Legal Issues in Phase I
what you need to know about incorporation, equity and
liability
Ben Sandel
(540)421-6976
Thane Joyal
(315)380-4522
BenSandel@cdsconsulting.coop
thanejoyal@cdsconsulting.coop
April 16, 2013
www.cdsconsulting.coop
Four Cornerstones in Three Stages
More information about the Four Cornerstones in Three Stages model
is available at:
http://cdsfood.coop/fourcorner
www.cdsconsulting.coop
Outline
Incorporation
– Why and How
– Paperwork basics (Articles, Bylaws)
Liability
Equity
Questions & discussion
Resources
www.cdsconsulting.coop
Incorporate sooner than later.
Why?
Mitigate or eliminate personal liability
Create your entity: A new business is a
“person”
– Eligible for Tax ID #
Commitment and action move the enterprise
forward
Develop early relationships with professionals
and others
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What form of Incorporation?
Cooperative Structure whenever possible
– This is a business, not a Non-Profit
– Operate as a co-op; organize as a co-op
– Tax advantages for cooperatives
– Carefully research new co-op forms
Next best is Corporate Structure
– Still operate as a co-op
– Consistent with business enterprise
– Many states this is the only option
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Where do we incorporate?
Preferably in Home State
– simplify capitalization strategy
Some states are more co-op friendly
– Do research your options
– Some co-ops choose out of state incorporation
despite complexity
Consider advocacy for better laws but don’t
delay your process
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What do we need?
Original Incorporators will sign Articles of
Incorporation
Articles of Incorporation establish the first Board
of Directors
Initial Bylaws usually are filed with Articles
Filing Fees typically are modest
Establish agent for service of process (often
Secretary of State)
Other details specific to state law
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So, what’s a Board?
The Board of Directors has a fiduciary
responsibility to the co-op
– Trust responsibility
• Duty of Care
• Duty of Loyalty
– Business judgement rule
• Decisions must be reasonable in light of
circumstances
• It is reasonable to rely on experts
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So what are bylaws?
Bylaws are the owners’ agreement with
the State of Incorporation
Basic lifecycle processes:
– Owner meetings
– Board composition, election
– Bylaw amendment process
– Capitalization information
– Dissolution process
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Initial Bylaws
Don’t give these short shrift!
Initial bylaws carefully done can be
adequate for years--in some cases for the
life of the co-op
Good templates exist: Use them!
• Fresh Start Bylaws Template
https://cdsconsulting.centraldesktop.com/cbld/file/12694422/
• FCI Legal Primer
http://www.foodcoopinitiative.coop/sites/default/files/LegalPrimer.pdf
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Bylaw Pitfalls: Watch Out!
Keep clear role delineation
– Avoid staff on board
– Avoid independent nominating committee
Maintain financing flexibility: keep options open
Address unclaimed equity
Allow board to amend bylaws with accountability
Allow board to remove a director for cause
Provide for extended balloting: decisions at owner
meetings should be advisory only
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A special note on quorums..
Be mindful of quorum and voting thresholds for decisions
by the board and decisions by members
Prevent overpowering by a vocal minority while
protecting broad participation
Distinguish certain decisions: ex: dissolution,
amendment of Articles of Incorporation
Imagine:
• 7 member board, quorum is 50%, 2/3 majority needed to remove a
member
• 4 members show up (quorum), 3 vote to remove others (2/3 majority)
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Liability Protection
Protect co-op and protect directors
Incorporation protects directors
– Generally no liability except where intentional wrongdoing
– Co-op’s failure to pay taxes can subject individuals to personal
liability
Best practices protect directors and the co-op
– Disclose conflicts within board
– Keep accurate records
– Use experts as customary (lawyers, accountants, general
managers)
www.cdsconsulting.coop
But we can’t afford a lawyer!
You can’t afford not to have a lawyer--they are insured!
Sometimes (not always) you get what you pay for
Co-op experience counts!
Ask for recommendations from existing co-ops
Ask for recommendations from consultants and professionals
Buy wisely: check references
– Is the attorney responsive? Work products reported timely?
– Is the work solid? Did clients need follow up of any kind?
Buy wisely: do your homework.
– Ask for a review of your drafts: is anything missing? Anything
there that isn’t consistent with State Law?
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Other notes on liability...
Directors and Officers Insurance provides
additional protection to Board
Board is the decision-maker: EVERYTHING the
co-op does is the board’s responsibility
– Have a governance system
– Show up and participate in meetings
– Keep good records. Keep good records.
Keep good records. I said, keep good records.
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Legal Aspects of Equity
Planning
Sources of Equity: Keep your Options
Open!
– Member paid in capital = member equity
• Refundable if co-op solvent
• But this WILL be spent--that’s what it’s for
• Thus, it is at risk
– Preferred shares, investor shares are treated
differently
• Securities laws can apply if not designed carefully
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More equity planning:
Include bylaw provisions for retaining patronage
dividends as capital
– important in mature co-ops
– start off right by creating expectation of patronage:
don’t use register discounts!
Include bylaw provisions to protect unclaimed
equity
– possible in most states
– valuable as owners move, lose touch, etc.
www.cdsconsulting.coop
Still More on Planning Equity:
Plan for any legal person to be members
(individuals, corporations, organizations)
Avoid household memberships.
– Stick to one member, one vote
– Promotes cooperative value of equity (in
the sense of parity, fairness)
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There will always be surprises...
Specific to State of Incorporation and
Structure, watch for:
–
–
–
–
Annual fees as income rather than equity
Statutory limits on member share price
Option for additional shares not “preferred”
Restricted to intra-state members until state
securities filings made
– Registration and approval required for all member
loans and preferred shares
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Cooperative Principles
1. Voluntary and Open Membership Cooperatives are voluntary organizations, open to all people able to use its
services and willing to accept the responsibilities of membership, without gender, social, racial, political or religious
discrimination.
2. Democratic Member Control Cooperatives are democratic organizations controlled by their members—those
who buy the goods or use the services of the cooperative—who actively participate in setting policies and making
decisions.
3. Members' Economic Participation Members contribute equally to, and democratically control, the capital of the
cooperative. This benefits members in proportion to the business they conduct with the cooperative rather than on
the capital invested.
4. Autonomy and Independence Cooperatives are autonomous, self-help organizations controlled by their
members. If the co-op enters into agreements with other organizations or raises capital from external sources, it is
done so based on terms that ensure democratic control by the members and maintains the cooperative’s autonomy.
5. Education, Training and Information Cooperatives provide education and training for members, elected
representatives, managers and employees so they can contribute effectively to the development of their cooperative.
Members also inform the general public about the nature and benefits of cooperatives.
6. Cooperation among Cooperatives Cooperatives serve their members most effectively and strengthen the
cooperative movement by working together through local, national, regional and international structures.
7. Concern for Community While focusing on member needs, cooperatives work for the sustainable development
of communities through policies and programs accepted by the members.
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The Madison Principles
Declare Conflicts of Interest: Cooperative developer subscribe to the highest level of ethics and shall declare any conflict of interest, real
or perceived, so that they can be a credible source of objective feedback and an articulate advocate of the project as needed.
Develop Co-ops Using Proven Models: There are essential development steps that must be taken in a critical path to success.
Facilitate the Goals of the Steering Committee: An enthusiastic group of local, trustworthy leaders is a prerequisite for providing technical
assistance. The effective cooperative developer nurtures that leadership by helping them shape a vision that will unite members and provide
ongoing training.
Use a Market Driven Approach: Cooperatives only work when they are market driven; the cooperative developer works to ensure that
accurate market projections precede other development steps.
Acknowledge the Importance of Member Involvement: Member control through a democratic process is essential for success. Success
also depends on the commitment of the members’ time, financial resources and loyalty to the cooperative.
Seek Tangible Benefits: There must be tangible benefits for members.
Steer Toward Revenue Generation: The cooperative’s products and services must generate sufficient revenue so the effort can be
financially self-sustaining. Provisions must be made to share any surplus equitably.
Honor Diversity: Each cooperative responds to its unique economic, social and cultural context; as a consequence, each cooperative is
different.
Make Co-op to Co-op Connections: Cooperative developers link emerging cooperatives with established cooperatives to facilitate mutual
communication and learning.
Promote Social and Economic Empowerment: Cooperatives are tools for development and promote social empowerment and economic
goals.
Understand that Cooperatives Work Everywhere: Applied appropriately, cooperatives have value to all population groups and for all
businesses and services in the public and private sectors.
Our Vision of the Cooperative Community Is Global: Opportunities for human cooperation exist throughout the world. Cooperative
development transcends national boundaries.
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Links to more resources
CBLD Startup Policy Template
https://cdsconsulting.centraldesktop.com/cbld/file/15334222/
CDS CC Fresh Start Bylaws Template
https://cdsconsulting.centraldesktop.com/cbld/file/12694422/
Food Co-op Initiative Resources Page http://www.foodcoopinitiative.coop/resources
CDS CC CBLD Library http://cdsconsulting.centraldesktop.com/cbld/doc/3154572
Roberts Rules of Order http://www.robertsrules.com
CDS Consulting Co-op Information for Startups http://www.cdsfood.coop/for-startups
Webinars for Startup Food Co-ops
http://cdsconsulting.centraldesktop.com/cbld/doc/5469096/w-Fc500WebinarArchives
www.cdsconsulting.coop
Thank you!
If you have questions or desire further information/support for your co-op about the
issues discussed today, please feel welcome to contact:
Ben Sandel
CDS Consulting Co-op
540-421-6976
BenSandel@cdsconsulting.coop
www.cdsconsulting.coop
Thane Joyal
CDS Consulting Co-op
315-380-4522
ThaneJoyal@cdsconsulting.coop