How do I develop a Cooperative? Legal Issues Study Group: Cooperatives Session 3 Elijah M. Hutchinson

Get some things out of the way… There is no single “accepted” legal or organizational structure for organizing worker-owned cooperatives Basic Coop Definition – 1. Owned and controlled by its “patrons” (i.e. customers, producers, or workers) – 2. One person one vote – 3. “Surplus” is returned to the owners on the basis of their patronage Note that these characteristics can be built into almost any legal structure

Considerations for Legal Structure Financing Sources Operations/Accounting Democratic processes Taxation of earnings Legal liability of members; corporation Profit distribution Types of permissible activities

Popular Legal Structures in US Cooperative (157A, Massachusetts General Laws) Partnership or Limited Partnership Limited Liability Corporation (LLC) L3C Corporation (S or C) Tax Exempt Corporation B Corp GET A LAWYER …FROM YOUR STATE

Some History Massachusetts enacts first statue in United States supporting cooperative formation…in 1866! Massachusetts enacts first statue in United States specifically for worker-owned cooperatives in 1982 Legislature passed “Industrial Cooperative Associations Law”, inspired by Basque cooperative model All states now have cooperative statues; Four principal parts: – Allows corporation conversion into cooperative membership organization democratically controlled by workers – Permits equitable allocation of earnings and loses to members based on their relative contribution of labor, not relative capital investment – Authorizes cooperative capital structure and accounting – Sets forth a capital allocation procurement structure consistent with Subchapter T

Cooperative Corporations Entitled to benefits of all corporations: – Limited liability; perpetual existence; tax-deductible fringe benefits for employees Incorporated under state’s cooperative statutes: – Able to use “cooperative” in name – Able to issue membership instead of shares of stock – Exemptions from or simplified procedures for registering members with SEC and State agencies – Payment of patronage refunds based on participation – Possible exemption from stock permit fees required for most for-profits – Take advantage of Subchapter T of Internal Revenue Code; avoid double taxation on profits

Mass. General Laws; Employee Cooperative Corporations (Part I, Title XXII, Chapter 157A) Section 1 Short title Section 2 Definitions Section 3 Corporations organized under chapter 156D; election to be governed as employee cooperative Section 4 Revocation of election Section 5 Corporate name Section 6 Members; membership shares; fees; rights and responsibilities Section 7 Voting shares; by-laws; amendment of articles of organization Section 8 Net earnings or losses; apportionment, distribution and payment Section 9 Internal capital accounts; recall or redemption of shares; interest; collective reserve account Section 10 Internal capital account cooperatives Section 11 Conversion of membership shares and internal capital accounts upon revocation of election; consolidation or merger

Governance Articles of Incorporation – constitution or business charter Bylaws – describes operations; can be general or specific Directors – approve budgets, contracts, and work plans; responsible for records, elections, financial statements; procures professional help Managers or Officers – Responsible for operations; legal authority to enter into contracts Shareholders/Workers/Members/Owners – Vote!; amend bylaws, etc; operations Outside Investors – Restricted voting rights; may have veto power

Partnership or Limited Partnership Automatically created when a group of people get together to run a business – no filing required No liability protection for partners – each partner is personally liable for any liabilities or debts of the partnership May be sheltered from State taxes (e.g. franchise tax) Pass through entity for tax purposes Partners are not employees

Limited Liability Corporation (LLC) LLCs have the limited liability of a corporation and are taxed like partnerships (they can elect to be taxed as corporations) Owners (members) are not employees Member managed vs. manager managed All earnings subject to self employment tax (guaranteed payments and profits) Cannot have unallocated equity – all equity is allocated to member capital accounts (can create instability) You can't use an LLC if you need a contractors license (some States) Very flexible; No formalities required Superior with respect to outside liability protection Phantom income problem

L3Cs – Low-Profit, LLC - NEW L3Cs are LLCs specially designed to attract foundation investments – LC3s formed in Vermont can be used in any state Foundations are required to distribute five percent of the value of their net assets for charitable purposes each year. To meet this requirement, foundations primarily make grants to charitable organizations. However, foundations are also permitted under the Internal Revenue Code to invest this five percent of net assets in for-profit entities that meet a three-pronged test: – The entity must be formed primarily for charitable or educational purposes; – No significant purpose of the entity is the production of income or the appreciation of property; – No purpose of the entity is to conduct legislative or political activities; – (Internal Revenue Code (IRC § 4944(c) and Treas. Reg. § –3) The investment (called a Program-Related Investment or PRI) are relatively uncommon because foundations are unwilling to risk the uncertainty of having the IRS determine that a PRI it makes does not in fact meet the statutory requirements. L3Cs were created in response to this problem. An L3C is identical to an LLC except that it is organized for a business purpose that satisfies and is at all times operated to satisfy each of the requirements for a PRI.

S - Corporation Just like a C - corporation (standard corp.) but with taxed like partnership Special requirements to maintain S Corp status: – No more than 100 shareholders – Shareholders must be individuals; citizens or legal residents – Only one class of stock (different voting rights not considered a different class) Failure to meet these requirements results in automatic loss of S status California: 1.5% tax on entity Owners are employees – no self employment tax Phantom income problem

B Corp Certification system by B-Lab to support socially beneficial corporation Not a statutory business form; any type of business can be a B Corp A state (20 States) without a “constituency statute” must do what is in the best interests of the shareholders (investors) – period. Board cannot legally put the interests of the community, the environment, workers, or any other stakeholder group ahead of shareholders’ interests Commitment can expose a corporation’s board to potential liability

Issues Conflicts and Tensions; Who’s the Boss? Surplus Distribution; Compensation Deficits; Labor Surplus; Wage Loss Outside Investors Accounting and Compliance w/SEC, State Regulators Financing Start-up/Capital Improvements; Lending Market Case-Law; Other Liabilities; i.e. Taxation of Patronage Dividends Organize as Not-for-Profit?; i.e. 501(c)6 or 501(c)12 Conversion of Incorporation What can we think of?

Speakers Ed DeBarbieri ?q=node/14&pid=15245 Jenny Kassan NOTE: some slides in this presentation are edited versions of larger presentation from Ms. Kassan that can be publically accessed from the weblink above

mitcooperatives.wordpress.com Suggested Readings; References Toolkits-Handbooks Organizational Charts and Checklists Supporting Organizations Massachusetts State Regulations Sample Bylaws and Articles of Incorporation Conference Publications Legal Journal Articles