The nature of the L3C

Cite this Article
Larry Ribstein, The nature of the L3C, Truth on the Market (June 17, 2010),

LLCs have always been all about experimentation. This keeps things interesting for those like me who study them. It also provides evidence of the laboratory of state law at work, particularly in business associations, and more particularly uncorporations. But not all experiments are successful. Sometimes it’s television, sometimes it’s electric underwear.

Witness the L3C, or “low profit limited liability company.” As discussed in Ribstein & Keatinge, Section 4:10:

[S]everal statutes have enacted provisions for “low-profit” LLCs that are intended to signal to foundations and donor directed funds that entities formed under these provisions intend to conduct their activities in a way that would qualify as program related investments. The first such statute was adopted in Vermont. See Vt. Code, title 11, ch. 21, §3001(27); Low Profit Limited Liability Company, This statute requires the L3C, among other things, not to have a “significant purpose” of producing income or property appreciation.

A recent article celebrates this development as “the first American legal form to embrace and facilitate social enterprise.” However, Ribstein & Keatinge notes some potential problems with the L3C:

It is not clear precisely what is accomplished by these special provisions that cannot be done under standard LLC statutes. Also, the statutes may create complications to the extent that they entail name, prospectus disclosure or other special requirements * * * and raise questions as to whether they achieve the objectives of investors seeking to use the entity to get tax breaks on “program related investments.” For criticisms of the L3C see Bishop, The Low-Profit LLC (L3C): Program Related Investment by Proxy or Perversion?. . .; Kleinberger, A Myth Deconstructed: The ‘Emperor’s New Clothes’ on the Low Profit Limited Liability Company
. . . .; Kleinberger & Callison, When the Law is Understood – L3C No . . .

Apart from the logistics, in theory firms ought to be able to provide a contractual mechanism to commit an enterprise to social purposes. In 2005 I responded to a Geoff Manne post on the British “Community Interest Company” which, as I summarized, “lets firms contract into social responsibility by restricting (though not prohibiting) dividends.” I noted that firms “may contract to take society’s interests into account.” But this really isn’t much of an issue under current corporate law given managers’ significant discretion to take society’s needs into account under the business judgment rule. Thus, CICs can be viewed as a mechanism for enhancing the managerial discretion that is already inherent in the corporation.

The real business association question is the extent to which the firm can significantly reduce managers’ discretion whether to enhance owner welfare, including by committing to earning money and distributing it to owners. This is where uncorporations such as the LLC come in. As I explain in The Rise of the Uncorporation, a basic feature of uncorporations is that they eschew corporate-type capital lock-in and subject managers to contractual commitments regarding distribution of cash. Thus, both the CIC and the L3C would differ more sharply from uncorporations than they would from corporations.

It follows that the biggest theoretical problem with L3Cs is what I would label their “incoherence.” As discussed in Rise of the Uncorporation, business association provisions need to work together rather than at cross-purposes. Coherence, among other things, enables courts to fill gaps because the statute gives them a fairly clear idea of what it’s supposed to accomplish. L3Cs’ feature of not having a significant purpose of producing income is fundamentally at odds with a central feature of uncorporations in general, and LLCs in particular, of directly constraining managers to act in owners’ interests, including through distribution obligations. Thus, as discussed in Rise of the Uncorporation Chapter 7, “L3C provisions raise issues as to the costs of flexibility and tradeoffs between flexibility and coherence.” The fact that LLCs can be made to do just about anything undercuts the beneficial coherence of the form.

It follows that, assuming there’s a need for a new business entity that accomplishes what the L3C attempts to do – that is, provide for constraints that satisfy tax and other law on program related investments – and that the tax issues with program related investments can be dealt with, it would be better to attach these provisions to a brand new corporate type of business association, perhaps including the CIC, rather than mucking up the LLC.