Wednesday, July 19, 2017
What Is a Cooperative Director’s Liability to Member-Shareholders and Others?
Many farmers and ranchers belong to one or more agricultural cooperatives, commonly referred to as co-ops. A co-op is a business entity that distributes its income to its members in accordance with a member's use of the co-op. Co-ops are designed to give farmers and ranchers the benefits of group action in the production and marketing of agricultural commodities, and in obtaining supplies and services.
A co-op is characterized by two levels of management – a board and a manager. The board of directors is the policymaking body and board members are elected from within the membership by members to represent them in overseeing the co-op's business affairs. The directors establish policy, report to members, give direction to the manager, and are accountable to the membership for their actions in conducting business affairs.
But, what are the responsibilities of the directors to the member-shareholders? That’s the focus of today’s post.
Co-op directors have the same fiduciary duties of obedience, loyalty and care that corporate directors have. Fiduciary duties are duties assigned to or incumbent upon someone who is a trustee or in a position of trust, such as a co-op director. The duty of obedience requires directors to comply with the provisions of the incorporating statute, articles of incorporation, bylaws, and all applicable local, state and federal laws. The duty of loyalty requires directors to act in good faith, and the duty of care requires directors to act with diligence, care and skill. Both the duty of loyalty and the duty of care are dependent upon the particular state's statutory or common law standard of director conduct.
Obedience to Articles of Incorporation, Bylaws, Statutes and Laws
Illegality. Directors engaging in an act, or permitting the co-op to engage in action, that violates the articles of incorporation, bylaws, state co-op statute, other state law, federal law, or public policy may incur liability for damages. Damages from such liability normally accrue only to the co-op. However, directors causing their co-op to engage in illegal actions may be personally liable for culpable mismanagement for violating their duty of care by failing to attend to co-op activities or neglecting their decisionmaking responsibilities.
Ultra Vires. Board of director actions that are not within the powers conferred by the co-op's articles or bylaws are “ultra vires.” When a director acts outside of the scope of authority as established in the co-op's articles, bylaws or applicable state statute to the injury of the co-op, the director may be liable to the co-op for the resulting damage. Directors may be liable for ultra vires acts both in jurisdictions that consider a co-op director to be a fiduciary or trustee and in jurisdictions that consider a co-op director to be an agent of the co-op. The non-timely return of member equities is a frequent subject for an allegation that the co-op has acted beyond the scope of its powers.
Fiduciary Duty of Obedience, Loyalty and Care
Co-op directors must discharge the duties of their respective positions in good faith. To satisfy the duty of obedience, a director must comply with the cooperative’s articles of formation, bylaws and all applicable local, state and federal laws. In general, good faith includes doing what is proper for the co-op, treating stockholders and patrons fairly, and protecting the shareholders’ investments in a diligent, careful and skillful manner. The duty of loyalty is the fiduciary duty that is most often litigated. The duty of loyalty requires directors to avoid conflicts of interest, not to take advantage of corporate opportunities for personal gain (such as self-dealing and insider trading), to treat the co-op and the shareholders fairly, and not to divulge privileged information.
Conflicts of Interest. A conflict of interest arises between a director and a co-op when a director has a material personal interest in a contract or transaction that either affects the co-op or includes the co-op as a party. In general, a director's duty of loyalty requires interested directors to disclose any conflict of interest between themselves and their co-op. Also, conflict issues may arise in situations involving capitalization of the cooperative, redemption rights of members and preferential treatment in insolvency. Major potential areas of conflict of interest include decisions involving director compensation, the payment of dividends, marketing and purchasing contracts, and whether a directorship position should also be taken with a second co-op or corporation.
Corporate Opportunities. A co-op director's duty of loyalty prevents a director from personally taking advantage of opportunities that would also be of value to the co-op unless the co-op chooses not to pursue the particular opportunity. This applies to business opportunities that the director learns about by reason of the director's position with the co-op. A director is liable if the director appropriated a business opportunity rightfully belonging to the co-op where there was also a violation of the director's fiduciary duty of loyalty in appropriating the opportunity.
Fairness. A director must act fairly when making decisions or taking actions that affect the competing interests of the co-op, its stockholders or patrons, or minority holders of co-op interests. Fairness may also involve the open and fair disclosure of information from both the co-op and its directors to the co-op and its directors, stockholders and patrons. In general, a co-op's bylaws are a contract between the members and the co-op which imposes on the board of directors an implied duty of good faith and fair dealing in its relationship with its members.
Co-op directors may breach their duty of fairness in providing for the payment of dividends to current members or in redeeming co-op equities of former members. But, this is largely a matter that is governed by state statute, and those statute vary widely on the manner in which retained equities must be returned to former members.
Where directors have the authority to either allocate net earnings as patronage refunds or pay dividends on preferred stock, the failure to pay dividends on stock could be unfair. The injustice arises because the preferred stockholder is not receiving any return on money invested in the co-op. Director discretion in the redemption of co-op retained equities also may be a breach of loyalty if the directors provide different treatment for different persons or classes of members or patrons. For example, some courts have ruled unfair a board of directors' refusal to redeem certificates when other certificates had been redeemed upon demand. See, e.g., Mitchellville Cooperative v. Indian Creek Corp., 469 N.W.2d 258 (Iowa 1991).
Confidentiality. The fiduciary relationship existing between a director and co-op includes the duty of confidentiality. This duty prohibits a director from disclosing privileged information. Lawsuits against directors for the breach of this duty are rare. The federal and state securities acts, with their strict provisions concerning the nondisclosure of certain information, constitute more demanding legislation which may affect the directors' duty of confidentiality.
Duty of Care
Co-op directors have a duty to act carefully in directing co-op affairs. In general, directors must use that degree of diligence, care and skill which an ordinarily prudent person would exercise under similar circumstances and in the same position. The facts and circumstances of each case determine how much care a director must use in fulfilling directorship responsibilities.
Attention to Co-op Matters. Directors must attend to co-op matters in a timely fashion. This duty requires directors to attend meetings, follow the articles and bylaws, be cognizant of the various laws affecting the co-op and comply with their provisions, appoint and supervise officers and employees, and perform any other matters that reasonably require the directors' attention. The main issue for consideration is the standard of attention required. Usually, this is determined by reference to a particular state's corporation laws.
Reliance on Officers and Employees. This duty concerns the ability of a director to rely on information, reports, statements or financial data prepared or presented by co-op officers or employees. Directors may not rely upon information from others unless the directors have first made a good faith inquiry into the accuracy and truthfulness of the information.
Delegation of Duties. The board of directors manages co-op affairs. Administrative functions are performed by the co-op's executives and managers. The board of directors should be able and willing to delegate duties to provide for the business operations of the co-op, but must have the authority to do so.
Decision Making—The Business Judgment Rule. The Business Judgment Rule is a defense that a director may assert against personal liability where the director has fulfilled the duty of care. If a board of directors decision proves to be unwise or unprofitable, the directors will not be personally liable unless the decision was not made on the basis of reasonable information or was made without any rational basis whatsoever. But, the rule does not protect the directors from liability for self-dealing, lack of knowledge and personal bias.
Common Law Liability
Fraud. Co-op members, or former members if the cause of action occurred during their membership, who are dissatisfied with the management of the co-op may institute an action against the co-op and its directors for fraud. For example, director action that conceals information that should be disclosed to co-op members constitutes fraud.
Conversion. Co-op directors may also be sued for conversion. Such examples may include approving chattel mortgages which result in the loss of members' property. The absence of director authorization or inaction involving a wrongful property transfer is a defense which may shield defendant directors from liability for conversion.
Tort. Corporate directors may also be sued in tort for personal injury or damages resulting from their negligent or intentional acts.
Corporate Waste. Co-op directors may also be sued for the waste of corporate assets. While courts generally do not interfere with directors' management of a co-op, one court stated that “directors will be held liable if they permit the funds of the corporation or the corporate property to be lost or wasted by their gross or culpable negligence.”
Nuisance. The directors of co-ops that create offensive odors, dust, noise or other pollution may be named in lawsuits brought by neighbors seeking to stop the offensive activity.
Co-ops play an important role in agriculture. Being a member of a co-op’s board is an important role, but along with it comes the responsibility to act in the best interest of co-op members.