Author; Steven G. Johnson
If you were to ask someone to list the types of business entities in Utah, they would most likely name corporations (including S corporations), partnerships, limited partnerships, limited liability companies and partnerships, and sole proprietorships. Few would know to also mention cooperatives.
Cooperatives have played an important role in the economic development of this country, especially in rural areas. They continue to play a significant role in providing agricultural products, cooperative housing, rural power and communication services and credit union services. In fact, one would be safe to say that just about every Utahn consumes on a daily basis goods or services provided by cooperatives.
Cooperatives have existed throughout history as people have worked together for the common good. One of the earliest verified cooperatives in this country has been discovered in central Arizona, where early pioneers found approximately 150 miles of irrigation canals dug by the Hohokam Indians to bring water to their desert farms in the Salt and Pima River basins. Legend suggests that the first cooperative established by settlers in the thirteen colonies was an insurance company organized by Benjamin Franklin in 1752, called the Philadelphia Contributorship for the Insurance of Houses from Loss by Fire.1
One of the best-known cooperatives in history was the Rochdale Society of Equitable Pioneers, organized in Rochdale, England in 1844. The Society was established to help weavers who had lost their jobs through the mechanization of the textile industry. These weavers, together with other craftsmen (including a shoemaker, clogger, tailor, joiner and cabinet maker), studied both successful and unsuccessful cooperatives. From their studies, they developed a set of rules by which the Society would be governed.
The Rochdale policies and practices were:
1. open membership
2. one member, one vote
3. cash trading
4. membership education
5. political and religious neutrality
6. no unusual risk assumption
7. limitation on the number of shares owned
8. limited interest on stock
9. goods sold at regular retail prices
10. net margins distributed according to patronage.
Cooperatives in this country and throughout the world still follow these principles.
The Rochdale Society started with only 28 members. Its shop was originally open only on Monday and Saturday nights. By the end of the first year, membership had grown to 74 craftsmen, and the Society recorded a small profit. By 1850, membership had grown to 600, and the Society was a success.
In March of 1868, the Zions Cooperative Mercantile Institution, the "People's Store," was established in Salt Lake City. ZCMI, as it became known, was a community-owned merchandising business dedicated to the support of home manufacturing. One of its goals was to sell goods as low as possible, and to divide the profits among the people at large. Although not a true cooperative, ZCMI spawned a region-wide system of local cooperatives owned and operated by the people.
In 1874, representatives from the Grange, an organization set up to help farmers and rural America after the Civil War, went to England to study successful cooperatives. A year later, the Grange published a set of rules for the organization of cooperative stores to serve the rural community. These rules are based on the Rochdale principles.
In the early part of the 20th Century, many farmer cooperatives were established. By the 1920s, there were about 14,000 farmer cooperatives operating in the United States. Many of today's major farmer cooperatives were formed during this period. Some of these cooperatives are now ranked as some of the largest food companies in the world. This article discusses the basic laws relating to agricultural cooperatives.
LEGAL MILESTONES FOR COOPERATIVES
Two events, one statutory and one judicial, have helped to define cooperatives and have made possible their development in the 20th Century. The first is the Capper-Volstead Act.2 The Capper-Volstead Act was enacted in 1922 as an amendment to the 1914 Clayton Antitrust Act. Capper-Volstead provides a limited exemption from the antitrust laws for agricultural producers to market their products on a cooperative basis. It also contains provisions to ensure that producers of agricultural products do not abuse their collective power to the detriment of consumers.
The Act liberalizes the eligibility requirements for cooperatives, and affirmatively grants authority to farmers to act together for processing, preparing for market, handling and marketing the agricultural products they produce. In a leading case interpreting Capper-Volstead, National Broiler Marketing Ass'n v. United States,3 the Supreme Court recognized that the Act allows farmers to raise capital and engage in value-adding activities that prepare their products for market without violating the antitrust laws. It increases the economic strength of farmers so they can better weather adverse economic periods and deal on a more equal basis with processors and distributors.
The second milestone for cooperatives arose out of a dispute by a Washington workers' cooperative with the Internal Revenue Service over the payment of federal income taxes. In Puget Sound Plywood, Inc. v. Commissioner,4 the Tax Court defined what it means to do business on a cooperative basis. Reviewing the history of cooperatives and citing the principles established by the Rochdale Society, the court recognized that any type of a business, including stock corporations, may qualify as a cooperative if it is doing business on a cooperative basis. This case has been cited in numerous cooperative cases since it was written, not because it makes new law, but because it defines what an entity must do to be treated as a cooperative for tax purposes. These principles have been adopted in other non-tax cooperative areas as well.
The Puget Sound Plywood case discussed the three guiding principles which define modern cooperatives. They are (1) the subordination of capital, (2) democratic control, and (3) the allocation of profits to the members on the basis of their patronage of the business. These principles are codified in Utah's agricultural cooperative laws, and are the basis for defining how agricultural cooperatives operate today.
SUBORDINATION OF CAPITAL
Unlike corporations and other entities that are established to return company profits to the equity owners of the businesses, agricultural cooperatives are established to provide services and goods to their members. Profits are secondary to their purposes.
In the Agricultural Cooperative Associations Code, Utah has codified the "subordination of capital" principle by mandating that common, voting stock may only be issued to current producers of agricultural products.5 If a member ceases to be a current producer of agricultural products, that person's membership is terminated,6 and they may no longer exercise control over the facilities, assets or activities of the association.7 Preferred shareholders are not entitled to vote or otherwise control the cooperative,8 unless they are also members of the association. To become and to remain a voting member of a cooperative, a person must actually be using the services or goods provided by the cooperative. Passive investors may not be cooperative members. In other words, the members of an agricultural cooperative are the farmers who use the services or the products of the cooperative. In these matters, cooperatives differ from corporations or limited partnerships which place the greatest importance on the ownership of equity. They are more like those partnerships and limited liability companies where all of the owners are the active participants in the business.
A Utah agricultural cooperative member may only hold one share of the common voting stock of the business.9 Dividends on common stock or membership capital may not exceed 8% per annum.10 Earnings in excess of dividends and reserves are allocated not on the basis of stock ownership or investment, but on the basis of patronage (see below).
Control of a cooperative is by the people who actually use the business, and not by nonmember equity holders. As stated above, members must be current producers of agricultural products. Members may hold only one share of the common voting stock of the business. Each member is entitled to only one vote (this is referred to as the "one man-one vote" cooperative principle),11 so that each member has an equal right to control the business. Equity ownership is traditionally irrelevant in voting because each farmer owns only one share of common voting stock.
During the 2003 legislative session, the Agricultural Cooperative Associations title of the Utah Code was amended to allow cooperatives to provide that members may have not only the one vote based on membership, but also additional votes based on actual patronage with the association.12 This amendment recognizes that those who use the cooperative more than other members may be granted more control over the cooperative than those members who use it less. The amendment is permissive rather than mandatory, allowing cooperatives to continue with the single vote per member if they desire.
A vote may not be cast by proxy,13 although a vote may be cast by a signed, notarized ballot.14 These rules encourage a person to be present at the cooperative's meetings in order to participate in the management of the business. Not only must a person patronize the business in order to be a member, but also that person should actively control the business. In this regard, a cooperative differs from equity-based entities such as corporations and limited partnerships.
ALLOCATION OF PROFITS
Unlike other businesses where profits are distributed based on the ownership of the equity in the business, cooperatives distribute profits in proportion to the members' active participation in the cooperative endeavor.15 The participation in the business of the cooperative is called "patronage."16 The more a member uses a cooperative, the greater share of the profits the member receives. For example, a farmer who produces 10% of the apples sold by a cooperative will receive 10% of the profits of the business for that year, while a farmer who produces only 3% of the apples marketed by the cooperative will receive only 3% of the profits for that year.
In this respect, a cooperative is different from all other types of business entities. Other entities usually make distributions based on ownership of equity capital, or equally, as the case may be. Cooperatives base the amount of their distributions instead on the use of the cooperative by the members.
TAXATION OF COOPERATIVES
With respect to income taxes, cooperatives are not taxable entities, although they may pay taxes on their profits from non-member business. They do pay property taxes as well as sales and use taxes. In this respect, they are treated much like other pass-through entities such as partnerships and most limited liability companies. These entities do not pay taxes on their profits. Instead, the individual cooperative members, partners or LLC members pay taxes on their share of the income. Generally, cooperative members are each taxed on the distributions they respectively receive based on their patronage of the business. Cooperatives fall within the exemption from corporate income and franchise taxes found in Section 59-7-102(1) of the Code.
LIABILITY OF MEMBERS
Although cooperatives are treated in many respects as partnerships for tax purposes, from a liability standpoint, they are similar to corporations and limited liability companies. A member of a cooperative is not personally liable for the debts and obligations of the cooperative.17 Creditors must resort only to the assets of the cooperative, and not to the assets of the individual members, in order to satisfy a cooperative debt. There are no known cases in Utah that have faced the issue of piercing a "cooperative veil" as one sometimes sees with corporations.
COOPERATIVES IN UTAH
A very high percentage of agricultural goods consumed by Utahns are produced by cooperatives, especially dairy products and canned fruits and vegetables. Many agricultural products are sold under well-known cooperative trademarks such as Norbest, Sunkist, Welch's, Ocean Spray, Land O'Lakes, TreeTop, Blue Diamond, Florida's Natural, Birds Eye, Cenex Harvest States and Agway. Some agricultural cooperatives headquartered in Utah are Intermountain Farmers Association, Norbest, Inc., Moroni Feed Company, Utah Wool Growers, Inc., Mountainland Apples, Inc., Payson Fruit Growers, Inc., Cache Valley Select Sires, Inc., and Producers Livestock Marketing Association.
In addition to agricultural cooperatives, there are many other kinds of cooperatives in Utah. Like agricultural cooperatives, these non-agricultural cooperatives also follow the requirements of operating on a cooperative basis identified in the Puget Sound Plywood case. South Jordan-based Deseret Generation & Transmission Cooperative is a power cooperative. It provides wholesale electric services to its six member distribution cooperatives. These six member cooperatives, Bridger Valley, Dixie Escalante, Flowell, Garkane, Moon Lake and Mt. Wheeler, provide electrical services to much of rural Utah. Empire Electric, Strawberry Electric and Wells REC are three other rural electric cooperatives that service parts of the State that are not served by the Wasatch Front power companies.
There are three rural telephone service cooperatives in Utah. UBTA-UBET Communications, Emery Telcom, and South Central Utah Telephone provide telephone service to 54,000 rural telephone customers. Without these rural telephone cooperatives, many rural areas may not have access to telephone service.
There are 128 credit unions in Utah. They range from very small to very large associations. Some serve employees of school districts. Others serve employees of hospitals or other companies. Some serve members of unions or residents of certain geographical areas.
Associated Food Stores is a cooperative that provides the products sold by its member retail stores in Utah.
As our society evolves, the use of cooperatives also evolves. Interest has been expressed regarding the establishment of child-care cooperatives. They are becoming popular in several urban areas of the country. Another type of cooperative seeing increased popularity is the value-added cooperative. In this kind of cooperative, raw agricultural commodities are converted into consumer products, with the profits from the venture returning to the farmers who produced the agricultural commodity.
Cooperatives are not leftovers from a bygone era. They continue to play a very important part in the economy of the State of Utah. They provide hundreds of jobs and a high percentage of the products and services we use on a daily basis. They have characteristics of other business entities, as well as important distinctions. Attorneys should know enough about cooperatives to avoid confusing them with other forms of businesses.
1. United States Department of Agriculture, Co-ops 101: an Introduction to Cooperatives, Cooperative Information Report 55, 1997 (p.2).
2. 42 Stat. 388 (1922), 7 U.S.C. ¤¤ 291-292, entitled "An Act to Authorize Association of Producers of Agricultural Products." The Statute is commonly referred to as the Capper-Volstead Act in honor of its principal sponsors, Senator Arthur Capper and Representative Andrew Volstead.
3. National Broiler Marketing Ass'n v. United States, 436 U.S. 816, 824-827 (1978).
4. Puget Sound Plywood, Inc. v. Commissioner, 44 T.C. 305 (1965), acq. 1966-1 C.B.3.
5. Utah Code Annotated, ¤ 3-1-10(1)(a). Unless otherwise noted, all references to Code Sections are to the Agricultural Cooperative Associations provisions of Utah Code Annotated. Other kinds of cooperatives such as housing cooperatives and credit unions have separate statutory schemes.
6. subsection 3-1-10(3).
7. subsection 3-1-11(4).
8. subsection 3-1-11(5).
9. subsection 3-1-10(2).
10. subsection 3-1-11(2). The 2003 Legislature amended this section to allow dividends on preferred stock to exceed 8% per annum. The amendment does not apply to common stock.
11. subsection 3-1-10(5)(a)(i).
12. subsection 3-1-10(6).
13. subsection 3-1-10(5)(a)(ii).
14. subsection 3-1-10(5)(b).
15. subsection 3-1-11(3).
16. subsection 3-1-10(1).
17. subsection 3-1-10(4).