tion and not as an additional expense. It takes money to go into business. Farmers, when they form and operate a cooperative, are in business and should supply an appropriate amount of the required capital.

Some cooperatives use a revolving-fund plan of financing to resolve the 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.2

Many cooperatives began business with a small amount of capital. Over the years, the amount increased through an accumulation of capital savings without giving patrons a clearly defined right with respect to the sums that each by reason of his patronage had provided. Frequently, the early patrons of an association were largely responsible for building up its capital, while later patrons were not expected to make comparable investments. A revolving-fund plan of financing can avoid such inequalities.

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

In farm supply cooperatives under the revolving-fund plan, most capital originates from savings the patrons authorize the association to keep for them, or from the sale of certificates of various kinds. Thus, with patrons' consent, these cooperatives pay a portion of each year's savings in

'See United States v. Mississippi Chemical Corp. 405 U.S. 298 (1972), holding that the cost of certain class "C" stock in a bank for cooperatives was not a deductible expense but the acquisition of a capital asset. Lower courts have split on the issue presented in this case. Compare, e.g., M.F.A. Central Cooperative v. Bookwater, 427 F.2d 1341 (8th Cir. 1970), reversing 286 F. Supp. 956 (E.D. Mo. 1968), certiorari denied, 405 U.S. 1045 (1972), with Penn Yan Agency Cooperative, Inc. v. United States, 417 F.2d 1372 (Ct. Cl. 1969).

2Sanders, "Retains" That Nobody Feels, 3 News for Farmer Cooperatives 5-6, Farmer Cooperative Service, U.S. Dept. Agr. (1936); Sanders, Organizing A Farmer's Cooperative, FCS Circ. 18, Farmer Cooperative Service, U. S. Dept. Agr. (1956); Nieman, Revolving Capital In Stock Cooperative Corporations, 13 Law & Contemp. Prob. 393 (1948). See also Hulbert, Griffin, and Gardner, Revolving Fund Method of Financing Farmer Cooperatives, FCS General Report 41, Farmer Cooperative Service, U.S. Dept. Agr. (1958).

cash (at least 20 percent to qualify the refunds as "qualified written notices of allocation" under the tax laws),3 and the remainder by an offset against the obligation of each patron to invest in the capital of the association.4 The resulting patrons' investment in capital may be evidenced by stock, capital book credits, or some form of certificate of ownership.

In marketing cooperatives under the revolving-fund plan, money for capital purposes is furnished in a manner similar to that used by farm supply cooperatives, and also through authorized "capital retains" made on a percentage or unit basis.5

The meaning of the term "revolving-fund plan" becomes more apparent when a cooperative reaches the stage when the oldest capital investments of patrons of previous years may be returned to them.

There is wide latitude with respect to the terms and conditions that may be adopted for a revolving-fund plan of financing. Under this plan of financing, amounts furnished for capital purposes should be recorded on the books of the association so that the ownership interest of those who provided the capital will be known. Some associations set up book credits and, although not essential, also issue to pa

3See "Federal Income Taxes," supra, at p. 426. Some cooperatives pay more than 20% in cash. Griffin, A Financial Profile of Farmer Cooperatives in the United States, Res. Rpt. 23, Farmer Cooperative Service, U.S. Dept. Agr. (1972).

"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. 135, 143 (1955).

"See "Capital Retains,” supra, at p. 443.

"Hulbert, Griffin, and Gardner, Revolving Fund Method of Financing Farmer Cooperatives, FCS General Report 41, Farmer Cooperative Service, U.S. Dept. Agr. (1958); Griffin, How Adjustable Revolving Fund Capital Plan Works, FCS General Report 111, Farmer Cooperative Service, U.S. Dept. Agr. (1963). For bylaw provisions, see "Sample Legal Documents," infra, p. 567.

trons some type of certificate to evidence their ownership interest. These credits or certificates have been called "capital credits," "revolving-fund certificates," "cer

tificates of equity," or "certificates of ownership." Regardless of the designation used, the rights of both the cooperative and the patrons would depend upon the terms and conditions under which the capital was supplied.

Some associations organized with capital stock issue stock certificates to evidence patrons' investments increasing the capital revolving fund. From a legal standpoint, there appears to be no reason why either stock or nonstock associations 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 a capital stock association plans to revolve its stock, it should either: (1) issue more than one class of common stock, keeping one class as voting stock and revolve the other class, or (2) issue both common and preferred stock and revolve the preferred, keeping the commonusually issued on the basis of one share to each produceras the voting stock.

The organization papers of a cooperative should clearly show how its revolving-fund plan of financing is intended to function. Nothing should be left to surmise or inference. If no interest is to be paid on capital funds, the papers should so state. Likewise, if it is intended that interest be paid on capital funds, definite provision should be made for it. In some instances, the payment of interest is made optional with the board of directors and is not to exceed a stated percent per annum.

Usually, the certificates issued do not have due dates and are subject to retirement only at the discretion of the board of directors. If such certificates do have due dates, the capital status of funds they represent is changed. In the true sense, these funds would no longer be considered equity cap

"See text at footnote 16, in this section. See also the requirements for “qualified" and "nonqualified" written notices of allocation under the tax laws discussed under "Federal Income Taxes," supra, at p. 430.

See Co-operative Grain & Supply Co. v. Commissioner, 407 F.2d 1158 (8th Cir. 1969), and Rev. Proc. 73-39, 1973-2 Cum. Bull. 502.

ital because they have taken on the basic characteristic of debt capital.

Some associations maintain contingency reserves with the thought that this will "insure" that certificates issued or credits given for funds obtained for capital purposes will remain at par. Such reserves are expected to operate as a cushion to absorb losses. If reserves are set aside for meeting contingencies, they should be allocated to the patrons on the books of the association and revolved when circumstances warrant. In case of losses, the allocated interest of patrons in such reserves might be reduced on some equitable basis. The bylaws of some associations give the board of directors authority to make such a reduction.

As previously indicated, a sharp line of demarcation should be drawn between operating expense items and capital investments made by members and patrons of an association. 10

In recent years, a number of cooperatives, including several large fruit and vegetable marketing cooperatives, have modified or adjusted their revolving-fund plans in an effort to provide for a more equitable and more permanent capital structure.11

When a cooperative has been in business for a number of years, a portion of its membership may become inactive for various reasons and deliveries of products to the cooperative, or purchases from it, become irregular. As a result, some financial inequities among members arise in the administration of revolving-fund financing plans.

"See "Federal Income Taxes," supra, at p. 407.

10See "Nonprofit Associations," supra, at p. 219.

Griffin, How Adjustable Revolving Fund Capital Plan Works, FCS General Report 111, Farmer Cooperative Service, U.S. Dept. Agr. (1963); Griffin and Wissman, Financial Structure of Farmer Cooperatives, FCS Res. Rpt. 10, Farmer Cooperative Service, U.S. Dept. Agr. (1970); Mather, Sun-Maid Moves to Adjustable Capital Plan, Reprint 370, News for Farmer Cooperatives (May 1970); and Griffin, Modern Cooperative Financing, a talk given at a seminar on cooperatives at Chippewa Lake Field Station, Clam Lake, Wis., August 10, 1970. See Rev. Rul. 70-298. 1970-1 Cum. Bull. 82, holding that the exchange of revolving-fund credits for share interests in a permanent capital fund by a section 521 farmer cooperative constitutes a recapitalization and therefore a reorganization within the meaning of section 368(a)(1)(E) of the Internal Revenue Code of 1954.

The modified plan is generally referred to as a permanent or base capital plan of financing. Basically, it provides for a temporary freezing of existing revolving funds, an independent determination of total capital requirements, and an annual determination of individual capital requirements, generally based upon relative patronage over a specified number of years. There is no separate retention or revolvement of funds, but essentially net retain or revolvement, depending upon the extent to which a member's existing capital measures up to the requirement allocated to him.12

The validity of the revolving-fund plan of financing has been specifically recognized. 13 A member of a cooperative, like a member of any other business corporation may, of course, provide capital for his corporation or he may be an ordinary creditor. He may make an outright loan to a cooperative and thus become a creditor in the sense in which that term is customarily used. Likewise, a member who supplies money to an association for capital or other purposes may make it available subject to specific terms and conditions. In the absence of fraud, the courts will ordinarily enforce the terms of such agreements.

A cooperative of retail grocers operated a wholesale agency. Under its bylaws, 1 percent was added to all statements for the purpose of creating a credit reserve fund "to guarantee the accounts of all members with the Association who receive credit." The bylaws also provided that the amount credited to each member's reserve account "shall be returnable with interest upon the member ceasing to be a member of the Association," less a pro rata percentage

12 For a detailed explanation of how this plan works, see Mather, SunMaid Moves to Adjustable Capital Plan, Reprint 370, News for Farmer Cooperatives (May 1970). See also Rev. Rul. 70-298, 1970-1 Cum. Bull. 82, which describes an exchange of revolving fund credits for share interests in a permanent capital fund. See footnote 11 in this section.

13 Reinert v. California Almond Growers Exchange, 9 Cal. 2d 181, 63 P.2d 1114 (1936), 70 P.2d 190 (1937); Adams v. Sanford Growers' Credit Corporation, 135 Fla. 513, 186 So. 239 (1938); Ozona Citrus Growers' Association v. McLean, 122 Fla. 188, 165 So. 625 (1935); Proodian v. Plymouth Citrus Growers Association, 143 Fla. 788, 197 So. 540 (1940); Parker v. Dairymen's League Cooperative Association, Inc., 222 App. Div. 341, 226 N.Y.S. 226 (1927); Loomis Fruit Growers' Association v. California Fruit Exchange, 128 Cal. App. 265, 16 P. 2d 1040 (1932). See Farmers Union Co-op Gin Co. v. Taylor, 197 Okla. 495, 172 P.2d 775