Rhode Island passed legislation in June to authorize low-profit limited liability companies (L3Cs). The bill was signed by the Governor on June 20, 2011, and will take effect on July 1, 2012. With the passage of this legislation, Rhode Island becomes the ninth state to authorize L3Cs, joining Illinois, Louisiana, Maine, Michigan, North Carolina, Utah, Vermont, and Wyoming.

An L3C is a specific type of limited liability company, one whose primary purpose is not to earn a profit but rather to “significantly further the accomplishment of one or more charitable or educational purposes.” 2011 R.I. Pub. Laws ch. 79 (H. B. 5279A). I have previously written about L3Cs, here and here.

The promoters and advocates of L3Cs say that private foundations, as well as commercial investors, will be encouraged to invest in L3C enterprises. The state legislatures seem to be jumping on the bandwagon: L3C bills were introduced in at least nine states this year in addition to Rhode Island, which I wrote about in March, here.

These L3C bills are being pushed because the non-profit community is strongly interested in collaboration between the not-for-profit world and the for-profit-world, and wants to leverage the financial strength of the for-profit, investment-oriented community into charitable and educational activities. Arthur Wood, Transcript: New Legal Structure to Address the Social Capital Famine, 35 Vt. L. Rev. 45 (2010).

The fly in the ointment is that commentators – business lawyers and professors – have written at length about perceived defects in the L3C structure. For example, Bill Callison, a partner at Faegre and Benson, and Allan Vestal, Dean and Professor of Law at Drake University, have written about what they call the L3C illusion.  J. William Callison & Allan Vestal, The L3C Illusion: Why Low-Profit Limited Liability Companies Will Not Stimulate Socially Optimal Private Foundation Investment in Entrepreneurial Ventures, 35 Vt. L. Rev. 273 (2010).

Another: Daniel Kleinberger, Professor of Law at William Mitchell College of Law, published an article last year that analyzes a number of L3C issues. Daniel S. Kleinberger, A Myth Deconstructed: The “Emperor’s New Clothes” on the Low-Profit Limited Liability Company, 35 Del. J. Corp. L. 879 (2010). If the title of his piece doesn’t give you its thesis, let me list the titles of the sections covered in Part Vof his article, The L3C Concept Debunked: (A) The L3C is Unnecessary, (B) The L3C “Brand” is Unwise, (C) The L3C Construct is Inherently Misleading, and (D) Current L3C Legislation is Nonsensical and Useless. I refer you to his article for Professor Kleinberger’s lengthy and detailed analysis.

With serious questions being raised by academics and business lawyers, one has to wonder why the states are rushing to adopt L3C legislation.

To quote Paul Newman in Cool Hand Luke: “What we’ve got here is a failure to communicate.” The business lawyers and professors are analyzing and criticizing the L3C structure, the non-profit community and other promoters are pushing the L3C law hard at a local level, and state legislatures are passing the laws. But the issues raised by the commentators are apparently being ignored. This is not a good way to make public policy.

What should happen here? There are clearly substantial problems and issues with the current form of L3C law that the states are adopting. The existing L3C laws should either be taken off the books or changed to address the problems, and new laws in the current L3C form should not be passed. Conceivably a form of L3C that addresses the problematic issues could be promulgated for consideration by the states.

I think one of the national bodies with expertise and a broad constituency, such as the National Conference of Commissioners on Uniform State Laws, the American Law Institute, or the Business Law Section or Tax Law Section of the American Bar Association, should take this issue in hand, study it, and make recommendations after thoroughly analyzing the issue and considering input from the various groups and experts. Such a process would result in recommendations and possibly a model statute that would be persuasive to state legislatures.

If you are an NCCUSL commissioner, an ALI member, or a member of the ABA’s Business Law Section or Tax Law Section, think about getting your organization involved in taking a hard look at L3Cs.