Abstract

Director Liability in Agricultural Cooperatives

by Douglas Fee, Allen C. Hoberg, and Linda Grim McCormick

School of Law

University of Arkansas

under a cooperative research agreement with

Agricultural Cooperative Service

U.S. Department of Agriculture

Farmers and others who serve as directors of farmer

cooperatives are subject to responsibility rules applicable to all

corporations and are subject to the same liabilities when those

responsibilities are not met. This study surveys and discusses

sources of liability faced by cooperative directors and suggests

practices and behavior that may help avoid liability risks. The

common law sources of liability are described. Liability of directors

for criminal activities is noted, and statutory laws placing liability on

directors for their violation are outlined. Liabilities for improper

distribution of dividends, depletion of capital, improper patronage

refunds, and antitrust violations are singled out for discussion.

Key Words: Agricultural cooperatives, cooperative law, directors,

director liability, cooperative management

Cooperative Information Report No. 34

December 1984

Reviewed and approved for reprinting February 1996
Preface

“Membership on the board of directors of a cooperative is

ordinarily looked upon as a post of honor, but the board member who

has examined the statutes and court decisions on the subject will also

look upon the office as a post of great legal responsibility. Not only

does the welfare of the cooperative rest upon the board as a group,

but the office of director carries with it the possibility of large personal

liability both at common law and under statutes.”

This statement, made first in the 1929 edition of Legal Phases of

Farmer Cooperatives, is as true today as it was more than 50 years

ago. A number of publications have addressed the issue of director

responsibilities, but none has focused on the more disturbing aspect

of serving as a cooperative director--personal liability. This

publication surveys situations and laws related to cooperative

directors’ personal liability for actions taken and decisions made as a

director.

An attempt has been made in this study to anticipate an increase

in lawsuits against cooperative directors by reviewing situations

where they have become involved in lawsuits and by analyzing and

applying specific corporate law to those situations where there has

been little or no litigation against cooperative directors. This study

also identifies areas of legal liability where cooperative directors are

treated differently from those of noncooperative corporations.
Contents

HIGHLIGHTS .............................................

DIRECTORS AND COOPERATIVES .....................

How Directors Are Sued .............................

COMMON LAW LIABILITY

Fiduciary Duty .........: : : : : : : : : : : : : : : : : : : : : : : : : : : : : :

Negligence ...........................................

Intentional Torts .....................................

CRIMINAL LIABILITY ..................................

Public Health and E*nvironment .....................

Other Criminal Acts

SECURITIES REGULATION’ l l : : : : : : : : : : : : : : : : : : : : : : : : : : : : :

RECORDS AND FINANCES ..............................

False or Misleading Financial Statements ..........

Books and Records

: : : : : : : : : : : : : : : : : : : :

.............

Reports ............. .............

Inspection of Records ...............................

Reliance on Records, Books and Reports ..........

Accounting Procedures .............................

Tax Liability .........................................

Improper Distribution of Dividends ..................

Depletion of Capital .................................

Patronage Refunds and Retained Equities .........

Other Actions of Directors ..........................

ANTITRUST REGULATION ..............................

Applicable Corporate Antitrust Principles ..........

Derivative Suit - Personal Liability

for Antitrust Violation ................................

Criminal Antitrust Enforcement .....................

Realities of Personal Liability .......................

State Antitrust Laws .................................

INDEMNIFICATION AND INSURANCE ..................

Indemnification ......................................

Insurance ............................................

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APPENDIX: GLOSSARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33
Highlights

Directors of agricultural cooperatives are key persons in the

organization. Their position as decisionmakers carries with it serious

responsibilities and liabilities. Because cooperatives operating under

principles of member ownership and democratic control usually elect

directors from the membership, directors may have little or no

experience as executives of a complex business enterprise.

Directors require guidance in carrying out their duty to manage

the affairs of the cooperative while protecting themselves from

adverse consequences of avoidable errors or wrongful acts. The

subject of director liability is as complex as the operation of the

cooperative itself.

The Problem

Cooperative directors, like directors of investor-owned

corporations, are charged with the ultimate responsibility of operating

the cooperative by acting in concert as a board of directors to set

policy, overseeing the cooperative’s operation, and making top-level

decisions affecting the welfare of the cooperative and its members.

When a director violates a duty imposed by statute, common law, or a

rule of the cooperative, he or she could be held liable. Directors can be

sued by other directors, by the cooperative’s members, by third parties,

and can be sued or criminally prosecuted by agencies of Federal or

State Government.

Common Law Liability

Directors are held to certain standards of conduct and

performance. Liability may be founded on common law rules or on

statutory law.

Common law, arising from judicial decisions, requires directors to

act as fiduciaries for the benefit of the cooperative and its members.

Directors therefore have a duty to act with undivided loyalty,

diligence, and obedience. If directors don’t act accordingly and the

cooperative or member suffers any loss, they could be held liable.

These duties require directors to maintain a high standard of careful

conduct. A director must avoid conflicts of interest, favoritism,

dishonesty, carelessness, violation of rules and statutes, and many

other acts that constitute breach of fiduciary duty.

Directors are liable for negligence that injures the cooperative,

members, or third parties. Negligence is chargeable when a director’s

failure to comply with a duty of reasonable care causes damage to

another’s person or property. The concept of negligence is broad and

. . .

III
represents a tremendous potential hazard to directors. A duty to act or

to refrain from injurious carelessness may be based on a statute,

common law, or rule of the cooperative. Some examples of duties are

supervision of officers, diligence in handling the cooperative’s

business, and reasonable inquiry about matters requiring

investigation. Directors may avoid liability through operation of the

business judgment rule, ratification by the cooperative, or the

plaintiff’s failure to prove causation.

Intentional injuries (torts) are another source of director liability.

Cooperatives are active in many fields of business activity, so

directors may be charged for the cooperative’s wrongs. Therefore,

they must be careful to avoid causing intentional injuries. Liability can

result from actions such as misrepresentation, nuisance, and

conversion.

Criminal Liability

Directors may be charged alone or along with the cooperative for

violations of Federal and State criminal laws. Because most criminal

violations require proof of intent, there can be criminal negligence as

well, especially where laws protecting health and safety are

concerned.

Statutes imposing criminal liabiiity on directors cover areas such

as food purity, occupational safety, handling of chemicals, and

environmental regulation, Laws also regulate conditions of

employment and disposal of agricultural commodities. Obvious acts

of dishonesty such as fraud, embezzlement, and theft subject the

director to liability.

Cooperatives may issue several kinds of instruments to members

and other persons. Some of these instruments are considered

securities and are subject to Federal and State regulation designed to

protect investors. If the instrument is a security, directors have

special liabilities.

Issuing and trading securities are strictly regulated. Reports,

disclosure, and correct and complete prospectuses are required.

Because directors must sign these documents, any fraud or

negligently incorrect information in them can result in director

liability. Directors must obtain advice of qualified counsel in dealing

with instruments that may be securities.
Although directors are seldom charged with violating laws

concerning records and finances, liability exists nonetheless.

Directors can be held liable for false or misleading financial

statements that cause a loss to another person. Directors have

responsibilities, often explicitly detailed in statutes, to see that books

and records are properly maintained. Cooperatives may be required

to make periodic reports on their financial situation to a State agency

or to members. If the cooperative fails to do so, directors can be held

accountable. Member access to records may be demanded of

directors who in many States are required by statute to allow access

or be held liable.

The cooperative’s books of account provide the basis for many

decisions by the board of directors. Directors may rely in good faith on

books and financial statements if there is no reason to doubt their

correctness or authenticity. They must, however, see that an

appropriate system of bookkeeping is adopted and used to guard

against error.

The tax status of cooperatives, different in some respects from

that of other corporations, can trigger requirements of income

reporting and tax payments that must be accomplished by officers

acting for the cooperative. Failure to file returns or filing incorrect

returns can result in director liability for civil or criminal violations.

Distribution of dividends, patronage refunds, or retained equities

can cause liability to directors. They must comply with statutes and

the cooperative’s rules regarding interest limitations, minimum cash

distributions, and retentions for reserve accounts. Members have

sued directors to compel a distribution of retained equities, but that is

a matter within the reasonable discretion of the board of directors

unless mandated otherwise by a statute or cooperative rule.

Directors must comply with statutes and rules governing the

cooperative’s capital structure. They may not act to impair the capital

stock or other instruments. Directors who consent to indebtedness of

the cooperative beyond statutory limits can be held liable for the

excess debt. Payments to shareholders that result in cooperative

insolvency is another ground for director liability. Directors are liable

for depletion of capital caused by commodities speculation,

mismanagement, unjustified reliance on others, and wrongful

distribution of assets on liquidation.

Patronage Refunds and Retained Equities

Payments of refunds and equities to member-patrons are usually

V
a matter within the discretion of the board of directors. Abuse of

discretion may occur, however, if the board shows favoritism or no

rational reason for resisting a demand for payment. Liability is usually

found in the cooperative, not the directors, when a claimant

demonstrates a right to be paid. Directors, however, have a fiduciary

obligation to members, and abuse of discretion may violate fiduciary

duty.

Antitrust Regulation

Laws against monopolies, constraint of trade, and unfair pricing

are fully applicable to cooperatives and their directors. Although few

directors of cooperatives have been prosecuted under antitrust and

related laws, they are still liable for violations. Penalties may include

treble damages. Directors have no defense of good faith, ignorance of

law, or in the fact that they acted merely as the cooperative’s agent.

Liability may be based on a director’s acquiescence in or

ratification of illegal acts, as well as an authorization, ordering, or

commission of an illegal act. Conspiracy to violate antitrust laws is an

offense for which a director can be punished. Both civil and criminal

penalties may be assessed against a culpable director.

A director may be sued for antitrust violations by other directors

or cooperative members in a derivative suit brought to enforce the

cooperative’s rights. Both civil and criminal actions may be brought

against directors by the Department of Justice or the Federal Trade

Commission.

Indemnification and Insurance

Cooperatives have the right, and in some instances the

obligation, to reimburse a director for expenses incurred in defending

against legal actions. If directors have adhered to a proper standard

of conduct, they can be indemnified for costs of counsel, court

expenses, and the amount of judgments rendered against them.

Directors may insist on indemnification if their defense in the action is

successful. The right to indemnification depends on State statutes

and the cooperative’s rules.

Insurance against costs resulting from director liability is

increasingly available. Not all risks are insurable; however, most

liabilities caused by good faith error or simple negligence may be

covered. The board should consider the possible means of insuring

directors against costs resulting from liability.

vi
Director Liability

in Agricultural Cooperatives

Douglas Fee, Allen C. Hoberg, and Linda Grim McCormick

University of Arkansas School of Law

DIRECTORS AND COOPERATIVES

The board of directors of an agricultural cooperative is elected by the

membership to govern the cooperative. The board is responsible for the

management, specific operating policies, and supervision of business

performance. In carrying out these responsibilities, directors are often faced

with important questions about the legality of their actions.

Many farmers asked to serve as directors are not fully informed or aware of

their legal responsibilities and liabilities that accompany such service. In

addition to being legally responsible to the membership, a director can be

held personally liable for actions as a board member.

A director is sometimes told service on the board will not take much time

because the board meets infrequently, operates informally, and the real

business of the cooperative is managed by key hired personnel. Actually,

the growing burden of director responsibility, the increased assertiveness of

members, and economic conditions suggest every director should be

concerned with the personal liability associated with the position.

Cooperatives, like other corporations, are viewed in law as business

organizations. They are usually incorporated under State law. Cooperatives

differ from other corporations most notably in their purpose: to provide a

service to member-owners at cost rather than produce profit to distribute to

owners on the basis of their investment. Otherwise, with a few significant

exceptions, the cooperative functions similarly to an investor-oriented

corporation.

The cooperative director serves in substantially the same capacity as does a

director of another corporation. Courts and legal scholars apply the

principles of corporate law when a question rises about cooperatives and

when no relevant cooperative cases are available. Relatively few cases deal

specifically with director liability in a cooperative. However, this situation

could change quickly.

The simplest way directors can reduce the risk of an adverse legal action is

to resist the temptation to do something wrong or achieve personal gain at

the expense of the cooperative, exercise the highest quality of care in official

actions, and hold themselves to a justifiably high standard of honesty.
Many reasons can prompt civil or criminal action against

Basically, a director can be sued or prosecuted four ways:

Criminal actions

local authorities.

may be brought in the public interest by Federal, State, or

A civil suit may be brought by a third party, such as a person who had

contracted with a cooperative orbought something from the cooperati

A director coul d be sued by the

majority of the other directors.

a director.

cooperative in an action brought by a

Any stockholder may bring

benefit of the cooperative.

action against a director on behalf of and for the

ve.

Some reasons directors are sued or prosecuted include:

violation of statute

violation of bylaws or articles of incorporation

fraud

negligence

commission of torts or crimes

antitrust violations

securities law violations

misappropriation or misuse of the assets and property of the cooperative

l authorizing preferential treatment to directors

l speculating on the commodities markets

l paying patronage refunds in cash exceeding current savings

l failure to require financial statements with resulting injury to the business

l failure to give annual reports to members

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0 illegal political activity

l becomi ng a party to contracts with the

contracts with other parties

cooperative that differ from its

0 failure to attend board meetings to the exten

financial problems as a result of inattention

t the cooperative suffers

l obtaining a property interest adverse to the cooperative

l operating a business that competes with the cooperative

l failure to adequately insure the cooperative’s assets or obligations.

In most cases where the cooperative and its directors are successfully sued,

the cooperative may be hurt financially and may have to change its

operations. It is not likely, judging from past experiences, that the directors

will be held personally liable for their actions.

COMMON LAW LIABILITY

Common law liabilities are based on judge-made doctrines that often have

preceded statutory liability and are still recognized as sources of liability.

The many and varied State statutes on director liability are not examined in

this publication. Common law doctrines are the source of much litigation

concerning directors and are nearly universal. They express the high

standard of conduct a director must observe. The fiduciary duties of loyalty,

due care, and obedience are part of a director’s role as steward of the

cooperative. The duties place a heavy burden of personal risk on a director

for failure to comply with them.

Fiduciary Duty

A director is a fiduciary and owes fiduciary duty to the cooperative, to its

members, to other directors, and occasionally to the cooperative’s creditors.

A fiduciary status signifies a special relationship between a director and the

cooperative, characterized by trust and confidence in a director and by a

director’s integrity and candor toward the cooperative. As a fiduciary, a

director is obliged to act prudently and primarily for the benefit of the

cooperative and to avoid benefiting personally or prejudicing the

cooperative unless complete disclosure is first made and consent obtained.

A director has by virtue of the position assumed a fiduciary duty and is

therefore liable for damages resulting from a breach of the duty. Three

3
principal aspects

obedience.

of a director‘s fiduciary duty are loyalty, due care, and

Loya/ty A director’s duty of loyalty is most comprehensive and most

frequently litigated. It includes a duty of undivided loyalty, a duty to forego

seizure of the cooperative’s business opportunity, a duty to refrain from

conflicts of interest, and a duty of honesty and good faith. These duties are

owed to all members and shareholders, to the cooperative as an entity, to

other directors, and may extend to the cooperative’s general creditors.

Breaches of the undivided loyalty duty can occur if a director prefers one

group of members over another group, or if the interests of any one group

of members are disregarded. A director may take no special advantages not

available to the membership.

Additionally, loyalty prohibits a director from appropriating opportunities

that properly belong to the cooperative. The difficult question is identifying

which opportunities are rightfully the cooperatives’s and therefore

prohibited to directors. To be considered as belonging to the cooperative,

the opportunity must be one that it could and would take for itself if given

the chance. But if the opportunity has been rejected in good faith by the

cooperative for reasons of financial or other disability, and no

misrepresentation by the director has occurred, then the director may

personally pursue the opportunity.

Conflicts of interest between a director and the cooperative unfortunately

can occur rather easily. In general, a conflict exists if a director uses the

position or the cooperative’s assets for personal gain, resulting in a breach

of the fiduciary duty of loyalty. A director has the obligation to disclose a

recognized conflict of interest. Conflicts may include a director’s

involvement with a competing business, use of a director’s position to blunt

the cooperative’s competitive effort for the benefit of another enterprise,

and a director’s sitting on more than one board.

Conflicts of interest can occur in business transactions between a director

and the cooperative. Self-dealing by a director can be a breach of loyalty in

view of the constraints against taking special advantage or profiting by the

director’s position. In transactions with the cooperative, a director must

disclose personal interest, be honest and fair, and not retain unfair or secret

profits.

Finally, the fiduciary duty of loyalty raises an obligation to act honestly and

in good faith. Honesty prohibits deeds such as misappropriation of
cooperative assets, a director’s sale of influence with the board, undisclosed

profits or commissions, or any other act of dishonesty that harms the

cooperative or secretly enriches a director. Good faith prohibits a director

from committing or condoning fraud. Good faith requires a director to

behave toward the cooperative with utmost fidelity and fairness, a standard

stricter than that demanded in normal marketplace relations. Good faith

also requires an intent to benefit the cooperative.

Due Care A director owes a fiduciary duty of due care to the cooperative.

The standard of conduct in State law may be phrased in terms of diligence or

reasonable care, but the standard of due care under Section 35 of the Model

Business Corporation Act (MBCA) is defined as the degree of skill,

diligence, and care that ordinarily prudent men would exercise in similar

circumstances in like positions. Section 35 provides a flexible standard of

conduct for both professional and nonprofessional directors, while still

requiring the exercise of due care’s essential feature: prudence.

Under this standard, exact limits of the duty are defined by circumstances

and needs of the particular business, type of business, and customs and

usage in the business. A director’s failure to use the degree of care required

by the particular situation can result in personal liability for losses suffered

by the cooperative. Due care requires exercise of independent judgment

that is vigilant, skeptical, scrutinizing, and at all times honest and unbiased.

Though not normally expected to personally operate the cooperative, a

director has the duty of delegating responsibility and monitoring

performance - a duty of prudent selection and adequate supervision - as a

function of the duty of due care. It is no defense to breaches of this duty that

a director was a mere figurehead or was not compensated. Further, as a part

of this duty, a director is presumed to have knowledge of the contents of the

cooperative’s books and records, and to have knowledge of a director’s duties.

Corresponding with a director’s duty of due care is the right to rely on

certain parties and information. Assuming the director has no knowledge to

the contrary that would make reliance unwarranted, a director may rely on:

advice of counsel, officers, or employees whom a director reasonably

believes to be competent; public accountants; other experts; and

committees of the board. Reasonable reliance on statements, opinions, or

reports from these sources satisfies the fiduciary duty of due care.

Because a director is required to make so many decisions, some error is

bound to occur despite all reasonable precautions. The so-called “business

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judgment” rule was developed to prevent a director from being held liable

for business losses when duties were performed in good faith, for the best

interests of the business, and in the exercise of unbiased, independent

judgment. The business judgment rule recognizes a director is not an

insurer of business success and the director is required to do only what

reasonably can be done. The rule recognizes that without allowance for

honest error, no director could afford the risk of liability associated with the

position. Several States have codified a form of the business judgment rule.

Codification of the rule also occurs in those States that have adopted

Section 35 of MBCA.

Obedience The third principal fiduciary duty is obedience. A director must

comply with the cooperative’s charter, articles of incorporation, and bylaws,

as well as with statutes and contracts. Obedience is required in a director’s

role as an agent for the cooperative. Accordingly, a director may act only

within the limits of the power granted.

The case of Fagerberg v. Phoenix Flour Mills Co. 50 Ariz. 227,71 P.2d 1022

(1937)) illustrates the requirements of the obedience duty. Part of the

plaintiff mill’s operations included entering the wheat futures market for

legitimate hedging purposes. Two directors went beyond their assignment

and secretly used hedging funds to buy futures on margin as a speculation.

Large losses resulted. In an action against the directors, the court held they

had engaged in unauthorized and ultra vires activity and were jointly liable

for the loss.

Directors have been held liable for other ultra viresacts such as engaging in a

line of business not authorized by the bylaws, making payments to silence

complaints of unlawful business activity, causing depreciation of stock

value, and publication of a libel.

Of course, the party to whom a director owes obedience will vary depending

on the conduct in question. If the conduct involves a failure to obey a

positive commandment (nonfeasance), obedience is owed only to the

cooperative and gives no cause of action to third parties. But if the conduct

is wrongly doing some permissible act (misfeasance), a director may be

directly liable to the person injured, including the cooperative or a third

party. A director may be relieved of liability to the cooperative when ultra

vires actions are ratified by all voting members, whether ratification is prior

or subsequent to the action, so long as notice and disclosure are given.

Negligence

A director can be sued for negligence as a result of official actions or failures
to act that cause injury to the cooperative or a third party. A director’s

conduct may give rise to both legal and equitable remedies for some injured

parties. If a director breaches a fiduciary duty and injures a party to whom

the duty is owed, that conduct can result in the plaintiFs having equitable

remedies such as an injunction or accounting. A director’s conduct could be

negligent as well as a breach of fiduciary duty (for example, when the duty

of due care is negligently breached). The plaintiff then can choose between

equitable remedies and legal remedies, which include consequential and

punitive damages.

If the director owes no fiduciary duty to a party injured by the director’s

negligence, the party has no equitable remedies and may sue only in an

action for negligence. The plaintiff in a negligence action must prove these

elements: duty owed by the director; failure to conform to the standard of

conduct, or breach of duty; causal link between the breach and resulting

injury; and actual loss or damage to the plaintiff.

Perhaps least clear is the standard of conduct a director must observe to

avoid a charge of negligence. Violation of the standard is sometimes

referred to as “gross” or “ordinary” negligence, or simply conduct that

fails to meet the requisite standard of care. When applied to cases involving

directors, distinctions between these standards seem to vanish. Because

almost every case of negligence must be evaluated on its own particular

circumstances, the standard of care is dictated by fact as much as by law.

Liability may be more realistically assessed by considering the areas of

conduct in which directors owe a duty of care.

A director has a duty of care and diligence in administration of the

cooperative and safeguarding its assets. The director has ultimate

responsibility but may delegate specific tasks. The director can select

trustworthy officers and employees but must maintain some supervision

and oversight of their activities. A director can be charged for wrongful acts

of employees or officers if a director has been negligent in their selection or

supervision.

In Parish v. Maryland & Virginia Milk Producers Ass’n., 250 Md. 24, 242

A.2d 512 (1966), directors were charged with negligence for improper

supervision of officers. After they were put on notice that certain officers

had breached their fiduciary duties, the directors failed to act against those

officers. The directors’ duty to act was owed both to the cooperative and to

third parties harmed by the acts of its agents, because the harm could have

been prevented by directors’ diligence.

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While a director need not be personally involved in operating the business

of the cooperative, a director does have a management duty. That duty is

not diligently discharged if a director repeatedly misses board meetings or

otherwise avoids paying careful attention to the cooperative’s activities. It is

no defense for a director to claim to be a mere figurehead or to be ignorant if

ignorance results from a failure to be diligent.

Diligence requires in some instances that a director investigate certain

matters, such as the known questionable character and activities of agents

and proposed transactions of the cooperative. A director must review and be

familiar with contents of reports, books, and records of the cooperative to

be aware of significant developments and as a means of verifying oral

representations of others. Again, Parish v. Maryland & Virginia Milk

Producers Ass’rz is a useful example. Most of the directors’ misdeeds in this

case resulted from unjustifiable reliance on representations of unfaithful

officers. Some of the directors’ mistakes, however, were prima facie

evidence of gross negligence, as when they approved the high-priced

purchase of a dairy that clearly violated antitrust laws, then sold the dairy at

a price substantially below its value and without security. Liability for the

dairy transaction was based on the directors’ presence at the meetings where

these actions were approved and the absence of their dissents in the

minutes.

A director is liable for misfeasance when a loss is caused by acts of

incompetence or recklessness. One example is failure to make an accurate

statement in registering securities. A director owes a duty to securities

owners to accurately report the cooperative’s state of affairs and can be

charged for negligently disclosing untrue information or omitting material

facts in the registration statement. Failure to conform to statutory duties has

sometimes been held to be negligence as a matter of law, causing liability

independent of that arising from failure to observe the nonstatutory duty of

diligence. Conceivably, this principle of negligence liability resulting from

violation of a statutory duty might be extended, at least far enough to show

some evidence of negligence, to violations of a cooperative’s bylaws or

articles of incorporation.

Ordinarily, a director may avoid a charge of negligence just by attending

meetings and being inquisitive. But a director still can make a business

decision that causes a loss to the cooperative or its members. If a director

has acted diligently and in good faith, and the loss results from an honest

mistake of independent judgment, the director may be protected by the

business judgment rule. While this rule generally allows directors discretion

free from second-guessing by the courts, it has limited applicability to some

types of violations such as Federal securities, antitrust, and labor law

8
violations. Yet even allegations that a director’s fiduciary duty has been

breached may sometimes be defeated by the business judgment rule. In any

event, the business judgment rule is not directly a defense against

negligence, but rather prevents the exercise of honest judgment from being

called negligence, and thus it can help avoid costly litigation.

Another barrier to establishing a charge of negligence is the plaintiffs

burden to prove cause. A director may breach a duty and still not be charged

if the breach was not the direct cause of the plaintiffs loss. Though some

courts may employ reasoning generous to a deserving plaintiff, not every

breach of duty followed by loss will support a charge of negligence.

The principal defense against, or avoidance of, charges of negligence is a

director’s adherence to a careful standard of conduct. While the standard is

always judgmental and based on the particular circumstances, a complacent

and thoughtless director invites litigation and a prudent, interested director

minimizes the liability risk.

Perhaps equally important, if a director has the ill fortune to commit an act

of negligence causing a loss to the cooperative, the act can still be ratified by

the voting membership. This could be a reasonable course of action if it

would be fruitless or self-defeating to sue the director. It usually is better to

devote valuable resources to the cooperative’s business rather than to futile

litigation.

Above all, a director is advised to insure against suits for negligence by at

least attending all or almost all board meetings, asking questions about

reports and representations, having any dissent reported in the minutes,

and seeking advice of counsel when in doubt.

Intentional Torts

Directors can be charged for intentional torts. As an agent of the

cooperative, a director may be sued when third parties are injured even

though the act was on behalf of the cooperative. A director can be charged

for tortious action toward the cooperative.

Directors can be charged by both third parties and the cooperative for deceit

or misrepresentation. Liability is based on the loss resulting from a

director’s fraud or deceit. A director can be charged for writing checks

against insufficient funds, misrepresentations about security backing bonds,

refusal to return fraudulently obtained money after learning of the

misrepresentation, negligently making false representations, and making

misrepresentations to creditors.

9
Liability is greater when a director has a fiduciary relationship to the

plaintiff. Misrepresentations to the cooperative can even occur by

nondisclosure, which really amounts to misleading by silence. To avoid a

charge of fraud or deceit, a director must not make negligent or knowingly

false misrepresentations, either by assertion or omission, designed to make

another person act on the assertion or omission.

Additional intentional torts include nuisance (ordering or consenting to the

creation or maintenance of a nuisance) and conversion (serious

interference with another’s personal property). To illustrate, directors of a

bankrupt grain milling company were sued for an alleged conversion when

the plaintiffs demand for grain in exchange for warehouse receipts was not

met. The directors did not actively participate in the operation of the

company, but did participate in meetings and had carefully reviewed written

and oral reports on the company’s condition. However, they were unaware

of the transactions resulting in the plaintiffs holding the warehouse

receipts, and therefore had neither knowledge of nor had acquiesced in

those transactions. Because of the directors’ diligence and lack of

knowledge, the claims against them were dismissed. This case shows that a

director’s liability in tort must be based on negligence or participation.

CRIMINAL LIABILITY

A trend in recent years has been to fix criminal liability on corporate

decisionmakers. Environmental consciousness, the growth in Government

regulation, and a heightened public sense that responsible persons in the

business organization should account personally for violations committed in

the conduct of the business have all combined to place directors in an

increasingly vulnerable position.

A special group of crimes, the “public welfare” offenses, have developed

that dispense with the traditional scienter (previous knowledge or guilty

knowledge) requirement for criminal liability. This development involving

liability includes the doctrine of the responsible corporate official, who will

be found liable along with the business organization itself. The doctrine

reflects the strong public policy that the public health and safety take

precedence over burdens on businesses and the individuals who control

them.

Public Health and Environment

One case especially serves to alert directors of cooperatives of the risk of

criminal liability. In Unitedstates V. Park, 421 U.S. 658 (1975), the defendant

10
was president of a business that stored food. Inspectors found violations of

the Federal Food, Drug and Cosmetic Act (FDCA). These violations were

reported to the defendant, who ordered remedial action. When reinspection

showed unsanitary conditions continued, the defendant was charged with

criminal violation of FDCA. The defendant argued that he had done all he

could and discharged his obligations by ordering reliable employees to cure

the violations. The United States Supreme Court held the defendant

criminally liable because he had a responsible relationship to the situation

causing the violations, could have prevented it, but had failed to do so.

Liability was based on the defendant’s position and authority and on his

duty under FDCA to exercise the highest standard of foresight and

vigilance. Indeed, the court dispensed with any requirement that the

defendant be aware of wrongdoing.

The principle of “responsible corporate official” as laid down in the Park

case makes it crucial that directors properly supervise officers and

employees to ensure FDCA rules are observed.

Director liability exists for other special statutes and rules. The Poultry

Products Inspection Act makes it unlawful to deal in misbranded or

adulterated poultry products and states that “any person” who violates its

provisions is criminally liable. The Wholesome Meat Act creates numerous

responsibilities for processors of cattle, sheep, swine, and the like. The

Clean Air Act has an express provision that responsible corporate officers

may be sued for knowing violations of regulatory orders or standards of

performance, or for making false statements involving air pollution. The

Federal Water Pollution Control Act (FWPCA) provides that willful or

negligent violations of its sections relating to effluents, standards of

performance, toxic pollutants, permit conditions, and recordkeeping are

punishable as criminal offenses. Liability for water pollution can exist under

the Refuse Act, which prohibits pollution of, or the dumping of debris into,

navigable waterways. Cooperatives involved in the distribution and

application of insecticides, fungicides, and rodenticides are within the

authority of the Federal Insecticide, Fungicide and Rodenticide

Act (FIFRA), which provides that a distributor who knowingly violates

FIFRA provisions is subject to criminal liability. The Consumer Product

Safety Act regulates possibly injurious products and specifically provides for

director liability in the event of a willful violation. The Toxic Substance

Control Act (TSCA) is intended to control the use of chemicals not already

covered by FIFRA.

While some of these statutes have no express provision for applying the

principle of “responsible corporate official,” actions that imperil the public

health and safety can be attributed to responsible directors under the rule of

11
Park. Certainly, absence of specific provisions about responsible persons in

management does not prevent application of the Pa&doctrine. This list of

some Federal statutes concerning environment and public health at least

should put responsible directors on notice that their conduct must be

vigilantly prudent in this developing area of the law.

Other Criminal Acts

Numerous acts in addition to the public welfare offenses are proscribed and

punished as criminal offenses. In operating a cooperative, a director may

break the law through lack of caution or as a result of wrongful intent, either

of which can satisfy the usual scienter requirement that the individual

willingly or knowingly did the act in question. Therefore, carelessness is as

much to be guarded against as is bad purpose. The concept of responsible

corporate official is fully applicable to the many criminal statutes that

provide that “any person” who violates a particular prohibition shall be

criminally liable. Several criminal statutes specifically provide (more by way

of emphasis than necessity) that directors are liable for violations.

Liability for employment policies can occur in the areas of safety, hours, and

wages. The principal statute concerning employment safety is the

Occupational Safety and Health Act (OSHA). This law is intended to

provide a work place free from hazards, and violations of it are analogous to

the public welfare offenses. Although criminal prosecutions have been

relatively few under OSHA, potential liability exists in view of the

numerous hazards that can occur in handling, processing, and distributing

agricultural commodities and supplies. Directors who are aware of safety

problems or OSHA violations must act to reduce or eliminate danger to

employees. Otherwise, directors could be charged with a criminal offense

under OSHA.

Similarly, wage and hour policies can result in directors’ criminal liability

under the Fair Labor Standards Act. This law is concerned with minimum

wages, maximum hours, child labor, and related subjects. Its penalties are

applicable to “any person who willfully violates” the Act’s provisions.

Commodity Credit Corporation (CCC) operates a Grain Reserve Program.

After a CCC price support loan has been granted, the grain may placed in

the reserve and cannot be removed by “any person,” subject to penalty,

until the national average market price reaches a designated level. A

director who votes for an early removal of reserve grain conceivably could

be sued.

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Directors’ criminal liability is becoming greater with the growing diversity of

cooperative activities and business ventures. However, it would be

impossible to relate here all the many specialized activities that have

spawned control agencies and regulations. In addition to Federal laws, every

State has laws to punish various acts of dishonesty such as fraud,

embezzlement, and theft. As a result, where activities are regulated by

Federal or State agencies, a director must seek appropriate advice about the

often particular requirements of action or avoidance in the supervision of

the cooperative.

Agricultural cooperatives have a variety of financial arrangements with

members and others for sources of equity capital. Some of these

arrangements fall into the category of securities. When they do, directors of

cooperatives can have special liabilities in connection with the issuance and

transaction of the security. Risk can be minimized by seeking counsel of a

securities lawyer.

Several financial relationships between cooperatives and members are not

considered to be securities. However, the Securities and Exchange

Commission (SEC) has not given assurance on some financing methods

that it would not prosecute for failing to register them as a security. If the

cooperative can arrange financing without issuing securities, a director can

be spared liability for securities violations.

Even if securities are issued, they may be exempt from the requirement to

register and associated liabilities. Less than half of all agricultural

cooperatives qualify for tax treatment under Section 521 of the Internal

Revenue Code. However, Section 521 allows an exemption from

registration under the Securities Act of 1933 so transferable shares or other

securities may be issued by these cooperatives without director liability for

registration violations. Some cooperatives may be exempt from the

provisions of the 1934 Securities Act, which requires, among other things,

registration for certain securities traded on a national exchange or in the

over-the-counter market.

Additional exemptions are based on how the security is transacted, such as

exchange of securities, intrastate sales, and private or limited offerings.

These exemptions can save the cooperative the expense of registration and

avoid director liability for registration violations.

If the cooperative, the security, or the transaction is not exempt under the

13
1933 and 1934 Securities Acts, a director may be charged with securities

violations in several areas. Even if an exemption applies, a director still can

be charged for violations of the antifraud provisions of the Securities Acts.

In addition to Federal liabilities, a director must be aware of liability under

State securities regulations. States have adopted so-called blue sky laws

concurrently with Federal securities laws. Each State has a blue sky law that

can contain registration requirements and antifraud provisions. Many

provide specific exemptions for agricultural cooperatives and their

securities, but considerable diversity appears in these provisions.

Few suits have been successful against directors of cooperatives for liability

associated with records and finances. Most cases involving records and

finances have been against the cooperative. Nevertheless, it is likely an

increasing number of suits may develop against directors. Suits will be based

on corporate analogies and legal precedents. The next logical step in suing

for damages resulting from financial dealings with a cooperative is to sue the

decisionmakers, the directors, when their actions have caused the financial

,

’

injury.

False or Misleading Financial Statements

14
performance of corporate duties (mismanagement of the business) in the

wake of insolvency and the closing of the elevator. The auditor’s report

showed substantial mismanagement and improper use of funds, including

personal use of corporate funds. The court said the directors had breached

their fiduciary duty to the corporation even though they had neither

assumed active duties nor involved themselves in the day-to-day affairs or

financial management of the corporation. Where directors have knowledge

of mismanagement and misappropriation and fail to take steps to correct

these facts, they breach their duty. However, the court went on to say that

for liability to be found a director’s knowledge must at the least amount to

acquiescence.

Direct rulings by the courts on the general duty to keep correct books and

records, in the absence of any specific statutory requirement, are few in

number. However, in the general course of a corporation’s business, it is

necessary that proper books of account be kept. Thus, even where a statute

does not require a record of the corporation’s business transactions to be

kept, the director, by virtue of the position as a trustee with respect to

members, should see that proper books of account are kept. However, the

duty to keep full and accurate accounts does not mean a director must be

able to render a bookkeeper’s account of all receipts and disbursements.

Reports

Most States require incorporated cooperative associations to make periodic

reports to a State agency concerning the association’s business affairs. Some

State statutes require cooperatives to make the same annual reports

required of other corporations. Others require cooperative marketing

associations to make annual reports that may differ somewhat from annual

reports made by other corporations. An association that fails to file required

annual reports may be subject to penalties. These penalties range from loss

of good standing to involuntary dissolution.

Accordingly, directors of a cooperative have been charged for failure to file

annual reports and for filing false reports when their actions have caused

injury. In one case, the court held directors of the cooperative liable for its

debts to the plaintiffs because the directors failed to file an annual report

and made a false report in violation of State statute. The directors had

delayed filing the report for 3 months after being elected. An annual report

had not been filed in previous years. The report also contained false

statements about the solvency of the cooperative.

In a recent case, a cooperative’s creditors sued it, contending individual

15
directors were liable along with the cooperative on certain leasing

agreements for which the cooperative was in default because of the failure

to file a required annual report. However, annual reports were filed during

the period in which the leasing agreements were made. The Supreme Court

of Montana acknowledged the penal nature of the directors’ statutory

liability for failing to file an annual report, but held the directors were only

liable for the debts of the cooperative incurred during the period of default

in making and filing the annual report.

Although State statutes may require an annual report to be filed with a State

agency or official, it may not always be necessary to furnish the membership

with annual reports. In one case, the court held the directors of the

cooperative were not guilty of fraud and mismanagement for failure to

furnish annual reports when the cooperative discontinued furnishing

annual reports because of lack of membership interest.

Inspection of Records

A director has a liability concerning inspection of records. Many State

statutes require association books either to be open to inspection by

members or to be distributed to members. A director may be charged for

failure to comply with this type of statute. Courts generally will allow

shareholders to examine corporate records if they show “good cause” to

discover evidence in their claim against the corporation.

Reliance on Records, Books, and Reports

A number of States have adopted statutory provisions that allow directors to

rely in good faith on the corporate books of account or on financial

statements of officers having supervision of the accounts. Good faith

reliance is recognized as an absolute defense. The Model Business

Corporation Act provides that a director may rely on information, opinions,

reports, or statements prepared or presented by officers and employees,

counsel, public accountants, committees of the board, and others if they

are, or if the director reasonably believes them to be, reliable and

competent. Also, some State cooperative statutes recognize the reliance

defense. Even in the absence of statute, directors may, in the exercise of

due care, ordinarily rely on the advice and reports of officers, provided the

directors exercise good business judgment concerning the accuracy of the

reports furnished them and use care to inspect the reports.

16
Accounting Procedures

A director can be sued if the cooperative does not follow proper accounting

procedures. Directors should see that an approved system of bookkeeping is

adopted to protect against mistakes and false entries. This does not mean,

however, that the duty of supervision requires a director to proceed on the

theory that officers’ and employees’ actions are under suspicion, that a

director is required to examine the books, or that an expert accountant must

be employed to detect embezzlement.

Therefore, without a specific statute to the contrary, or until something

happens to put reasonably prudent directors on notice, directors are entitled

to assume that officers, if selected with reasonable care, are honest and

following an approved system.

Tax Liability

Liability associated with records and finances may relate to taxation.

Circumstances can exist under which a corporation, or its officers, directors,

and employees, will be held civilly or criminally responsible for errors,

misstatements, and omissions (whether accidental or intentional) that

might occur in the corporate Federal or State income tax return. It is clear a

corporation’s directors, officers, and employees can be convicted of tax

evasion while acting on behalf of the corporation. In criminal tax cases, the

prosecutor can decide to try the corporation alone, the responsible officers,

directors, and employees alone, or join them all as defendants.

The Internal Revenue Code (IRC) and other Federal statutes specifically

set forth a series of substantive acts that, if violated in connection with the

preparation and filing of corporate Federal income tax returns, can result in

civil and criminal sanctions against corporations, their officers, directors,

and employees. The IRC also says an officer or employee of a corporation

can be punished for any tax crimes committed in connection with official

corporate duties. Futhermore, civil fraud sanctions are contained in the

IRC. Both the corporation and its officers may be assessed penalties for

violations of the fraud and negligence provisions of the IRC because

violations depend on the acts and intent of the officers.

Improper Distribution of Dividends

A director may be su.ed for violating various limits on interest or dividends

or for violating restri ctions on changes and modifications in dividends.

17
State statutes or articles or bylaws of the cooperative can limit dividends or

interest payable on capital stock. Limits can apply to common stock,

preferred stock, or patronage-based equity. An alternative requirement of

the Capper-Volstead Act provides that an association may not pay dividends

on stock or membership capital in excess of 8 percent per annum. Most

States place a maximum limit on interest or dividends paid on common or

membership stock and preferred stock. Changes in capital stock structure or

modification of rights to dividends or interest may include changes in the

amount of capital stock and changes in preferences for various classes of

stock. Changes are normally made by an amendment to the articles of

incorporation or bylaws. However, some State statutes specifically describe

circumstances and voting requirements necessary for such modifications.

Cases have arisen where shareholders have sought to require distributions

by the board of directors. Although shareholders generally have sued only

the cooperative association, directors could become targets. In one case, a

court said failure to pay dividends and allow redemptive rights was an abuse

of director discretion because the charter and its bylaws required a revolving

fund for the retirement of stock in those years when adequate capital had

been accumulated. The court held it was not valid to pay active members

first to meet the competition for those members, especially when the

directors’ business with the cooperative comprised 80 percent of its total

business.

In another case, preferred stockholders brought an action for an accounting

and an order compelling an agricultural cooperative to comply with its

articles of incorporation requiring payment of dividends on and retirement

of preferred stock. A dividend of 6 percent was to have preference over all

other dividends and distributions, and preferred stock was to be retired

when a reserve account established for that purpose exceeded a specific

amount. The cooperative paid patronage refunds out of its net margins

rather than build up the reserve account. Losses were charged against the

general reserve and no allocation was made to the retirement reserve

account. Although the board of directors of the cooperative were all

common stockholders, the operation of the cooperative was financed by

preferred stock. The court said directors of the cooperative abused their

discretion in failing to develop and maintain a rational balance between the

amounts paid to the preferred stockholders and the active members, and in

failing to provide, maintain, and build the preferred stock retirement

reserve account required by the articles of incorporation.

Some questions arise over whether shareholders can successfully sue

directors personally to pay required dividends. 0ne case concerning

18
misfeasance (specifically, the misappropriation of corporate property) and

the right to dividends indicates that if a cooperative’s member tried to

enforce a personal right to a declaration of dividends, the court could first

require the member to bring a derivative action (a shareholder’s suit on the

business’s behalf to enforce the corporate claim). Misappropriation can

occur, for example, by paying patronage dividends rather than required

preferred stock dividends, or by purchasing unnecessary assets rather than

paying dividends. The court in this case noted that a suit to compel a

declaration of dividends is a suit to vindicate primary and personal rights

and is not the proper basis of a derivative suit. Once restitution of corporate

property is obtained by means of a derivative suit, however, proper

dividend payments could be made. If the directors still refused to declare

dividends, an individual action could then be brought. Of course, an

individual action could be brought initially to compel payment of dividends

for monies available that had not been misappropriated or misused (i.e.,

where the directors merely refused to declare a dividend).

Depletion of Capital

Generally, a business corporation may repurchase its own stock provided its

capital stock is not impaired. This general principle has been applied to

cooperatives. Many States place limitations on common and preferred stock

repurchased by cooperatives. Suits can arise over stock purchase plans or

restrictions on stock repurchase. In suits seeking to defeat stock purchase

plans, courts have upheld the purchase so long as the corporation does not

use its funds or property for a stock purchase that, when accomplished,

would cause any impairment of its capital stock or its financial status, or that

would diminish the corporation’s ability to pay its debts or lessen the

security of its creditors.

In one case, a former member of a fishermen’s cooperative sought to

recover the value of his stock or membership interest in the cooperative, as

well as to have an accounting for patronage to which he was allegedly

entitled. The court held that an amended bylaw adopted by the cooperative,

which altered the consideration to be received upon the redemption of

shares from “fair book value” to original purchase price, did not change the

former member’s right under the bylaw in effect when he purchased his

stock. The court found the amended bylaw infringed upon a vested right of

the plaintiff and exceeded the authority of the cooperative to amend the

bylaws. Though directors were not held personally responsible, a similar

interference by directors with members’ vested rights could result in their

being charged for ultra vires acts.

19
Additionally, suits may arise over debts and losses sustained by the

cooperative. Some States place credit limitations on cooperatives. Wyoming

makes directors liable to creditors when they consent to an excess of

indebtedness over assets or subscribed stock. A director can be liable for

payment of dividends or refunds causing the association to become

insolvent unless the director filed an objection to the board action causing

the insolvency.

In one case, a chemical company sold fertilizer to an agricultural

cooperative. After the cooperative became insolvent, the company sought

to recover the unpaid portion of the purchase price from directors of the

cooperative on the ground that the directors had negligently permitted the

indebtedness or liabilities of the cooperative to exceed the limits permitted

in the bylaws, and were therefore liable for the balance due. The court said

the seller could not recover from the directors if the seller knew the

indebtedness limit was exceeded. However, the court also said the burden

was on the directors to prove the seller knew the cooperative had exceeded

its limits of indebtedness. The court found the directors liable.

Similarly, commodities speculation that results in depletion of capital can

provoke lawsuits against directors. Some courts, noting specific authority to

buy or sell commodities outside the State, have held speculative

transactions to be legitimate (not ultra viresand not gambling or otherwise

unlawful), and therefore actions against the directors of these companies

were not successful. In contrast, when directors have used certain funds to

speculate without authority, other courts have said that although directors

are authorized to handle ordinary business affairs according to their best

judgment, they are not excused by good faith from responsibility for

speculative losses unauthorized and outside of the corporation’s ordinary

and usual scope of business. Courts following this line of reasoning

generally label speculative transactions as ultra vires, if not absolutely illegal.

On the other hand, courts have upheld hedging practices of cooperatives as

not being ultra viresor not outside the objects for which the corporation was

created.

Certainly, mismanagement or misuse of funds can injure the member and

confer standing to sue the directors for breach of fiduciary duty. When

challenged for mismanagement or misuse of funds, directors have

traditionally relied on the “business judgment rule” as a defense. Another

common defense is reliance upon others, which is allowed because directors

are not normally required to supervise day-to-day operations.

Finally, it should be noted that State statutes following the Model Business

20
Corporation Act may impose liability on directors for wrongful distribution

of the assets of the cooperative upon liquidation, and for any loans made to

any director or officer, unless the loans are repaid in full.

Patronage Refunds and Retained Equities

Patronage refunds have traditionally been the method cooperative

associations use to operate at cost and return net margins or savings to

patrons on the basis of business done with the association. Although use of

patronage refunds is widespread, many State statutes do not describe them

in any detail. However, several terms used with respect to patronage

refunds are implicitly defined in statutes. In addition to references made to

the nonprofit nature of cooperatives, many statutes refer directly to the

distribution of net margins or savings. In other words, certain statutory

language may be taken as direct or indirect recognition of the patronage

refund system and the requirement that net margins or savings be returned

to patrons.

The timing, level, and manner of redeeming patronage equities is usually

covered in the bylaws and is usually held to be a matter within the discretion

of the board of directors. Nevertheless, equity redemption is still an

important issue. The dual demands of cooperative financing and member

requests for redemption may conflict.

No cases have held directors personally liable for failure to pay patronage

refunds or credits, but cases have been decided against the cooperative on

the basis of abuse of director discretion. Courts more commonly side with

the cooperative and its directors and are hesitant to interfere in this aspect of

a cooperative’s business. In the absence of bylaws, articles of incorporation,

or statutes requiring payment, courts usually have held that boards of

directors may in their reasonable discretion deny payment on demand to

any member of the cooperative, even to the estates of deceased members,

especially if expansion of operations would otherwise be seriously

jeopardized, or where payment would cause undue financial hardship to the

cooperative.

Courts have recognized, however, that a plaintiff-member may be able to

show abuse of director discretion. Decisions finding abuse have been based

on proof of the cooperative’s sound financial condition, lack of equality of

treatment in repayment of capital credits, or that directors have a fiduciary

obligation to members in regard to decisions affecting member capital.

One court, upholding the plaintiff-member’s claim against a cooperative

21
that had refused upon demand to make payment of deferred dividends, held

the directors had abused their discretion because they had previously paid

deferred dividends to other members in a like situation, because the

cooperative was in a healthy financial condition, because the directors could

not show payment of deferred dividends would create any undue hardship,

and because the cooperative had received a benefit from the plaintiffs

dividends.

Suits involving directors can arise as a result of disagreements over setoffs.

The member can claim a setoff for accrued but unpaid patronage dividends

or equity credits, and can even demand the balance due. Then questions

arise concerning whether the directors should have declared payments or

made distributions, whether indebtedness is due and payable, and whether

there has been an abuse of discretion. Decisions have gone both ways in

regard to allowing setoffs for patronage dividends.

Questions involving patronage dividends can arise when cooperatives

merge. In one case involving an alleged merger, the court said when

agricultural cooperatives merge, dissatisfied members are entitled to

revolving fund credits at the discretion of the board of directors because the

right to payment simply follows the fund. But when there actually is not a

merger, but rather a sale of assets followed by a dissolution of the

“merged” cooperative (the one going out of existence), dissatisfied

members of the “merged” coperative are entitled to immediate payments

of their revolving fund credits.

Other Actions of Directors

Directors of cooperative associations are liable for their actions in a variety

of other circumstances relating to records and finances. Directors can be

sued for breaches or defaults in the cooperative’s marketing agreements

when the cooperative’s payments were insufficient. These defaults can

constitute mismanagement of the cooperative’s affairs. However, if

directors make good faith errors of judgment in marketing-sales

transactions, no liability normally is placed on them or the cooperative.

Directors who have permitted another director to conduct the corporation

as a personal affair have been charged with misapplication of corporate

funds when they acted without reasonable care in failing to preserve,

conserve, and protect the assets of the corporation. Conversely, directors of

a farmers’ grain cooperative were not charged for an alleged willful

conversion of grain belonging to a farmer when his oats were sold and no

remittance made to him. In that case, the court said nothing indicated the

22
directors did not exercise care and prudence in selection of the manager

(who arranged the wrongful transactions), and neither did the directors

assume general supervision of the conduct of the business nor did they have

knowledge of, or acquiesce in, the wrongful conduct of the manager.

Finally, many State “conflict of interest” statutes prohibit a director from

becoming a party to a contract for profit with the association differing in any

way from business relations with regular members, or holders of common

stock, or others, or differing from generally current terms. Nevertheless,

despite a conflict of interest statute, one court upheld the right of a

cooperative to employ a director as a business manager for a fair

remuneration. On the other hand, in a derivative action against a

cooperative and its directors and former directors, another court found

failure of the board of directors to investigate two employees’ conflicts of

interest, after having actual knowledge that they were faithless employees,

was prima facie (self-evident) gross negligence and culpable

mismanagement for which the directors were liable because of resulting

losses to the cooperative.

Few cases have held directors personally liable for authorizing false or

misleading financial statements and reports, improper distributions of

dividends, depletion of capital, improper payment of or denial of payment of

patronage dividends, for failure to give annual reports, or for authorizing

other actions involving misappropriation or misuse of cooperative property

or funds.

It is most important for directors to be knowledgeable about the

cooperative’s relationship with antitrust laws. Agricultural cooperatives are

not totally immune from antitrust prosecution and civil proceedings despite

exemptions granted by the Capper-Volstead Act, other Federal statutes,

and State antitrust statutes. Uncertainties pervade the antitrust laws,

especially concerning the personal criminal and civil liability of directors.

Moreover, antitrust law is one area where corporate law diverges

considerably from cooperative law because of the specific exemptions from

antitrust laws that apply to farmer cooperatives. Otherwise, many principles

of antitrust law apply equally to cooperatives and other corporations.

Applicable Corporate Antitrust Principles

The primary’ purpose underlying the antitrust laws was the desire of

Congress to protect the public from business combinations that tend.ed to

23
monopolize and restrain interstate trade. To implement this purpose, a

procedure was established authorizing the Federal Government to

investigate suspected violations and institute both criminal and civil

proceedings. Further compliance was ensured by Congressional solicitation

of participation by private individuals in enforcement. To encourage private

suits for antitrust violations, Congress enacted Section 4 of the Clayton Act,

which gives to anyone injured in “business or property” by reason of an

antitrust violation of any kind an action for treble damages (triple the

amount of damages actually suffered).

Section 4 of the Clayton Act places no limitation on the person the private

litigant may name as a defendant in a treble damage suit. Therefore,

questions can arise about directors’ liability under the treble damage

provision. Although private antitrust suits are numerous, relatively few

cases have named corporate officers and directors as defendants. This is

understandable considering the greater likelihood of a corporation being

able to satisfy a large treble damage judgment. However, some plaintiffs do

sue both the executive and the corporation. A plaintiff can decide to sue the

director alone where the corporation is insolvent.

The corporate executive is liable for torts personally committed.

Consequently, a director cannot use the corporation to shield unlawful

conduct. However, if a director’s tort is committed within the scope of

director authority, the corporation as principal also may be liable with its

agent, and an injured third person may look to either or both for

satisfaction.

An antitrust action by a private individual seeking treble damages is an

action based on the defendant’s personal liability for the damages actually

caused to “business or property.” The leading case applying the agency rule

of liability for treble damages to a corporate executive is Kentucky- Tennessee

Light & Power Co. v. Nashville Coal Co., 37 F. Supp. 728 (W.D. Ky. 1940,

affirmed 136 F.2d 12 (6th Cir. 1943). The court held that if the participation

in the unlawful antitrust transaction were proved, the executive would not

be relieved of liability merely because he was an agent of the corporation

making the illegal payment; he must personally bear the consequences of

his own tortious conduct.

Under antitrust laws, a director cannot escape liability on the grounds of

acting with good intentions or in good faith, or that the violation of the law

was not recognized.

Even where an officer is not charged with active participation in prohibited
conduct, liability can result from passive acquiescence or ratification of

illegal activities. To prove acquiescence, it must be shown that an official

had knowledge and approved of the activities and their unlawful objective.

Of course, an officer will have little to fear if, upon learning of illegal

activities, the officer repudiates and disassociates from them. However,

actual knowledge is not the sole requirement. Once put on notice that

something is unlawful, an officer is charged with knowledge of all a

reasonable inquiry would have revealed.

A second legal theory imposing civil treble damage liability on directors is

based on the corporation’s criminal liability. Section 14 of the Clayton Act,

the so-called personal guilt provision, provides that whenever a corporation

violates any of the penal provisions of the antitrust laws, the violations will

be applied also to those of its individual directors, officers, or agents who

authorized, ordered, or did any of the illegal acts.

The Supreme Court of the Unites States has never held mere corporate

liability sufficient to extend liability to corporate agents who have no

consciousness of wrong-doing. On the other hand, Congress, by express

statutory provision in Section 14 of the Clayton Act, has applied the

antitrust laws to corporate officers as distinct from corporations. The history

of Section 14 shows it was enacted to create a method of punishing directors

who took part in unlawful conduct under the antitrust laws. This places a

director’s liability on an equal footing with that of the corporation, so both

are within the civil liability provisions of Section 4 of the Clayton Act.

The Supreme Court has held that Section 14 of the Clayton Act does not

provide an exclusive remedy for violations of Section 1 of the Sherman Act,

and therefore does not preclude prosecution of corporate personnel under

the Sherman Act. Most of the litigation in antitrust centers on the more

stringent criminal penalties of the Sherman Act. Thus, any corporate officer

can be prosecuted who: knowingly participates in an illegal contract,

combination, or conspiracy; authorizes, orders, or helps perpetuate the

crime; or acts toward those ends in a representative capacity.

Sections 1 and 2 of the Sherman Act refer to offenses committed by any

“person” or “persons.” Those provisions apply to “every person engaged

in business whose activities might restrain or monopolize commercial

intercourse among the States.” Liability under the Sherman Act has been

extended to all persons who knowingly participated in, aided, or abetted a

violation of its provisions. The Supreme Court has included individual

corporate officers and directors in the definition of “persons” because a

corporation can act only through its officers and directors.

25
An individual director cannot be charged with conspiring with the

corporation to restrain trade or to monopolize or attempt to monopolize

trade in violation of Sections 1 and 2 of the Sherman Act. Most courts have

taken the view that a conspiracy requires at least two persons or entities, and

there is only one entity (the corporation) where the executive acts for the

corporation in the ordinary scope of duties. When acting in other than a

purely official capacity, however, an officer is regarded by the law as an

entity separate from the corporation and a conspiracy can be in violation of

either Section 1 or 2 of the Sherman Act.

It is well recognized a conspiracy between a parent corporation and its

subsidiaries or between two or more subsidiaries can be in violation of the

Sherman Act where the purpose and effect of the concerted action is to

restrain the trade of outsider entities. Presumably, a conspiracy can also

exist between the officers of the corporation and the officers of the

subsidiary or between the officers of one entity and another corporate

entity.

A distinction can be made between Sections 1 and 2 in this regard because

Section 1 does not make a restraint of trade, standing by itself, a substantive

offense. Because a corporation is incapable of violating Section 1 by itself, it

follows that concerted action between members of the same corporate

family does not constitute a conspiracy within the meaning of Section 1.

However, in Section 2 cases under the rationale recognized by some

authorities, if the corporation itself can violate the antitrust laws, its officers

and directors or its subsidiary corporations can conspire to commit a

Section 2 offense (e.g., by devising a monopoly scheme).

The matter of whether a cooperative and its subsidiaries, and therefore its

directors, officers, and employees, can conspire to violate the antitrust laws

has been a subject of frequent litigation. Most cases have considered only

the threshold question of whether the organizations themselves have

conspired to violate the antitrust laws, and not the question of whether the

directors are individually liable for conspiracy. But by analogy it can be

argued that the Capper-Volstead exemption to the antitrust laws will not

protect combinations of producer and nonproducer interests, and therefore

directors involved in the conspiracy may be held liable for Sherman Act

violations. Additionally, Section 2(a) of the Clayton Act, as amended by

Section 1 of the Robinson-Patman Act, specifically prohibits “any person”

from engaging in certain discriminatory pricing practices. Courts have

uniformly held that an officer, director, or employee of a corporation may

be sued in an individual capacity for acts done on behalf of the corporate

employer if those acts violate the Robinson-Patman Act. Corporate
personnel have been held liable under this section for unlawful or improper

acts in which they knowingly participated. Further, Section 3 of the

Robinson-Patman Act makes it a crime to sell goods at unreasonably low

prices for the purpose of destroying competition or eliminating a

competitor. Sales made below cost without any legitimate commercial

objective and with specific intent to destroy competition violate the antitrust

laws because of Section 3. However, Section 4 of the act provides a limited

exemption for cooperative associations by allowing them to return to their

members all or any part of the net margins or surplus resulting from the

cooperative’s trading operations. Section 4 applies only to the payment of

net margins to members, however, and does not give cooperative

associations blanket exemption from the prohibitions of the RobinsonPatman or the antitrust laws generally.

Derivative Suit - Personal Liability for Antitrust Violation

A corporate officer has a fiduciary relationship to shareholders of the

corporation. Thus, an officer owes shareholders and the corporation a duty

to employ only reasonable means in performing the management functions.

To violate the antitrust laws in performing those duties is not an exercise of

reasonable care. If officers do act outside the scope of their authority in

violating the antitrust laws, they may be liable to the corporation for any

damages. An officer can be liable to the corporation for its fines, single or

treble damages, and litigation expenses. If the corporation unjustifiably

refuses to enforce its cause of action against an officer, one or more of its

shareholders may bring a derivative suit against the guilty officer and seek

recovery on behalf of the corporation.

To maintain a derivative suit, the shareholder must allege and prove the

officer has breached fiduciary duty (e.g., by a willful violation of statute) to

the corporation and to shareholders. Secondly, the shareholder must prove

an officer knew, or with the exercise of reasonable care should have known,

that antitrust laws were being violated. The third element to be proved is

that the corporation has suffered an injury because of the unlawful conduct

of an officer. Proof used to establish the injury must be of an independent

nature. The damages recovered against an officer in a derivative action are

single damages, not the treble damages awarded under Section 4 of the

Clayton Act.

Criminal Antitrust Enforcement

The Antitrust Division of the Department of Justice and the Federal Trade

Commission have primary authority to enforce the antitrust laws. The

27
Antitrust Division has authority for enforcing the Sherman Act, the

Clayton Act, and the Robinson-Patman Act. Jurisdiction is shared with the

Federal Trade Commission with respect to the Clayton and RobinsonPatman Acts. The Federal Trade Commission enforces Section 5 of the

Federal Trade Commission Act, which declares as unlawful unfair methods

of competition and unfair or deceptive acts or practices in, or affecting,

commerce. The Federal Trade Commission has no authority, however, to

act solely in the interests of individual complainants who have been exposed

to unlawful practices. Even so, violations of the Sherman or Clayton Acts

also may be violations of the Federal Trade Commission Act.

Whether a criminal or civil action will be brought by the Antitrust Division

depends in part on the defendant’s conduct. It is a rule of the Antitrust

Division that criminal prosecution will be initiated for willful violations of

the law (willfulness may be established by actions constituting per se

offenses or by intentional violations). Not all antitrust statutes, however,

are criminal in nature. Criminal actions may be brought under Sections l-3

of the Sherman Act, Section 14 of the Clayton Act, and Section 3 of the

Robinson-Patman Act. But even if the Antitrust Division does not initiate

criminal prosecution, it is not precluded from filing a civil action based on

the same alleged violation. Indeed, it is agency policy to do so.

Realities of Personal Liability

In the vast majority of civil antitrust cases, proof of damages is not simple.

Proof cannot be based on conjectural theories of injury or remote economic

injury that would involve the courts in difficult cause and effect

relationships. Plaintiffs must allege and prove they were forced to pay

higher prices due to a defendant’s restrictions, that market price rose as a

result of a defendant’s activities, and that they were within a defendant’s

“target area” of alleged anticompetitive behavior. A significant causal

relationship must be shown to exist between the violation and the injury.

The leading case for holding directors and officers of a corporation liable for

antitrust violations is Hartford-Empire Co. v. United States, 323 U.S. 386

(1945). Although the directors of a corporation can be sued personally for

antitrust violations, this case pointed out that shareholders and employees

of a corporation may have no individual claim for personal relief under the

antitrust laws for injuries they suffer as a consequence of injury done to a

corporation by the directors in violation of antitrust laws. Normally, the

proper course of action for this type of injury is a shareholder derivative

action for breach of fiduciary duty.

28
In few cases over the years have a cooperative’s officers or directors been

sued individually for violations of antitrust law. Moreover, when directors

have been specifically named as defendants, they usually have not been

held liable. In derivative actions against officers and directors of

cooperatives, as with actions against executives of other corporations,

courts generally find liability only for gross and culpable negligence in the

management of the cooperative. Contentions that directors of cooperatives

should be held to a higher standard of care like that imposed on trustees of

an express trust have gone unheeded. The courts have held the fiduciary

relationship that exists in the cooperative setting is not the “Simon-pure”

relationship governing in the law of trusts. In other actions, courts have

limited the liability of officers and directors of cooperatives to participation

in “inherently wrongful conduct.” Thus, plaintiffs in antitrust suits must

prove gross and culpable negligence or inherently wrongful conduct in the

management of the cooperative before directors will be held liable.

Nevertheless, in areas where the Capper-Volstead exemption does not

extend, the courts have sometimes been strict with individual directors. In

one case, a charge of conspiracy to restrain trade by price-fixing was inferred

from course of dealing and circumstances when a cooperative raised “outof-store” prices even though wholesale prices had not been increased, fixed

different prices for different customers, gave secret cash rebates,

indiscriminately cut prices without valid explanation and not in an effort to

meet the competition, and utilized deceptive practices and bullying

methods. The antitrust exemptions did not apply in this case because the

actions of the cooperative (supplier) affected noncooperatives (customers);

therefore, the defendant-cooperative was subject to the antitrust laws. The

court said fixing retail prices violated Section 1 of the Sherman Act, and

predatory acts showed intent to monopolize in violation of Section 2. The

court awarded damages against the defendants, as well as attorneys’ fees,

and issued an injunction prohibiting the cooperative’s unlawful actions.

In another private antitrust action against a farmers’ marketing cooperative

in which officers and directors also were named defendants, the court held a

corporate officer acting in official capacity can individually perform

predatory acts for which the officer is personally responsible. The court said

the corporation as principal is responsible for the acts of its agents who

violate the antitrust laws, but the agents also can be individually

responsible. The court said further that officers or directors acting in other

than their normal capacity can be held individually responsible for

conspiracy to monopolize, and the corporation as principal also may be

responsible for their violations.

29
State Antitrust Laws

Most States have statutes concerning agricultural marketing cooperatives

that include a provision to the effect that a cooperative incorporated

pursuant to State statute does not violate the antitrust laws of the State by

either operations or by agreements with members. Another common

statutory provision does not refer specifically to antitrust rules but permits

activities among cooperative associations that might otherwise have

antitrust implications. Forty-three States have statutes with this type of

provision allowing inter-association agreements. The public policy of these

types of statutes generally has been upheld by the courts.

INDEMNIFICATION AND INSURANCE

Because even the most careful, faithful, and knowledgeable director may

become a defendant in a lawsuit based on official actions or position, some

thought should be given to protecting the director through indemnification

and insurance.

Indemnification

Indemnification is the act of a cooperative in reimbursing the director for

expenses resulting from legal actions taken against the director in official

capacity. In the typical case, the director is sued by a third party or by

members or shareholders of the cooperative in a derivative action. A

director can incur expenses of counsel, court, and settlement or judgment.

Depending on the nature of the legal action, it may be possible to reimburse

a director for some or all of these expenses through indemnification from

the cooperative.

Statutory provisions for corporate indemnification exist in every State.

These statutes apply to corporate directors and therefore to the directors of

incorporated cooperatives. Most statutes are a recognizable version of the

Model Business Corporation Act Section 5, which, as revised in 1980,

provides for and puts limitations on indemnification. A director may be

indemnified for some or all expenses by right or by discretion. But under

some circumstances, a director may be barred from indemnification

altogether.

To qualify for indemnification, it must be determined that a director of a

cooperative has met the prescribed standard of conduct of the Model

Business Corporation Act or the cooperative’s bylaws. In one recent case,

an employee of a cooperative was denied indemnification when found guilty

30
of making illegal campaign contributions in which the directors had

acquiesced. A bylaw allowed indemnification to the extent permitted by law,

but only for acts done in good faith. The court held a knowing violation of

law, though done to benefit the cooperative, was not an act in good faith,

and the employee was left to pay the fine and attorney fees out of his own

pocket.

Nevertheless, directors have been indemnified by right even though they

had not been found innocent. In one case, directors had been criminally

convicted of securities violations. After reversal of the convictions, they

were retried. The suit was finally settled by pleas of nolo contendere and the

directors’ agreements not to appeal in return for additional charges being

dropped. The company resisted a demand for indemnification, claiming the

directors had not made a successful defense. The court held that any

outcome to a criminal charge other than a conviction was successful for

purposes of indemnification, and there could be partial indemnification on

any successfully defended independent count.

While components of Section 5 are found in the statutes of most States,

variations are many. Because some States place significant limitations on

the otherwise generous indemnification provisions of Section 5, directors

and attorneys must be aware of the scope of possibilities for indemnification

in their particular jurisdiction.

Insurance

Businesses are looking more frequently to insurance policies to cover

director liability. The general increase in litigation with directors as

defendants and the high cost of litigation recently have prompted a demand

for and availability of insurance policies intended to accomplish the twin

goals of insuring directors against liabilities not covered by indemnification

and indemnifying the business concern when it suffers a loss in

indemnifying the director.

As a primary matter, each cooperative must decide whether insurance of

this type (commonly referred to as a director and officer, or D & 0, policy)

is a worthwhile investment, because costs and risks will vary.

In brief, suggestion

insurance follow:

s for protecting directors by indemnification and

(1) Provide in a bylaw that directors shall be indemnified to the full extent

permitted by law.

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(2) Include in the bylaw specific provisions relating to settlements, partially

successful defenses against multiple charges, and expenses in defending

against securities law violations where acts are not deliberately wrongful.

(3) When applying for insurance, poll each director individually to avoid

misrepresentative answers in the application that, as warranties, may allow

the insurer to avoid liability.

(4) To reduce the expense of a D & 0 policy, shop around for low

premiums, consider a high deductible, consider a special policy limited to a

particular risk or event, and consider insuring only the directors, and not

the cooperative, for expenses of indemnification.

32
Appendix: Glossary

Abuse of Discretion: a board of director’s act or failure to act, concerning

a matter within the board’s discretion (e.g., retiring a member’s reserved

equity), in a manner that is irrational, discriminatory, arbitrary, or

otherwise clearly unsupportable by any proper business purpose.

Accounting: an equitable judicial remedy requi

up profits or funds wrongfully acquired (e.g., by

ng the defendant to give

breach of fiduciary duty).

Adulteration: act or omission to act by which food becomes unfit for

consumption under Food & Drug Administration regulation S.

Agent: a role the director assumes in representing the cooperative to third

parties or acting on the cooperative’s behalf; the cooperative then assumes

the character of the agent-director’s principal, to whom the director owes

fiduciary duty.

Articles of Incorporation: a document filed with a government agency

containing required information about the cooperative’s structure and

operation. The articles set up basic rules along with bylaws under which the

cooperative is run.

Blue Sky Law popular name for State statutes controlling offers and sales

of securities and intended to protect investors from fraudulent schemes that

“have no more basis than so many feet of blue sky.”

Bona Fide: good faith; refers to acts done honestly, sincerely, without

deceit or fraud.

Business or Corporate Opportunity: the cooperative’s interest in a

business transaction, whether the interest is tangible or intangible, present

or future, that is in opposition to the interests of its fiduciary (e.g., a

director). A business opportunity usually represents a chance for the

business organization to secure or act on its interest and thus should be

denied to the fiduciary who is barred by the duty of undivided loyalty from

taking the opportunity as his or her own.

Byraw: a rule ad#opted by a cooperative to govern the conduct of its affairs.

Bylaws are often the source of directors’ responsibilities and liabiliti.es.

Capital: as used in this work, the assets held by the cooperative that

represent contributions of the members and shareholders, and which the

cooperative owes them after creditors’ claims are liquidated.

33
Capper-Volstead Act: a Federal law that allows farmers to collectively

market agricultural products through cooperative associations without

violating antitrust laws merely for having acted as a group.

Causation: an element to be proved in an action in tort against a director.

Liability-inducing causation must be proximate (i.e., direct or reasonably

probable as the source of injury), not remote or incidental.

C/ayton Act gives a limited exemption to the Sherman Act, allowing

nonstock cooperatives to operate without being considered combinations in

restraint of trade merely because of organizational structure; allows a

plaintiff in an antitrust suit to recover treble damages.

Commodities Speculation: the act of incurring purchase or sale

obligations in the futures market that exceed the cooperative’s needs to

hedge against unfavorable price fluctuations.

Common Law: case law, or the body of law, principles, and rules of action

that has its source in usage and custom as announced by judicial decisions,

as opposed to statutory law.

Conflict of Merest a clash between the personal pecuniary interest of the

fiduciary/director and the interests of the cooperative to which the fiduciary

duty of undivided loyalty is owed.

Contract an agreement between two or more persons that creates an

obligation courts will enforce. A contract requires competent, assenting

parties, a subject matter, and an exchange or promise. Some contracts are

enforceable even though orally made.

Conversion: unauthorized control or disposition

property inconsistent with the rights of the owner.

of another’s personal

Damages: refers both to the injury s uffered and the

compensation that may be recovered in court.

monetary

Deceit: an untrue statement of fact intended to deceive or mislead.

Derivative Suit a suit filed by a member or shareholder of the cooperative

and instituted on the cooperative’s behalf, enforcing the cooperative’s right

against another (e.g., a director) when the cooperative fails to assert its right

(as by neglect or intransigence ofthe board of directors).

34
Diligence: attentiveness, care, and prudence such as is properly

expected from a reasonabl.e person under the circumstances.

to be

Dissolution: termination of the cooperative’s existence, as by winding it up

in voluntary dissolution under appropriate corporate law, or by bankruptcy

proceedings.

Dividend: distribution to a shareholder based on investment or ownership.

Courts sometimes use the term “patronage dividends” when referring to

patronage refunds, which are distributions of net margins according to

patronage.

Embezzlement: the taking or conversion of another’s money or property

of which the embezzler acquired possession through an office, employment,

or position of trust.

Equitable Remedy: refers to the kinds of judicial relief traditionally

available in courts of equity. Federal and most state courts have merged law

and equity to make equitable remedies available in civil suits. Remedies

include accounting, injunction, specific performance, and restitution.

Equity Redemption:

issed equities.

payment of cash or other property for previously

Fiduciary: a person with a duty, created by his own undertaking, to act

primarily for the benefit of another in matters connected with the

undertaking. Breach of fiduciary duty results in liability for damages caused

the person to whom the duty is owed.

Fraud: an intentional false representation, unfair scheme, or deceit

intended to make another act in reliance to his or her detriment or in

derogation of his or her right.

Futures: refers to a kind of contract giving a present right to or obligation of

future delivery at a fixed price. Cooperatives often engage in the

commodities futures market to secure a price for members’ agricultural

commodities.

Hedge: a means of protecting commodity sellers against price fluctuations.

The seller (or cooperative) makes a futures contract for sale of the amount

of the commodity he or she expects to deliver to guard against unfavorable

movement in price at the time for delivery. At the time for delivery, the

seller will make a purchase contract to offset the previous sales contract,

35
with the effect that any movement in contract price is countered by the

actual sale of the commodity, and the seller’s original futures sale contract

price is secured.

Injunction: a commandment by a court requiring the party enjoined to do

or refrain from doing a particular thing where the conduct or failure to act,

threatened or current, harms a plaintiff who has no other remedy.

Insolvency: the condition of being unable to pay debts as they fall due or in ,

the usual course of business.

Liability:

obligation

a broad term that can include every form of legal

or responsibility whether absolute 7 contingent,

hazard,

or likely.

Libel: a false and unprivileged pu blication in writing that tends to ha

person’s reputation or injure that person in business or profession.

rm a

Malfeasance: a wrongful act that the actor has no legal right to do, such as

when a director uses the position for personal enrichment by

misappropriating cooperative assets.

Misappropriation: the taking or using

purpose of benefitin.g the appropriator.

of another’s property with the

Misfeasance: the improper performance of an act that the actor has

authority to perform, such as when a director approves a contract on the

cooperative’s behalf that contains disadvantageous terms that could have

been deleted had the director been diligent.

Misrepresenta

mislead.

tion: an untrue statement of fact intended to deceive or

Negligence: the omission to do something that a reasonably prudent

person would have done under the circumstances, or the failure to use

appropriate care, where there is a duty to act or be careful.

/Vet Margins: Gross income from all sources minus all allowable expenses.

Net savings, net earnings, and net income are often used in place of net

margins.

Nolo Contendere: a plea in a criminal case that neither admits nor denies

the charge, though penalty may be imposed pursuant to the plea. The plea

may not, however, be used against the defendant in a civil suit based on the

same facts (as where a director is charged with violations of antitrust law).
Nondisclosure: a concealm en.t of or

ought to be disclosed; a type offraud.

failure to disclose information that

Nonfeasance: failure to perform some act that one has a duty to perform,

as when a director who is required by the cooperative’s bylaws to attend

meetings of the board never attends.

Nuisance: an activity or use of property that causes disturbance of or

interference with another’s reasonable use and enjoyment of his or her

property.

Patronage Refund: net margins of a cooperative allocated to a patron in

proportion to the value or quantity of the individual’s patronage, whether

distributed in cash or left in the cooperative. Refunds left in the cooperative

may be in qualified or nonqualified form. Also known as patronage

dividends.

Per Se: in itself; inherently. Per seviolations are those in which the act

complained of is enough to cause liability without further proof of harm

(e.g., certain antitrust violations).

Per-Unit Retain: equity invested in a cooperative based on the value or

quantity of products marketed or supplies procured for the patron. Funds

are usually withheld from the proceeds of products marketed or, added to,

the price of supplies.

Prima Facie: on the face

evidence to the contrary.

of it; a fact presumed true unless disproved by

Principal: the party on whose behalf an agent acts. Directors often act as

agents for the cooperative and are controlled in that role by the

cooperative’s instructions, bylaws, contracts, and articles of incorporation.

Agents owe fiduciary duty to their principals and are liable for damages

caused by breach of the duty.

Public Welfare Offenses: a group of crimes (e.g., violations of the Food,

Drug & Cosmetic Act) that have in common the purpose of protecting

public health and safety, and which permit responsible corporate officials to

be held criminally liable when the business organization is found guilty of a

violation.

Ratification: the act of the cooperative’s members in adopting and being

bound by acts of a director that the cooperative could have disavowed, such

as when a director makes an unauthorized contract.

37
Responsible Corporate Official: an official in a business organization

(conceivably, a cooperative director) who had authority to halt violations of

health and safety laws but who failed to do so and hence is liable for the

violation.

Restitution: the act of restoring something (usually money) to its rightful

owner by requiring its return from one who has been unjustly enriched at

the owner’s expense, such as when by nondisclosure a director profits to the

cooperative’s disadvantage.

Retained E@@I equity invested in the cooperative by evidences of

investment (certificates, stock, capital credits) issued as part of a patronage

refund instead of cash, or through per unit capital retains.

Revolving Fund P/an: a system of cooperative financing by patrons where

the earliest investments are redeemed as new investments are made to meet

the cooperative’s financial needs.

Robinson-Patman Act a Federal law that prohibits discriminatory pricing

that tends to create a monopoly or injure competition. Price differentials

must be based on cost of manufacture, sale, delivery, quantity discounts, or

purchaser’s status as a wholesaler.

Security: as used in contract law, property that is encumbered to secure

payment of an obligation and which the security holder may obtain or cause

to be sold on default of the obligation.

Securities: investment instruments evidencing a right to participate in

corporate earnings and/or to distribution of corporate property, and that are

subject to regulation under Federal securities laws or States’ blue sky laws

(e.g., stocks, bonds, notes). Cooperatives’ membership certificates and

stock shares evidencing membership are usually not considered to be

securities.

Self-Dealing: a transaction in which a trustee, who owes strict fidelity to

his or her fiduciary, engages where self-interest is opposed to duty (for

example, where a director purchases from the cooperative at favorable

prices not generally available).

Setoff: a claim to cancel part of a debt in recognition of a debt owed the

claimant, as when a cooperative member who owes the cooperative (e.g.,

for supplies) seeks to reduce that debt by claiming a setoff for amounts the

cooperative allegedly owes the member; such member-claimant may seek
to show (probably un

being used in setoff.

.successful.ly) that retained equities are debt su.bject to

Sherman Antitrust Act: the basic Federal antitrust law, it contains broad

prohibitions of conduct in unreasonable restraint of trade and

monopolization.

Stock: as used here, stock refers to certificates evidencing contribution to

the cooperative and entitling the holder to an ownership interest in the

cooperative. A cooperative may issue both common and preferred stock;

preferred stockholders have a prior claim on dividends and, in the event of

dissolution, assets.

TM& PZW~JC as used here, a party who is neither a member nor director of

the cooperative, nor the cooperative itself (e.g., a creditor or other

claimant).

Tort: an injury to person or property in violation

operation of law (i.e., a noncontractual duty).

ofa duty raised by

Trustee: one who has a fiduciary obligation with respect to another’s

property, with a duty to faithfully act solely for the benefit of the owner. A

director is a trustee of the cooperative’s and members’ assets.

Unfair Profits: profits made by a director in a transaction with the

cooperative that are so much greater than profits usually made in such

transactions as to constitute a breach of fiduciary duty.

U/&I V&es: an act beyond the scope of one’s powers, as when a director

approves the entry of a cooperative into a line of business forbidden under

its articles of incorporation, or when the director on behalf of the

cooperative makes a contract that is in violation of a bylaw, article of

incorporation, or statute.

Vested Right: a right that has so accrued and settled in a

not subject to can.cellationby another persIon.

person that it is

39