ESG and DEI legislation: State corporate law responses

The number of ESG and DEI advocates keeps growing. And state legislators have noticed. Most states have enacted legislation addressing these advocates’ concerns. This includes amendments to the state corporation statutes. Considering that corporations are creations of state law and only exist because state legislators enacted corporation statutes allowing them to exist, this should come as no surprise. This article will discuss two of those statutory responses — amendments authorizing benefit corporations and amendments addressing board of directors’ diversity.

The benefit corporation statutes

One of the state legislative responses to the increasing interest in ESG and DEI has been to enact benefit corporation statutes. Most states have enacted either a benefit corporation law or the similar (but not exactly the same) public benefit corporation law. These are for-profit corporations — subject to the provisions of the state’s general corporation law except where the statute specifically provides otherwise — that differ from a traditional for-profit corporation in three main areas:

• Corporate purposes
• Director duties
• Annual reporting

Corporate purposes

Every benefit corporation has a purpose of creating a general public benefit. A general public benefit is defined by many statutes as “a material positive impact on society and the environment, taken as a whole, assessed against a third-party standard, from the business and operations of the benefit corporation”. A benefit corporation can also have one or more specific public benefits which can include, for example, providing beneficial products or services to low-income or underserved individuals or communities, improving human health, and promoting the arts, sciences, or advancement of knowledge.

Public benefit corporation laws differ slightly. Delaware’s PBC statute, for example, provides that “public benefit” means a positive effect (or reduction of negative effects) on one or more categories of persons, entities, communities, or interests (other than stockholders in their capacities as stockholders) including, but not limited to, effects of an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific, or technological nature.

Directors’ duties

Most benefit corporation laws provide that the directors, in discharging their duties, must consider the effects of any action or inaction upon:

• The benefit corporation’s shareholders
• The benefit corporation’s employees
• The benefit corporation’s customers as beneficiaries of the general or specific public benefit
• Community and societal factors
• Local and global environmental interests
• The benefit corporation’s short term and long term interests
• The benefit corporation’s ability to accomplish its general and specific public benefits

Public benefit corporation laws are slightly different. Delaware, for example, provides that a public benefit corporation shall be managed in a manner that balances the stockholders’ pecuniary interests, the best interests of those materially affected by the corporation’s conduct, and the public benefit or public benefits identified in its certificate of incorporation.

The benefit corporation report

In most states, a benefit corporation is required to prepare an annual benefit report describing, among other things, the way it pursued public benefits, the extent to which these benefits were created, any circumstances hindering the creation of benefits, and an assessment of its overall social and environmental performance measured against a third-party standard. The report must be provided to shareholders, posted on the corporation’s website, and in some states filed with the state.

Public benefit corporation laws may differ. Delaware, for example, permits biennial reporting and does not require the report to be made available to the public.

However, the corporation may decide to require more frequent reporting and may choose to make it public.

In general, an existing corporation may become a benefit corporation or public benefit corporation by amending its articles or certificate of incorporation to add the statement that it is a benefit corporation or public benefit corporation. An existing corporation may also become a benefit or public benefit corporation by merging into a benefit or public benefit corporation. Typically, the shareholders must approve the amendment or the merger by a supermajority vote, often a two-thirds vote. By becoming a benefit corporation or a public benefit corporation, the corporation shows its commitment to making a positive impact on society.

Diversity, equity, and inclusion provisions

States have also responded to DEI concerns by amending their corporation laws to address the lack of diversity on boards of directors.

California, for example, enacted legislation to amend its corporation statute to require the board of directors of domestic and foreign publicly traded corporations with their principal offices in California to have a minimum number of women and individuals from under-represented communities. (It should be noted that California's legislative response was controversial, as questions were raised about the legality of imposing quotas. And, in fact, Los Angeles Superior Court judges have ruled these laws in violation of the state's Constitution - decisions the Secretary of State may, or may not appeal. Although, regardless of the outcome, the California laws have brought attention to the issue of a lack of diversity and some proponents claim they have already led to an increase in diversity.). 

Another state that responded to DEI concerns is Washington, which amended its corporation law to require domestic publicly-traded corporations to either have a gender-diverse board or deliver to shareholders a board diversity discussion and analysis explaining why they do not.

Other states, such as New York, Illinois, and Maryland, amended their corporation laws to disclose information about the composition of their boards in their corporate reports filed with the Secretary of State (or similar filing office). By having the composition of their corporations’ boards made available to the public, these states are giving investors, consumers, employees, and others the opportunity to choose for themselves whether they want to invest in, buy from, or work for corporations lacking diversity. 

Furthermore, some states enacted legislation requiring their corporate filing offices to prepare reports on board diversity or encouraging their corporations to have diverse boards. Several other states have pending legislation addressing board diversity.

Conclusion

In recent years there has been much discussion about how corporations can pursue societal goals, such as environmental protection, social justice and equity, and economic development, while still pursuing profits for their shareholders. Numerous states have made an effort to support their corporations’ efforts to be socially and environmentally responsible.

One way is by allowing them to become benefit corporations — which means their management is required, by statute, to consider both shareholder and stakeholder interests and cannot be held liable for putting people over profits.

The other way is by enacting laws that encourage a diverse and inclusive board of directors and bring attention to the lack of diversity — which not only benefits society, but has been shown by studies to increase profits as well.