Cooperative Legal Environment

1. Cooperative Legal Environment Legal Issues Handled Differently by Cooperatives than by Corporations

2. Various Laws Impact Coops • Cooperatives are chartered under state laws • Federal law gives cooperatives limited exemption from anti-trust prosecution • State “Corporate Farming” laws often exempt cooperatives • Various federal and state laws relating tax treatment, franchise tax, securities registration and other areas may have explicit definitions for cooperatives • But for most issues cooperatives have the same treatment as other corporations. There are some important differences to note.

3. Cooperative Issues Filling the Gaps in the Law • Agricultural statutes tend to be brief and broad. • Corporate law is often used as the final interpretive power of cooperative statutes and bylaws.

4. Voting Systems • Corporate systems are based on stock • Cooperative systems are • One member One vote or • Based on the amount of business done with the cooperative • Pure one member/one vote is the IRS standard of a cooperative

5. Cooperative Issues(addressed in bylaws) Member/Shareholder Votes • What decisions must be taken to a vote by the membership and how can a group of members petition for a vote? Voter Eligibility • Who can vote? Husbands, Wives, Children? Access to Information • How much information are members entitled to? How much is too much?

6. Cooperative Issues Dividends (on invested capital) • Dividend limits referred to as subordination of capital • Many states have “Bright Line Test” (example: dividends limited to 8% in Oklahoma) • Cooperative-IOF hybrids raise the issue of what is the appropriate mix of dividends and patronage

7. Cooperative Issues Liquidation Distributions • Cooperatives, like corporations, are required to take care of valid claims of creditors in connection with liquidation. • BUT any remaining surplus is distributed as patronage to active members based on past patronage unlike investor corporations where it is distributed in proportion to ownership • Tends to favor active members rather than passive members

8. Cooperative Issues Retention and Allocation of Earnings • Cooperatives issuing qualified stock refunds must pay 20% of patronage earnings to members and patrons in cash. • IRS states that cooperatives cannot retain excessive amounts of their earnings in unallocated reserves • Many cooperatives have more than 50% of total equity in unallocated and some question whether this violates cooperative principles. So far it has not been challenged by IRS

9. Cooperative Issues Capital Stock • IOFs may issue capital stock • Cooperatives may issue stock and operate as stock cooperatives or without capital stock and operate as membership cooperatives. Handling of Losses • IOFs allocate losses in proportion to ownership • Cooperatives charge losses to the members according to the amount of business done with the cooperative during some appropriate period

10. Contractual Obligations of Owners • Corporate shareholders generally have no contractual relationship to the corporation. • Cooperatives often make contracts with members to insure that those members will do business with the cooperative. • Cooperatives have the right to take action against those members who fail to fulfill their contract but may be reluctant to sue someone who is also an owner

11. Director Eligibility • IOFs can have any natural person as a director. • Cooperatives are required to have only agricultural producers who are members of the cooperative as directors. • Can lead to loss of diversity and balance. • Cures • Outside advisory members • Management teams • Consultants

12. While Corporations and Cooperatives have some common threads… Cooperatives are truly unique.

13. Definitions • Investor owned firms (IOF) • Businesses owned by investors. IOFs include sole proprietors, corporations, partnerships, and limited liability companies (LLC’s). • Unallocated reserves • Equity not allocated to individual members. Sources include tax-paid net income retained but not allocated, unclaimed checks, and appraisal surplus.

14. Chapter 9: Antitrust Laws

15. Antitrust Laws • Sherman Act-prohibited restraint of trade. Farm associations were unintended consequence • Clayton Act-attempted to excluded farm associations but did not prove useful • Capper-Volstead-1922-provided cooperatives limited immunity and prescribed organizational form

16. Sherman Antitrust Act-1890 • Prohibits agreements which “unreasonably” restrain trade. • Specifically prohibited • Price Fixing Agreements • Market Division Between Competitors • Certain Boycotts • Other activities are judged by their impact on competition (example: joint ventures)

17. Unintended Consequences of the Sherman Anti-Trust Act • While the act was intended to curb the behavior of big banks and railroads the first groups prosecuted were farm associations and labor unions • Two farmers meeting to discuss collectively marketing their crop to achieve a better price were regarded as two businesses in the same industry who were attempting to fix prices

18. Clayton Act-1914 • Excluded farm associations without capital stock • Exclusion proved not to be very useful • The act also expanded anti-trust protection by prohibiting mergers or acquisitions where competition may be substantially lessened. (That aspect of the act is not as important for our understanding of cooperatives.)

19. Why Wasn’t the Clayton Act Not Useful? • Did not describe the organizational requirements for a “farm association” so it was not clear what qualified • Did not explicitly describe the activities that were protected • This made lawmakers think more closely about what they were trying to exclude and look to the defining characteristics of a cooperative

20. Robinson Patman Act- 1936 amendment to Clayton Act • Prohibits price discrimination by a supplier where the effect may be to substantially lessen competition. • Protects small retailers • Specifically exempts cooperatives who pay refunds to members. (note that the amendment was passed after Capper Volstead so the definition of a cooperative was now used)

21. Capper-Volstead Act of 1922 The Magna Carta of Cooperatives

22. Capper-Volstead-1922 • Provided cooperatives with limited immunity from anti-trust regulations • Defined appropriate activities for cooperatives to have immunity • Prescribed organizational form for cooperatives to have immunity

23. Purpose • Allows farmers to be active participants in the market rather than simply price-takers. • Allows value added cooperatives to exist without fear of legal action against them. • Allows economies of size without violation of antitrust. • Allows for the continued local control of products and services.

24. Organizational Requirements • Mutual benefit of members (profits distributed in proportion to use) • Voting or limit dividends -- Either one member one vote or limit dividends to less than 8% • Cooperative cannot engage in the marketing of non-member products more than they do the products of their members • Note that the requirements to qualify for Capper Volstead relate back to cooperative principles

25. Role of the Secretary of Agriculture • Capper-Volstead grants enforcement authority to • Take corrective action in controlling unduly enhance prices • Challenge the operation of that association • An agricultural producer or association can enhance prices, but not “unduly” • This why we refer to is a limited immunity

26. Other Limits • Exemption available to agricultural producers only. • Only applies to marketing activities • Combinations of producers and non producers not allowed

27. Capper Volstead has strict interpretation of “producer” Person engaged in production of agricultural products=producer Non-producers who own packing houses or poultry processors who don’t take all of the risks of productions do not qualify As agriculture has changed and farm operations have become more complex this distinction has become problematic

28. “Not Even One” requirement • Case Swayne Co, Inc vs Sunkist • 15% of of Sunkist volume came from non-member packing house • Court ruled that the existence of even one ineligible member eliminated Capper Volstead eligibility

29. SUMMARY • Sherman Act-prohibited restraint of trade-farmers unintentionally effected • Clayton Act-attempted to excluded farm associations • Capper-Volstead-1922-provided cooperatives limited immunity and prescribed organizational form • State enabling legislations looked to Capper Volstead for required form

30. Recent Challenges to Capper Volstead • Joint Department of Justice and Dept of Agricultural hearings • Eastern Mushroom Marketing Cooperative-supply control • United potato growers of America-managing potato supplies • Dairy cooperatives-herd reduction • United Egg Producers-shrink egg flocks

31. Dept of Justice Challenges • Congress granted this benefit in recognition of hardships that producers face when standing alone in the market place • “Might conclude that Capper Volstead Act is not the right law for the state of the industry at this time”

32. NCCFC Response • Market concentration is as strong or stronger as in 1922 • Cooperatives subject to numerous practical constraints that limit them from achieving excess market power • Farmer cooperatives increase competition, lower production costs and increase farmer income • Any action to dilute Capper Volstead would harm cooperatives and damage rural America

33. Recent challenges to Capper Volstead • Revolve around the question of what a cooperative can and cannot do to manage supply and improve prices • Can a cooperative engage in supply control? • Another issue is whether a grower who also processes (example operates a potato packing house) is still a grower or is an ineligible member

34. Eastern Mushroom Marketing Cooperative • Removed 8% of mushroom production capacity by purchasing or leasing mushroom farms and shutting them down • The court found it "troubling that the EMMC appears to have been organized for the benefit of mushroom distributors," rather than growers • The Court was unwilling to apply Capper Volstead protection to the structure in which the grower members had a 50 percent ownership interest in the separate distribution company, with a third party owning the other 50 percent.

35. United Potato Growers of America • Regional cooperative operating in 10 states • In its motion for dismissal, United Potato argued that its practice of limiting U.S. potato acreage in order to strengthen markets is protected under the Capper-Volstead Act, which provides agricultural cooperatives limited exemption from federal antitrust laws. • Plaintiffs argued that no court in the 85 years since Capper-Volstead was passed has ruled specifically on the issue of “production controls” — limits placed on plantings • Another issue is whether a grower who also processes (example operates a potato packing house) is still a grower or is an ineligible member • Cooperative agreed to pay $25M to retailers and consumers without admitting wrongdoing

36. Recent Challenges-Conclusions • Existence of Capper Volstead limited immunity is essential for the continuation of cooperatives • Recent challenges have related to supply control and the complexity as farmers have ownership in other businesses • Cooperatives have reached settlements leaving the question open • Clearly the legal environment is not as friendly to cooperatives as in 1922