Business Law

Governor Newsom Signs AB 283 Allowing Cooperative Corporations to Make Equity-Related Distributions to Members Without the Hardship and Expense of Qualification Requirements

The Nonprofit Organizations Committee of the Business Law Section of the California Lawyers Association is pleased to announce that, on October 5, 2021, Governor Newsom signed its sponsored cooperative corporations bill, AB 283 (Assemblymember Chen).

Under existing law, cooperative corporations are unduly burdened by qualification requirements related to distributions made to co-op members. These qualification requirements impose a significant hardship on cooperatives that is not shared by other corporations. This bill allows cooperative corporations to make equity-related patronage distributions to its members without the hardship and expense of these qualification requirements.

Whereas a traditional corporation generates earnings for its owners or shareholders, a cooperative corporation conducts its business primarily for the mutual benefit of its members or patrons. Unlike other corporations, when cooperative corporations retain income, tax law provides the cooperative an income tax deduction for the distribution of patronage-related income provided certain requirements are met. From an accounting perspective, retained patronage income is equity of the cooperative, either as part of unallocated “retained earnings” of the corporation or earnings allocated to each member. From a California securities law perspective, the patronage allocation may be viewed as an issuance of a security, requiring the cooperative to obtain a permit from the California Department of Financial Protection and Innovation (“DFPI”) for qualification to offer or sell securities.

The current language of Corporations Code Section 25100(r) specifically exempts the issuance of any shares or memberships if “the aggregate investment of any shareholder or member in shares or memberships… does not exceed… $1,000,” provided that no compensation (other than reasonable salary) is paid to any “promoters” involved and that the member has voting rights in the co-op. This cumulative $1,000 limit is easily exceeded by many co-ops which allocate patronage in equity-related instruments for the non-cash portion of patronage refunds. Co-ops distributing refunds generally allow the board of directors to determine the cash and non-cash portions of the refunds, although the Internal Revenue Code requires a minimum 20% cash distribution for the full “qualified” refund to currently reduce taxable income under Subchapter T.

If the retention and distribution of patronage is viewed as the sale of a security, such a retention and distribution requires a cooperative to qualify to issue equity credits on an annual basis. Thus, the qualification requirement imposes a significant hardship on cooperatives that is not shared by other corporations. Other corporations seek a permit only when they are raising capital, but they are not required to obtain a permit annually merely to do their bookkeeping. Because the DFPI permit system operates on an annual basis, cooperatives must seek a permit for each year they believe they may have net income which will be retained as allocated patronage. 

This bill resolves the issue identified above by amending Corporations Code Section 25100(r) to exempt from the qualification requirements, under Corporations Code Sections 25110 (issuer transactions), 25120 (recapitalizations and reorganizations) and 25130 (nonissuer transactions), equity-related securities and other equity “credits” issued by a cooperative corporation incorporated under the California Cooperative Corporation Law. Thus, this bill allows cooperative corporations to make equity-related patronage distributions to its members without the hardship and expense of these qualification requirements.

This e-Bulletin was prepared by Saul Bercovitch, California Lawyers Association Director of Governmental Affairs, Van Baldwin, primary drafter of the bill, and Joel Corwin, Nonprofit Organizations Committee Vice Chair – Legislation.

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