Washington State recently passed a law setting forth a new business entity type: Limited Cooperative Associations (LCA). This new statute will become effective July 28, 2019. Limited Cooperative Associations function similarly to traditional cooperatives with some key differences. The greatest difference lies in the ownership of the organizations. Ownership of traditional cooperatives is restricted to those who patronize the cooperative. In contrast, the ownership of Limited Cooperative Associations is open to “investor-members” who do not patronize the association. The addition of the investor-member increases cash flow into the cooperative but risks diluting the core concept of a cooperative, namely the establishment of a business run by its patrons and for their benefit.
Washington’s Limited Cooperative Association statute is modeled after the Uniform Limited Cooperative Associations Act. Nothing in the Uniform Limited Cooperative Associations Act or Washington’s code alters or suggests alterations to the existing cooperative statutes. Limited Cooperative Associations 2019 Wash. Sess. Laws (effective July 28, 2019). The Limited Cooperative Association is added as a different type of business entity with a slightly different toolkit than the traditional cooperative.
Washington’s new code attempts to strike a balance between enabling increased investments through the addition of investor- members and staying true to the culture and mission of traditional cooperatives. The resulting framework restricts the role of investor-members in certain key respects in order to protect the position of patron-members in the organizations.
In the past two decades a new type of cooperative business entity that allows for non-patron investor-members has emerged in several states. Limited Cooperative Associations (“LCAs”), as they are called, are substantially similar to other types of cooperatives in most respects. LCAs subscribe and adhere to the core cooperative attributes developed since the establishment of the Rochdale Society of Equitable Pioneers. They are member owned, democratically governed, and are intended to grow and operate sustainably for the benefit of their members.
Unlike traditional cooperatives, a member of an LCA does not need to be a patron. By allowing non-patron investors to become members, LCAs have more capacity to generate financing than the traditional cooperative. LCAs are able to entice investors with voting rights. Investor-members also receive revenue allocations proportionate to the ratio of their investments to those of other investors.
To ensure that the balance of power in the LCA does not shift in favor of investor-members, patron-members are given certain protections. Those protections can include: capping the percentage of profits allocated to investor-members, mandating that patron-members control the majority of the vote, and requiring a majority of patron-member votes in order to approve any action.
II. WASHINGTON’S LIMITED COOPERATIVE ASSOCIATIONS STATUTEThe most recent state to adopt the LCA structure into its code is Washington. Washington’s statute is based almost entirely on the Uniform Limited Cooperative Associations Act (“ULCAA”). Notably, the Washington code prohibits the formation of an LCA for the purpose of conducting any electric energy business. Below are the highlights from Washington’s new code.
A. LCA Members
An LCA may include investor-members who may or may not patronize the cooperative and who have similar benefits to their patron-member counterparts. Members can be either investor-members, patron-members, or both. Each member is entitled to a seat at the table in organization meetings, though the allocation of voting rights favors patron-members.
Profit distribution is addressed in sections 803-04.The profits of the business that are not retained by the cooperative must be allocated between the members, unless the organic rules state otherwise. The patron-members’ allocation is determined by the ratio of their patronage to that of all patron-members combined, and the investor-members’ is determined by the ratio of their investments to those of all the investor-members combined. The collective allocation distributed to patron-members cannot be less than half the total allocation distributed, with each individual LCA determining exactly how to break it down beyond that.
The framework allows investor-members to benefit from the cooperative, but ensures that they do not come away with more than the patron-members do. In designing the framework as such, the statute makes investing in an LCA a worthwhile endeavor but keeps the patron-members as the central focus of the organization.
Section 604 of the Limited Cooperative Associations Act of 2019, Wash. Sess. Laws 29 addresses the makeup of an LCA board of directors. While investor-members are allowed to serve on the board of directors of an LCA, at least one-third of the board must be made up of patron-members. Additionally, a majority of the board must be elected exclusively by patron-members, and, unless an LCA’s organic rules require otherwise, the remainder of the board must be elected exclusively by the investor-members.
This setup keeps the patron-members in control of the leadership of the LCA while allowing investor-members to serve in leadership roles. Further, it gives LCAs the latitude to choose how much authority investor-members will have in electing the leadership.
Many of the protections for patron-members come from the arrangement of the LCA voting structure. Though a great deal of leeway is afforded to individual LCAs’ organic rules when it comes to allocating voting power, some limitations to investor-members’ voting powers are statutorily required. Voting regulations are described in sections 411-15.
Voting power can be distributed among patron-members in one or a mix of three ways: one vote per member, weighted voting based on patronage, or, in the case of a member that is itself a cooperative, one vote per each of its patron-members. The organic rules may also allocate patron votes by class or district or a combination of the two.
In contrast, the voting powers of investor-members can be significantly more limited. By default each investor-member would receive one vote, but an LCA may provide otherwise in its organic rules. In regard to voting allocation among investor-members, votes may be allocated by class, classes, or any combination of classes.
Patron-members are required to control the overall majority of the LCA’s voting power, though individual LCAs may determine to what extent. Further, for any action to be approved at least a majority of patron-members voting must have voted in its favor. Individual LCAs can require more than a simple majority of patron-member votes to pass an action in their organic rules. This insures that investor-members do not take over the voting process, even in meetings where there are more investor-members than patron- members present and voting.
Investor-member votes are not pointless. An action cannot be passed if it does not receive the majority of the votes cast at a meeting. Therefore, unless all the patron-members were voting against all the investor-members, investor-member votes would likely be required to pass an action.
The allocation of voting rights in the statute is meant to ensure that LCAs keep the cooperative culture of an organization built to serve its patrons. Nonetheless, LCAs still incentivize those who do not patronize the cooperative to invest in it by offering investors some measure of control. Individual LCAs determine how much control they are willing to give over to investor-members and by extension how enticing the investment is.
III. TAXATIONFor federal tax purposes, LCAs are treated like partnerships. That means that LCAs are pass through entities. The members themselves are taxed as they would be in a partnership, and the institution is not taxed at that level.
Like the ULCAA, Washington’s LCA statute balances the potential for greater financial investments with the need to preserve the core characteristics of a traditional cooperative. The statute restricts investor-members’ profit allocations, presence on the board of directors, and voting power. LCAs are given some discretion in determining how limited the investor-members’ role will be, and whether or not to include investor-members at all. Overall, the statute leans more toward protecting the rights and powers of patron-members than opening the cooperative up to investors.