of directors of the association deems advisable, is then returned to the patrons of the association on the basis of the volume, or of the value, of the products each marketed through the association.92

It is apparent, therefore, that patronage refunds are a means of returning to patrons savings effected by cooperatives in marketing their products or purchasing their supplies. Manifestly, this is fundamental to cooperation, because there would be less incentive to cooperate if the savings effected in marketing expenses, or otherwise, could not be returned to patrons. Patronage refunds are based primarily upon products delivered and sold or upon purchases made and not upon the money invested.

The amount of the patronage refunds to which a patron is entitled is ascertained, by some associations, in substantially the following manner: The total amount available for distribution among the patrons at the end of the year or other period is determined. This amount is then divided by the volume of business handled by the association in terms, for instance, of cars, bushels, pounds, head, or the value of the product handled in dollars, or the amount paid to the association as handling charges. The figure thus found, when multiplied, for example, by the number of bushels handled for a given member, gives the amount of his patronage refund.93 In other associations the patronage refunds are ascertained by dividing the total amount available for distribution by the total sale price of the products handled and then multiplying the resulting percentage by the price received for the products of each patron.

Patronage refunds, it may be assumed, would not be paid in many instances if, at the time the members of an association delivered their products to it or at the time of their sale, the association knew the exact amount it would cost to market the products of its members and provide for expansion purposes. It is apparent that patronage refunds are the result of necessity, in many instances at least, and that they simply furnish a medium by which the undertaking of the association to operate on a cost basis, or as near thereto as possible, may be carried out.

A novel case involving patronage refunds arose in Kansas 94 in which the plaintiff, who was not only a farmer and a stockholder in the defendant corporation but was also engaged in the grain business, was held not to be entitled to patronage refunds on grain that he had purchased from the corporation, but that the other shareholder patrons were entitled to the amount involved. The statute of Kansas under which the elevator company was incorporated, provided that, after the payment of a fixed dividend upon stock, the remainder of its earnings should be prorated to its several stockholders upon the basis of their purchases or sales, or on both. The court was of the opinion that the purchase by the plaintiff of grain from the elevator on a commercial basis was not such a purchase as was contemplated by the statute and, hence, that he was not entitled to patronage refunds. The Grain Futures Act of September 21, 1922,95 provides that the Secretary of Agriculture may designate any board of trade as a "contract market,” if among other things—

the governing board thereof does not exclude from membership in, and all privileges on, such board of trade, any duly authorized representative of any lawfully formed and conducted cooperative association of producers having adequate financial re

92 Sometimes the distribution is only among patrons who are members. In such case, only that part of the distribution which represents the margins on the member business is a true patronage refund.

93 Mooney v. Farmers' Mercantile & Elevator Co., 138 Minn. 199, 164 N. W. 804. McClure v. Cooperative Elevator & Supply Co., 105 Kan. 91, 181 P. 573. 95 42 Stat. 998, 1000, 1001.

sponsibility which is engaged in cash grain business, if such association has complied, and agrees to comply, with such terms and conditions as are or may be imposed lawfully on other members of such board: Provided, That no rule of a contract market shall forbid or be construed to forbid the return on a patronage basis by such cooperative association to its bona fide members of moneys collected in excess of the expense of conducting the business of such association.

The Supreme Court of the United States, in passing upon and upholding the constitutionality of the Grain Futures Act,96 referred particularly to the paragraph of the statute in part quoted above and said:

Nor do we see why the requirement that the relation between them and this representative, looking to economy of participation on their part by a return of patronage dividends, should not be permissible because facilitating closer participation by the great body of producers in transactions of the Board which are of vital importance to them. It would seem to make for more careful supervision of those transactions in the national public interest in the free flow of interstate commerce.

97

The State of Kansas passed a statute 9 requiring boards of trade in that State which were not operating under the Federal Grain Futures Act to admit cooperatives. This act specifies that the making of refunds by a cooperative shall not be a cause for exclusion. This statute was passed upon and upheld by the Supreme Court of Kansas, and in the opinion the court said:

98

The sole objection is that plaintiff sees fit to distribute its profits in a manner objectionable to defendant. One is tempted to inquire: What concern is it of defendant what plaintiff does with its profits, whether it retains them for additional working capital, or disburses them to its stockholders? And if it does disburse them to its stockholders, why should defendant be concerned with the basis of such disbursement, so long as it is satisfactory to plaintiff and its stockholders, and in conformity with the statute under which it was created? It may be doubted whether plaintiff's method of disbursing profits is correctly construed as a violation of defendant's bylaws against rebating or refunding commissions.

The Packers and Stockyards Act, 1921,99 recognizes the right of cooperative livestock market agencies to pay patronage refunds to their producer members. This statute was upheld by the Supreme Court of the United States.1 The Robinson-Patman Act permits associations of producers or consumers to pay patronage refunds.2 In addition, there are certain other Federal statutes which recognize the right of cooperatives to pay patronage refunds.3

Where a marketing agreement obligated a grower to deliver a certain percentage of his products to an association and the bylaws provided that patronage refunds were payable only to those growers who fulfilled their marketing contracts, a grower who failed to deliver the required percentage of his crop was not entitled to receive a patronage refund.a

A nonmember patron of an association cannot compel it to pay him patronage refunds where its organization papers and procedure do not provide for doing so.5

96 Board of Trade of the City of Chicago v. Olsen, 262 U. S. 1, 43 S. Ct. 470, 67 L. Ed. 839.

97 Laws of Kansas 1925, ch. 6.

98 Farmers' Coop. Commission Co. v. Wichita Board of Trade, 121 Kan. 348, 246 P. 511, 513, 54 A. L. R. 295, writ of error dismissed in 275 U. S. 574, 48 S. Ct. 17, 72 L. Ed. 433.

99 42 Stat. 159, 7 U. S. C. A. 181.

1

Stafford v. Wallace, 258 U. S. 495, 42 S. Ct. 397, 66 L. Ed. 735, 23 A. L. R. 229.

2 Quality Bakers of America v. Federal Trade Commission, 114 F. 2d 393.

3 See Federal Statutes Mentioning Cooperatives, p. 247.

4

Rusconi v. California Fruit Exchange, 101 Cal. App. 750, 281 P. 84.

Farmers Truck Association v. Strawberry & Vegetable Auction, Inc., 163 So. 181 (La. App.).

In two cases decided by the Supreme Court of Arkansas, it was held that nonmember tenants and sharecroppers of a landlord member of a cooperative gin were entitled to a share of the patronage refunds paid by the gin to the landlord. Both suits were against the landlords, but the court lay great stress on the fact that the organization papers of the gin required it to treat all patrons, members and nonmembers, alike in the distribution of patronage refunds. The court said, in part:

The making of such payments results in a refixing and reduction of the original charge for ginning and a corresponding increase in the net proceeds derived from the sale of cotton. The fact that the legal title to the cotton was in appellant does not lessen his obligation to pay over to appellees one-half of such net proceeds under the terms of their contract. In the absence of a stipulation in the contract to the contrary, appellees were, therefore, entitled to share equally with appellant in the patronage payments;

* * *7

8

As pointed out in the discussion regarding the liability of associations for Federal income taxes an association cannot qualify for "exemption" unless it deals with nonmembers on the same basis as that on which it deals with members. If such an association pays patronage refunds to its members it must likewise pay such refunds to its nonmember patrons.

It is a fact frequently overlooked that virtually all persons who carry life insurance in a mutual company receive what amounts to patronage dividends or refunds." It is true that these dividends are not referred to as patronage dividends, but in essence they are practically the same thing. The undertaking of a mutual insurance company may be said to contemplate the furnishing of insurance on a basis that will enable it to meet all of its obligations, including current and prospective expenses incident to maintaining and operating the company. At the end of a year or other period it is the practice for mutual insurance companies to ascertain the amount of the items referred to (due consideration being given to the risks and hazards involved) and then to return to the patrons or policyholders sums of money called dividends which are based upon the amounts paid by the policyholders and found unnecessary for the purposes specified. An insurance company cannot determine in advance the precise amount which should be charged for insurance to cover the items in question, nor can a cooperative determine in advance the precise amount necessary to meet its expenses and any other necessary charges. The insurance companies charge enough for the insurance to cover all possible contingencies, with the idea of returning any surplus to policyholders at the end of a given period. Cooperatives follow a like practice.

It has been said that—

So-called dividends upon life insurance policies are not really "dividends," but are the return by a mutual company of the unearned portion of the premium for the past year, unearned because of saving in expected mortality, saving in expense loading, and increase in investment earnings over the expected 32 percent. To the extent of the combined savings due to these three elements, theoretically at least, the premiums paid in advance are regarded as having been excessive or unearned.1o

There is no magic or mystery about patronage refunds; they simply represent a practical means of achieving a given result, namely, the return to the members of an association of savings effected by it.

6

Houck v. Birmingham, 217 Ark. 449, 230 S. W. 2d 952; Collie v. Coleman, 223 Ark. 206, 265 S. W. 2d 515.

Houck v. Birmingham, supra, at 955.

8 See Federal Income Taxes, p. 195.

Williams v. Union Central Life Insurance Co., 291 U. S. 170, 54 S. Ct. 348,

78 L. Ed. 711, 92 A. L. R. 693.

10 Atlantic Life Insurance Company v. Pharr, 59 F. 2d 1024, 1026.

Inasmuch as the amount of patronage refunds arises either from "underpayments" by marketing cooperatives or "overpayments" to farm supply cooperatives, after operating costs and expenses have been deducted, it is clear that there is no basis for the payment of a patronage refund on account of current operations unless an association actually has a net margin available for distribution to its patrons. It should be remembered that directors of an association act at their peril in authorizing the payment of refunds of any character unless the facts justify doing so.11

At common law the declaration of a dividend, whether patronage or otherwise, is a matter for action by the board of directors and not by the stockholders.12 But bylaws could provide for referring this matter to the members.13

In the absence of specific agreement or conditions to the contrary, dividends, whether patronage or otherwise, do not constitute a liability of an association until declared.14 Following the declaration of a dividend it represents a debt of the corporation.

THE

15

Revolving-Fund Plan of Financing

HE problem of how equitably to capitalize a cooperative so that the capital furnished by a particular member will bear a direct relation to his patronage and ultimately will be returned to him is believed by many competent cooperative leaders to be solved best through use of the revolvingfund plan of financing.16

Many cooperatives have begun business with a small amount of capital, which has been gradually increased from deductions or savings without giving to the respective patrons a clearly defined contingent right with respect to the sums that each by reason of his patronage has provided. Frequently, the early patrons of an association are largely responsible for building up its capital, while those who later become its patrons are not required to make comparable investments therein. Such inequalities are avoided by the revolving-fund plan of financing.

Broadly speaking, this plan is one under which, after sufficient capital has been accumulated to justify doing so, money supplied by current patrons or others for capital purposes is used to retire the oldest outstanding investments of patrons or others in its revolving fund.

In marketing associations, under this plan, money for capital purposes is obtained principally from retains or deductions on a percentage or a unit basis, or from the sale of certificates of various kinds. In farm supply associations, the major part of the capital is usually obtained from savings. Such associations, instead of paying out patronage refunds in cash, pay them

11 Fawkes v. Farm Lands Investment Company, 112 Cal. App. 374, 297 P. 47; Ellis v. French-Canadian Cooperative Association, 189 Mass. 566, 76 N. E. 207; Towles v. South Carolina Produce Association, 187 S. C. 290, 197 S. E. 305; Doss v. Farmers Union Coop. Gin Co., 173 Okla. 70, 46 P. 2d 950.

12 Callaway v. Farmers Union Cooperative Association of Fairbury, 119 Neb. 1, 226 N. W. 802.

13 Ibid., No. 12.

14 Fruit Growers' Supply Company v. Commissioner, 56 F. 2d 90, affirming 21 B. T. A. 315.

15

II Fletcher CYCLOPEDIA CORPORATIONS, Perm. Ed., sec. 5365.

tives 5-6.

16 Sanders, S. D. "RETAINS" THAT NOBODY FEELS. 3 News for Farmer CooperaFarmer Coop. Serv., U. S. D. A. 1936; Sanders, S. D. ORGANIZING A FARMER'S COOPERATIVE. Farmer Coop. Serv., U. S. D. A. Circ. 18, 39 pp. 1956; Nieman, REVOLVING CAPITAL IN STOCK COOPERATIVE CORPORATIONS, 13 LAW & CONTEMPORARY PROBLEMS 393 (1948).

by offset against the obligation of each patron to invest in the capital of the association.17 The resulting investment is evidenced by stock, some form of certificate of interest, or a book credit.

The derivation of the name "revolving-fund plan" becomes more apparent when an association reaches the stage when the oldest investments of the patrons of previous years may be retired. It is only when an association reaches this stage that its revolving fund begins to revolve. Money which is thus furnished by the patrons of an association for capital purposes should be regarded by them as an investment in their own association and not as an additional expense. It cannot be overemphasized that it takes money to go into business. Farmers, when they form and operate a cooperative, are in business and should supply the required capital.

There is a wide latitude with respect to the terms and conditions which may be adopted for the revolving-fund plan of financing.

18

Accumulations or retains for capital purposes, under this plan of financing, should be at least recorded on the books of the association as credits in favor of the proper persons. Generally, associations issue certificates to evidence such funds. These certificates are sometimes referred to as "certificates of indebtedness," "revolving-fund certificates," "certificates of equity," or "certificates of interest." The terms and conditions of such certificates differ and the rights of the holders vary accordingly.

Some associations organized with capital stock issue "certificates of stock" to evidence investments that increase the revolving fund. From a legal standpoint there appears to be no reason why an association formed with capital stock, as well as one formed on a nonstock basis, may not issue certificates other than certificates of stock. If an association revolves its capital stock, at least one share of voting stock should be held at all times by producers who are to continue as members of the association. If an association is formed with common and preferred stock, the preferred may be revolved while the common-usually issued on the basis of one share to each producer-would not be affected.

If an association is to employ the revolving-fund plan of financing, its organization papers should clearly show how it is intended to function; nothing should be left to surmise or inference. If it is intended that interest be paid on such capital funds, definite provision should be made therefor. In some instances it is preferred to make the payment of interest optional with the board of directors and to provide only that interest may not exceed 6 percent per annum. It is believed that, as a rule, the certificates issued should not have due dates and should be subject to retirement only at the discretion of the board of directors. If such certificates have due dates, the status as capital of funds which they represent is at least somewhat impaired, because ordinarily a suit may be brought against the association by the holder of such a certificate just as in the case of any other legal claim. It is believed to be the better practice for an association to acquire and maintain contingency reserves for the purpose of "insuring" that certificates issued or credits given for funds obtained for capital purposes will remain

17 The practice of setting off the cooperative's obligation against the patron's obligation is frequently referred to as paying the net margins "in" stock or some other noncash form. The use of this "shorthand" way of speaking has tended to obscure the actual character of the transactions and the legal theory underlying them. It undoubtedly has contributed to some unsound analysis and thinking on the part of many people, especially those unfamiliar with the cooperative method of doing business. See, Nieman, MULTIPLE CONTRACTUAL ASPECTS OF COOPERATIVES' BYLAWS, 39 Minn. L. Rev. 136, 143 (1955).

18

For suggested forms of bylaw provisions, see pp. 317–325.