Finding a Regulatory Framework for Social Enterprise

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How can regulators effectively enforce social and environmental bottom lines for multi-purpose enterprises?

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The social enterprise movement, a movement of organizations using business solutions to tackle environmental issues and drive social change, continues to grow in the United States and around the world. Particularly popular among millennials, the social enterprise sector—made up of companies like Warby Parker, FoodCycle, Divine Chocolate, and SoleRebelsis unlikely to wane as a fleeting phenomenon. Its longevity depends, however, on an effective regulatory regime that enforces social, environmental, and profit-driven bottom lines.

Since 2008, over thirty states have passed legislation authorizing new, social enterprise-enabling corporate forms. These new corporate forms—for example, the benefit corporation, the social purpose corporation, and the low-profit limited liability company—vary in state requirements. However, they are similar in that they allow corporations to pursue social and environmental goals while cultivating shareholder value. Yet the question of how to enforce these new corporate forms, which do not fall neatly into existing regulatory schemes governing traditional for-profit corporations and nonprofit organizations, might have been neglected in the rush to regulate.

That is the issue that Robert T. Esposito, a member of the Impact Finance practice group at Orrick, Herrington, & Sutcliffe, takes up in a recent article. Esposito argues that ineffective regulation “fosters investor uncertainty” and “inhibits the growth of the nascent social enterprise sector.” While some state regulators suggest that these new corporate forms should fall under existing nonprofit regulatory regimes, Esposito argues that the social enterprise sector requires a new legal framework “tailored to the innovative corporate purposes these organizations pursue.”

These mixed-purpose enterprises present a challenge for the traditional corporate regulatory regime. For-profit corporate law generally supports maximizing shareholder value. Thus, it can be ill-equipped to regulate for-profit companies that forego some profits in favor of achieving social or environmental ends. When can a company prioritize one goal, like environmental benefit, over another, like profit, when those goals are in conflict? Do directors get free reign? How can regulators—and the courts—ensure accountability to shareholders?

Some scholars claim that the social and environmental purposes that social enterprises pursue are akin to “charitable purposes,” and thus fall under the jurisdiction of charity regulators. Proponents of the charitable regulation approach argue that social enterprises should register as charities and abide by the applicable state regulations, including laws aimed at preventing fraudulent charitable solicitations.

Yet Esposito believes that charitable solicitation laws are “the wrong regulatory tool” for for-profit social enterprises. The crux of Esposito’s argument is that proponents of charitable solicitation regulation for social enterprise fail to recognize the “important distinction between charitable purposes and social or environmental purposes.” Esposito explains that charitable solicitation laws are only applicable to organizations with “charitable” purposes, and are therefore an ineffective mechanism for regulating social enterprises.

Although some social enterprises do have charitable purposes, others seek to effect social or environmental change as “a byproduct of [their] business enterprises.” For example, low-profit limited liability companies “must be organized for a charitable or educational purpose,” whereas other corporate forms need only create a “general public benefit.” To explain the difference, Esposito highlights Blessed Coffee, a benefit corporation that sells coffee beans from Ethiopian coffee cooperatives and pays farmers at a high profit margin. The company’s workers earn high wages relative to the industry standard, but the social and economic benefits incident to these farmers earning a living wage are not “charity” according to Esposito. Blessed Coffee is simply a coffee-selling business, he argues, and its labor-centric benefit is “embedded in,” and “proportional to, the success of its profit-making” activity: selling coffee.

To further illustrate the distinction between a charity and a non-charitable social enterprise, Esposito posits a hypothetical corporation “dedicated to minimizing negative effects on the environment.” Although such a corporation might power itself entirely on renewable energy, Esposito argues that alone would not make it a charitable organization. A charity or non-profit, on the other hand, may directly provide renewable energy technologies to an underserved region. Just because the social enterprise is environmentally conscious does not mean it provides any direct charitable relief to a population in need. Additionally, Esposito suggests that categorizing social enterprises as charities may actually be an oversimplification. Although the goal of “minimizing negative effects on the environment” in Esposito’s hypothetical example may be “laudable and desirable,” it is not an “explicitly ‘charitable’ purpose in the eyes of the law.”

In support of his argument that social enterprises are not properly regulated as charitable organizations, Esposito cites the Model Charitable Solicitations Act, a model act concerning solicitation of funds for charitable purposes. For a corporation to fall within the purview of the Act, it must have more than just a “charitable” purpose; it must also “solicit” charitable funds. According to Esposito’s interpretation of the Act, to “solicit” charitable funds means to “seek a charitable contribution or gift.” Since many social entrepreneurs fund their ventures with investment capital rather than through charitable donations, Esposito argues they do not “solicit” charitable funds. He explains that, since “investors, unlike donors, do expect…a return on their investment,” the funds many social enterprises work with are not charitable contributions.

Based on this analysis, Esposito concludes that regulating social enterprise-enabling corporate forms under “antiquated” charity regulatory regimes rides against legislative intent. Instead, the social enterprise sector could benefit from government agencies specializing in multi-purpose, multi-mission organizations. Social enterprise organizations, he states, “require a specialized agency that is designed for the social enterprise sector’s unique and complex array of corporate purposes.” While acknowledging that the creation of a new federal agency to regulate social enterprises is unlikely in the United States because corporations exist under state law, Esposito points to the United Kingdom’s Office of the Community Interest Company Regulator as a model from which state regulators can learn.

For the past ten years, the social enterprise movement has been shaking the foundations of corporate law in the United States. Now, according to Esposito, the movement will shake the foundations of regulatory law.