab certified B Corp standard. But I haven’t gone through any of them in detail.
Q: Do you know anything about other countries that are a step ahead of in terms of conscious capitalism?
Take a look at the Companies Act of 2006 in Britain. It is nationwide and it looks pretty much like a constituency statute. There are a lot of interesting things happening in Europe on this front.
Q: Can you tell us a little bit about the theme of your book?
A: I wrote this book for your generation and my kids. It’s so obvious to me that because of colonialism, the northern European corporate form got exported across the world, especially after World War II resulted in the hegemony of the United States. The basic corporate architecture has been promulgated in every country on the planet. There is 500 year old DNA in that architecture that reflects the mercantile conscience and consciousness of the Kings of Europe. A corporation was designed kind of like a heat seeking missile. It was designed to do two things: conquer territory for the monarchy and get money for the royal treasury. The king served as the external conscience. If you were running Hudson’s Bay Company and Hudson’s Bay Company started misbehaving and fraternizing with the Dutch, you’d get called to London and your charter would get revoked. You’d be out of business. It was a very effective external conscience.
I think the Occupy movement is a symptom that We the People to whom the sovereignty of the kings devolved are sensing that we are the ultimate givers of life to corporations. We are waking up to the fact that our founding fathers didn’t contemplate that there would be a society dominated by corporations and didn’t’ address what the rights and moral responsibilities of those social collectives are. There’s a gap in our constitutional documents. The collective is slowly waking up to that gap. The Supreme Court has tried to fill it in. It’s given some rights of personhood to corporations, but the fundamental philosophical questions about what the hell we do with these commercial collectives has not been answered.
My belief is that we ought to have a constitutional convention. We the People are the ultimate sovereign. We are allowing these corporations that have the power of immortality to run in our midst. What are the moral obligations that we should impose on them? What do we expect of them? I think we ought to expect that the collective conscience of a collective body like a corporation be more robust than an individual conscience. We the People should hold those corporations accountable to society and the environment.