Mutuals' Redeemable Shares Bill 2013: The Detail

On Monday afternoon Lord Naseby introduced a private members' bill in the House of Lords which will, if passed, be very helpful to co-ops, friendly societies and mutual insurers. It removes some of the technical legal obstacles that limit their use of shares to raise capital. This Bill lays the essential legal foundations to make capital more easily available to co-operatives, friendly societies and mutual insurers.

The Bill is a vital part of the improved legal infrastructure being developed for mutuals over the next year or two. That includes the new Co-operatives and Community Benefit Societies Bill, increased limit on withdrawable share holdings in and regulations to apply the administration procedure to those societies (Budget 2013 at para 2.260), commencement of the Co-operative and Community Benefit Societies and Credit Unions Act 2010, and the publication of new FCA Guidance. For more information on those developments download the mp3 and listen to my Co-operatives Fortnight Lecture and follow the slides for it.

The Bill also complements the valuable work of the Co-operatives UK and Locality  Community Shares Unit (funded by the UK Department for Communities and Local Government) which makes the use of IPS shares available as a concrete reality on the ground and promotes best practice and investor protection.

The Mutuals' Redeemable Shares Bill has been promoted by Mutuo and the information from them on it can be found here. The Co-op News has also given the new Bill considerable coverage.

To access a full copy of the Bill and follow its future progress go here.

This post explores the rationale and effect of the various clauses of the Bill as it stands at its First reading in the House of Lords. I must declare the interest that I took part in the initial drafting of this Bill on a paid basis for Mutuo through DWF LLP.

Why is the Mutuals Redeemable Shares Bill needed?

The Bill addresses a number of problems faced by different types of mutuals when it comes to using share capital to raise funds.

For friendly societies, it would for the first time permit societies registered as corporate bodies under the Friendly Societies Act 1992 to issue shares - see clauses 1(1) and 5.

For mutual insurers, it would allow those using either a company structure or a structure based on their own private Act of Parliament to issue shares - see clauses 1(1) & 5. Currently a company limited by guarantee, the structure used by some mutual insurance companies, may not have share capital if it was registered after 1980 - Companies Act 2006 s5

For industrial and provident societies, the problem is about the possibility of exit for holders of shares that are not defined as "withdrawable". Since  January 2012 when the limit on holdings of nonwithdrawable society shares was removed, there has been interest in exploring the use of such shares. However, it is likely that the old Company Law "Rule in Trevor v Whitworth" would apply to such shares to prevent their purchase or redemption by the society itself (see the Hayes vs Snaith debate for the arguments on this). That means that people holding non-withdrawable shares in societies need to transfer them to other people to recover their investment. That severely limits the effect of the liberalisation of the holding limit.

How The Mutuals' Redeemable Shares Bill would Work

Like the previous private members' Acts used to improve the law for co-operative or mutuals in the UK in 2002, 2003, 2007 and 2010, this Bill, if it becomes law, will empower HM Treasury to change existing legislation by the use of secondary legislation to permit the use of redeemable shares.

That means that if the Bill becomes Law, its effects will still depend on the preparation of one or more Statutory Instruments, consultation on them, and a resolution of each House of Parliament to approve them under the affirmative resolution procedure - clause 1(3). That will all take time.

The Nature of Redeemable Shares

The Bill proposes that redeemable shares in an IPS may be transferable but not withdrawable - clause 1(2)(a). That leaves the society's rules or the terms of issue to decide on the details of the rights attached to the share, subject to other provisions of the Bill, as long as the share is not withdrawable. That will permit the use of redeemable shares without limit on the value held. For friendly societies and mutual insurers, that question is left to the regulations to be issued by HMT to permit such shares - clause 1(2)(b) & (c).

When will it be possible to redeem the shares? That will be found in the terms of issue of the shares and there is flexibility about those terms. It can be a date fixed there, a date worked out as the terms provide, or a date chosen either by the mutual or the holder of the share - clause 2(1).

After redemption, there will have to be at least one share left which is neither withdrawable nor redeemable - clause 2(4). This reflects the equivalent Companies Act provision on redeemable shares and ensures that there will always be at least one share in the mutual which has not been redeemed.

Other terms of redeemable shares, e.g. par value, number issued, minimum and maximum holding, and detailed provisions for redemption, can be left to the mutual's board as long as either the mutual's constitution or a members' resolution allows that, otherwise the mutual's constitution must itself set out those terms - clause 3(1) to (4).

Protecting Mutuality

The decision on whether to issue redeemable shares will have to be to be made by members - the mutual's constitution must allow it and may restrict the use of them - clause 2(3) & (4). That means the members will have to decide whether or not to allow their use and can define the limits within which they can be issued. This protects basic member control.

In addition, the Bill requires that redeemable shares:

    
• are held only by members

    
• entitle the member to only one vote regardless of how many shares they hold

    
• only give the holder a level of return allowed by the constitution of the mutual

    
• can be redeemed only at nominal (par) value with no other bonus or right to participate in surplus

- Clause 1(2)(d)

The Bill also prevents the use of redeemable shares for demutualisation. It limits the voting rights of anyone who gains membership only by holding a redeemable share as they cannot propose or vote on a resolution to convert the mutual into a company - clause 4. So even the one vote the member has cannot be used in that way. On the other hand, a user-member of the mutual who happens to hold a redeemable share will still be able to use their single vote on any demutualisation proposal.

Protecting Creditors

The basis for the Rule in Trevor v Whitworth that  prevents corporate bodies from buying back or redeeming their own shares is creditor protection. People who lend or give credit to companies and other corporate bodies, whose owner-members have limited liability for business debts, take the risk of business failure. However, if that happens and the business is wound up, there is a clear order of priority among the creditors for a share of the remaining assets. The rights of holders of shares are postponed and they get nothing until all the debts and costs of the insolvency process have been paid. If the company buys back its shares or redeems them and then is wound up the holders of shares may have jumped the queue. as a result the courts refused to allow companies to do that.

Over the years, parliament relaxed that rule and the current position is that, so long as certain procedural safeguards and rules about funding the redemption or buy back are observed, a buy back or redemption of shares is allowed. Those safeguards can be found in sections 658-737 of the Companies Act 2006.

Broadly, the redemption or purchase must be out of distributable profits or the proceeds of a new share issue. However, in the case of a private company, if sufficient funds are not available from those sources, shares may be redeemed out of capital, as long as the directors and auditors formally report on the solvency of the company, the redemption is approved by a special resolution and public notice is given of the redemption out of capital. It is then open to any shareholder who voted against the resolution or any creditor to apply to the court for the resolution to be cancelled.

Clause 3(5) of the Mutuals' Redeemable Shares Bill 2013 allows regulations to apply the same protections where redeemable shares are issued by mutuals.

A Vital Development

We must hope that this Bill succeeds in its passage through the two Houses of Parliament despite being a private members' bill.

It deals with a basic legal problem for co-operatives and bencoms and extends the ability of friendly societies and mutual insurers to raise capital. It also represents an important level of co-operation between those different but related mutual sectors. It's important that everyone rallies in support of it.

So write to your MP to support it.

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Protect the "Co-operative" Name - contact BIS by 22.05.13

It is vital that everyone supports Co-operatives UK's campaign on the Government's proposal to remove the current protection for the use of the word “Co-operative” in the name of a company, LLP, sole trader, limited partnership, or unregistered general partnership. Do that by sending your opinion BY 22^nd May 2013 to catherine.crowsley@bis.gsi.gov.uk

It may be helpful to give some of the technical legal background to the proposal here and to explain its importance to UK co-operatives.

Co-operatives UK's excellent response  to the consultation provides practical evidence and coherent and convincing arguments against the change mooted by the government. I support that 100%. This short post elaborates the background and some of the arguments to complement the Co-operatives UK response.

Why Is Protection Needed?

In the UK legal system there is no requirement for co-operatives to use any particular business structure. Many co-ops use a society registered under the Industrial and Provident Societies Acts 1965 to 2003 (IPSA's) - soon to be renamed Co-operative or Community Benefit Societies Acts. But many co-ops use registered companies and limited liability partnerships because they find them more convenient. It is also possible for co-ops to use a limited partnership registered under the Limited Partnerships Act 1907 or an unregistered general partnership governed by the Partnership Act 1890 for a co-operative, although this is less common due to problems with liability in those cases. While a co-op cannot, by definition, be a sole trader, protection of the name against abuse by sole traders is important.

This freedom to choose any business structure arises from our liberal tradition of business law and has advantages. It allows flexibility and the development of new co-op businesses and initiatives without the constraint of one rigid legal straitjacket. On the other hand, as the whole concept of a co-operative is based on values and principles, some protection of their identity is needed.

The FCA Mutual Registrations team require that any society registered as a co-op under the IPSA's, meets the ICA definition. In the case of other business structures, protection against misuse of the name “co-operative” depends on the legislation now being reviewed by the Department for Business Innovation and Skills (BIS).

These protections are vital to ensure that the public are not misled into believing that they are dealing with a co-operative when they are not. They also prevent the co-operative idea from being tarnished by fraud and abuse.

How Does the Current Protection Work?

The regulation of words used in business names is governed by the Companies Act 2006 and regulations made under it. However, the protection extends to all business structures and not just to companies. How does this work?

Section 55  and Part 41  of the 2006 Act set the system up.

Section 55 requires permission from the Secretary of State (in practice Companies House) for the use of certain words in company or LLP names- See reg 2 of SI 2009/2615  for the application of this to LLP's.

Sections 1192 and 1194 require the same permission for any of those words to be used to carry on business in an unregistered or limited partnership or as a sole trader. They make it a criminal offence for anyone to do that in the UK.

Under The Company, Limited Liability Partnership and Business Names (Sensitive Words and Expressions) Regulations 2009 SI 2009/2615the word “co-operative” is protected from use in a company name, an LLP name, or to carry on business using any unregistered structure.

What Change is Proposed?

The current consultation by the Department for Business Innovation and Skills (BIS) questions whether any of the names on the list in those regulations should remain protected.

It does this by asking whether regulations are necessary at all and, if so, whether they can be “reduced, simplified or improved”.

Why Does it Matter?

In paragraph 39 of the consultation document the rationale for the protection is set out:

“39. All the words specified as “sensitive” and listed in Schedule 1 of SI 2009/2615 (see Annex A) were included to protect the public from being misled by a business’ name as to either its status or the nature of its businesses activities (e.g. charity, co-operative, Institute). However, as language evolves words, which may have been considered worthy of protection at the time, may no longer be considered such a risk”

In paragraph 52 certain names are suggested as being particularly in need of protection:

“52. Those which appear to be particularly important to protect include: Accredited, Bank, Charity, Institute, Insurance, Police and University. Misuse of these words poses a high risk to the general public.”

The internationally accepted ICA Statement of Co-operative Values and Identity  gives a clear focus for the meaning of the word “co-operative” and clear criteria against which to judge a business or person seeking to use the name.

The misuse of the word “co-operative” leads to similar risks to the misuse of the words listed in paragraph 52 (above) of the BIS document.

People may well wish to trade with a firm because it is a co-operative and because the name implies certain standards of behaviour and an ownership structure which protects and facilitates that. For legal structures other than industrial and provident societies, there is no other agency or government body that provides that assurance so the preservation of this protection is essential.

The use of the name is not restricted in the IPSA's because the flexibility to use a range of business structures for co-operatives is beneficial. In addition, to impose such a restriction, primary legislation would be required. Such a change would not amount to a consolidation so it could be achieved as part of the current Law Commission and HMT project.

If the regulations are to be removed or reduced radically, it is essential that protection is retained for the word “co-operative – and extension to the words “coop” and “co-op” is desirable.

Maybe the function could be removed from BIS to the FCA which carries out the same role for societies, or to Co-operatives UK as the custodian of co-operative values in the UK.  However, that would be unlikely to reduce red tape as a different government body would be involved in the process on the registration of a company or LLP and in prosecuting for violations by sole traders or unlimited and limited partnerships.

It makes sense for the function of approving the name to remain with the body involved in company and LLP registrations and for the prosecuting function to stay with the same body.

UK International Obligations

The International labour Organisation in its Recommendation 193 of 2002 makes clear the expectation that states who have signed up to the ILO Convention will promote co-operatives. That applies to the UK.

Paragraph 7(2) of the recommendation provides that:

"Cooperatives should be treated in accordance with national law and practice and on terms no less favourable than those accorded to other forms of enterprise and social organization."

To fail to protect the identity of co-operatives taking advantage of the flexible system of business structures in the UK would fail to meet that requirement.

Under paragraph 10 states are to adopt  legislation and regulations on cooperatives guided by the cooperative values and principles. The removal of the protection afforded by the UK Business Names rules would fail to do that.

Given that governments are also urged in paragraph 10 "to consult cooperative organizations in the formulation and revision of legislation, policies and regulations applicable to cooperatives", the submission of Co-operatives UK should carry particular weight.

As a member state of the European Union, the UK should also have regard to the European Commission's Communication of 23rd  23.02.2004 (COM(2004)18) on the Promotion of Co-operative Societies in Europe. In paragraph 3.2.4. the Commission emphasises the importance of  the co-operative definition, values and principles set out by the International Cooperative Alliance (ICA) in 1995, and refers to their endorsement by the UN and the ILO. It goes on the state:

"Consequently national legislators should be based on the co-operative definition, values and principles when drafting new laws governing co-operatives. In this context however Member States  are required also to be sufficiently flexible in order to enable co-operatives to compete effectively in their markets and on equal terms with other forms of enterprise."

That Communication has been endorsed and applied by the European Court of Justice.

This all shows that the removal of the protection of the word "co-operative" would be a violation of the principles expressed by the EU, the ILO and the UN. This adds weight to the campaign on this issue.

What To Do

You can help :

• Check out the Co-operatives UK draft response  and
• email your own to catherine.crowsley@bis.gsi.gov.uk 
• Write to your MP

BY 22^nd MAY 2013

© Ian Snaith 2013 This work is licensed under the Creative Commons Attribution-NonCommercial-Noderivs 2.0 England and Wales Licence. To view a copy of this licence visit http://creativecommons.org/licenses/by-nc-nd/2.0/uk/ or send a letter to Creative Commons, 559 Nathan Abbott Way, Stanford, California 94305, USA

Changes for Co-ops and Bencoms from April 1st

Among co-ops, the Financial Services Act 2012 will have the biggest impact on credit unions. Most of their regulation moves to the Prudential Regulation Authority on 1st April 2013 - see my last post.

However, other industrial and provident societies may see some changes on or after 1st April 2013. That may happen for two reasons:

• the move of the registration role to the Financial Conduct Authority (FCA) on 1st April 2013 and
• the implementation (whenever that happens) of section 1 of the Co-operative and Community Benefit Societies and Credit Unions Act 2010.

Clearer Regulatory Role for the FCA and nature of Its Guidance

In general, the draft Mutual Societies Order simply transfers the functions of registering societies under the Industrial and Provident Societies Act 1965 to the FCA with a possible role for the PRA where necessary -see Schedules 2 to 4 of the Draft Order. However, Schedule 1 of the Draft Order makes two interesting changes.

Paragraph 4(1) of the Schedule provides:

"The FCA must maintain arrangements designed to enable it to determine whether persons are complying with requirements imposed on them by or under the mutuals legislation"

That imposes a legal duty on the FCA to have systems in place to police whether or not people (and societies) are complying with  requirements imposed on them by or under the "mutuals legislation". That expression includes the Industrial and Provident Societies Acts - see   para 1 of Schedule 1 of the Draft Order and section 50(2) of the Financial Services Act 2012 (which was the old clause 47(2) when the Draft order was written).

One of the requirements imposed on every society "by or under" that legislation is that, while they are registered, they should be either a bona fide co-operative or a community benefit society.

So, if the Mutuals Order is enacted as drafted, there will be an explicit legal duty for the FCA to "maintain arrangements" to make sure that is the case. That requires systems to ensure that on registration and while registered societies comply with those requirements so that, if they don't, their registration can be cancelled under the mutuals legislation.

Resources will have to be found by the FCA to operate that system and there will no longer be any ambiguity about their role. They are a registrar of co-operatives and bencoms and that involves more  scrutiny than is needed to register a non-CIC company and keep it on the register.

So how will the FCA decide who meets those requirements? They already publish some guidance together with the application form for registration - see pages 8-9 here. They have already taken legal advice and consulted on the advice and its suggested guidance and work continues on that.

While the content of future Guidance will be subject to further work and more consultation, the Draft Order makes it clear beyond doubt that FCA Guidance about mutuals is Guidance under the amended Financial Services and Markets Act 2000 and not just information provided under the mutuals legislation -see paragraph 2(2)(f) of the Draft Order and section 139A of FSMA 2000 to substituted in the 2000 Act by section 24(1) of the Financial Services Act 2012.

This does not impose the full panoply of formal consultation applicable to Guidance given to regulated persons in the financial services sector. But it does give the Guidance a more formal status than the present brief note to an application form. Interestingly, it also places beyond doubt the power of the FCA to pay other persons or organisations to give the guidance on its behalf - see new section 139A(2) of the amended FSMA 2000.

This means that the role of the FCA as the UK body making sure the society structure is only used by bona fide co-operatives or bencoms will have a firmer legal footing from 1st April 2013. It is  legally required carry out that function effectively.

Implementation of ss 1 and 2 of the 2010 Act

It is not clear when this will happen. It ought to happen by 1st April 2013. When it does, two important changes will be put in place.

One is that societies will formally, legally and for all purposes be known as co-operative or community benefit societies and not industrial and provident societies. Section 2 of the Act will achieve that.

The other is that any society which is registered will be registered formally and officially as EITHER a co-operative or a bencom.

Up to now, as long as a society met the criteria for one of these categories, it would be registered and there was room for some uncertainty or ambiguity about which category it was in at the time. Section 1 of the 2010 Act will amend industrial and provident society legislation with effect from the time of the amendment to make the basis of registration in one category or the other clear.

This, like the more formal legal status of Guidance on the criteria for these categories, makes clarity about the nature and role of the organisation vital.

Both of these developments bolster the role of the FCA as registrar and assist in protecting the "brand". The registration of phoney co-operatives or bencoms should be harder. Continued compliance with the registration conditions to avoid cancellation of registration is just as important.

Finally, when will this happen? In March this year, the Law Commission plans to provide a "draft Co-operative and Public (sic) Benefit Societies Bill to HMT" - see page 11 of this business plan. Will the 2010 Bill's implementation have to wait until parliament passes that new consolidating Bill?

Surely, it makes much more sense for sections 1 and 2 of the 2010 Act to be effective  on 1st April 2013 to coincide with the implementation of the Financial Services Act 2012 and a Mutual Societies Order made under it?

Why Theory Matters - even to lawyers

A thoughtful analysis of the effect of the history of co-operative law in the UK on the way co-operatives see themselves and function has recently been published by Tara Mulqueen of Birkbeck College London:
Tara Mulqueen, "When a business isn't a business: law and the political in the history of the United Kingdom's co-operative movement" Onati Socio-Legal Series v 2 n. 2 (2012)

Tara argues, essentially, that the corporate status of co-operatives in law has tended to move them away from the possibility of social transformation. Over the nineteenth and twentieth century, the emphasis moved to their role as businesses in a capitalist market place. Their potential to reshape the social interaction between people by operating on the basis of community and showing what could exist if the economy were organised differently was underemphsised. They were, she argues, depoliticised by being defined "primarily in commercial terms as corporate bodies" (p40).

The paper looks at the idea of community from a theoretical point of view and highlights the writers who argue the emptiness of its modern use in the phrases such as "the business community" or the "national community". Co-operative history is based in the early nineteenth century sense of community as a distinct grouping depending on mutuality. Robert Owen's Co-operative Communities and the idea of mutuality as a vision of "fully liberated humanity" contrasted with the competitive market system was critical and subversive. Retail and the divi were less subversive.

The corporate status of societies as singular legal entities, the paper argues, tended to marginalise the idea of co-operatives as a group of individuals who came together for mutual aid. The example of the changing position on the taxation of societies from the period of the Ritchie Committee in 1905 to the 1980's is an interesting example explored in the paper. Are co-operatives to be seen as business structures or "as alternative forms of association which have the potential to open our thinking about the very organisation of the economy and to merge the economic, the political and the social"? that is the point posed in the conclusion of the paper and it goes to the core of one of the dilemmas faced by co-operatives.

Reading Tara's paper brought home to me the importance of the history of the legal developments. That is especially true in areas such as tax, where the pressure from other businesses to deprive co-operatives of what were seen as "unfair" advantages was important - and maybe still is. Maybe this is what our continental legal colleagues mean when they refer to the double identity of the owning group as an association and operating it as a business. Common lawyers tend to ignore such theoretical issues but that has its dangers. The Law affects and influences the way we all see things. It contributes to the radicalisation or de-radicalisation of people. It forms society and ways of thinking as well as regulating activities. Our legal assumptions can blind us to other ways of seeing things and, especially in the Common Law tradition, make pragmatists and formalists of us.

We are, as Keynes said of theory in the economic context:

"ruled by little else. Practical men who believe themselves to be quite exempt from any intellectual influence are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air,are distilling their frenzy from some academic scribbler of a few years back." 

J. M Keynes, General Theory (1947 ed.) Ch 24 from Angela Partington (ed.) Oxford Dictionary of Quotations 4th Ed 1992 p395

So "academic scribbling" has its value after all. It can take us outside our usual way of thinking and remind us of the ideals that lie behind co-operatives and the possibility of social change that they demonstrate.
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Advice to FSA on New Registration Guidance

From the Autumn of 2011 until March 2012 I was involved, as part of a team in Cobbetts LLP in developing advice for the FSA on the registration requirements for co-operatives and community benefit societies. Those involved were Michael Cook and Ramona Taylor of the FSA, and Kevin Jaquiss, Cliff Mills and Ian Snaith of Cobbetts LLP. On 27th February 2012 a consultation meeting on the opinion and linked matrix about financial services regulation was held at Cobbetts LLP. The meeting was attended by a representatives of a wide range of co-operative and social enterprise bodies and advisors, invited by the FSA. Here is the advice and here is the matrix put online at the request of Michael Cook.

It will be interesting to see what the next stage of this process will be from the FSA which is currently undergoing substantial reorganisation in readiness for the changes in the Financial Services Bill 2012 and the draft regulations referred to here.

© Ian Snaith 2012 This work is licensed under the Creative Commons Attribution-NonCommercial-Noderivs 2.0 England and Wales Licence. To view a copy of this licence visit http://creativecommons.org/licenses/by-nc-nd/2.0/uk/ or send a letter to Creative Commons, 559 Nathan Abbott Way, Stanford, California 94305, USA

Co-op Law Consolidation: Where is it now?

The project to consolidate the legislation for co-operatives and community benefit societies in the UK still seems to be at the stage of a brief being drafted by HM Treasury for the Law Commission. As of today I could find nothing on the English Law Commission website or the HM Treasury website.There was an estimate in the March report of Co-operatives UK's management to its board that once the Law Commissions are briefed it will take 9 months to achieve the drafting of the consolidated statute.  Then it has to be reviewed by the appropriate Parliamentary Committee and passed. Could be a  long job........

© Ian Snaith 2012 This work is licensed under the Creative Commons Attribution-NonCommercial-Noderivs 2.0 England and Wales Licence. To view a copy of this licence visit http://creativecommons.org/licenses/by-nc-nd/2.0/uk/ or send a letter to Creative Commons, 559 Nathan Abbott Way, Stanford, California 94305, USA

Thoughts on European Court 2011 Co-op Case

The Narrow Specifics

In terms of its strict legal effects, Joined Cases C-78/08 to C-80/08 Ministero dell’Economia e delle Finanze v Paint Graphos Sarl are very narrow. It deals with one particular aspect of the EU State Aids regime. The choice about whether to provide tax benefits or other assistance for co-operatives is one for national governments. The role of EU Law is only to deal with any potential distortion of competition that may be involved in such a national rule. This case provides guidance about how that EU regime should be applied if states do choose to provide such support for co-operatives on the basis of their business structure.

However, within that narrow scope the case does recognise particular features of those co-operatives which lock assets in to the society and prevent any distribution to members. Such co-operatives may be provided with tax concessions as far as the State Aid rules are concerned - as long as they are genuine.

It is less clear how far this would extend to other types of co-operative. The Italian tax provisions required that a certain proportion of transactions must be with members. Is this a necessary condition for the tax benefit to be justified or is it enough that the return on capital is limited so that it becomes more difficult to raise funds and impossible to make much use of the equity markets?

The answer appears to lie in the two sources consulted by the court in reaching its decision. They are the Commission Communication of 2004 and the Preamble to the SCE regulation. The wider implications of the case for the existence or development of a specifically European Co-operative Law hinge on the importance attached by the court to those two documents.

The Key Co-op Features defined in the case

In its judgment the ECJ listed a number of features of co-operatives which led it to see them as distinct from other economic operators due to low profit margins and limited access to capital markets (paragraphs 55 to 59):

• The principle of the primacy of the individual as stated in recital 8 of the Preamble to the SCE Regulation

• Distribution of assets on winding up to another co-operative pursuing “similar general interest purposes”

• Management in interests other than those of outside investors

• One member one vote

• Reserves and assets commonly held and not distributable but dedicated to the common interest of members

• Activities conducted for the mutual benefit of members as users, customers, or suppliers so that benefit goes to each member in accordance with his participation in co-op activities and transactions with it

• Payment of limited interest on loan and share capital.

This suggests there are some co-operatives which meet the definition for registration in national co-operative law and fall within the ICA statement of Values and Principles but do not meet the conditions laid down in this judgment.

It is important to recognise the context of the judgment to decide how it might affect any state tax benefits or other assistance provided to co-operatives. Since the purpose of the State Aid rules is to prevent the distortion of competition in the EU, it is necessary to find some disadvantage or problem which justifies more favourable treatment for co-operatives which then has to be proportionate to the problems they face. The ECJ identified the obvious and central issue which is the difficulty in raising capital.

That mainly arises, as the court suggested, from the vesting of control in individuals equally and not according to capital contribution as in investor controlled companies. The principle that capital should enjoy a limited return rather than a right to the whole of any surplus on dissolution or by way of periodic distribution of profits is also crucial to the problems co-ops have in raising capital. Those features generally prevent the use of the capital markets and can justify some countervailing assistance without distorting competition.

However, it is less clear that it is necessary to prevent all distributions of assets or surplus to members on dissolution. Surely, a distribution to members in accordance with their transactions over a particular period (fixed by the rules) before the winding up would be sufficient? Such a provision would sever the link between the level of investment and the return to the member just as a patronage refund from a periodic surplus on trading does?

It seems that the court's inclusion of the “disinterested distribution” on winding up requirement comes from the Preamble to the SCE regulation and the Commission Communication rather than the logic of the argument about lack of access to capital markets.

In that sense, one can argue that state aids might be justifiable in EU Law for a wider range of co-ops as long as the ECJ relied on the logic of market disadvantage and did not slavishly follow the Commission Communication and the SCE Regulation Preamble which had their own contexts and purposes.

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European Court Recognises Co-op Business Structure: The Judgment

In a judgment of 8th September 2011 the European Court of Justice recognised the distinctive nature of co-operatives and their difference from other businesses - see Joined Cases C-78/08 to C-80/08 Ministero dell’Economia e delle Finanze v Paint Graphos Sarl

In this post I'll give an outline of the case and the text of the relevant part of the judgment. In the next post I'll discuss the implications of the case.

The case concerned the famous tax concessions available in Italy for co-operatives but dealt with them as they stood between 1984 and 1993. Those tax breaks included exemption from local income tax for agricultural and small-scale fishery co-ops and workers' and producers' co-ops; reductions in corporation tax for co-ops and an exemption for worker's co-ops.

The benefits depended on co-ops having full mutuality with undistributable reserves locked in and impossible to distribute to members either during the co-op's life or on its dissolution.

The disputes in the case involved allegations by the tax authorities that the conditions requiring mutuality had been breached by these particular co-ops so that no tax exemptions should be allowed.

The cases had been within the Italian national court system for up to 18 years. They reached the European Court of Justice by a reference from the highest Italian court, the Corte suprema di cassazione. The reference by the Italian court was under Article 234 of the EC Treaty on the question of whether the tax concessions for co-ops under Italian Law were compatible with EU Law or amounted to unlawful state aids from the Italian Government contrary to Articles 87 and 88 of the EC Treaty.

As article 234 EC provides, the European Court of Justice gave an opinion on EU Law to help the national court to decide the case.

The European Court's decision focused on the 3 conditions that all have to be satisfied before a national tax break or other state measure amounts to a state aid:

• Is it financed by state resources?
• Does it affect trade between member states and distort competition?
• Is it "selective"?

Unsurprisingly, the court found that a tax break is financed by the state - see paragraphs 44 to 47.

The test about the effect on trade and distortion of competition is easy to pass. There is no need for the business in question to be involved in international trade and it is enough to show that the aid could affect trade and competition. It need not actually do so. So the court found that these tax breaks passed that test - see paragraphs 77 to 82.

That left the issue of "selectivity". The court's case law lays down that, in the case of a tax measure, it has to be compared with the country's "normal" or "common" tax regime. This is done to decide whether the measure in question discriminates between economic operators who are actually in a comparable factual and legal situation given the objective of the national tax system. Here the use of net profit to assess corporation tax applied to the co-ops and to other firms but the co-ops had the benefit of exemptions not available to other firms because of their legal form. So the question was whether the co-ops were in "a comparable factual and legal situation" to the other firms.

The Court ruled that in principle they were not in a comparable situation and so the tax exemptions could be justified. This was because they operated for the mutual benefit of their members who are users, suppliers, or employees who benefit in proportion to their transactions with the co-op. In addition, the co-ops' limited access to equity markets and the limited return offered on share and loan capital make it harder for them to raise capital. The lower profit margin that flows from those characteristics makes their position not comparable with that of commercial companies - ECJ judgment paras 55-61 (below).

However, societies which do not "truly pursue an objective based on mutuality" in accordance with the EU Commission Recommendation on the promotion of cooperative societies in Europe of 23rd February 2004 COM (2004) 18 final would be treated differently and might be regarded as being comparable to commercial companies so that any tax benefit could amount to a state aid - ECJ judgment para 62 (below).

Text of Relevant Paragraphs of the Judgment:

"55 Cooperative societies, the form taken by the legal entities at issue in the main proceedings, conform to particular operating principles which clearly distinguish them from other economic operators. Both the European Union legislature, in adopting Regulation No 1435/2003, and the Commission, in its Communication on the promotion of cooperative societies in Europe, have highlighted those particular characteristics.

56 As stated in particular at recital 8 in the preamble to Regulation No 1435/2003, those characteristics essentially find expression in the principle of the primacy of the individual, which is reflected in the specific rules on membership, resignation and expulsion. Moreover, recital 10 in the preamble to that regulation states that net assets and reserves should be distributed on winding-up to another cooperative entity pursuing similar general interest purposes.

57 Cooperative societies are not managed in the interests of outside investors. According to recitals 8 and 10 in the preamble to Regulation No 1435/2003 and section 1.1 of the Communication on the promotion of cooperative societies in Europe, control of cooperatives should be vested equally in members, as reflected in the ‘one man, one vote’ rule. Reserves and assets are therefore commonly held, non-distributable and must be dedicated to the common interests of members.

58 As regards the operation of cooperative societies, in the light of the primacy of the individual, their activities – as stated in particular at recital 10 in the preamble to Regulation No 1435/2003 and section 1.1 of the Communication on the promotion of cooperative societies in Europe – should be conducted for the mutual benefit of the members, who are at the same time users, customers or suppliers, so that each member benefits from the cooperative’s activities in accordance with his participation in the cooperative and his transactions with it.

59 Moreover, as stated at section 2.2.3 of that communication, cooperative societies have no or limited access to equity markets and are therefore dependent for their development on their own capital or credit financing. That is due to the fact that shares in cooperative societies are not listed on the stock exchange and, therefore, not widely available for purchase. Moreover, as is also made clear by recital 10 in the preamble to Regulation No 1435/2003, there is limited interest on loan and share capital, which makes investment in a cooperative society less advantageous.

60 As a consequence, the profit margin of this particular kind of company is considerably lower than that of capital companies, which are better able to adapt to market requirements.

61 In the light of those special characteristics peculiar to cooperative societies, it must therefore be held that producers’ and workers’ cooperative societies such as those at issue in the main proceedings cannot, in principle, be regarded as being in a comparable factual and legal situation to that of commercial companies – provided, however, that they act in the economic interest of their members and their relations with members are not purely commercial but personal and individual, the members being actively involved in the running of the business and entitled to equitable distribution of the results of economic performance.

62 Producers’ and workers’ cooperative societies with characteristics other than those normally associated with that type of society would not truly pursue an objective based on mutuality and would therefore have to be distinguished from the model described in the Commission’s Communication on the promotion of cooperative societies in Europe. "

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