C O M M E N T A R Y
States need to carefully consider new “cooperative” laws
On July 1, 2001, a new state statute,
the Wyoming Processing Cooperative
Law, became effective. This law authorizes
a limited liability corporation-like
business structure (with a modicum of
cooperative characteristics) to process
and market agricultural products. Other
states are being asked to consider
enacting similar legislation. Promoters
suggest this will permit cooperatives to
attract outside equity.
While this may seem attractive in
the abstract, cooperative leaders in
each state need to think through
whether to embrace entities formed
under a statute such as this for at least
two reasons. First, such entities may be
incompatible with the traits that distinguish
a cooperative from an investorowned
firm. Second, serious questions
exist as to whether such an entity is eligible
for the public policy benefits
available only to cooperatives.
While there is no single definition
of a cooperative for all purposes, cooperative
scholars, leaders and professional
advisers agree that for any organization
to be considered a
cooperative, it must have these three
unique characteristics:
- It is owned by the people who use
its services.
- It is controlled by the people who
use its services.
- Earnings are allocated to the
users based on patronage, rather than
to investors based on investment.
A business formed under the new
Wyoming law can have several traits
that are at odds with those usually associated
with being a cooperative. Under
this law, a cooperative can have an
unlimited number of investor nonpatron
members who aren’t required to
do business with the association, but are
entitled to vote and share in its earnings
on the basis of their level of investment.
Patron members are limited to one vote
each, while non-patron members may
have an unlimited number of votes.
Only one of an unlimited number of
directors must be elected by producer
patron members. Director(s) chosen by
the producer-patron members are entitled
to 50 percent of the voting power on
the board. But this may fall short of the
level of producer control that is necessary
to operate as a farmer cooperative.
No limit is imposed on the rate of
return investor-members can realize
on their investment, and up to 85 percent
of each year’s earnings may be
distributed to investor members based
on investment. One or more outside
investors with two-thirds voting control
can merge or consolidate the
entity into another entity, or liquidate
it without any support from the producer
patron-members.
Cooperative leaders need to stop for
a moment and ask themselves: “Is a law
that permits this much deviation from
the cooperative norms of user-ownership
and user-control coupled with a
provision that only 15 percent of earnings
must be returned to users based on
patronage really a law authorizing the
formation of cooperatives?” If someone
can answer this question “yes,” a second
question needs to be addressed:
“Just what, if anything, does the term
cooperative mean?”
When an organization calls itself a
“cooperative,” it has an obligation to
meet expectations that it will act like
one. Delaware could amend its laws to
create another statute that lets General
Motors or any other large investorowned
firm call itself a “cooperative.”
But if such entities disregard the key
cooperative characteristics user ownership
and control and benefits flowing
to the users based on patronage the
integrity of all cooperatives is called
into question.
Also, the thousands of successful
agricultural and non-agricultural cooperatives
challenge the notion that
inherent defects in the cooperative
model make co-ops so inflexible and
unresponsive to change that they can’t
survive in today’s business environment.
A true cooperative may not be
the appropriate structure for every
rural business. But if the founders of a
new business don’t believe they can
achieve their objectives with a cooperative,
then they can organize an LLC
or some other form of business, rather
than use political power to enact a law
that tarnishes the credibility of other
cooperatives.
Congress has bestowed a number of
privileges on businesses that conform
to the generally accepted vision of
organizing and operating as a cooperative.
An entity structured to take full
advantage of the Wyoming Processing
Cooperative Law might have trouble
qualifying under any of the following
statutes:
Antitrust Immunity
Producer
associations formed under the
Wyoming law, which choose to give
voting power to non-producer/
investors, may well be in conflict with
the requirement for antitrust protection
under the Capper-Volstead Act that all
voting members must be agricultural
producers. The same eligibility questions
arise concerning access to the protection for sharing market information
provided by Section 5 of the Cooperative
Marketing Act of 1926.
Subchapter T Tax Treatment
The Wyoming law is written so an
entity it authorizes can receive singletax
treatment without having to meet
the qualifications for “operating on a
cooperative basis” under Subchapter T
of the Internal Revenue Code. Proponents
of the law applied for and
received a letter ruling from IRS that a
company formed under the law qualifies
for single tax treatment as a partnership
under Subchapter K, rather
than as a cooperative under Subchapter
T. This process was completed before
the law even took effect.
Security Exemption
The Securities
Act of 1933 exempts farmer cooperatives
qualifying for 521 tax status from
its registration and prospectus requirements.
Only farmers’ associations qualify
for 521 tax status. If a Wyoming Processing
Cooperative has non-producer
investors, it is questionable whether it
can qualify for 521 tax status, a necessary
prerequisite to be eligible for the
exemption in the ‘33 Securities Act.
Borrowing from CoBank
The Farm Credit Act and Farm Credit
Administration regulations bar CoBank
from making loans to marketing cooperatives
that have more than 20 percent
of their voting power in the hands of
non-producers or are authorized to pay
dividends on member capital that
exceed 10 per cent per year. Thus, it is
questionable whether an association
organized under the Wyoming law that
gives more than 20 percent of the voting
control to investor “non-producer”
members or permits returns on member
equity of more than 10 percent is
eligible to borrow from CoBank.
The Agricultural Marketing Act
of 1929
This Act is the only federal
statute of relevance that purports to
define the term “cooperative.” The definition
is patterned on the tests set out
in Capper-Volstead. To qualify, an association
must, among other things, be
composed of “farmers” and must either
not permit a member to have multiple
votes based on equity, or limit returns
on equity to 8 percent. While the definition
is no longer used for its original
purpose, to describe an entity eligible to
borrow from the Farm Credit System,
it has been incorporated by reference
into several other laws that benefit
cooperatives. It is the test to qualify for:
- The protections against handler
coercion and discrimination in the
Agricultural Fair Practices Act,
- The cooperative exemption from
the registration requirements of the
Securities Act of 1934,
- The cooperative exemption from
the trust provisions of the Perishable
Agricultural Commodities Act,
- The cooperative exemption from
trucking regulation under the Interstate
Transportation Act.
Taken together, all of these statutes
reflect a consistent pattern of Congressional
recognition that a cooperative
operates within certain prescribed limitations.
Cooperative leaders need to
consider the implications of a state
statute authorizing the formation of
cooperatives that may not qualify
under any of these federal laws.
Unfortunately, simply suggesting the
Wyoming Processing Cooperative Law
goes too far in discarding cooperative
tenets doesn’t solve the bigger problem
that it was intended to address: What
must be done to ensure that entities
owned and controlled by their memberusers,
and operated for the benefit of
those member-users, cannot only survive,
but thrive in the years ahead?
Some serious thought and discussion
are needed as to how to build flexibility
into the cooperative model without
destroying the unique features that
justify favorable public policy treatment.
Let these comments serve as a
challenge to all cooperative leaders to
begin thinking about how the cooperative
of the future must to be organized
and operated to meet the needs of
tomorrow’s member-users.
Randall E. Torgerson,
Deputy Administrator,
USDA Rural Business-Cooperative
Service
