When Social Enterprises Fail

This Article identifies the conflicts between social enterprise legislation and bankruptcy law and presents a normative argument for a legal regime that would harmonize the two. Focusing on benefit corporations, the most widely adopted social enterprise form, this Article observes that existing law leaves uncertainty as to the role of directors at a time of financial distress and will produce outcomes that are at odds with the core goals of social enterprise legislation. Then, drawing on academic proposals for contract-based systems of bankruptcy, this Article argues that just as a firm may opt out of a corporate governance norm of pure shareholder wealth maximization through the selection of the benefit corporation form, a firm should be permitted to opt out of a bankruptcy norm of pure creditor wealth maximization through that same selection. A firm and its creditors could thus effectively contract into a unique bankruptcy regime for benefit corporations. Looking to the distinctive treatment of nonprofits and railroads in bankruptcy as precedent, this Article proposes a regime in which the same stakeholder interests that must be considered by the directors of a solvent benefit corporation would be required to be considered by such directors, and by the court, in a bankruptcy proceeding. Finally, this Article argues that the availability of such a regime as a default rule for benefit corporations would on the whole produce more efficient bankruptcy outcomes. Investors in benefit corporations exhibit a preference for trading off some degree of wealth maximization in exchange for the in-kind returns associated with reducing the negative externalities, and increasing the positive externalities, of corporate behavior. By opting into a stakeholder-friendly bankruptcy system, investors could similarly trade off some degree of wealth maximization, by virtue of a higher cost of debt, in order to reduce the negative externalities and increase the positive externalities of financial failure. By better aligning bankruptcy outcomes with such preferences, the proposed regime would on the whole result in greater efficiency and societal wealth. This Article proceeds as follows. Part II assesses the origins of social enterprise legislation, the key components of benefit corporations and related social enterprise forms, and the academic debate as to the necessity of such legislation. Part III explores why bankruptcy law matters for benefit corporations and argues that existing law and scholarship provide unsatisfactory guidance as to both the application of existing law and the normative question of what should happen to benefit corporations in bankruptcy. Part IV finds theoretical support for a unique set of bankruptcy rules for benefit corporations in the rich academic literature regarding the theoretical underpinnings of bankruptcy law. Part V draws from the bankruptcy law of nonprofits and railroads to propose specific amendments to both the Bankruptcy Code and benefit corporation statutes so as to implement a unique bankruptcy regime for benefit corporations.6 Then, it analyzes the ex ante efficiency implications of such a regime