Introduction

Cooperatives are a unique business model, emphasizing democratic control, equitable distribution of benefits, and member participation. Within the cooperative world, two common structures are cooperative corporations (simply “cooperative(s)”) and limited cooperative associations (“LCA(s)”). While these two forms share fundamental principles, they contain key important differences in their legal frameworks and operational flexibility. This blog post will discuss cooperatives and LCAs each generally, before comparing these models and explaining when either form may be most useful. While the discussion of these models will be approached by considering Colorado law, many of these concepts will apply under the laws of other states. However, for further inquiries about how these concepts operate under the laws of other states, we recommend reviewing those other state laws or consulting with an attorney licensed in those states.

 

Cooperatives

Colorado has several statutes relating to the organization and operation of cooperatives, but the most commonly used statute is the Colorado Cooperative Act, Title 7, Article 56, a general cooperative statute.[1] Article 56 governs Cooperatives generally, including worker cooperatives, stock cooperatives or membership cooperatives, as well as standard purchasing and marketing cooperatives. The majority of cooperatives in Colorado have been formed under or converted to Article 56 cooperatives.

These cooperatives have members or patrons– persons who receive membership in the cooperative in exchange for a membership fee or purchase of stock, or who utilize the cooperative through the purchase or sale of goods or services to or from the cooperative (i.e., through “patronage”).[2] Members are the “owners” of the cooperative,[3] while patrons are the persons who utilize the cooperative but who are not necessarily members. There may be multiple and different types of classes of these members as well (such as producer, worker, vendor, and customer classes), but they all still must patronize the cooperative. Members participate in the cooperative’s governance (as discussed below), and while a cooperative may still issue or accept investments, those investments  will be in the form of nonvoting stock or equity.[4]

The governance structure in these cooperatives follows a democratic model, with members typically electing a board of directors to oversee strategic decisions and appointing executive management to handle day-to-day operations. Cooperatives typically follow a one-member-one-vote model, where each member has one vote for the larger organizational decisions outside of the day-to-day operations, regardless of their level of investment or patronage. Colorado law does, though, permit cooperatives to adopt proportional voting rights, allowing members more than one vote, which may be based upon their patronage with the cooperative, the amount of their patronage equity held in the cooperative, or any combination of these methods.[5] However, no member may be entitled to more than one vote in any case where the law specifically requires otherwise.[6] Regardless, the members (and not just the board) must vote on certain significant decisions for the cooperative, such as amending the articles of incorporation or bylaws, disposing of all of the cooperative’s assets, or merging or converting the cooperative into another entity.[7]

Although not required by law, cooperatives tend to adopt a democratic philosophy. Cooperatives should have a shared vision among the members with members working together toward advancing that vision. The cooperative may also adhere to the seven widely recognized Cooperative Principles.

Finally, cooperatives are mostly taxed as subchapter T corporations. When taxed in this way, income generated by cooperative members by or through the cooperative is not included as income at the cooperative level (rather, it is deducted by the cooperative from its income). The cooperative’s net margins (i.e., profits) created after deducting all expenses from income generated by members can be (but does not have to be) allocated to the members according to how much they have used the cooperative in the prior year. Any net margins not allocated to members go into a reserve account and are taxable at the cooperative level at corporate tax rates. Any income not generated by members (for example, rental income earned by the cooperative by renting space it owns to third parties) is taxed at corporate tax rates.

 

Limited Cooperative Associations (LCAs)

The Colorado Uniform Limited Cooperative Association Act, Title 7, Article 58 (“ULCAA”), is a hybrid statute combining standard cooperative principles with partnership and limited liability company principles, the result of which allows the creation of LCAs.  Many attributes of LCAs under the ULCAA are similar to those of cooperatives organized under Article 56. However, there are notable features specific to LCAs which permit a new type of membership and make the entity more attractive to outside investment.

One of the key characteristics of LCAs is that they may have two types of members: patron members (who are the same as members in cooperatives, explained above), and investor members. Patron members are those who are patronizing the cooperative by utilizing its services and being rewarded in proportion to their patronage in order to receive or retain their membership interest in the LCA, while investor members are either not permitted or not required by the articles of organization or bylaws to conduct patronage with the LCA as an investor member.[8] Rather, they are required to make a contribution to the LCA, and that is the basis of their membership and the benefits they receive.[9] Investor members, may, of course, also patronize the LCA through a joint membership as a patron member.

LCAs have a similar governance structure to cooperatives, except that the ULCAA takes into account the presence of investor members and works to balance the democratic principles of cooperatives (such as one-member-one-vote) with giving investor members a say in decision-making and the ability to share in profits and losses. However, investor members are not allowed to “take over” a cooperative, per statute. For example, if an LCA has both patron and investor members, then the total voting power of all patron members must not be less than a majority of the entire voting power (including patron and investor members entitled to vote).[10] Further, the ULCAA requires that if the LCA has investor members, approval by at least a majority of the voting patron members is needed to approve certain major decisions, such as amendments to articles or bylaws, dissolution, disposition of assets, conversion, or  merger of the LCA.[11]

Even though LCAs include investor members as well as patron members, LCAs may still be a good vehicle for the members to work toward advancing a collective vision, just like cooperatives. LCAs may adopt the seven cooperative principles, but like cooperatives, there is no requirement under Colorado law to adopt any specific principles or shared vision.

Finally, like cooperatives, LCAs may be taxed using subchapter T status. However, LCAs may instead want to take advantage of subchapter K tax status, also known as partnership taxation. Under this tax status, the LCA itself is not subject to income tax at the federal level, and instead, the income and losses are passed through to the owners, just like in many limited liability companies. While subchapter K is an option, it is harder to implement for some groups wanting to form a cooperative due to certain features such as limitations on unallocated reserves, and self-employment taxes.

 

Major Differences Between Cooperatives and LCAs

As alluded to above, the major difference between cooperatives and LCAs comes down to the inclusion of investor members. Notably, what makes the ULCAA different from cooperative statutes in Colorado (and other states) is the ability of a Colorado LCA to admit outside investors as members with voting rights and the potential for participation in guiding the direction of the company as well as the financial gains or losses from the operations of the LCA.  This is a significant change from traditional cooperatives, which typically only permit members to participate in the financial gains or losses of the entity based on the members’ patronage. For instance, an Article 56 cooperative may issue or accept investments in stock or equity that may have specific rights and preferences as provided in the articles or bylaws, but such stock or equity will not have voting rights.[12] By permitting voting rights to investor members, the LCA model allows these members to have a some say in the organization’s decision making, even if it is checked by the voting limits imposed by the ULCAA that protect patron members and the democratic bedrock of cooperatives.

Another major difference related to governance relates to composition of the board of directors. The ULCAA further protects patron members by requiring that a majority of the board of directors of an LCA must be elected exclusively by patron members.[13] Through these measures, in addition to requiring majority patron member approval for certain major decision in the LCA, investor members may still participate in the LCA’s management without the LCA compromising its cooperative principles.

 

Utilizing the Cooperative or LCA Model

Because the ULCAA is very flexible and may allow but does not require investor members, one could create an LCA that operates exactly as an Article 56 cooperative. So if that’s the case why might a group of founders want to choose one over the other? Why might they choose an LCA? When would an LCA or a cooperative be a better fit?

First, an LCA is attractive to potential investor members who want to support a worker-owned business or any member-owned business, but who also want a say in guiding the business since this may impact their investment. If a group wants to pursue a member-owned business model, but also wants, or plans, to leave the door open to outside investment, an LCA may be a better choice because it will be more attractive to investors who want voting rights while still sharing in gains or losses of the LCA. However, if the organization is not interested in seeking outside investment, and wants to focus solely on the presence and participation of patron members, then a traditional cooperative corporation model may be a better fit.

Second, while most states recognize cooperatives in some form, not all recognize LCAs. So if a Colorado entity will have a consistent business presence in other states, or even just hire employees in those other states, then the entity likely needs to be registered to do business in those states. Because LCAs are relatively new, a state (outside of Colorado) where the business will need to register itself may not have a statute that describes an entity like an LCA, or may not recognize the LCA as a business entity otherwise. For example, a state may have a cooperative statute, a limited liability company statute, and a corporation statute, but no LCA statute, whether in name or in function. Accordingly, it may be difficult to register the Colorado-formed LCA to do business in such a state because the state’s laws do not expressly label or recognize the LCA structure. Accordingly, an argument can be made for why an LCA may meet the definition of a “cooperative” or other entity under a state’s particular cooperative or other statute. But the discretion for whether an LCA qualifies under a given state statute is ultimately up to the state’s Secretary of State office and their decision makers.

 

Conclusion

While cooperatives and LCAs are very similar entity models, they differ in a few significant ways. And even though a Colorado LCA may be formed to function exactly like a cooperative, there are circumstances  where forming either a cooperative or an LCA will make more sense than using the other model. The major differences involve the possibility of investor members, and the most important factors affecting the entity decision involve investor presence and interstate operations.

Please note, this is not an exhaustive discussion of Colorado cooperatives and LCAs. The blog on our website contains various posts discussing the particulars and the operation of these entities, such as posts on patronage, financing/investment options, equity capital and income, and many more concepts. Organizations with questions about cooperatives or LCAs should reach out to an attorney before making any definitive decisions and may contact our firm directly.

[1] C.R.S. § 7–56–101- 901.

[2] C.R.S. § 7-56-103 (11) & (13).

[3] C.R.S. § 7-56-103 (11).

[4] C.R.S. § 7-56-301.

[5] C.R.S. § 7-56-305(3).

[6] Id.

[7] See C.R.S. §§ 7-56-202, -208, -602, -610, and -702.

[8] C.R.S. § 7-58-102.

[9] See id.

[10] See C.R.S. § 7-58-514.

[11] See C.R.S. §§ § 7-58-405, -1206, -1504, -1603, -1606.

[12] C.R.S. § 7-56-301(6).

[13] C.R.S. § 7-58-804.