Statutory Middle Age for Cooperative Legislation

Terence J. Centner

The outdated provisions of some of the legislation governing the formation and operation of agricultural cooperatives should be revised to provide a more functional set of guidelines for these organizations. Revisions should include a new model cooperative statute to foster a common set of cooperative law among the states and additional state legislation governing equity redemption. The limitations of the ex- ceptions and exemptions for cooperatives under our federal antitrust and securities laws should be respected in order to preserve the ability of persons to act together in self-help organizations.

Much of the legislation governing the formation and operations of agricultural cooperatives was enacted in the latter part of the last century and the first three decades of the present century. The cooperative enabling statutes provided for the formation of cooperatives whereby persons could work together for the com- mon benefit. The antitrust and federal securities laws contained exceptions which relieved cooperatives from some of the more onerous provisions of these laws. These statutory provisions, which for the most part are still governing American cooperatives, responded to conditions and problems which existed during those periods. However, marked structural changes have occurred at the farm level, in the marketplace, and in the operations and management of cooperatives since the enactment of many of these provisions. The absence of legislative modifi- cations responding to these changes and a glance at other business legislation leads to the conclusion that the legislative guidelines for cooperatives are out- dated; some of the provisions of this cooperative legislation have reached middle age.

Statutory middle age connotates legislative provisions which no longer serve current needs and may be inconsistent with the new social and legal values of our society. ' The out-of-date statutory provisions for cooperatives may unduly restrict their management and adversely impact the economic efficiency of these business organizations.' Unseasonal legislative provisions also create judicial dilemmas.3 Notwithstanding their constitutionally limited judicial powers, judges must decide whether to honor the legislative supremacy of the dated provisions or adopt an anomalous interpretation of the statute in order to keep the law functional or reach an equitable result.' The judiciary's response to equity re- demption and antitrust challenges shows this conflict between upholding the statute and an equitable solution. Much of the criticism of judicial activism may be attributed to the judiciary's response to outdated laws.

Terence J. Centner is an Assistant Professor in the Department of Agricultural Economics, University of Georgia, Athens, Georgia.

.4grihusiness, Vol. 1, No. 1, 53-60 (19851 0 1985 by John Wiley & Suns, Inc. CCC 0742-4477/851010053-08$04.00

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The inadequacies of the present middle-aged legislative framework create legal and economic problems for cooperatives that adversely affect their business op- erations and their ability to contribute to a healthy agricultural sector. The shortcomings of the various cooperative statutes should be identified and analyzed in order for cooperatives to determine what legislative action, if any, might be appropriate to mitigate the effects of the outdated provisions. This article iden- tifies four sets of legislative provisions that warrant special attention: (1) the state cooperative enabling statutes, (2) the inadequacy of provisions governing equity redemption, (3) the cooperative exceptions to the federal antitrust laws, and (4) the cooperative exemption provisions to the federal Securities Acts. The problems associated with these middle-aged provisions are discussed in order to delineate suggestions for legislative reform.

CHANGED CONDITIONS

Our country’s agricultural sector has changed significantly since the high-water mark of cooperative legislation in the 1920s. The farm population is no longer as significant a segment of our populace, and economic, social, and cultural changes have drastically altered the business needs of farmers. Cooperatives have evolved from small local farmer organizations generally prevalent in the 1920s to a mixture of local cooperatives and large business organziations. Be- tween 1920 and 1980 cooperatives increased their business from an estimated $806 million of sales and purchases4 to over $92 billion worth of business.’ Technology in communications, the availability of market information and the possibility of transporting farm products and supplies anywhere in the world have been accompanied by the development and growth of some cooperatives into large regional, national, and international business organizations.

The development of large cooperatives has impacted the legislative needs of these business organizations and has operated to emasculate some of the co- operative principles because of the size and complexity of the organization. A member of a large cooperative is unlikely to know the officers and directors of the association and may know very little about the cooperative’s business and affairs. A member’s single vote is reduced to relative insignificance and in some cases the cooperative may deviate from the one-member, one-vote concept and adopt weighted voting. Although the cooperative may be managed by member directors, the major decisions are often made by nonmember management.

The digression of some cooperatives from cooperative principles and the struc- tural and operational changes of their business activities have altered the leg- islative needs of these organizations. It may be argued that large cooperatives tend to be more analogous to business corporations than cooperatives, which raises a question of whether such organizations are entitled to the special co- operative legislative exceptions. These conditions, together with the middle-aged legislative framework, entreat legislative

STATE ENABLING STATUTES The earliest cooperative statutes were enacted during the latter part of the nine- teenth century in order to enable individuals to come together and form self- help organizations.’ Many of these statutes have evolved into general cooperative

COOPElRATIVE LEGISLATION

statutes that provide for the formation of cooperatives for most any purpose. In the 1920s many states adopted an agricultural marketing statute to promote, foster, and encourage the marketing of agricultural products by persons engaged in the production of these products modeled after “The Bingham Cooperative Marketing Act.”‘) Several states enacted additional statutes so that our country has over 90 different cooperative enabling statutes for agricultural coopera- tives.“’.” Furthermore, there exist 40 additional statutes which provide for the formation of housing or utility cooperatives.

Baarda has compiled an excellent compendium of statutory provisions for agricultural cooperatives which shows the confusing array of rules and reguIations governing cooperatives. Although this informational source delineates categories of provisions which show some correlation among statutes, i t also demonstrates the impossibility of defining legal provisions for cooperatives without specific reference to the incorporating statute. The diverse provisions make it difficult to define a cooperative and presumably operate to foster the general public’s unfamiliarity with cooperatives.

The absence of consistent cooperative laws also has been inimical to the exchange of ideas and procedures by cooperatives. Differences in statutory legal restrictions may mean that a successful practice of a cooperative in one state is illegal in a second state. An example concerns the equity redemption provisions of cooperative statutes in North Dakota, Kentucky, and Iowa. A federal court found that under the North Dakota statute for Cooperative Associations a co- operative cannot discriminate in redeeming equities among deceased natural members and dissolved or bankrupt corporate members. * However, in consid- ering this issue under a Kentucky cooperative statute, the Kentucky Court of Appeals found that the death of a natural person did not have to be equated with the dissolution or bankruptcy of a corporation.? The Iowa cooperative statute requires cooperatives to differentiate between deceased natural persons and others in certain instances. Therefore, cooperatives must use care in adopting organizational plans, equity redemption programs, or bylaw provisions from co- operatives organized under a different statute.

Many of the statutes also contain provisions which have become antiquated because of new technology, business developments, changes in governmental regulations, and judicial reform. Communications technology may obviate the statutory requirement that directors must be present at a meeting in order to be counted for a quorum or to vote. The membership limitations for directors and officers may unduly preclude persons who could best direct the cooperative. Since governmental regulations and judicial decisions during the past decade have resulted in the individual liability of directors where the directors knowingly caused the cooperative to violate a law, cooperatives may need statutory authority to indemnify directors or to provide indemnity insurance. Judicial develop- ments concerning the fiduciary duties of officers and directors and the equity rights of business shareholders also impact the statutory provisions of many of the cooperative statutes.

The lack of up-to-date, interstate provisions for cooperatives may be contrasted to the statutory provisions governing corporations and partnerships. A majority

* in re Great Plains Royalty Carporetion, 461 F. 2d 1261 (8th Cir. 1973). ?Richardson v. South Kentucky Rural Electric Cooperative, 566 S.W.2d 779 (Ky. 1978).

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of the state legislative guidelines governing corporations and partnerships show a marked degree of consistency among the states. Although each state has its own corporation statute, a majority of these statutes are modeled after the Model Business Corporation Act which was developed by the Committee on Business Corporations of the Section of Corporations, Banking and Business Law of the American Bar Association in 1950. l4 State legislatures have continued to adopt new and amended provisions to their corporation statutes as suggested by the American Bar Association or as requested by business in order to meet tech- nological changes, additional governmental regulation, and legal reforms. ‘’

The formation and activities of general and limited partnerships are governed by state partnership laws which for the most part are adopted from a model act. New statutory provisions for partnerships which are responsive to current eco- nomic and social conditions are continually being developed by a group of legal experts serving on the Committee on Continuing Professional Education of the American Law Institute and the American Bar Association. l6 Recommendations by these legal experts have assisted a majority of the state legislatures in the amendment of their partnership laws so that they are responsive to similar conditions that led to the changes in the laws governing corporations.

Model codes and statutes abound in other areas of state law. The advantages of a succinct, consistent, and modern set of state enabling provisions emulating the appropriate provisions of the model corporation act and partnership law should lead cooperatives to seek the development of a model cooperative enabling statute.

INCOME TAX EXEMPTION AND EQUITY REDEMPTION

Subchapter T of the Internal Revenue Code provides that earnings returned to patrons as patronage dividends in qualifying written notices of allocation and per-unit retain certificates need not be taken into account when determining the cooperative’s taxable income. Under this income tax exemption, cooperatives can avoid taxation at the firm level for earnings returned to patrons. However, written notices of allocation only qualify for special tax treatment if 20% or more of the amount of the patronage dividend is paid in money or qualified check.

Patronage dividends paid in written notices of allocation are redeemed and paid in cash as provided by law, the cooperative’s bylaws, or other agreement. The absence of a mandatory statutory redemption requirement and the failure of many cooperatives to adopt systematic equity redemption programs or to make provision for the return of the investments of former cooperative members creates an injustice that lacks an expedient solution. The involuntary investment of cooperative members who terminate their membership may be accompanied by a low return or no return on the investment. In many cases former members do not have any voting rights despite their investment in the cooperative,

In 1969 the House Committee on Ways and Means proposed to ameliorate the inequities that result from the retention of dividends of former patrons by amending the cooperative income tax provisions of the Internal Revenue Code. l 7

The proposal would have required cooperatives to return at least 50% of their patronage dividends in money or qualified check in order for the written notices

COOPERATIVE LEGISLATION 57

of allocation to qualify for exemption from the firm’s taxable income. The equity redemption problem has also been noted by the General Accounting Office. In 1977 the Comptroller General recommended that national legislation for man- datory equity redemption programs be proposed if cooperatives failed to vol- untarily adopt systematic redemption programs.

The holders of retained patronage dividends and other instruments evidencing a monetary interest in a cooperative by reason of former membership have applied to our courts for judicial assistance in securing the return of their monetary interests. The judiciary has not been very sympathetic to their plight. Instead, the courts have relied on established legal principles, including the obligation of contracts, noninterference with the business judgment of the board of directors, and the preservation of the business enterprise, to deny relief to these former patrons and others holding the interests of former patrons.

It is conceivable, however, that the inadequacy of the statutory provisions on equity redemption and the unfairness of the situation may lead an activist judge to adopt equitable considerations in providing judicial relief to holders of retained equities of former patrons. The equity redemption problem may not be too dissimilar to a corporate or partnership problem for which there exists a legal or equitable remedy. Dissatisfied former members may seize upon any number of causes of action, including breach of trust, unjust enrichment, fraud, or constructive trust as a basis for judical action to secure the return of their invested funds.

COOPERATIVE ANTITRUST EXCEPTIONS

Three federal exceptions serve as affirmative defenses to prosecution of coop- eratives under the federal antitrust laws. Section 6 of the Clayton Act declares that the antitrust laws do not forbid the existence and operation of nonprofit, nonstock labor, agricultural, or horticultural organizations instituted for the pur- poses of mutual help. Capper-Volstead authorizes the formation of organizations comprised of persons engaged in the production of agricultural products to engage in the legitimate objects necessary to accomplish their assigned purpose of effective farmer representation. The Robinson-Patman Price Discrimination Act enables cooperatives to proportionally return net earnings or surplus to members, producers, or consumers without violating the price discrimination provisions.

The antitrust exceptions for qualifying cooperatives have not been interpreted as providing outright immunity from prosecution for antitrust violations. Rather, the judiciary has struggled to interpret the exceptions as enabling cooperatives to engage in legitimate objects in order that farmers might have the same unified competitive advantage as is available to businessmen acting through corporations. Cooperative activities that are predatory or anticompetitive with an unlawful intent to stifle or smother competition are not immunized from antitrust prose- cution.

Anderson surmises that the current status of the large agricultural cooperatives in the economy supports a conclusion that, for most purposes, they should be subject to the same antitrust restrictions as corporations.’ The basic argument for the repeal of agriculture’s broad exception from the antitrust taws is that the

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economic justification has been mitigated. Unlike agricultural producers of the last century or the beginning of the current century, producers of agricultural goods face market forces and conditions that are not too dissimilar to producers of other goods.6 The problem of perishability of agricultural products has been greatly reduced by improvements in transportation, commodity processing, and storage techniques. Governmental programs provide greater flexibility in han- dling cyclical overproduction. Furthermore, the honored family-farm social and cultural values that have existed since Jeffersonian and Jacksonian eras are no longer fostered by these exemptions which apply equally to corporate and small family farms.

These conditions do not support a conclusion that the antitrust exceptions for cooperatives should be repealed. The ability of persons to come together and form cooperative organizations is still imperative for our agricultural sector. Thus, the antitrust exceptions should preserve the rights of group action by farmers but do not need to sanction activities that constitute a monopolization or restraint of trade violatiom6

FEDERAL SECURITIES ACTS The Securities Act of 1933 and the Securities Exchange Act of 1934 contain exemptions for the securities of qualifying cooperative organizations. These pro- visions do not, however, exempt cooperatives from all of the requirements of the Securities Acts. The exemptions simply mean that qualifying cooperatives may issue securities without complying with all of the provisions of the Acts, partic- ularly the registration requirements of the 1933 Act and the periodic reporting requirements of the 1934 Act.'' It is clear that cooperatives may incur liability by making an untrue statement of a material fact, by omitting to state a material fact, or by engaging in a fraudulent practice in the sale or issuance of a security.

The exemptions for cooperatives under these Acts are not identical. The 1933 Act exempts securities of cooperatives that meet the organizational requirements of section 521 of the Internal Revenue Code. The 1934 Act exempts securities of cooperative organizations as defined in the Agricultural Marketing Act of 1929. A proposed Federal Securities Code would adopt the more inclusive definition of cooperatives contained in the 1934 Act.

It is unclear whether retained patronage dividends of agricultural cooperatives are exempt from the registration and reporting requirements of the Securities Acts.". ''. l9 The purpose of the Acts was to protect investors, eliminate abuses in the marketplace, and prevent fraud. If the retention of patronage dividends by a cooperative fails to protect cooperative investors, creates an abuse, or operates as a fraud, then the Securities Exchange Commission or a court could interpret the Securities Acts as being applicable to these instruments.

The failure of a cooperative to adopt a systematic equity redemption program for the return of the patronage dividends of former cooperative members could be found to constitute a need for the protection of the Securities Actsi9 The indefinite interest-free investment by former members or patrons in a cooperative constitutes an unfair situation. A legal challenge could result in the judicial interpretation of the definition of a security to include patronage dividends in order to remedy the unfairness of the nonredemption of equity interests.

C 00 P E RAT I V E LEG ISLXF I0 N

LEG IS LATIVE REFORM

The problems and issues that exist under current cooperative legislation do not lend themselves to simple solutions. The unique characteristics of cooperatives and differences in size and objectives create varied needs that are important to the well-being of these business organizations. Legislative changes should be studied thoroughly in order to avoid adverse or injurious consequences.

It is not clear, however, that cooperatives can afford to accept the current legislative framework. A cursory analysis of the state enabling statutes, the equity redemption problem, the antitrust exceptions, and the Securities Acts' exemp- tions suggest that some of the legislation is outdated and should be revised. Cooperatives should identify those statutes that need to be revised and the projected benefits of new provisions should be weighed against the estimated costs that might accrue from a legislative revision. Cooperatives could then seek reform only for those statutes where benefits outweigh costs.

Cooperatives should emulate the successful codification of corporation and partnership law through the development of a new model cooperative statute. A model enabling statute that could be enacted by the individual states would provide a more functional set of guidelines for these organizations. The obvious advantages of consistent legal provisions among states should lead cooperatives and their leaders to seek the appointment of a model commission by the American Bar Association, the American Law Institute, the National Council of Farmer Cooperatives, a philanthropic foundation, or other national organization of legal experts charged with the responsibility of developing a model cooperative ena- bling statute.

The equity redemption problem needs to be addressed in the state enabling statutes. Regardless of whether a model enabling statute is developed, cooper- ative interests would best be served by the adoption of a statutory provision that resolves the most egregious equity redemption problems. Such a provision could reduce the potential of legal challenges by dissatisfied equity holders and could foster the spirit of cooperation by more closely correlating investment to membership.

The redemption provisions for former cooperative members of Chapter 499 of the Iowa Code provide an example of statutory requirements which help minimize some equity redemption problems. The statute mandates that cooperatives must pay former stockholders the value of their stock or membership interest within 60 days of expulsion or two years of death or other ineligibility." The statute also requires the payment of deferred patronage dividends and the redemption of preferred stock of deceased natural persons (as opposed to corporate or other business members) prior to other payments of deferred patronage dividends or redemption of preferred stock held by members. l2 The statute thereby operates to resolve the problem of the return of interests to former members without mandating a specific time schedule.

The exceptions and exemptions in federal laws governing cooperatives are generally satisfactory. However, the equity redemption problem created by co- operatives that fail to return the retained equities of former patrons could lead to an unfavorable modification of one or more of the federal provisions. Thus, additional state regulation in the area of equity redemption to respond to economic and legal problems created by the inadequacies of existing statutes would be

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advantageous to mitigate the likelihood of an adverse judicial decision or leg- islative change.

REFERENCES

1. G. Calabresi, A Common Law for the Age of Stattires, Harvard University Press, Cambridge,

2. T. J. Centner, “State Cooperative Statutes-Conflict of Cooperative Concept with Efficiency,”

3. G. Gilmore, The Ages of American Law, Yale University Press, New Haven, CT, 1977. 4. U.S. Bureau of the Census, Abstract of the Fourteenth Census of the ffnited States 1920,

5 . U.S. Department of Agriculture, Agricultural Statistics 1982, Washington DC, 1982. 6. Notes, ‘Trust Busting Down on the Farm: Narrowing the Scope of Antitrust Exemptions for

7. A. M. Anderson, “The Agricultural Cooperative Antitrust Exemption-Fairdale Farms, Inc.

8. M. A. Abrahamsen, Cooperative Business Enterprise, McGraw-Hill, New York, 1976. 9. Kentucky Acts, Chapter 1 , 1922.

1982.

J. Northeast Agricultural Economics Council, 12, 91 (1983).

Washington, DC, 1922.

Agricultural Cooperatives,” Virginia Law Rev., 61, 341 (1975).

v. Yankee Milk, Inc.,” Cornell Law Quarterly, 67. 396 (1982).

10. N. E. Harl, “Cooperatives,” in Harl Agricultural Law, Vol. 14, Matthew-Bender, New York, 1982 and Suppl. 1984.

11. J. R. Baarda, State Incorporation Statutes for Farmer Cooperatives, U.S. Department of Agriculture, Agricultural Cooperative Service, 1982.

12. Iowa Code Annotated c. 499 (West Suppl. 1983). 13. D. Fee and A. C . Hoberg, “Potential Liability of Directors of Agricultural Cooperatives,”

Arkansas Law Rm., 37, 60 (1984). 14. American Bar Association-American Law Institute, Model Business Corporation Act, Com-

mittee on Business Corporations, 1950. 15. A. B. Todd, Ed., The Corporation Mantiat, United States Corporation Company, New York,

1982. 16. American Law InstituteAmerican Bar Association, Partnerships: UPA, UPLA, Securities,

Taxation, and Bankruptcy, 3rd. ed., Committee on Continuing Professional Education, 1982. 17. U.S. Congress, House of Representatives, H. Rep. No. 413, 91st Cong., 1st Sess. 1, 1969. 18. General Accounting Office, “Family Farmers Need Cooperatives-But Some Issues Need to

be Resolved,” Report to the Congress by the Comptroller General, CED-79-106, 1979. 19. T. J. Centner, “Agricultural Cooperatives: Retained Patronage Dividends and the Federal

Securities Act,” North Cent. J. Agricultural Economics, 6 , 36 (1984). 20. J. P. Weiss, “Fact vs. Fiction in Regulation of Agricultural Securities,” The Cooperative

Accountant, 31, 12 (1978). 21. J. P. Weiss, “So You Think You’re Exempt From the Federal Securities Laws,” The Cooperative

Accountant, 28, 2 (1975).