I. The Central Argument
A. The New Legal Form
Social enterprises that combine the pursuit of social mission and profit are on the rise worldwide. They create significant and substantial social and economic impact. A recent survey of 1,030 social enterprises found that they generated more than €6.06 billion in revenue, impacted more than 871 million beneficiaries, employed more than half a million people, and benefitted about 5.5 million people.Footnote 1 According to the European Commission, there are 2.8 million social enterprises employing around 40 million people, engaging more than 200 million volunteers, and providing 13.6 million jobs, accounting for 8% of the EU GDP.Footnote 2 Further, in a 2019 Deloitte Global Human Capital Trends survey which polled almost 10,000 respondents in 119 countries, 56% of the respondents agreed that social enterprises would play a more important role in society in the next three years, and 40% agreed that social enterprises would continue to play the same important role in the next three years.Footnote 3 Moreover, social enterprises have assumed considerable salience: In view of the recent high-profile repudiation of shareholder primacy and the adoption of stakeholder value by business leaders, social enterprises have been hailed as innovative business models that can deliver positive social impact and yet be profitable.Footnote 4
Asia, being no exception, has witnessed a significant increase in such businesses. Social enterprises have been regarded as an innovative and vital solution to the pressing problem of socioeconomic inequality and as playing an important role in the delivery of public goods and services.Footnote 5 More broadly, social enterprises have been considered an important tool for the provision of public benefit particularly for the disadvantaged and vulnerable. Social enterprises in Asia include but are not limited to sellers of affordable and essential goods and services, microfinanciers, as well as organizations that provide employment and training to the disadvantaged and disabled members of the community.Footnote 6 Unsurprisingly, among the top five most innovative and impactful social enterprises in the world, two are from Asia.Footnote 7
In light of the vital social and economic roles played by social enterprises, it is important to assess whether the existing law enables social enterprises to flourish and if not, what legal reforms should be adopted. There is no separate legal form for social enterprises in nearly all of the Asian jurisdictions,Footnote 8 unlike in the UK,Footnote 9 US,Footnote 10 and Europe.Footnote 11 The social enterprises in most of the Asian jurisdictions rely on the existing legal forms, the most common of which is the private company limited by shares.Footnote 12
Using the four leading common law jurisdictions in Asia (Singapore, Hong Kong, Malaysia, and India) as case studies, the central argument in this book is that there should be a new legal form for social enterprises in Asia comprising a framework of five criteria: (1) corporate purpose; (2) directors’ duties; (3) decision-making powers; (4) reporting, impact measurement, and certification; and (5) distribution of dividends, assets, and tax benefits. The new legal form should take into account the distinctive social, economic, and political contexts within which different types of social enterprisesFootnote 13 operate in the different Asian jurisdictions, and that is responsive to the evolving needs of social enterprises and the community.Footnote 14
To make this argument, I critically analyze the three principal types of conflicts of interest – between social entrepreneurs and investors; between pro-social investors (or members) and for-profit investors (or members); and between social entrepreneurs on the one hand, and consumers, clients and intermediaries on the other – that affect social enterprises in general. Next, I demonstrate why the existing legal forms used by social enterprises in Asia – company limited by shares, company limited by guarantee, sole proprietorship, society, partnership (including limited liability partnership), as well as cooperative society – fail to address the conflicts of interest. Then, I advance a framework for a new legal form consisting of five criteria that can address the conflicts of interest: (1) corporate purpose; (2) directors’ duties; (3) decision-making powers; (4) reporting, impact measurement, and certification; and (5) distribution of dividends, assets, and tax benefits. While I argue that the four Asian jurisdictions should create a new legal form for social enterprises, the precise characteristics that this legal form should take will vary within each jurisdiction. The five criteria consisting of ex ante rules and ex post standards, mandatory and default rules, should be carefully tailored to the differing needs of different types of social enterprises in different jurisdictions, bearing in mind in particular the integrity and competence of the political and legal institutions responsible for implementing, monitoring, and enforcing the laws.
The five criteria set out in the framework provide a basis for designing the characteristics of the new legal form for social enterprises not only in the four jurisdictions in Asia, but also in other jurisdictions that do not have a separate legal form for social enterprises. Further and importantly, I demonstrate why and how this new legal form for social enterprises in Asia should be different from the existing legal forms for social enterprises in the UK and US – the UK’s community interest company (CIC) and the US’s benefit corporation (including public benefit corporation (PBC)) and social purpose corporation (SPC).Footnote 15 These legal forms are critiqued in light of the framework comprising the five criteria.
B. Common Law Asian Jurisdictions
I have selected the common law Asian jurisdictions as case studies for three reasons. First, none of the four Asian jurisdictions (Singapore, Hong Kong, Malaysia, and India) has a legal form for social enterprises. Social enterprises in those jurisdictions have to use existing legal forms, with the limited liability company being the most widely used. On the one hand, there is an assumption in certain jurisdictions that the current legal forms are sufficient. On the other hand, it has been highlighted that arguably the biggest problem facing social enterprises in Asia is the lack of a distinct legal form,Footnote 16 and yet there is no critical analysis of what this legal form will entail. I expose the deficiencies of the existing legal forms and make the case for a distinct legal form for social enterprises in Asia by developing a framework comprising five criteria that can accommodate different types of social enterprises in different jurisdictions.
Second, while these four Asian jurisdictions are based on the common law, their distinctive characteristics call into question whether the legal forms for social enterprises in other leading common law jurisdictions, particularly the UK’s CIC and the US’s benefit corporation, can be transplanted to the Asian jurisdictions. This makes it interesting and worthwhile to examine these four Asian jurisdictions. These four Asian jurisdictions can be appropriately compared with the UK and US because the corporate laws of the Asian jurisdictions are based on or derived from the UK. However, the political and legal institutions in the four jurisdictions, which are different from those of the US and UK, have an important bearing on the features of the new legal form for social enterprises. The five criteria of the proposed legal form consist of ex ante rules (such as the requirement to have a corporate purpose; decision-making powers; reporting, impact measurement, and certification; as well as distribution of dividends, assets, and tax benefits;) and ex post standards (such as directors’ duty to act in the company’s best interests and to exercise powers for proper purposes; and decision-making powers, i.e. enforcement rights). Ex ante rules require responsive and independent regulators as well as efficient legislators. And ex post standards require an efficient, independent, and competent court system. The quality of the judicial and regulatory regime in the UK and US (particularly Delaware) is generally not in doubt. But this cannot be said for the Asian common law jurisdictions which exhibit varying quality among themselves.Footnote 17 The quality of the judicial and regulatory regimes in the Asian common law jurisdictions has crucial implications for the type and scope of the characteristics of the legal form for social enterprises. For example, the judicial system in India is known for its persistent inefficiencies,Footnote 18 and the regulatory monitoring and enforcement regimes in India and Malaysia are afflicted with inefficiencies and to a certain extent corruption.Footnote 19 By contrast, the judicial and regulatory regimes in Singapore and Hong Kong are generally of a high quality.Footnote 20 This suggests that a carefully tailored combination of ex ante and ex post mechanisms is needed for the effective functioning of the new legal form for social enterprises in different jurisdictions. The new legal form for social enterprises in each of the four Asian jurisdictions should encompass all five criteria, but the devil is in the detail. I elaborate on these criteria in this book.
Finally, as I explain in the next section, social enterprises in the common law Asian jurisdictions (especially India, Malaysia, and Hong Kong) play an important role in alleviating pressing socioeconomic problems as well as in addressing the problem of inadequate provision of essential goods and services. These social enterprises deliver a range of services that are not provided by the public or private sector. This makes it vital to understand whether current corporate law is adequate to support these business ventures and if not, what reforms should be made. There are numerous domains in which social enterprises have created impact. Examples of three domains are given for now (and more will be discussed in the book): employment, empowerment of women, and education. Social enterprises generate significant employment. More than 50% of the social enterprises in India create direct employment by employing disadvantaged groups in their workforce.Footnote 21 In Malaysia, social enterprises have increased job creation by 23% from 2017 to 2018.Footnote 22 Moreover, social enterprises play a key role in empowering women. Twenty-four percent of the social enterprises in India are led by women, higher than 8.9% of female-led firms in mainstream business/private sector firms.Footnote 23 This is important because Indian women generally face deep-seated cultural prejudice and discrimination and thus, becoming a social entrepreneur can elevate a woman’s status in her family and community, develop her confidence, and increase her sense of self-worth.Footnote 24 In Malaysia, a Muslim patriarchal society, 54% of social enterprises are led by women.Footnote 25 Further, social enterprises have improved marginalized youth’s access to education by providing them with life-skill training and mentorship.
Before I examine the social enterprises in Asia in detail – their operational domains, their driving forces, their challenges, the conflicts of interest, and the existing legal forms used by them – it is valuable to provide a broader view of why the study of social enterprises matter for corporate governance. The next section deals with this topic.
II. Social Enterprises and Long-Term Value Creation
A central and perennial issue in corporate law and governance is for whom companies should be managed. In 1997, the Business Roundtable, an organization of chief executive officers of America’s leading companies, issued a “Statement on the Purpose of a Corporation,” stating that companies should primarily promote the interests of shareholders, usually equated with the maximization of share price.Footnote 26 But in a remarkable repudiation, the Business Roundtable in 2019 declared that companies should be managed to promote the interests of all stakeholders.Footnote 27 Similarly, in 2019, the British Academy published a report stating that “the purpose of business is to profitably solve problems of people and planet, and not profit from causing problems.”Footnote 28 Further, the World Economic Forum has issued the “Davos Manifesto 2020: The Universal Purpose of a Company in the Fourth Industrial Revolution,” stating that the purpose of a company is to engage all its stakeholders in shared and sustained value creation.Footnote 29 The ideology of shareholder primacy has been rejected in favor of long-term stakeholder value creation. The age of “stakeholder capitalism” has arrived.Footnote 30
In 2018, Deloitte carried out an extensive survey of more than 11,000 business and HR leaders and released a report “The Rise of Social Enterprises” in which 65% of the respondents rated “inclusive growth” as a top three strategic concern, more than three times greater than the proportion citing “shareholder value.”Footnote 31 And 77% of the respondents regarded “citizenship and social impact” as “very important or important.”Footnote 32 It has been argued that companies seeking to operationalize the concept of long-term stakeholder value should take a leaf from social enterprises.Footnote 33 Social enterprises can provide a valuable, concrete example of how businesses have sought to further the long-term value of stakeholders by promoting inclusive growth and delivering social impact in two aspects: purpose and business models. Social enterprises have also become significant because it has also been said that companies that receive subsidies from the government as a result of the COVID-19 pandemic could be required to become social enterprises.Footnote 34
The raison d’etre of social enterprises is to deliver social benefit by identifying and solving social problems through the use of business models. The social problems, often involving the socially and financially vulnerable, include but are not limited to social exclusion or marginalization (related to certain classes of people in society such as ex-convicts, drug users, and delinquent youth), unemployment of vulnerable segments of the community (such as women and the disabled), and deprivation of critical goods and services (such as clean water, housing, healthcare, food, transportation, and loans). Social enterprises deploy existing legal forms (the most common of which is the company limited by shares) to set up businesses involving the production, management, sale, marketing, and delivery of goods and services for the overriding purpose of solving these problems, and delivering social benefit. Given that it is a business, a social enterprise strives to be profitable so that it can continue to effectively deliver social benefit. In short, the fundamental and overriding purpose of a social enterprise is to deliver social benefits by solving social problems, while striving to be financially viable.
However, conventional profit-oriented companies that engage in CSR are not established for the overriding purpose of delivering social benefits by solving crucial social problems. Rather they are set up first and foremost to deliver profitable goods and services.Footnote 35 These conventional profit-driven companies are concerned with the interests of stakeholders insofar as these will impact on shareholders’ interests, usually (but not necessarily) equated with stock price and shareholder returns.Footnote 36 These companies address stakeholders’ interests when they take measures to mitigate negative externalities or more broadly, when they consider the social, economic, or environmental impacts resulting from their business operations, also known as the business case for sustainability.Footnote 37 After all, many companies take the view that attending to nonfinancial considerations are either consistent with – or are means to serve the ends of – generating financial returns. This is also known as the enlightened shareholder primacy model that is prevalent in the USFootnote 38 and UK.Footnote 39
But if these nonfinancial considerations were to conflict with the financial ones thereby sacrificing shareholders’ returns, then it is unlikely that directors of these companies will pursue the former. In other words, conventional companies are unlikely to prioritize the pursuit of stakeholders’ interests at the expense of long-term profitability. By contrast, social enterprises prioritize the promotion of social goals over profit-making.
Further, the profits or surpluses generated by social enterprises are primarily used to promote social goals in light of their raison d’etre, but this cannot be said for conventional profit-driven companies.
Thus, in seeking to operationalize the concept of stakeholder value in its corporate purpose, companies need to consider whether they will follow social enterprises in (a) elevating the identification and resolution of social problems as their raison d’etre; and (b) prioritizing the delivery of social benefit even if it conflicts with profit-making. The first is less demanding than the second and hence should be more attractive to companies seeking to promote stakeholder value. In this regard, we turn to various business models adopted by social enterprises.
B. Business ModelsFootnote 40
To understand how the business models of social enterprises can be distinguished from those of conventional profit-driven companies, it is helpful to differentiate three different levels. On the first level, companies may set aside a certain portion of the profit generated from the sale of goods and services to promote social benefit. But this is not part of their core mission. A prime example is corporate philanthropy. On the second level, where taking into account stakeholders’ interests is part of the core mission of companies, their business models will be related – but only indirectly – to the promotion of social benefit in the sense that companies will disclose the impacts their business operations have on stakeholders and the measures taken to address those adverse impacts. An example is compliance with environment, social and governance (ESG) reporting requirements (including the Global Reporting Initiative).Footnote 41
However, on the third level, the generation of goods and services is explicitly tied to, directly impacts on, and is a means for, the promotion of social benefit for the targeted members of the community. Level three is what distinguishes social enterprises from conventional companies. There are at least two models that illustrate this level: base of pyramid and inclusive business.Footnote 42 The main difference between these two models is that base of pyramid social enterprises seek to deliver social benefit by selling essential goods and services to the disadvantaged customers or clients, whereas inclusive social enterprises engage with the beneficiaries of the social impact – whether as employees (in the Work Integration Social Enterprise (WISE) model), suppliers (in intermediary model) or decision-makers (in cooperatives model) – in order to co-develop the business of the social enterprises.
1. Base of Pyramid
Social enterprises address the pressing needs of the poor and outcasts, those at the base of the pyramid. Although extreme poverty rate has decreased in the past thirty years, poverty remains the world’s biggest challenge.Footnote 43 As a result of the COVID-19 pandemic, global extreme poverty rose in 2020 for the first time in twenty years.Footnote 44 Moreover, as a result of the COVID-19 pandemic, there will be an additional estimated 143 to 163 million people who will be plunged into extreme poverty, increasing the total number of people living in extreme poverty to approximately 751 million.Footnote 45 This group of people consists of the base of pyramid who can provide an untapped source of revenue for business. But most businesses avoid transacting with the poor as they are not able to pay for the goods and services consumed by those in developed countries. However, social enterprises view these group of people as an important source of revenue. Social enterprises have to deliver quality and yet affordable goods and services on a large scale to this segment of the population. The goal is to produce social benefit for the poor and at the same time be profitable. The most prominent and successful example is the microfinance institution Grameen Bank, founded by the Nobel Laureate Mohammed Yanus, which extends loans to the rural poor people without requiring collateral in order to reduce poverty and to empower the poor to set up their own businesses in order to be financially independent.Footnote 46 As of January 2021, Grameen Bank has 2,568 branches in 81,678 villages, as well as 9.38 million members, 97% of whom are women.Footnote 47
2. Inclusive BusinessFootnote 48
Inclusive businesses involve integrating the beneficiaries of the social enterprise in its value chain not only as consumers or clients, but also as employees, distributors, and suppliers. The social benefit extends beyond delivering essential goods or services to the needy and vulnerable to allowing them to participate in how the benefits are being structured and delivered. In other words, they are not merely passive recipients of the benefits (in the form of acquired goods or services) but they play a role in creating and delivering the benefit. Three important illustrations of inclusive business are WISEs, intermediaries, and cooperatives. WISEs provide not only financial benefit to the needy and disadvantaged in the form of wages earned from employment, but also crucial upskilling so that they can become more employable, which increases their social mobility. Further, WISEs help to integrate the severely neglected members of the community such as the disabled and ex-convicts back to society, thereby restoring their dignity. Depending on the nature and extent of their roles as employees, they can make important contributions to how the goods and services are being produced, marketed, and sold. For example, WISEs are the most prominent type of social enterprises in Europe.Footnote 49 The clients or consumers of the goods and services produced, managed, or sold by the employees may or may not be another disadvantaged group within society.
The second illustration of inclusive business is intermediaries whereby social enterprises engage with Fair Trade businessesFootnote 50 or other types of sellers and producers by acquiring or marketing their products. In doing so, social enterprises increase the access of these fair trade producers and suppliers.
The final illustration is cooperatives, which represent 3% to 5% of the world’s GDP.Footnote 51 These are organizations in which the beneficiaries of the social benefit are also the customers or clients, and crucially, these beneficiaries have the decision-making powers to govern the organizations. Cooperatives allow for democratic participation, unlike other types of social enterprises such as WISE or intermediaries or those catering to the base of pyramid in which the beneficiaries generally do not have governance rights.Footnote 52 In a cooperative, the interests of the beneficiary, the customer, and the decision-maker are aligned. A McKinsey study comparing forty-seven cooperatives with fifty-four publicly listed companies found that cooperatives are better at growing market share than publicly listed companies.Footnote 53 Cooperatives can be found in the retail, insurance, agriculture, and financial sectors. The beneficiaries of cooperatives include not only the members, but also nonmembers who acquire the goods and services from the cooperatives.
In sum, as shown in these two main types of business models – Base of Pyramid and Inclusive Business – social enterprises seek to create social benefit first and foremost and the means through which they do so is by establishing and sustaining a viable business. Social enterprises thus play critical roles in reducing poverty, integrating the socially excluded into society, and delivering essential and quality goods and services to otherwise neglected segments of society, while being financially viable. Further, they are engines of economic growth in societies because the combined pursuit of social mission and profit enables them to tap into underexplored markets and gather important market intelligence on goods, services, workers, suppliers, and consumers that is usually neglected by nonsocial enterprises.
Given that social enterprises are a valuable and workable model of how businesses can protect and promote the long-term interests of stakeholders as evidenced in their purposes and business models, the question is whether the law enables or undermines the role of social enterprises in advancing stakeholders’ interests and social benefit. I argue that the existing legal forms used by social enterprises in common law Asia are ill-equipped to serve a critical and unique function of social enterprises, that is, to prioritize social mission over profit while remaining financially viable. In Section III, I first provide a brief overview of the social enterprises in Asia by explaining the domains in which they operate, the factors that drive their development, and the challenges facing them. After that, I analyze the six legal forms used by social enterprises in Asia and I demonstrate that they are afflicted with one or more of the conflicts of interest and that none of the legal forms could satisfactorily address these conflicts.
III. Social Enterprises in Asia
A. Operating Domains
In Asia, social enterprises have adopted the above business models to make impacts in the domains of providing essential goods and services (especially to the base of pyramid), generating employment, providing education, supporting children, women and youth, and protecting the environment.
Regarding the provision of essential goods and services, the Indian government had earmarked INR 5,000 crores (US$780 million) as part of the Inclusive Innovation Fund for social enterprises whose social mission is to benefit those at the bottom of pyramid.Footnote 54 The plan was to have the government contribute 20% of the social enterprise’s capital and the remaining 80% to be derived from private investors.Footnote 55 Among the key providers of essential services are microfinancing organizations as they play a significant role, especially in India, where 8% to 11% of its population live below the international poverty line of US$1.90 a day,Footnote 56 and where 75 million people fell into poverty in 2020 as a result of the pandemic (which accounted for 60% of the global increase in poverty).Footnote 57 For example, SKS Microfinance provides loans and insurance to destitute women in some of the poorest regions in Asia.Footnote 58 Loans are extended with no requirement for collateral to small groups of women and repayment is essentially based on peer pressure within the group. Social enterprises also provide affordable healthcare services to address the problem of inadequate and poor quality healthcare, an example of which is Vaatsalya Healthcare, serving over 150,000 patients and which has an annual turnover of $2.97 million.Footnote 59
Regarding employment, more than half of the estimated two million social enterprises in India focus on employing and providing training to disadvantaged or vulnerable members of society in their workforce.Footnote 60 A good example is Mirakle Couriers, which was established to hire deaf people to provide delivery services.Footnote 61 To date, this company has sixty-four deaf employees and four management staff. It handles more than 65,000 deliveries per month to more than forty companies.Footnote 62 In Hong Kong, 71% of social enterprises create jobs for the disadvantaged and the social enterprises provide a variety of training to the employees (including occupation training, customer service, communication skills, marketing, IT, etc.).Footnote 63 Creating employment opportunities is ranked as the number one objective of social enterprises in Malaysia.Footnote 64 In Singapore, the provision of employment opportunities to the disadvantaged is the most important activity undertaken by social enterprises.Footnote 65
Regarding education, about 25% of the population in India are illiterate and about 98% of the youth enter the job market with no proper skill sets.Footnote 66 Thus, there is a huge demand for quality and affordable education. Social enterprises set up private coaching institutions, create educational contents, and to a lesser extent set up private schools. One example is Rumi Schools, a private company which has set up nine foundation schools with approximately 4,000 students.Footnote 67 In Singapore, which has sizable population of migrant workers vis-à-vis its citizens and residents,Footnote 68 social enterprises such as SDI Academy designs and delivers high-quality and affordable education and training courses to migrant workers related to entrepreneurship, financial literacy, communication, and technological skillsets.Footnote 69
Social enterprises in the four Asian jurisdictions also provide education and training for vulnerable and stigmatized groups of people such as marginalized women and delinquent youth. For example, 24% of the social enterprises in India are led by women, higher than the 8.9% female-led firms in mainstream private sector.Footnote 70 In Malaysia, social enterprises that hired full-time female staff increased by 20% from 2017 to 2018.Footnote 71 Further, creating jobs for youth remains the top objective for social enterprises in Malaysia.Footnote 72 Creating employment opportunities and supporting vulnerable and marginalized communities account for 34% and 21%, respectively, of the social enterprises’ objectives in Malaysia.Footnote 73
There are at least three drivers of the development of social enterprises in the four Asian jurisdictions: (a) government policies in response to economic downturn and structural unemployment; (b) alleviating socioeconomic problems; and (c) the promotion of corporate social responsibility and social innovation.
Regarding the first driver, the policies adopted by the governments in certain Asian jurisdictions such as Hong Kong and Singapore to address structural unemployment caused by economic downturn include incentivizing and collaborating with the private sector and civil sector to generate employment and provide public service to the unemployed and disadvantaged.Footnote 74 Socialist welfare policies such as generous unemployment or disability benefits are eschewed.Footnote 75 The government expects citizens to play a greater role in addressing the needs of the vulnerable and disadvantaged, an important means by which is the setting up of social enterprises. For example, during the economic downturn following the Asian financial crisis, in order to reduce welfare expenditure, the Hong Kong government promoted “welfare-to-work” policy by providing basic funding to small businesses in order to encourage them to deliver social benefits through the employment of the vulnerable segments of the community.Footnote 76 The COVID-19 pandemic has spurred the Singapore government to create more jobs through public–private partnerships by assisting businesses including social enterprises to create temporary and full-time jobs through grants and subsidies.Footnote 77 This partly explains why WISEs are among the most prevalent type of social enterprises in the four Asian jurisdictions.
As for the second driver, the governments in MalaysiaFootnote 78 and India have fostered and relied in part upon social enterprises to address persistent socioeconomic challenges, given that social enterprises are able to come up with innovative solutions to deliver social impact. For example, the Malaysian government established the Malaysia Global Innovation and Creativity Centre (MaGIC) Social Entrepreneurship (SE), to which it allocated RM20 million, in order to finance and increase the number of social enterprises.Footnote 79 In addition to providing funding, MaGIC SE provides training, mentorship and network opportunities to social enterprises. Another important initiative launched by the Malaysian government was the Social Public-Private Partnership, a new type of social service provider that seeks to address social problems through collaborations between the government and the private sector.Footnote 80 In India, the government has put in place policies to support social enterprises, such as the Priority Sector Lending by the Reserve Bank of India, which requires banks to set aside 40% of their assets toward loans made to high-priority social sectors, including agriculture and microfinance.Footnote 81 Further, the Indian government set up the Indian Inclusive Innovation Fund (IIIF) in order to invest in social enterprises that operate in the domains of healthcare, agriculture, water, food, and energy.Footnote 82 The target of IIIF was to raise INR 5 billion, of which the government will contribute 20% and the remaining 80% was to be solicited from financial institutions.Footnote 83
The third driver is that corporate social responsibility and social innovation led to collaboration between the private–public sector and social enterprises. For example, in India, while the nonprofit sector has been the beneficiary of CSR initiatives, companies have increasingly partnered with social enterprises that share their social vision by providing the latter with capital as well as technological and management advice.Footnote 84 Such collaborative ventures are being facilitated by the Companies Act, which requires companies of certain size to spend, on an annual basis, at least 2% of their average net profits made in the three preceding years on CSR activities.Footnote 85 One study found that 220 social enterprises received approximately USD 1.6 billion in the last ten years from impact investors.Footnote 86 A significant CSR initiative of the Development Bank of Singapore is the provision of funding (whether loans or donations), training, and mentorship to over 1,000 different social enterprises in Asia.Footnote 87 In addition to the private sector, governments have been active in developing social enterprises. One example is the Social Innovation and Entrepreneurship Development Fund set up by the Hong Kong government, which has provided more than HK$31 million in funds to social enterprises and benefitted more than 280,000 beneficiaries consisting of the vulnerable and disadvantaged such as children and youth, elderly, disabled persons, and low-income families.Footnote 88
Despite the different domains in which social enterprises in the four Asian jurisdictions operate, and notwithstanding the different factors that drive their development, social enterprises in Asia share the same fundamental challenges.
Two critical challenges (amongst others) confront social enterprises in the four Asian jurisdictions: inadequate public awareness and poor access to funding.Footnote 89 For example, in Malaysia, 62% of social enterprises identified the lack of awareness of social enterprise business models as the most pressing challenge, followed by 46% of social enterprises who regard poor access to investors as the next most serious problem.Footnote 90 In India, 57% of social enterprises regarded access to capital as a barrier to growth, and 32% identified the lack of awareness of social enterprises among banks and support organizations as a barrier to growth.Footnote 91 In Singapore, the top four challenges faced by social enterprises include customer acquisition and market development, access to financial support, building internal capabilities, and lack of public awareness.Footnote 92
Inadequate public awareness is due to the fact that there are varying and contested understandings of social enterprises in different jurisdictions. For example, the UK government has a working definition of social enterprise which is a “business with primarily social objectives whose surpluses are principally reinvested for that purpose in the business or in the community, rather than being driven by the need to maximize profit for shareholders and owners.”Footnote 93 A legal form has been created for social enterprises known as the CIC in which a community interest test is imposed to ensure that the CIC acts on purposes that benefit the community.Footnote 94 The law subjects CICs, which are for-profit companies, to restrictions on the transfer of assets and the distribution of dividends. In the US, there is no working definition of social enterprises. Rather, there are different legal forms specifically created for social enterprises including benefit corporations, PBCs, SPCs, and low-profit limited liability companies.Footnote 95 For example, benefit corporations are required to create “general public benefit,”Footnote 96 defined 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 a benefit corporation.”Footnote 97
However, other than Malaysia – which has a legal definition of social enterprise, that is, a “business entity that is registered under any written law in Malaysia that proactively creates positive social or environmental impact in a way that is financially sustainable”Footnote 98 – there is no legal definition of social enterprises in the other three common law Asian jurisdictions. Nevertheless, governmental bodies and NGOs have come up with working definitions. For example, in Hong Kong, the Social Enterprise Business Centre defines social enterprise as one that “contains social objectives in doing business,”Footnote 99 distinguishing it from a charity “which contains social objectives but does not carry on business or adopt commercial elements in its activities.”Footnote 100 A distinction is also drawn between a conventional enterprise whose main objective is to maximize profits, whether or not it pursues corporate social responsibility, and social enterprise which seeks to “achieve specific social objectives through business approaches.”Footnote 101 The Singapore Centre for Social Enterprise defines social enterprises as “business entities set up with clear social goals; and where there is clear management intent and resources allocated to fulfil their social objectives.”Footnote 102 A recent report on social enterprises in India defines a social enterprise as “a business with a primarily social or environmental purpose, which aims to be financially self-sustaining and to principally re-invest a proportion of its profit or surplus either back into the business or for a social or environmental cause.”Footnote 103
Nevertheless, despite the varying definitions of social enterprises, two features can be discerned from the working definitions: The first is the deployment of business forms to achieve the primary objective of pursuing social good, and the second is the prioritization of social good above profit-making. However, even if a working definition containing these two features are accepted, thereby solving the issue of inadequate public awareness, there is still the problem of difficulty in accessing capital. This is because unless pro-social investors and consumers are assured that the social enterprises will, throughout their existence, prioritize social benefit over profit maximization, they will be reluctant to invest in or purchase products from social enterprises. But even if social benefit is accorded primacy, assurance still has to be given to these pro-social investors and consumers that the social enterprise is making the social impact and delivering the public benefit that it claims to be doing. Investors and consumers need to be assured that social enterprises are not using the social label merely as a branding exercise. In other words, the problem of accessing capital is linked to three sets of conflicts of interest involving social enterprises, which will be explained in the next section.
D. Conflicts of Interest
Social enterprises suffer from three main types of conflicts of interest: the first is between social entrepreneurs on the one hand, and investors on the other; the second is between pro-social investors (or members) on the one hand, and for-profit investors (or members) on the other; the final conflict is between social entrepreneurs on the one hand, and consumers/clients/intermediaries on the other.
1. Social Entrepreneurs v. Investors
From the perspective of investors, they are willing to accept a lower return on their investments in exchange for the pursuit of social good, which is one important reason why they choose to invest in a social enterprise instead of a conventional profit maximization company. But these investors may be concerned that social entrepreneurs embrace social impact in their mission statement as a form of branding or public relations exercise.Footnote 104 Further, they are concerned that social entrepreneurs, who could be the directors and managers, may subsequently change their minds and subordinate the promotion of social good to the pursuit of profit. Another concern the initial investors may have is that the social entrepreneur may subsequently bring in other investors who are more financially oriented, and thus potentially jeopardizing the social mission of the firm because these new investors either become the majority shareholders or have special rights such as board representation, special dividends, and exit rights (that are not available to the other shareholders). The challenge then is how social entrepreneurs can convince pro-social investors that they are genuine and committed to the pursuit of social good, and that the capital provided by the investors are being put to good use to achieve public benefit.
From the perspective of social entrepreneurs, they are interested in making sure that their pro-social vision and strategies are not only implemented but are also prioritized where the promotion of social benefit in a particular situation will reduce profits. They are concerned that the shareholders, while having pro-social objectives in investing in the company, may subsequently change their minds, and subordinate the pursuit of social benefit to profit. This risk is all the more real given that shareholders under the company laws of the four common law Asian jurisdictions wield tremendous voting powers (especially if they are controlling shareholders), including but not limited to the power to appoint and dismiss directors (who are likely to include the entrepreneurs), the power to alter the company’s constitution, and the power to dispose of corporate assets.Footnote 105 It would be a different matter of course if the entrepreneurs themselves are the majority shareholders. But this will give rise to a different type of conflict of interest – between social entrepreneurs and consumers, which will be discussed in Section III(D)(3).
2. Pro-social Investors/Members v. For-Profit Investors/Members
A unique characteristic of social enterprises is that they seek not only to promote social good through standard legal forms, but also to prioritize social good in the aggregate while aiming to make profits. This gives rise to the second type of conflicts of interest – between pro-social investors (or members) and for-profit investors (or members). Ideally, in a social enterprise, the interests of the public and community should not only be given effect to, but also, crucially, accorded primacy where those interests conflict with those of for-profit investors who aim for for-profit maximization. However, in reality, there are different types of investors whose interests may conflict. When for-profit investors invest in a social enterprise, they take a different view on the objectives and strategies of social enterprise from pro-social investors. To for-profit investors, social enterprises should take into account social good and public benefit – the interests of the wider constituencies – so that profits can be maximized. In other words, the promotion of social benefit is merely a means to an end. However, to pro-social investors, they invest in social enterprises with the primary aim of promoting social benefit and the secondary aim of making money, such that where both aims conflict, the former is given primacy. By contrast, to for-profit investors, the promotion of social benefit is subordinated to profit maximization; insofar as the corporate action benefits the public but do not maximize profits, for-profit investors will generally avoid them. The problem becomes pronounced when for-profit investors become the majority shareholders, and pro-social ones the minority, because the social enterprise subsequently is in need of critical financing. Where there are no shareholders but only members (such as in companies limited by guarantees and societies), there could also be a conflict of interest between the pro-social members and for-profit members as will be explained in Sections III(E)(2) and E(4).
Of course, to be clear, the dichotomy between pro-social and for-profit investors (or members) is not as stark as it seems. There are investors who may not fall into either category. But the point remains that because of the varying intensity of preferences and objectives of different shareholders (or members) at different stages of the social enterprise (such as an enterprise when it is first established versus one that has been operating for some years), there are bound to be conflicts of interest.
To be clear, from the perspective of pro-social investors (or members), social enterprises need not always give priority to social benefit in all transactions and all circumstances, but only that on the whole, social benefit is given primacy. This raises an important but separate question of how to, and who should, ascertain whether social benefit is prioritized on the whole,Footnote 106 which will be examined in Chapter 2.
3. Social Entrepreneurs v. Consumers/Clients/Intermediaries
To ensure that the social enterprise not only survives in the short-term, but also achieves long-term financial sustainability, it needs to be able to attract pro-social consumers or clients. But these pro-social consumers are willing to buy the social enterprise’s products and services, particularly if they are at above market price, if they can be relatively certain that the social enterprise is indeed contributing to the social cause that it claims to be pursuing. But these pro-social consumers may be concerned that the social entrepreneurs (who may be the shareholders, members, or directors/officers) may be using the label of social enterprise or the language of public benefit as a branding or public relations exercise, and in reality, is primarily pursuing profit-making. And they may be concerned that even if the social entrepreneurs may initially start out promoting and prioritizing social benefit, they may subsequently change their minds and subordinate it to the pursuit of profit.
The conflict can also arise between the entrepreneurs and their “clients,” specifically the government. The government could be an important source of funding. For example, one study found that 50% of the capital of social enterprises in Hong Kong comes from government grants.Footnote 107 Further, the government collaborates with social enterprises to deliver essential goods and services such as in India and Malaysia.Footnote 108 The government may be concerned that the social entrepreneurs will prioritize profit-making over the delivery of public benefit in how the funds will be used.
Finally, given that social enterprises have increasingly sought crowdfunding,Footnote 109 a conflict can arise between the social entrepreneurs and the intermediaries responsible for managing the crowdfunding platforms. On the part of the social entrepreneurs, there is a risk of greenwashing and the danger that they may not deliver the social benefit that they claim they will deliver. The intermediaries need to balance two objectives: First, they need to attract and protect the funders by preventing fraud and by ensuring that the social enterprises that they permit to solicit funds on their platforms are firmly committed to their social mission and are capable of producing verifiable social impact. Second, the intermediaries make money by charging fees to social enterprises who use their platforms. If the intermediaries are too demanding in their verification of the social objectives and the likely impact of social enterprises before permitting them to use the platform, and too stringent in their monitoring of the disclosures of social enterprises during the period of use, they may deter social enterprises from using their platforms.
In light of the conflicts of interest affecting social enterprises, the next issue is whether the existing legal forms used by social enterprises in Asia are able to address or mitigate these conflicts.
E. Existing Legal Forms Adopted by Social Enterprises in Asia
None of the legal forms adopted by social enterprises in Asia – companies limited by shares; companies limited by guarantee; societies; sole proprietorships; partnerships (including limited liability partnerships (LLPs)); and cooperative societies – are able to properly address the conflicts of interests examined earlier.
1. Company Limited by Shares
The private company limited by shares is the dominant legal form used by social enterprises in the four Asian common law jurisdictions, accounting for 72%, 58%, 43%, and 39%, in Singapore, India, Malaysia, and Hong Kong, respectively.Footnote 110 Are there any mechanisms in this legal form that can effectively address the problem of conflicts of interest? It has been said that the flexibility inherent in the corporate constitution enables shareholders and the company to design and enforce bespoke terms and conditions.Footnote 111 Consider the first type of conflict of interest – between social entrepreneurs and investors. For example, the corporate constitution can include provisions to the effect that the board and management have to prioritize and deliver social benefits. However, to begin with, there are transaction costs involved in the negotiation of the provisions that can promote and protect the social mission. The provisions do not pertain merely to corporate mission. These also include and are not limited to shareholders’ governance rights; reporting, impact measurement and certification mechanisms; as well as distribution of assets and dividends.
Even if the transaction costs are manageable and hence do not deter investors from incurring them, the pro-social provisions in the corporate constitution can be amended or removed by a special resolution (under the company laws of the four Asian common law jurisdictions).Footnote 112 Although the amendment is subject to the restriction that it has to be done bona fide for the company’s benefit as a whole,Footnote 113 it is a low threshold, and as long as shareholders can come up with a plausible reason for the amendment, it will not be invalidated by the court.Footnote 114 So, for instance, should majority shareholders amend or remove the provision such that profit maximization becomes the corporate goal, it is unlikely that minority shareholders will succeed in striking down this amendment insofar as the majority shareholders can provide a rational reason for this change. For example, these majority investors can say that prioritizing the social mission of the company is no longer a financially sound strategy for the company because it has been unprofitable for some time, and thus it is beneficial to give greater weight to profit generation.
However, to forestall shareholders from deviating from the social mission of the social enterprise by altering the constitution, the pro-social provisions in the corporate constitution could be entrenched such that they can be altered only with the unanimous consent of all shareholders or in accordance with certain procedures prescribed in the constitution.Footnote 115 Apart from the fact that entrenchment provision is only allowable at the point of incorporation (or with the unanimous consent of all members post-incorporation),Footnote 116 entrenchment provisions may not be effective in promoting the social mission. One reason is that because shareholders want to preserve their ability to change course, they will be inclined to retain as many control rights as possible and will be unwilling to bind themselves to provisions that severely curtail their ability to initiate/make decisions or to exit from the company. So either the entrenchment provision will be drafted at a high level of generality (and hence rendering it less efficacious) or the constitution will stipulate procedures (likely to be inserted by the investors that bring in the most funds) that permit the provision to be amended.
From the perspective of the shareholders, they will be concerned that the board or management will not give adequate or proper effect to the pro-social provisions in the corporate constitution. There are four options available to the shareholders.
First, they may consider enforcing this provision. But under the qua member rule, shareholders cannot enforce a provision in the corporate constitution unless the provision confers a benefit on them in their capacity as shareholders.Footnote 117 Thus, it will be difficult to argue that a provision that purports to deliver public benefit is intended to confer benefit on shareholders in their capacity as shareholders.Footnote 118
Second, shareholders can dismiss or threaten to dismiss directors for failing to give effect to the provision.Footnote 119 But this can work if the pro-social shareholders are in the majority but not if they are in the minority. For example, a social enterprise can start off by having all shareholders buying into the vision and mission of prioritizing social benefit. But midway through the life of the social enterprise, the majority of shareholders may change their minds and either seek to prioritize profit maximization or because of the need for additional funds, the social enterprise will attract investors who place a premium on profitability. However, it may be argued that to prevent the majority of for-profit investors from dismissing the pro-social directors, the company could, when it was incorporated, include a provision in the constitution that gives the directors who may be removed weighted shares so as to make it difficult or impossible for them to be removed.Footnote 120 But this is a double-edge sword: Should the directors deviate or act contrary to the corporate purpose of the company, there is a risk that pro-social investors may not be able to remove them. It may be argued that the pro-social investors can bring a derivative action against the delinquent director for alleged breach of duties if he cannot be removed or if he will not be sued by the board.
Third, while pro-social shareholders can bring derivative action on behalf of the company against the directors for alleged breach of duties,Footnote 121 there are several constraints. For a start, not only will the shareholder who brings the lawsuit has to generally pay for the lawyer and court fees, any damages that the court award will generally go to the company, not to the aggrieved shareholder. This creates a huge disincentive for the shareholders to bring any legal proceedings. Further, shareholders (in Hong Kong, Singapore, and Malaysia) face hurdles as they must demonstrate when they seek the court’s permission to commence the statutory derivative action that they are acting in good faithFootnote 122 and that the action is prima facie in the interests of the company.Footnote 123 India does not have a statutory derivative action and thus, shareholders have to rely on the common law derivative action,Footnote 124 but there are uncertainties as to the meaning of the requirements of fraud on the minority and of the wrongdoer being in control, and it is unclear whether the director must personally benefit from the breach of duties.Footnote 125
Finally, the aggrieved minority shareholders can bring an oppression or unfair prejudice action against the company to address the wrongs done to them personally if they can show that the company’s affairs are being conducted in a manner unfairly prejudicial or oppressive to their interests.Footnote 126 After all, a breach of directors’ fiduciary dutiesFootnote 127 or of the corporate constitutionFootnote 128 could amount to oppression. Further, there may be a breach of legitimate expectations arising from mutual trust and confidence that is characteristic of quasi-partnerships.Footnote 129 However, breaches of fiduciary duties or corporate constitution do not always result in unfair prejudice or oppression.Footnote 130 Moreover, should there be new investors midway through the social enterprise, it would be difficult to argue that it remains a quasi-partnership. In any event, it would be difficult to argue that shareholders have suffered prejudice or commercial unfairness if, for example, directors prioritize profit maximization in contravention of the corporate constitution, and social enterprise becomes highly profitable and dividends have been distributed to shareholders.
Having analyzed the difficulties and costs arising from using contractual devices to address the problem of conflict of interest between the social entrepreneurs and investors, another conflict of interest pertains to that between pro-social investors and for-profit investors. The concern here is that while a social enterprise may initially start off with pro-social investors or a majority of them, these investors may subsequently become for-profit. Or for-profit investors may subsequently invest in the social enterprise and they become the majority shareholders. If either situation occurs, the for-profit investors can set the agenda of the company by primarily appointing, re-appointing, and dismissing directors. The risk then is that the company will deviate from its social mission. It may be argued that shareholders can enter into an agreement under which all of them agree to prioritize the social mission. But the problem with such an agreement is twofold: First, unlike the corporate constitution that binds all future shareholders, the shareholder agreement has to be renegotiated and executed whenever there are new shareholders. A valid shareholder agreement requires the consent of all the parties. This will incur transaction costs. Second, whether the social mission of the social enterprise remains a priority depends on the objectives and strategies of the shareholders, of which those who contribute the bulk of the funding will have the greatest bargaining power in shaping the terms and conditions of the shareholders’ agreement. If the shareholders cannot come to an agreement, and if the new for-profit shareholders decide not to invest, the social enterprise will lose an important source of funding. But if an agreement is reached with the new for-profit investors, the social mission is likely to be compromised. The social enterprise is caught between a rock and a hard place. Alternatively, for-profit investors need not resort to shareholders’ agreement. In exchange for the funding they provide, they could enter into a contract with the company under which they are provided with board seats, special dividend rights, and exit rights. For example, special or additional governance rights could be given to the new investors such as the venture capital funds that will allow them to steer the social enterprise in the direction of profit-making, to the detriment of the interests of pro-social investors.Footnote 131 Thus, contractual devices such as shareholders’ agreements are not effective in addressing the conflicts of interest between different types of shareholders in a social enterprise.
Consider the third type of conflict of interest – between social entrepreneurs versus consumers/clients/intermediaries. The fundamental problem is how these third parties can know or be assured that the social enterprises are indeed pursuing the social purpose and delivering the public benefit that they claim they are doing. One possibility is for these third parties to inspect a copy of the corporate constitution, shareholders’ agreement, or any other relevant corporate documents. This will pose serious inconvenience to the third parties. It could be time and energy consuming to request, wait, and review the documents. Further, company law does not require the social enterprise to provide such information to third parties.Footnote 132 So the social enterprise has every right to reject such requests. Moreover, the shareholders’ agreement or other contracts could be confidential and thus directors will be in breach of confidentiality obligations should these documents be disclosed to third parties. And even if the social enterprise supplies the relevant documents to the third parties, the latter may not be able to identify and understand the relevant provisions and terms. In any event, even if third parties completely understand the nature, scope, and effect of the relevant terms in the relevant documents, they are unlikely to have the expertise to verify the social impact that the social enterprises claim that they are generating. Further, the claims of social impact made by the social enterprises are generally not certified.Footnote 133 After all, social enterprises are not legally required to subscribe to a certification system. Thus, the concerns of third parties are unlikely to be addressed. It is entirely up to the social enterprise whether they would like to be certified and if so, to what extent.
2. Company Limited by Guarantee
The available data shows that 5%Footnote 134 and 3%Footnote 135 of social enterprises in Singapore and Malaysia respectively are incorporated as companies limited by guarantee in which the liability of members to contribute to the assets of the company when it is wound up is limited to the amount that the members have guaranteed. Such companies do not have investors, unlike companies limited by shares. Thus, the first type of conflict of interest does not apply.
But the second type of conflict of interest – between pro-social members and for-profit members – will apply. Admittedly, the model constitution of companies limited by guarantee in Singapore states that any income or profits of the company are required to be applied toward the promotion of the objects of the company, and no dividends or profits could be issued to members.Footnote 136 However, companies limited by guarantee can opt out of the model constitution. Moreover, the Singapore Companies Act (notwithstanding the model constitution), Hong Kong Companies Ordinance, and Indian Companies Act do not prohibit members of companies limited by guarantee to participate in the divisible profits of the company.Footnote 137 This creates the risk that members in companies limited by guarantee can prioritize profit-making above social benefit. Further, nothing in the companies’ statute or model articles in Hong Kong seem to mandate the sort of pro-social clauses contained in the Singapore model constitution. Although Malaysia requires that the income and profits of the company must be used for the promotion of the corporate objects, dispensation can be sought from the Companies Registrar.Footnote 138
Even if the Singapore model constitution is adopted or the latter’s pro-social clauses are voluntarily adopted in the constitutions of companies in other jurisdictions, minority members of the company may not be able to enforce the provision in the corporate constitution that requires the income of the company to be used only to promote social objects. This is because the qua member rule may apply – it would be difficult to argue that a provision that prescribes the delivery of social benefit or restricts how income is to be used will benefit the members in their capacity as membersFootnote 139; such a provision is intended to benefit certain members of the community stated in the objects clause. It is also unlikely for an aggrieved minority member of a company limited by guarantee to pursue derivative actions against the delinquent director for breaching these pro-social clauses for three reasonsFootnote 140: the rules governing common law and statutory derivative actions can be unclear and restrictive; the litigation cost will be paid by the member bringing the action; and any compensation the court awards will go to the company and not to the aggrieved member. The aggrieved member may also encounter obstacles in proving that she has suffered unfair prejudice or oppression if she has not personally suffered detriment or the only detriment that she has suffered is the breach of the objects clause in the corporate constitution, which is intended to benefit third parties and not the members.
Finally, companies limited by guarantee will also be affected by the third type of conflict of interest – between the social entrepreneurs and the consumers/clients. Unless there is assurance from companies limited by guarantee that they are indeed delivering the social benefit and making the social impact that they claim to be doing, consumers will not be incentivized to acquire their goods and services at above market price, and donors may be reluctant to provide sustained funding. Even if companies adopt the model constitution such as the one in Singapore, consumers who acquire the goods and services from such social enterprises or the donors may not know of the existence of the model constitution; even if they do, they cannot enforce these clauses because they are not parties to the corporate constitution.
Another significant problem is that companies limited by guarantee deprive themselves of important sources of funding from shareholders particularly impact investors. They cannot gain additional funds through the issue of shares. Instead, they have to rely on donations from the public or philanthropic organizations. However, unless these donations are tax-deductible, donors will not be incentivized to donate on a regular basis. Other than Malaysia which provides tax deductions for donations to certified social enterprises (which include those that used the legal form of companies limited by guarantee),Footnote 141 the other three Asian jurisdictions do not automatically grant tax deductions for donations to companies limited by guarantee.Footnote 142 Instead, these companies have to separately apply for charitable status in order for donations to be tax deductible.Footnote 143 In addition, organizations with charitable status are not permitted to engage in business activities such as the provision of goods and services for the sole purpose of generating income even if the income is subsequently used to promote the charitable objects; the charity has to set up a subsidiary company to carry out such a business.Footnote 144
3. Sole Proprietorship
The sole proprietorship is among the top three legal forms used by social enterprises in Malaysia, Singapore, and India, accounting for 19%,Footnote 145 7%,Footnote 146 and 6%,Footnote 147 respectively. There appears to be no data for Hong Kong. An important reason for its popularity is that the sole proprietorship is not subject to any regulatory, filing, or reporting requirements. Nor is it subject to any restrictions on how the business should be governed, and how and to whom profits should be distributed. Given that a sole proprietorship has no shareholders or members, the first and second types of conflict of interest will not arise. But the third type of conflict – between the social entrepreneurs on the one hand, and the consumers, clients, and intermediaries on the other – persists. The conflict is arguably exacerbated because sole proprietors are less likely to obtain certification for their products and services – an important form of assurance that they are delivering the social impact that they claim to be doing – due to the time and expense involved. They are likely to hold the view that on a cost–benefit analysis, their products and services are of too small a scale to warrant certification. Other than the conflict of interest, a serious and intractable issue is that sole proprietorships will not be able to attract funding on a sustained basis and therefore not scalable. Shareholders cannot invest. And donations to sole proprietorships are not tax-deductible. At best, sole proprietorships can rely on short-term, limited, and sporadic government grants. But reliance on government funding alone cannot make sole proprietorships financially viable on a long-term basis. Finally, the sole proprietor is liable for the debts and obligations of the business as it is trite law that sole proprietorships unlike companies do not have limited liability.
The society is one of the most popular vehicles used by social enterprises. For example, 23% of social enterprises in India consist of societies and trusts.Footnote 148 The society is the third most popular legal form used by social enterprises in Malaysia, accounting for 11% of all social enterprises.Footnote 149 In Hong Kong, 60% of social enterprises use legal forms (including but not limited to the society) that are neither companies nor cooperatives.Footnote 150 But in Singapore, only 1% of social enterprises are societies.Footnote 151
In Singapore and Malaysia, the conflict of interest is not between the social enterprise and the consumers. This is because societies in Singapore and Malaysia do not seem to be allowed to engage in profit-making business according to the definition of society in the Singapore and Malaysian statutes, which excludes an association formed for the sole purpose of carrying on any lawful business that has for its object “the acquisition of gain” by the association or the individual members.Footnote 152 Rather, the conflict can arise between the society (the social enterprise) and its client, that is, the government who either provides funding to the society or collaborates with the society to promote social benefit (such as by providing assistance to the society in its production of goods and services to certain members of the community). There is nothing in the legal form of society to prevent societies from labelling themselves as social enterprises for marketing or public relations purposes. When the government provides funding, the legal form of society does not provide any assurance to the government that the society will deliver the social benefit; rather it depends on how the government sets the eligibility criteria for funding and whether the government monitors how the society uses the fund. If the funding criteria or conditions are insufficiently rigorous, or if the monitoring mechanism is not robust, then societies that label themselves as social enterprises can get away with it and there is little accountability as to whether the funds are being used to deliver the social impact claimed by the societies.
In Hong Kong, societies that are established solely for religious, charitable, social, or recreational purposes are exempted from registration under the statute.Footnote 153 Unlike the Singapore and Malaysian statutes, nothing in the statute in Hong Kong appears to bar societies from pursuing profit-generating business.Footnote 154 Thus, a society that is established for a social purpose can be affected by the second type of conflict of interest between pro-social members and for-profit members, and the third type of conflict between social entrepreneurs and consumers/clients. There is no mechanism in the law regulating societies that ensure that they prioritize social benefit above profit maximization. Nor are there mechanisms to assure the society’s consumers or clients – who pay above market price for the goods or services or who provide funding to the societies – that they are delivering social benefit or making the social impact that they claim to be doing. It may be argued, however, that if the object clauses in the society’s constitution state the social purpose of the society and when certain members of the society act contrary to the object clause, other members can sue to enforce the object clause and can sue the members for breaching the constitution. This is possible but there appears to be no reported cases of such lawsuits. Moreover, the fact that the objects clause contains the social mission of the society provides insufficient assurance to the consumers and clients: The clause alone does not verify or certify that social benefit has indeed been delivered or social impact has been created.
In India, societies will be affected by the second and third types of conflict of interest. A society is defined under the statute as persons associated with any literary, scientific, or charitable purpose, the latter of which refers to (i) relief of poverty, (ii) education, (iii) advancement of religion, and (iv) other purposes beneficial to the community not coming under any of the preceding heads.Footnote 155 Thus, social enterprises that adopt the legal form of societies are established to pursue charitable purposes. The fact that a society has been formed for a charitable purpose does not preclude it from pursing profit-making business. Nor is that society barred from distributing profits to its members (unless the society is seeking tax exemptions or deductions). Thus, there is a risk that the society will prioritize profit over social benefit, such as by distributing a significant percentage of the profits to the members instead of reinvesting the surplus in order to promote social benefit. Admittedly, the statute specifically prohibits the distribution of assets or profits to members after the society is dissolved and after it has discharged all its debts and obligations.Footnote 156 But there is no such restriction on the distribution of profits when the society is solvent. Further, the fact that the society is set up for a charitable purpose provides insufficient assurance to its consumers or clients that it has indeed delivered the social benefit or made the social impact. Thus, the legal form of society could hardly address the second and third type of conflicts of interest.
5. Partnership and Limited Liability Partnership
Another common type of legal form adopted by social enterprises in Asia consists of partnerships and LLPs. But these legal forms are not equipped to effectively address the conflicts of interest analyzed in Section III (D).
First, although there are no shareholders in a partnership and LLP unlike in a company, the conflict of interest between pro-social and for-profit shareholders will have parallels in a partnership. Such conflicts are likely to be absent at the start of the partnership and LLP given that the partners will have the same objectives. However, midway through the partnership and LLP, some partners may exit and new ones may join. The latter may take a different approach toward the goals and strategies of the social enterprise. They may be more financially oriented and thus place greater emphasis on profit-making rather than making social impact. Of course, the existing partners may insist that the new ones sign a new partnership agreement that upholds the vision and mission of the social enterprise. But the new ones who bring in new capital may be able to dictate new terms that benefit them but at the expense of the social mission. The existing partners will be torn between retaining the existing partnership agreement and being financially insecure or accepting the funding of the new partners in exchange for a more profit-driven approach.
Second, the conflict of interest between social entrepreneurs and third parties (consumers and clients) will still be present in a partnership and LLP. Although partners in a partnership and LLP can have strong pro-social terms and conditions in the partnership agreement that seek to deliver public benefit, these third parties do not have governance and enforcement rights, similar to those in social enterprises that adopt the company form. However, it may be argued that unlike companies, the contract laws of certain jurisdictions such as Hong KongFootnote 157 and SingaporeFootnote 158 (but not IndiaFootnote 159 and MalaysiaFootnote 160) permit partnerships (including LLPs) to confer third-party rights in the partnership agreements on consumers, clients, and even the beneficiaries that are enforceable by these third parties. However, most Asian jurisdictions are bound by the privity rule, which do not allow third parties to enforce rights in contracts to which they are not parties. Even in jurisdictions that allow third-party beneficiaries to enforce those rights, it is unclear how third-party beneficiaries know that rights have been conferred on them in the partnership agreements and that they can enforce these rights. Next, even if the consumers, clients, or members of the community know of these rights, it is unlikely that they will incur the time and cost of bringing legal proceedings against the social enterprise to enforce these rights. This is so especially if the gains from the lawsuit will not exceed (a) the litigation expenses (lawyer and court fees) and (b) the losses resulting from “walking away,” which means that the consumers and clients stop buying the products and services of the social enterprise and instead acquire them from a conventional profit-driven company. The third parties who will be adversely affected are the beneficiaries, that is, the disadvantaged and vulnerable members of the community whose interests the social enterprise was set up to promote and protect. But these people will not have the resources to bring lawsuits against the social enterprise for breaching the partnership agreement.
Third, because partners in a partnership do not have limited liability (unlike those in an LLP) and are therefore liable for the debts of a partnership,Footnote 161 financial considerations may subsequently or eventually weigh heavily in their minds, and hence there is a greater risk of them deviating from the social mission. They can deviate by amending the partnership agreement or by entering into a new one. On the one hand, it may be said that because a partnership (including an LLP) is governed by the partnership agreement, it has greater flexibility to design and enforce pro-social terms than the corporate constitution of a company. On the other hand, because partners in a partnership do not have limited liability (unlike partners in an LLP or shareholders in a company), there is a real risk that they will subsequently subordinate the pursuit of social benefit to profit generation by amending the partnership agreement. To address this problem, the partnership agreement can stipulate stringent conditions (such as unanimous consent) for the amendment of important terms. However, if unanimous consent is not obtained, the partners who wish to deviate from the social mission can simply leave. This is likely to result in the dissolution of the partnership, which is likely to harm the interests of the beneficiaries (such as the vulnerable and disadvantaged members of the community).
It might also be argued that the risk of unlimited liability is counterbalanced by the fact that partners are entitled to profits (according to the terms stated in the partnership agreement), whereas shareholders are not entitled to profits (but only dividends and only if and when declared by the board from the distributable profits as the board can choose not to distribute dividends and instead use the profits for other purposes). But this does not minimize the risk of deviation from the social mission. Precisely because partners (in a partnership and in an LLP) are entitled to profits, they may be tempted to maximize profits at the expense of the pursuit of social benefit. While the founding partners (in a partnership and in an LLP) can include terms in the partnership agreement that require them to prioritize social mission over profit maximization, and although the partners’ fiduciary duties require them to act in accordance with the partnership agreement, they are not barred from subsequently amending the terms to accord primacy to financial benefit. Although unanimous consent for the amendment of the partnership agreement is required, the partners are not subject to the common law restriction that applies to corporate constitution amendment – it has to be done bona fide for the benefit of the company as a whole.
Finally, social enterprises that adopt the form of LLP are at a higher risk of subordinating the pursuit of social benefit to profit as compared to partners in a partnership and shareholders in a company. This is because partners in an LLP enjoy the privilege of limited liability (like shareholders in a company but unlike partners in a partnership) and they are entitled to profits (like partners in partnership but unlike shareholders). This risk will not occur when the social enterprise LLP is established, but it could occur subsequently, especially if there is a concern with financial sustainability. Then the existing LLP partners can choose to prioritize profit-making. Or they can invite new partners to join the LLP who may in turn be more financially oriented.
6. Cooperative Society
A cooperative society is another legal form that has been used by social enterprises. However, it is one of the least popular forms: Only 1% of social enterprises in MalaysiaFootnote 162 and Hong KongFootnote 163 have used it. It is unclear what the percentage is in Singapore but it is likely to be low.Footnote 164 As for India, the percentage is unclear.Footnote 165
A cooperative society, which is a voluntary association of persons, has as its object the promotion of the economic interestsFootnote 166 of its members by allowing the members to share in the cooperative’s profits/surpluses divided among the members in proportion to the share capital held by them or in proportion to the volume of transactions entered into between the members and the cooperative.Footnote 167 Cooperatives are also democratic organizations as they are controlled by their members on the basis of one member having only one vote.Footnote 168 Cooperatives are also governed by the members who at the general meeting elect a committee or board to manage the cooperative.Footnote 169 Cooperatives provide education and training, and deliver goods and services to their members.Footnote 170 Thus a unique feature of cooperative is that the members are controllers, directors and managers, customers, and beneficiaries. To be clear, the beneficiaries can also include nonmembers but the primary objective of cooperatives is to advance the economic interests of their members. Moreover, members of cooperatives generally enjoy limited liabilityFootnote 171 (like members of a company limited by shares and guarantees). Cooperatives are active in areas including retail, insurance, and agriculture.Footnote 172
Because the raison d’etre of cooperatives is to advance the economic interests of their members (in terms of, for example, distribution of profits), the question is whether the legal form of cooperatives has mechanisms to address the second type of conflict of interest – between pro-social members and for-profit members. It may be argued that there should be no conflict because the interests of members will align given that they are one and the same shareholders, consumers of the goods and services (provided by the cooperatives), and the beneficiaries of the social impact (as the members are precisely the segments of the community to which the cooperative will deliver the social benefit in terms of the goods and services).
However, there could be a conflict between members who prioritize social benefit and those who prioritize financial benefit. Members who prioritize social benefit may insist that the profits be used predominantly to lower the price of the goods and services (through subsidies) while ensuring they are of higher quality (through investments in research and development). But members who prioritize financial benefit are likely to insist that the bulk of the profits be distributed to them, for example, as dividends (after the requisite amount of profits has been set aside as reserves if required by the statuteFootnote 173). If the by-laws are silent on how the profits will be used and distributed and for what purposes, those decisions will be made by the management committee to whom management powers have been delegated by the general meeting of members. And the management committee is likely to heed the wishes of the majority members of the general meeting. This is because should the committee defy the majority members, the committee can be removed by the requisite majority in a general meeting.Footnote 174
Alternatively, the general meeting can alterFootnote 175 the by-laws to prescribe that the bulk of the profits will be distributed as dividends (provided that the requisite sum is set aside for a reserve fund if required by the statute), subject to the registration of the amendment by the registrar.
The common law doctrine that the alteration of corporate constitution has to be done bona fide for the benefit of the company as a whole does not seem to apply to cooperatives. And even if it does, one can argue that altering the by-laws to prioritize financial benefit over social benefit by requiring a significant percentage of profits to be distributed as dividends benefits the members as it furthers the object of the cooperative as stated in the cooperative statutes, that is, to advance the members’ economic interests.Footnote 176 Conversely, it can be argued that to prioritize social benefit at the expense of financial benefit would be contrary to the objects of cooperatives, a contravention of the statutory law. In sum, the legal form of cooperatives does not ensure that the conflict of interest between pro-social members and for-profit members is properly addressed.
The other conflict of interest is between for-profit members and external, pro-social consumers or clients. Generally, the consumers of the goods and services provided by the cooperatives are also the members. Thus, their interests should be aligned. But cooperatives also sell their goods and services to nonmembers; in other words, it is not always the case that the consumers must be the members. The external, pro-social consumers may acquire the goods and services at above market value on the understanding that the cooperatives will prioritize and deliver social benefit. But where the members prioritize financial benefit, the profits generated by the sale of goods and services to nonmember consumers will be distributed to the members (in the form of dividends, bonuses or other means). The legal form of cooperatives provides no assurance to pro-social nonmember consumers that social benefit will be prioritized. It may be argued however that the by-laws of cooperatives can prioritize social benefit by restricting the amount of profits distributable to members. While possible, this depends on whether the requisite majority of members are pro-social. Even if the by-laws have such restrictions when these were first registered, the cooperative can change course midstream and should the requisite majority of members prioritize profit, they can amend the by-laws.
Company limited by shares
Company limited by guarantee
Partnership and limited liability partnership
Conflicts of interest
Social entrepreneurs v. investors
Pro-social investors (or members) v. for-profit investors (or members)
Social entrepreneurs v. consumers/clients/intermediaries
Because of the deficiencies in the existing legal forms used by social enterprises, conflicts of interest are not addressed and the transformative potential of social enterprises is not unleased. It is thus important to consider whether there are alternative legal forms or whether a new legal form should be created. I advance a framework for understanding and evaluating the new legal form consisting of five criteria: (1) corporate purpose; (2) directors’ duties; (3) decision-making powers; (4) reporting, impact measurement, and certification; and (5) distribution of dividends, assets, and tax benefits. I show how this framework can address the conflicts of interest. Chapters 2–6 explain each of these criteria. Under each of these criteria, I will evaluate the legal forms for social enterprise in the US, that is, the benefit corporation (including the PBC), the SPC, and the UK, namely, the CIC, and I will show how my framework can address the deficiencies in those forms. The five criteria in my framework, consisting of ex ante rules and ex post standards, can provide a menu of options that can be tailored to jurisdictions where there is a variation in the quality of the independence and competence of the legislature, regulators, and judicial system.
Chapters 2–6 critically examine the proposed framework for the new legal form comprising the first to the fifth criteria. Chapter 7 concludes.
Chapter 2 analyses the first criterion – corporate purpose. I begin by explaining the importance of purpose to social enterprises followed by distinguishing corporate purpose, corporate object, and corporate interest. Next, I demonstrate that the existing company laws of the four common law jurisdictions in Asia as well as the laws on the UK CIC and US PBC and SPC are ill-equipped to allow or protect a corporate purpose that prioritizes social benefit above profit. Crucially, I then advance and explain in detail my proposed corporate purpose – “on the whole, the pursuit and delivery of social benefit is prioritized over profit-making except where doing so will have a material and adverse effect on the financial viability of the social enterprise” – and I show how it can be enforced through private and public mechanisms.
Chapter 3 examines the second criterion – directors’ duties. I advance the central argument that the duties owed by directors to the companies in the four Asian common law jurisdictions, namely, the duty to act in good faith in the company’s best interests and the duty to exercise powers for proper purpose ought to be aligned with the proposed corporate purpose in Chapter 2. I demonstrate that the directors’ duties in common law Asia and in relation to the UK CIC and US PBC and SPC are not aligned. Finally, I consider how the directors’ duties can be enforced by giving beneficiaries or regulators the power to do so.
Chapter 4 analyses the third criterion – decision-making powers. I begin by demonstrating that the current position under which only shareholders have voting rights is problematic in the context of a social enterprise. I then argue that the three objections to giving beneficiaries a say in how social enterprises are being run – it will be disruptive and inefficient; beneficiaries will act opportunistically; and only shareholders have the incentive and ability to monitor – are unpersuasive. Finally, I propose and evaluate five different decision-making mechanisms for beneficiaries, namely, a beneficiary advisory panel; a director appointed from that panel; appointing an independent nonexecutive director; and having a public regulator.
Chapter 5 examines the fourth criterion – reporting, impact measurement, and certification. I first explain their different functions. I then assess the quality of reporting by social enterprises in the common law Asian jurisdictions. Next, I examine the problems with the reporting requirements imposed by the law regulating PBC, SPC, and CIC. Subsequently, I examine the disclosures of selected social enterprises in the four Asian jurisdictions and found that most of the social enterprises fail to distinguish between outputs and impacts, and importantly, fail to show how their outputs have led to the impacts that they claimed to have produced. I then consider why few social enterprises have adopted impact measurement tools or disclosed impacts. Subsequently, I examine whether social enterprises should be incentivized or required to use impact measurement tools. I then advance the argument that rather than requiring all social enterprises to use impact measurement tools, they should engage in a critically self-reflexive process on how they measure impact using a three-step framework. Finally, I assess the certification mechanisms available in common law Asia.
Chapter 6 analyses the fifth and last criterion – distribution of dividends, assets, and tax benefits. My main point is that the law ought to combine restrictions on the distribution of dividends and assets with allocation of tax benefits, and the structure should be designed in such a way that the losses from reduced dividends should not exceed the gains from tax benefits. I first assess the dividend cap and asset-lock mechanisms in the UK CIC. I then show that the arguments against granting tax benefits to social enterprises are misguided. Finally, I explore two methods for granting tax benefits, one to the social enterprise and the other to the investors.
Chapter 7 concludes by summarizing the contributions this book makes to comparative social enterprise law.