Basics of Forming and Maintaining Cooperatives in Maryland

This article provides an introduction to cooperatives, as well as an overview of the considerations involved in creating a cooperative. A cooperative is a business or nonprofit organization owned and operated by the people who either use or provide its services. Cooperatives exist in nearly every sector of the economy and employ millions of people each year.

What is a Cooperative?

A cooperative is a business or nonprofit organization owned and operated by the people who either use or provide its services. The people who own the cooperative are called “members.” Members can be the workers, producers, or consumers of the cooperative. Cooperatives exist in nearly every sector of the economy and employ millions of people each year. Common examples of cooperatives include credit unions, taxis, childcare, housecleaning, rural electric, health care, insurance, and farming.

Types of Cooperatives

There are many types of cooperatives. These include producer cooperatives, multi-stakeholder cooperatives, purchasing cooperatives, utility cooperatives, consumer cooperatives and worker cooperatives. Two of the most common types of cooperatives are consumer cooperatives and worker cooperatives.

Consumer cooperatives

Consumer cooperatives are enterprises that are owned by consumers who want to achieve better prices or quality in the goods or services they purchase.

Consumer cooperatives are typically democratically managed. Therefore, each member/consumer of the cooperative is allocated one vote.
As an example of how a consumer cooperative operates, picture a group of friends who enjoy eating cookies. They could create a consumer cooperative to purchase cookies collectively and obtain bulk discounts on cookies they purchase. Each member’s investment is measured by how many goods and services each buys from the cooperative.
Consumer cooperatives are located all over the world. Some of the most well-known consumer cooperatives include: REI, the largest American consumer cooperative specializing in outdoor sporting equipment; Co-op Kobe, the largest consumer cooperative in Japan with over 1.2 million members; and PCC, the largest consumer-owned food cooperative.
An example of a Maryland consumer cooperative is the Greenbelt CO-OP Supermarket and Pharmacy. Membership in this consumer cooperative provides shoppers the chance to share in the cooperative’s patronage refunds. A patronage refund is distributed to cooperative members when the business has a surplus (or profit) at the end of the year. It is usually distributed to the members based in direct proportion to a cooperative member’s patronage (or purchases) and is usually made up of patronage equity and store credit. More information about how Greenbelt CO-OP’s membership benefits and patronage refunds work is available on their website.

Worker-owned cooperatives

Worker-owned cooperatives are enterprises owned by the persons who perform the labor for the organization.

Individual worker ownership is a key element of the worker cooperative.
The cooperative’s members are generally very involved throughout the day-to-day operations of the business.
Although worker cooperatives are popular worldwide, they are just catching on in the United States.
Each member’s investment in the worker cooperative is measured by how much time he/she spends working for the cooperative or by the value of the work the member contributes to the cooperative.
Almost any business can be organized as a worker cooperative. Examples include restaurants, bakeries and retail stores.
Some well-known worker cooperatives are Equal Exchange headquartered in Massachusetts, a fair trade importer of chocolate and coffee and MONDRAGON Corporation located in Spain, one of the world’s largest worker cooperatives.
An example of a Maryland worker-owned cooperative is Glut Food Co-op. Glut is a worker-managed cooperative located in Mt. Rainier, Maryland that sells whole foods and other grocery store products.

Common Principles

Cooperatives generally share the following common principles:

Democratic Governance

Cooperatives generally have a one member, one vote rule. This is different from traditional business models, which often weight each owner’s vote by the amount of that person’s stake in the business. However, some cooperatives have an elected board of directors to oversee the day-to-day operations of the business, leaving strategic decisions to members as a whole.

Consensus Building

While each member has one vote, cooperatives encourage members to work with one another in their decision-making progress. If members want the cooperative to take a certain action, they must collaborate and gather most, if not, all members to agree.

Community-Centric

Most cooperatives have members from the same area. Because members live where they work, they are more likely to invest there. As cooperatives become a significant part of a community, they have less incentive to leave.

Member Satisfaction Superior to Capital

Cooperatives must earn a profit to survive as a business. However, a member's well-being is valued above earning more money. Many cooperatives have rules to keep the workplace fair and preserve the workers’ due process rights and safety.

Self-Determination

Members are more likely to invest their time and energy in the cooperative because they have input in its decisions and would share any wealth that comes from it. While traditional business models limit decision-making to senior leadership, cooperatives give each member a stake in its future.

Training

Cooperatives often have an apprenticeship or other training program that prepares new members to participate in the business. For cooperatives to survive, they must recruit, train, and continuously develop their members.

Open Membership

Cooperatives generally allow any person to join regardless of gender, race, religion, political, or social status. To become a member, many cooperatives require an entry-level training program, an initial capital investment, and final approval by the membership.

Forming a Cooperative

Any group interested in forming a cooperative must first make a series of important organizational decisions. The first is to determine under which legal structure the group will formalize and register with the government (i.e. organize or incorporate).

In Maryland, cooperatives may take several different forms.

A cooperative may choose to incorporate under the Maryland Consumer Cooperative Act if it plans to “engage in any lawful business to acquire, produce, manufacture, furnish, or distribute goods or services.”
Maryland cooperatives may also choose to organize themselves as a Limited Liability Company under the Maryland Limited Liability Act.
A cooperative may incorporate as a standard Corporation.

Factors to keep in mind when choosing a structure include:

the purpose of the cooperative,
the number of members,
the need for flexibility in adding and removing members, and
taxation.

Consider consulting with an attorney to determine the best legal structure for your cooperative.

Read the Law: Md. Code Ann., Corps. & Assns. Title 5, Subtitle 5a (Maryland Consumer Cooperative Act); Title 4a, Subtitle 2 (Limited Liability Company Act); Title 2, Subtitle 1 (Corporations in General)

Managing the Cooperative

Regardless of which legal structure the group chooses to organize or incorporate under, the group must adhere to the basic principles of cooperatives to be considered a cooperative. Therefore, the next organizational decision the group faces is how it will manage the newly formed cooperative.

The most basic principle of cooperatives requires that the entity be member-managed with each member having one vote.

Direct Democratic Process - Members vote regarding each organizational decision and the majority vote wins. Factors to consider with this option include: how often will members need to meet to vote on decisions, how many members must be present for a vote to take place, and what constitutes a majority.
Republican Structure - Each member votes for a subgroup of members to serve as representatives. The representatives are then responsible for making decisions for the organization as a whole.
Mixed Approach - A mix of both methods may also be used, allowing representatives to handle day-to-day managerial duties while requiring a direct democratic vote by all members for important organizational decisions.

Adding/Removing Members - After determining how the cooperative will be managed for the mutual benefit of all the members, consider how to add and remove members in the future. Many cooperatives require new members to “buy in,” making a monetary contribution to the cooperative prior to joining. Consider whether this membership fee will be returned if the member decides to later leave the cooperative.

Worker cooperatives may require that a prospective member work for the cooperative as an employee prior to joining the cooperative to ensure the prospective member will be a good fit. Worker cooperatives may also require a “buy in” before allowing a new member to join. Again, the cooperative should decide whether this fee will be returned if the member leaves. In addition, the cooperative should have a process in place that will allow it to remove (terminate) a member from the cooperative.

Taxing a Cooperative

The Internal Revenue Service provides special rules for taxing cooperatives under Subchapter T of the Internal Revenue Code. Under Subchapter T, a cooperative business is not taxed on income given to its owners through a patronage. A cooperative receives this special treatment so long as it has a method for paying patronage, even if patronage is not actually paid in a given year. (For cooperatives, distributions to owners are generally known as “patronage.” Patronage distributions are typically made when the cooperative’s board of directors, governing body, or membership determines that the cooperative has enough profits for the year to give excess to its owners.) Thus, cooperatives can benefit from the IRS's method of taxing the cooperative’s patronage. Also, certain cooperatives can be tax-exempt, such as certain types of farmers' and fruit growers' cooperatives.

The rules above apply to taxation from the Federal Government. In Maryland, a business entity is taxed as either a pass-through entity or a corporation. Therefore, any potential Maryland cooperative should seek the aid of a tax professional to determine their proper tax structure.

For those interested in learning more about the taxation of a cooperative, consider consulting with an attorney or tax professional that is familiar with cooperative businesses.

Read the Law: U.S. Code, Title 26, Chapter 1, Subchapter T - Cooperatives and Their Patrons

Source

Originally posted by Justin DeVault, Jordan Halle, Douglas Nivens, II, and Anna Sholl, Rule 16 Student Attorneys (Fall 2013), Community Development Clinic, University of Baltimore. Edited by PLL.