Should an organization be able to have social impact and generate profit? Sarah G. Fitzpatrick looks at the development of hybrid organizations in Canada – and how any further development would benefit from a comprehensive analysis of whether there is a need or space for hybrid organizations.
This is the fourth in a series of articles focused on various aspects of charity law that have been a burden on the Canadian charitable and non-profit sector for 70 years. The articles are written by members of the Canadian Bar Association’s Charities and Not-for-Profit Law Section, who deal with these issues on behalf of their clients on a regular basis.
The legal issue that exists
A hybrid organization is an organization that combines social impact with profit generation. Hybrid organizations’ utility is twofold. For the for-profit sector, hybrid organizations are for-profit entities that enshrine corporate social responsibility into their very corporate being, ensuring that business is being carried out with a social impact. For the non-profit sector, hybrid organizations generate profit that would not otherwise be permitted in a charity or a non-profit organization but continue to have ties to mission-based objectives.
Hybrid organizations: Should an organization be able to have social impact and generate profit?
A traditional vehicle for generating profit is a business corporation: a corporation whose capital is divided into shares and has shareholders. The shareholders are the ultimate owners of the business. They are also the beneficiaries of the profits of the business through the payment of dividends and participation in the distribution of the corporation’s assets on its dissolution. Often, for-profit corporations are viewed as being operated for the benefit of their shareholders, with directors responsible for maximizing profits for the benefit of the shareholders (known as shareholder primacy). This has certainly been recognized in legal jurisprudence in some states in the United States.[1] The statutory and common law context in Canada, however, is different. Canadian corporate statutes state that directors owe duties to the corporation, rather than shareholders. In carrying out their duty to the corporation, directors may take into account other stakeholders’ interests and are not necessarily required to maximize share value. Further, the Supreme Court of Canada has said that directors’ duty to act in the best interests of the corporation requires taking into account all relevant considerations, “including but not confined to – the need to treat affected stakeholders in a fair manner, commensurate with the corporation’s duties as a responsible corporate citizen.”[2] Accordingly, in the Canadian context, directors may take into account the interests of stakeholders other than shareholders. Arguably, this means directors can, when carrying out their duties, consider the social impact of their decisions. However, what it means to be a “responsible corporate citizen” has not yet truly been defined. Nevertheless, directors are ultimately subject to the whim of the shareholders. Shareholders can remove directors from office and, since social purposes are not enshrined in the governing documents of a business corporation, can change the direction of the corporation, including potentially disassociating with a particular social purpose adopted by prior leadership.
Charities and non-profit organizations can be structured in more than one way, the most common of which is to be incorporated as a corporation without share capital (referred to as “societies” in some jurisdictions). These corporations do not have shares or shareholders; instead, they have members who elect directors. Members do not receive dividends and normally do not participate in the distribution of the corporation’s assets when it dissolves. Unlike business corporations, these non-share capital corporations must have a purpose for which they are operated, generally some type of social purpose. That purpose sets the overarching framework within which the corporation operates because it is required to carry out activities that further that purpose.
Under Canada’s Income Tax Act, charities and non-profit organizations have restrictions on the types of revenue-generating activities they can carry out in order to maintain their exemption from income tax. If a charitable organization or public foundation carries on what is known as a business that is not a “related business” (a business substantially carried on by volunteers or that is linked and subordinate to one of its purposes), it can be subject to penalties, sanctions, and even revocation of its charitable registration.[3] A non-profit organization must be organized and operated for any purpose other than profit.[4] It is permitted to earn only limited revenue. Accordingly, if a charity or a non-profit organization wishes to carry out a revenue-generating activity to raise funds for its mission, it must move the activity to a separate corporate vehicle instead of carrying out the activity itself. A vehicle that is often used is a business corporation.[5] As noted above, one of the limitations of a business corporation is that while the original shareholders may wish it to be operated for a certain social impact, there is no true ability to enshrine that social purpose in the governing documents, meaning that subsequent leadership may “lose” the social purpose over time. Further, there is no preferential tax treatment for these entities: they are taxed the same as a regular for-profit business corporation, even though the charity or non-profit organization may be carrying on the revenue-generating activity to raise funds for its mission or carry out a mission-related activity. This limits the revenue available to the charity or non-profit organization to use on its activities and may, in certain situations, undermine the viability of the social enterprise.
Types of organizations impacted by the problem and how they work around it
Only two Canadian jurisdictions have enacted legislation that allows for the incorporation of hybrid organizations: British Columbia and Nova Scotia.[6]
British Columbia first introduced the “community contribution company” (the C3) in 2013 and later introduced the “benefit company” in 2020. Nova Scotia introduced the “community interest company” (the CIC) in 2016.
The British Columbia C3 and the Nova Scotia CIC are relatively similar. They are share capital corporations that must be operated for a community purpose. C3s and CICs must publish community contribution reports each year. The companies are also subject to restrictions on their assets, including (i) limitations on the dividends directors can declare,[7] (ii) restrictions on how the companies can use their assets, and (iii) restrictions on the assets that can be distributed to their shareholders, with the remaining assets being required to be distributed to qualified entities, such as corporations without share capital and registered charities. These corporations were modelled on the UK community interest company. C3s and CICs are taxed the same as business corporations. As such, while they enshrine a particular social purpose in the corporation’s governing documents, they are subject to restrictions with no real upside. They have not been attractive vehicles. The British Columbia C3 has existed the longest, but only a handful of the C3s that were originally incorporated are still active.
The voluntary sector would benefit from a comprehensive analysis of how organizations can carry out revenue-generating activities through separate corporate vehicles, how those vehicles should be structured, and whether there is a need or a space for hybrid organizations.
The British Columbia benefit company is modelled on the US benefit corporation. Benefit corporations started as a “B Corp” certification issued by B Lab, a non-profit headquartered in Pennsylvania.[8] B Lab then prepared model legislation for states to adopt, officially authorizing corporations to conduct business for a public benefit purpose and allowing directors to act in the best interest of the public. Benefit corporations were designed as a reaction to shareholder primacy: that in certain states, directors of business corporations were duty bound to maximize profit for shareholders and prohibited from taking into account other stakeholder interests in carrying out their duty. Benefit-company legislation requires directors to consider certain social purposes when carrying out their duties. Further, the legislation generally exempts them from liability for doing so. Benefit companies are generally required to issue a benefit report each year assessing how they carried out their activities against a third-party standard. The BC benefit company adopted this model. A BC benefit company must conduct business in a responsible and sustainable manner and promote one or more public benefits specified in its articles. BC benefit companies otherwise operate like regular for-profit companies, though there are additional dissent rights for shareholders if the benefit company attempts to alter its articles to cease to be a benefit company. Benefit companies are also taxed the same as business corporations but unlike C3s and CICs do not have any restrictions on dividends and assets.
Potential regulatory solutions that have been proposed
To date, the potential hybrid vehicles that have been proposed are the community interest corporation and the benefit corporation. Both of these are forms of corporate vehicles that have been developed in other jurisdictions. Our experience with these vehicles so far suggests that they may not properly reflect the needs in the Canadian legal landscape.
The C3s and the CICs are “true” hybrid organizations, as they have social purposes and asset-lock restrictions that keep their assets within the voluntary sector. Charities and non-profit organizations are subject to similar restrictions. As we have seen from almost 10 years of Canadian experience, these organizations have not been popular. C3s and CICs are not attractive because of their restrictions (which deters external investors) and additional annual reporting obligations. They provide charities and non-profit organizations with no true advantage over using a business corporation to carry out revenue-generating activities. Further, if a charity or a non-profit organization is the sole or controlling shareholder of a business corporation, it can ensure that the corporation is operated for mission-based objectives through exercising its votes as shareholder.
The benefit company may be the solution for problems faced by business corporations that want to enshrine a social mandate into their corporation while continuing to otherwise operate as a business. However, the dissent rights that shareholders can exercise, when a corporation opts to convert to a benefit company or subsequently ceases to be a benefit company, make it less attractive a vehicle for existing corporations to convert to benefit companies. The utility of the benefit company in the Canadian context has not been without debate.[9] The BC benefit company was introduced by a private member’s bill. Transplanting the benefit corporation model into Canada without considering the Canadian jurisprudence on director duties means we are not tailoring this corporation to our particular legal context and could potentially have implications on the development of director duties for traditional business corporations that do not opt to become benefit companies. Nevertheless, the lack of uptake in other provinces draws into question not only the utility of benefit corporations in Canada but also whether they will have any lasting impacts.
The benefits of solving this issue for the sector
The voluntary sector would benefit from a comprehensive analysis of how charities and non-profit organizations can carry out revenue-generating activities through separate corporate vehicles, how those vehicles should be structured, and whether there is a need or a space for hybrid organizations. Further, if hybrid organizations are recommended, it would be preferable for there to be uniform legislation adopted across Canada, to allow for consistency between the different jurisdictions and ease the adoption and regulation of these entities. However, for hybrid organizations to truly be successful, the adoption of preferential tax treatment also needs to be strongly considered.
[1] Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc, 506 A 2d 173 (Del. 1986); see, Carol Liao, “A Critical Canadian Perspective on the Benefit Corporation” (2017) 40:2 Seattle U L Rev 683-716 at 690.
[2] BCE Inc. v. 1976 Debentureholders, 2008 SCC 69 at para 82.
[3] Income Tax Act, ss. 149.1(2)(a) and 149.1(3)(a); Canada Revenue Agency, CPS-019, What is a related business? (March 31, 2003).
[4] Income Tax Act, s. 149(1)(l).
[5] Another option is a trust. However, trusts can be complicated to implement, but potentially provide greater tax efficiencies.
[6] A bill to enact legislation to introduce benefit corporations in Quebec has been introduced, but has not discussed or debated since it was re-instated during the 42nd Legislature, 2nd Session on October 20, 2021. See, Bill 797, An Act to amend the Business Corporations Act to include benefit corporations.
[7] In the case of a C3, there are no dividend limits on the shares held by qualified entities, which includes BC societies and registered charities. Community Contribution Company Regulation, BC Reg 63/2013, s. 5.
[8] The B Corp certification is given to companies who meet requirements prescribed by B Lab. It does not denote whether a business corporation has adopted a particular corporate structure, such as become a benefit corporation under statute.
[9] See, Carol Liao supra note 1.
