Worker cooperatives are an exciting alternative to traditional business structures, offering democratic governance and shared ownership among workers. However, navigating the legalities of forming a worker cooperative can be challenging. This post answers five questions that groups forming worker cooperatives are often hesitant to ask when beginning the journey of cooperative formation.
A. Can We Pay Worker-Members Differently While Still Being a Cooperative?
Why People Avoid Asking:
Many assume that worker cooperatives must pay everyone equally, but this can create uncertainty about how to reward seniority, skill level, or different levels of performance.
The Answer:
Yes, worker cooperatives can pay worker-members differently if the compensation structure is in alignment with the cooperative’s organizational documents (bylaws, operating agreement, etc.) and is democratically approved. The key is to ensure transparency and fairness:
- Legal Framework: Worker cooperatives can implement tiered wage systems or profit-sharing models that reward factors like hours worked, skills, or tenure.
- Compliance: The compensation system must comply with local wage laws, including minimum wage requirements, overtime rules, and pay equity laws.
- Awareness: Make prospective members aware of the compensation system while they are considering membership, and include detailed information about the compensation system in the membership agreement.
- Approval. If changes are made to the compensation system after the cooperative is formed, obtain consensus and approval from the membership of all changes.
B. Do We Need to Form a Legal Entity, or Can We Stay Informal?
Why People Avoid Asking:
Some groups are hesitant to spend money or resources on formally organizing the cooperative, and continue operating informally even when doing so may be detrimental.
The Legal Answer:
Legally organizing a cooperative entity is highly recommended for groups interesting in forming worker cooperatives. If the group begins providing goods or services or entering into agreements, operating informally without a legal entity can expose group members to personal liability for debts and legal claims. Formally organizing an entity provides:
- Limited Liability: Protects members from personal liability for acts of the cooperative.
- Tax Benefits: Allows access to cooperative-specific tax advantages under Subchapter T of the Internal Revenue Code (if applicable).
- Formal Recognition: Necessary for entering into contracts, leasing office space, applying for financing, and applying for grants and loans.
C. Can the Cooperative Terminate a Member-Worker, or Are They Untouchable?
Why People Avoid Asking:
Firing a member-worker sounds contradictory to the cooperative ethos, and can be an uncomfortable topic to bring up during the early stages of developing the cooperative.
The Legal Answer:
Whether and how member-workers can be terminated depends upon the cooperative structure and the rights held by the cooperative and its other members under the cooperative’s organization documents.
- If the cooperative is structured so that the member-worker is treated as an employee, the cooperative can terminate the member worker from employment provided it meets any state law requirements and follows the process in the membership agreement and the bylaws.
- If the cooperative’s documents separate employment rights from membership rights, terminating employment may not affect the member-worker’s rights as a member and owner of the cooperative.
- If the cooperative is structured as an LLC and the member-worker is working in his or her capacity as an owner, rather than an employee, the cooperative will have to follow the process in the membership agreement and operating agreement for removing the member-worker as a member of the cooperative.
- To minimize disputes over removing a member-worker as an employee and/or as an owner, the membership agreement and bylaws/operating agreement should clearly specify:
- The process for termination and/or removal
- Grounds for termination and/or removal, such as misconduct and failure to meet performance standards
- The process for disciplinary actions and appeals
- The distinction between employment rights and member rights.
- While worker cooperatives have flexibility in defining and implementing employment and termination policies, to maintain compliance with the cooperative principles, the policies should include democratic governance principles while still meeting any employment law requirements.
D. Will the Cooperative Pay Taxes Like a Regular Business?
Why People Avoid Asking:
Taxes can be a complicated and intimidating subject, and some cooperative groups delay discussion of taxes in favor of addressing what are perceived to be more immediate concerns.
The Legal Answer:
Worker cooperatives are not automatically tax-exempt. However, they can benefit from unique tax structures:
- Federal Tax (Subchapter T): Cooperatives can deduct patronage refunds (profits distributed to members based on their labor contribution), reducing taxable income and avoiding the double taxation faced by typical business corporations.
- State Tax: Some states offer additional tax benefits specifically for cooperatives.
- Employment Taxes: Cooperatives are responsible for withholding payroll taxes like any other employer.
- Accounting and Bookkeeping: Because cooperatives are required to track member patronage and have special tax requirements regarding patronage allocation and refunds, a new worker cooperative will need assistance from professionals familiar with cooperative tax structures.
- Groups considering forming worker cooperatives should consult with accountants familiar with cooperatives early in the process to ensure familiarity and compliance with cooperative tax requirements.
E. How Does the Cooperative Address Disputes Among Members?
Why People Avoid Asking:
Groups forming worker cooperatives often hesitate to address conflict resolution upfront. In some cases groups may assume the members will always be able to resolve disputes informally. In other cases groups may believe that decision-making processes will be sufficient to avoid serious conflicts.
The Legal Answer:
Disputes are inevitable in any organization, and cooperatives are no exception. While worker cooperatives often have a consensus mechanism for reaching decisions that is designed to avoid disputes, a formal dispute resolution process may still be required if a consensus can’t be reached. If there is no process, the only way to resolve a serious dispute may be a court proceeding.
The types of disputes that may arise include: (1) disputes over involuntary removal of a member or termination of a member’s employment; (2) disputes over calculation of patronage based on differing levels of work performance; or (3) disputes over performance evaluations.
For these reasons, worker cooperatives are encouraged to include a formal dispute resolution process in their governing documents, such as the operating agreement or bylaws. Processes could include:
- Mandatory mediation and arbitration clauses
- If a consensus approach is used, defining procedures for voting when consensus cannot be reached
- Establishing committees to handle disputes or grievances
- Summarizing how dispute resolution works in the member agreement and in materials provided to prospective members
F. Conclusion: Discuss the Hard Questions
Forming a worker cooperative is a bold and transformative decision, but legal clarity is essential to its success. By addressing these five questions head-on, the cooperative group can build a cooperative that is more likely to be compliant with legal and regulatory requirements and less likely to experience disruptive conflicts. Worker cooperative groups are encouraged to consult with accounting and legal professionals early in the process to ensure that these and other questions are recognized, understood, and addressed in the cooperative’s organization and member documents.
For more information about the information contained in this post, please contact Roland Hall at [email protected].