REPRINT

The Circle of Responsibilities

for Co-op Boards

Management Tip Series

By

James Baarda
2 January/February 2002 / Rural Cooperatives

Foreword

All boards of directors are under increasing pressure to perform well and justify their decisions. Cooperative boards are

no exception. But increasing scrutiny of director behavior is not always accompanied by better information about exactly

what directors are supposed to do and how they are to perform their many duties.

The series of articles reprinted here originally appeared during 2002 as Management Tip articles in three issues of

USDA’s "Rural Cooperatives" magazine. These articles lay out fundamental guidelines for cooperative directors. Along

with practical guides, the articles explain underlying principles and give suggestions for specific actions cooperative boards

and directors can take to improve their service to cooperatives. 

Cooperative members can use this well-received series to assess board and individual director performance and make

informed choices about directors. Directors can apply the information to carry out the full range of their responsibilities

with the assurance that they are satisfying the high standards of conduct required of them.

The U.S. Department of Agriculture (USDA) prohibits discrimination in all its programs and activities on the basis of race, color,

national origin, gender, religion, age, disability, political beliefs, sexual orientation, and marital or family status. (Not all

prohibited bases apply to all programs.) Persons with disabilities who require alternative means for communication of program

information (braille, large print, audiotape, etc.) should contact USDA’s TARGET Center at (202) 720-2600 (voice and TDD).

To file a complaint of discrimination, write USDA, Director, Office of Civil Rights, Room 326-W, Whitten Building, 14th and

Independence Avenue, SW, Washington, D.C. 20250-9410 or call (202) 720-5964 (voice or TDD). USDA is an equal opportunity

provider and employer.

Cooperative Information Report 61

Reprint Published: February 2003
Rural Cooperatives / July / August 2002 3

Co-op boards’ circle of

responsibilities

MANAGEMENT TIP

By James Baarda

USDA/RBS Ag Economist 

james.baarda@usda.gov

Editor’s Note: This is the first of a

three-part series about cooperative boards of

directors. This article identifies the sources of

authority for boards and describes seven

basic responsibilities imposed on every cooperative board of directors. The next article

discusses the legal standards directors must

meet and outlines practical ways directors

can protect themselves as well as the cooperative. The last article describes the numerous special difficulties faced by cooperative

directors and shows why a cooperative director’s task is more difficult than for directors

of other organizations. 

eing a director of a cooperative isn’t easy. In fact, it

is harder to be a good

cooperative director than

a director of almost any other organization, including the largest corporations

in the country. Cooperative directors

make decisions that aren’t required in a

non-cooperative corporation, and bad

decisions can hurt the cooperative and all

of its members.

Frequently, directors just have too

little information about what they need

to do as directors. Information that is

available to help them become excellent

directors is often not appropriate for

cooperative directors. Often, advice is

so general it isn’t applicable and some is

so specific that it cannot be applied easily. Advice and information may not

focus on the real issues and sometimes

the advice is conflicting.

The three articles in this series certainly don’t give all the answers. However, existing information related to cooperative directors, as well as the directors

of other kinds of organizations, can be

distilled and focused for cooperative

director use. Concise guidelines are given that can be tailored to the needs of

individual directors on the boards of a

specific cooperative.

This article identifies authority that

gives directors the rights and responsibilities to carry out their work as directors on behalf of the cooperative and its

members. Then it describes the seven

basic responsibilities imposed on all

directors of all cooperatives: the “circle

of responsibilities.”

Board authority

What gives a board of directors its

authority? The basic authority, and the

ultimate statement of responsibility, is

imposed by law. Statutes under which

cooperatives are incorporated identify

the board of directors as the key institution responsible for the direction and

management of the cooperative. A typical cooperative statute says: “The affairs

of the association shall be managed by a

board of not less than five directors,

elected by the members or stockholders

from among their own number.” Variations exist, of course, among statutes

and states, but the theme is always the

same: the law places a cooperative’s

management and guidance in the hands

of its board of directors.

The statutory mandate is broad but

isn’t described in further detail by most

statutes. This is one reason that further

explanation is needed to make the direc

tive meaningful. An added source of

guidance is a cooperative’s own bylaws.

The bylaws are not the place to give

detailed descriptions of what the board is

supposed to do, and bylaws typically do

not. However, in describing certain

processes and actions of the cooperative,

bylaws often identify decisions the board

must make on specific issues. Some of

these will be described when board function and personal responsibilities are noted in the next article in this series and—

even more so—when special issues are

described for directors in the final article.

The problem faced by directors (who

represent members) when members want

something that will be detrimental to

their cooperative (to whom directors also

owe a duty) is also noted in the final article.

Finally, the board will establish its own

internal structure, rules and operations to

supplement the broader statements in the

statutes and the bylaws. These cannot

remove or diminish the responsibilities

imposed by statute, but can create a

framework in which the overall responsibilities and authority are useful in the

everyday work of the board.

These are the technical sources of

authority. The ultimate authority,

though, comes from the cooperative’s

members. The cooperative is theirs, and

without members’ desire to create and

perpetuate the cooperative, the board

would not exist. Members place their

trust, their needs, and authority in a

board of directors of their own choosing.

Circle of seven responsibilities

Despite significant differences among

cooperatives in the United States in

B
4 Rural Cooperatives / July / August 2002 

size, function, complexity, organizational form, financing methods and

membership makeup, it is possible to

summarize a “circle” of seven responsibilities applicable to all cooperative

boards of directors. Of course, each of

the responsibilities will be carried out

differently depending on the cooperative, but fundamentally the circle of

seven responsibilities describes all

cooperative boards of directors.

1. Board represents cooperative

members

Cooperatives are created and operated to serve members’ needs. Members invest in the cooperative, they

patronize it and they exercise ultimate

control of the cooperative. The board

of directors is the means by which the

needs and desires of individual cooperative members are incorporated into

the cooperative. In some circumstances, of course, members vote

directly on a cooperative issue. But for

the most part, members are represented by the board of directors. 

Directors are elected by members

and directors’ role is to represent those

members. To represent members effectively, directors must know what members need. They also assess the cooperative’s capabilities to meet those needs.

Directors must understand the

strengths and weaknesses of the cooperative and make judgments based on a

thorough understanding of the cooperative’s resources and its employees so

they can be used to the members’ best

advantage in a successful cooperative.

2. Board establishes cooperative

policies

Directors put their

member representation

role into effect by making policy. Indeed, many

discussions about cooperative directors summarize the board’s job as

establishing cooperative

policy. Policies may be

broad and long-range or

they may be specific and

immediate. Both are

necessary. If the board

fails to establish cooperative policy, either someone else will establish the

policy or the cooperative

will operate without

direction and control. In

either case, the cooperative cannot be

successful and disaster is likely to follow.

3. Board hires and supervises management

Directors do not run the cooperative

themselves. Employees are used to do

the work necessary, given policies the

board has established about the purposes of the cooperative and specific policies guiding cooperative operations.

The board hires and supervises management. Normally, direct involvement by

board members is limited to only top

management, but the board’s responsibility does not end with the employment of a chief executive officer. Supervisory responsibilities vary according to

structure and circumstances.

4. Board is responsible for acquisition and preservation of cooperative

assets

Cooperatives acquire and use assets

to serve patrons in one way or another.

An overall responsibility of the board is

to establish policies with respect to

acquisition and preservation of the

cooperative’s assets. Cooperatives are

entrusted with other people’s money

and must account for it at all times. The

assets of a cooperative were purchased

with member money, and the cooperative is obligated to those members.

This board responsibility is shown

in two specific obligations. First, the

board is responsible for guaranteeing

that the cooperative establish and use

accounting systems that keep track 

of all aspects of the cooperative’s

finances and resources. The accounting system must also accurately

reflect the true financial condition of

the cooperative.

The second obligation is that the

board monitor the cooperative’s financial performance and establish policies

that protect the cooperative from

financial shocks and risky situations

that undermine its financial health.

Proper audits and careful board

response to audit reports is the first

step towards meeting this responsibility, but a range of board decisions can

spell financial success or failure.

Whether financially related policies are

short-term or long-term, the board of

directors has the ultimate responsibility for

the cooperative’s financial affairs.

It is clear that these

responsibilities require

a great deal of care,

attention, and skill by

each member of the board. Board

members must understand what a

financial reporting system is, what it

must do, and what financial information can and cannot tell directors

about the performance of the cooperative and its management.

5. Board preserves the cooperative

character of the organization

The board, as the policy-making

body and representative of the cooperative’s members, is responsible for

maintaining the special character of the

cooperative. If the cooperative is

General definitions:

Responsibilities: What boards of directors must do to

meet their obligations to the cooperative under laws

and other guiding sources.

Standards of conduct: Sometimes called duties, standards specify how the responsibilities must be carried

out. They impose standards of conduct on the board

and individual director board members.

Liabilities: These are consequences when directors

fail to carry out required responsibilities with the

required standards of conduct. Liability may be

imposed on the cooperative or individual members

of the board.

Boards of directors and management often struggle

with the division of duties, supervision, and operational detail between the board and management.

This issue can be detrimental to the cooperative if

conflicts are not resolved satisfactorily.
Rural Cooperatives / July / August 2002 5

allowed to deviate from principles to

the extent that it is no longer a cooperative, the directors have failed in this

responsibility. This can be a breach of

the trust that members have placed in

the board, and in some cases it can be a

violation of law.

At the same time, the board appreciates that a wide range

of operating methods

and structures is available to cooperatives.

Preserving cooperative

principles doesn’t mean

that the cooperative is

either small or simple.

It only means that the

fundamental character

of the organization is

that of a cooperative

regardless of size or

complexity.

The responsibility imposed on the

board to preserve the cooperative

character of the organization means

that the directors must know what that

character is, how it operates in the

structure of their organization, and

what kinds of events and actions may

undermine cooperative fundamentals.

6. Board assesses the cooperative’s

performance

Every organization evaluates its performance to assess the policies and

actions taken during the year and to plan

effectively for the future. For cooperatives, performance rules are not identical

to those that generally apply to other

types of businesses, although they are

deceptively similar. A cooperative is

indeed concerned with the “bottom line”

and its success as measured by financial

criteria, but it is not organized to simply

benefit itself. The cooperative’s performance is ultimately measured by the

benefit it confers on those who use it.

Performance is judged by the cooperative’s fundamental objectives. 

This may be accomplished in differing ways, as no single standard of measure is available to the board. The board

is faced with multiple criteria, and some

may be conflicting. Some criteria may

be measured in numbers, and some cannot be measured by any financial documents. Despite the variations, the board

must keep its eye on the cooperative’s

ultimate goals, make careful assessments

of performance and strategies, establish

appropriate policies, and make hard

decisions on behalf of the members.

7. Board informs members

Cooperative boards of directors

inform members about the cooperative

organization—the members’ own business. This duty is rather unique among

businesses in its importance and implications for member control. 

Without accurate information,

members cannot make decisions about

their cooperative and will not be prepared to make decisions imposed on

them as cooperative members. Members will not be able to understand

whether their cooperative is successful,

or whether basic changes must be made

to correct problems identified by the

board. And without accurate and complete information, members will not be

able to make judgments about cooperative management or about the board’s

own performance. 

Member information completes the

directors’ “circle of responsibility”

leading to member representation. ■

This may be one of the most misunderstood and

neglected of directors’ responsibilities. In most situations, it does not require specific action on the part of

the board, but only if the proper safeguards have been

established and are in place for all to see. A periodic

review of the cooperative along with established policies and rules requiring operation on a cooperative

basis are essential. But nothing gives the cooperative

as much protection as an articulated dedication to

cooperative principles understood by the board, the

members, and management.

Implementing exercise

At your next board meeting, consider conducting a complete assessment of

sources of the board’s authority, including statutory requirements, bylaw provisions, policies, board structures or another source of board authority.

• What is the source of the authority?

• What does it mean for the everyday operation of the board?

• Does the board fully appreciate its authority—and its limits?

• How can the board respond better to the authority it is assigned?

At each of the subsequent seven board meetings, thoroughly consider one

of the responsibilities listed.

• What specifically does the board currently do to meet the responsibility?

• What are the weaknesses in the board regarding its responsibility?

• Does each director have the skill, interest, and time to consider and respond to the

responsibility?

• Does the board have the knowledge and information necessary to meet each

responsibility?

• What specific steps can be taken to make the board meet every responsibility?

• Is there a consensus on the board’s performance?

• Would members agree with the board’s self-assessment?

The most effective way to make the responsibilities “up close and personal”

is to have each director individually address the issue and propose his or her own

solution to problems perceived about the responsibility under discussion. Board

meetings or ancillary sessions to board meetings can then provide the forum for

discussion within the board. These sessions may be more effective if management

is not present.
6 Rural Cooperatives / September / October 2002

Co-op directors held 

to high standards

MANAGEMENT TIP

By James Baarda

USDA RBS Economist

james.baarda@usda.gov 

Editor’s note: In the last issue we examined the circle of seven responsibilities that

all directors have. This second article in a

series of three discusses standards of conduct

applied to directors and the sources of legal

liability imposed on directors when they

don’t meet the standards. It concludes with

a discussion of protections for individual

directors against personal liability. Just as

responsibilities can be divided into seven

distinct, yet related, items, standards of

conduct, liabilities and responses can be

viewed in seven steps.

Directors’ roles in

perspective

A number of responsibilities are imposed on a

cooperative board of

directors, but where do individual directors fit in? Four perspectives of directors’ roles help identify board and individual director responsibilities. Starting

with the broadest perspective and narrowing the view to the individual director gives the following breakdown.

The cooperative is a business organization, almost always a corporation.

All of the substantial rules governing

cooperative directors come from corporate law.

The cooperative is a very special

kind of corporation. Cooperatives operate according to appropriate cooperative rules or principles. These unique

cooperative attributes define cooperatives’ unique objectives, they require

specialized income distribution and

financing techniques, they impose

unusual decisions on the board of directors and they give cooperative directors

“something else to think about.”

Narrowing the perspective further,

the board of directors acts as a body.

The power to act on behalf of the

cooperative is given to the board of

directors as a body, not to individual

directors. No special power is given to

an individual board member to act officially. As an individual, a board member has no greater authority than an

ordinary cooperative member. The

board derives its authority from the

incorporation statutes, articles of incorporation, bylaws, and the members.

These all identify the board of directors as the governing body.

This perspective further defines an

individual director’s participation in the

cooperative. Decisions are board of

director decisions, so an individual

director must be able to work effectively

within the dynamics of the board to

influence board decisions. The board as

a whole will be effective only if procedures, committee structures and interaction is conducive to good decision-making. If a director objects to a decision, it

is imperative that a negative vote be

recorded, otherwise the director will be

held to have agreed with the decision.

Responsibilities, standards of conduct and possible liabilities fall on

board members as individuals. If the

standards of conduct are not met, individual directors may be liable to shareholders and members, to the cooperative, to creditors, to patrons and to the

public through civil or criminal laws.

What are the standards of conduct by

which directors are measured?

2. Standards of conduct

Standards of conduct for corporate

directors have been developed over

many years by judicial decisions and

legislative action. Although cooperative

directors face numerous special problems, no separate set of standards has

ever been developed for cooperative

directors. Therefore, corporate rules

generally apply to cooperative directors.

Standards applicable to cooperative

directors (as is the case with corporate

directors) are usually divided into three

“duties.” These are summaries of many

decisions and statutes and are stated in

general terms in this article. The three

duties are “duty of obedience,” “duty of

care” and “duty of loyalty.”

1.

The Circle of Seven

Responsibilities

(As described in the previous article

in this series, see July-August 2002

issue, page 30.)

Directors:

1. Represent members

2. Establish cooperative policies

3. Hire and supervise management

4. Oversee acquisition and preservation of cooperative assets

5. Preserve the cooperative character of the organization

6. Assess the cooperative’s performance

7. Inform members
Rural Cooperatives / September / October 2002 7

3. Duty of obedience

The term “duty of obedience”

sounds odd but is logical when

explained. The duty means first that

directors must perform their roles in

conformity with the statutes and terms

of the cooperative’s documented

requirements for the directors. The

authority given to the board of directors is defined, as is the purpose of the

cooperative. Acts beyond those limits

are “ultra vires” and are not authorized.

Neither may the board make decisions that are either themselves illegal

or that will cause the cooperative to do

something illegal. The duty of obedience also implies that the board should

mandate necessary records and recordkeeping, internal procedures, policies

and compliance programs, then supervise the process to the extent necessary

to protect the cooperative from illegal

or improper actions.

4. Duty of care

The duty of care, also called the duty

of diligence, has developed in judicial

decisions but is also found in many corporate statutes. Statutes typically

describe the duty of care in three parts:

good faith, prudence and judgment.

Directors are required to act in

good faith in all circumstances. Directors must also exercise care that an

ordinary person in a like position

would in similar situations. Finally, a

director must make decisions for the

cooperative in a manner that he or she

reasonably believes to be in the best

interests of the cooperative. Directors

have the highest obligation to the

cooperative and stand in a relationship

of trust—a fiduciary relationship.

Good faith, conscientious care and best

judgments are expected of each and

every director.

Diligence and care raise two particular challenges for cooperative directors.

Directors may fail in their duty if the

board does not adequately supervise

management. The board must devise

some way to be sure that management

and employees conduct themselves in

the cooperative’s affairs in an ethical and

legal manner. The board also establishes

the cooperative’s strategic direction and

evaluates management’s progress toward

the cooperative’s goals. In addition to

selecting top management (usually the

manager or CEO), the board’s duty of

diligence requires that the board evaluate management’s performance, establish succession plans and, if necessary,

dismiss top management.

Often, questions about a director’s

performance revolve

around what the director knows. Generally,

ignorance does not

excuse a director from

liability. Directors must

know what they are

doing or they cannot

satisfy their duty of care.

The knowledge requirement is usually

divided into two important parts.

Directors will be held accountable for

what they know and what they should

know. A director who is actually ignorant of a fact is not excused if the law

requires that the fact should have been

known by the director.

How is a director to

gain this knowledge?

Directors are sometimes

said to have a duty to

inquire about facts

which are required for

them to carry out all of

their responsibilities.

Directors have a right to

inspect all books and

records. They have the

additional duty to

understand the financial condition of

the cooperative and its business operations. Directors are presumed to know

what is in the cooperative’s books and

records. As a general statement, directors will be charged with knowledge of

what it is their duty to know.

5. Duty of loyalty

Loyalty is perhaps the most troublesome area of liability in corporate law,

including cooperative law. It is troublesome because it is not well understood,

and the presence of disloyalty or conflicts

of interest is devastating to a director’s

personal position of trust in the cooperative. As has been mentioned, directors

occupy a position of highest trust and

confidence upon which the cooperative

and the entire membership relies. That

position must be protected in any action

taken and in any decisions made.

Several kinds of behavior are prohibited by the duty of loyalty. Self-dealing,

where the director makes a special profit by doing business with the cooperative, is a breach of the duty of loyalty. 

As discussed in the previous article,

directors of cooperatives are placed

almost automatically in a position of

dealing with the cooperative. This is

not a problem if handled properly. In

fact, a common statutory provision

describes permissible situations. A typical provision states “No director, during

the term of his office, shall be a party to

a contract for profit with the association

differing in any way from the business

relations accorded a regular member or

holders of common stock of the association or others, or differing from terms

generally current in that district.” Conflicts of interest situations always pose

special challenges.

Do corporate statutes apply

to cooperative directors?

Generally yes, for two reasons. Cooperative incorporation statutes usually state that corporate law applies

to cooperatives unless corporate law conflicts. Cooperatives are incorporated bodies that have all of the

basic characteristics of corporations; directors’ roles,

duties and responsibilities are no exception.

Conflicts of interest

Conflicts of interest involving directors are unavoidable and can have serious consequences if not handled

properly by the board and the cooperative. This topic

will be further examined in the third part of this series.
8 Rural Cooperatives / September / October 2002

The duty of loyalty imposes other

restrictions on directors. A director

will violate the duty of loyalty by dealing with someone directly who could

have otherwise dealt with the cooperative. This is called “appropriating the

cooperative’s opportunity.” Loyalty

also requires the highest degree of

honesty and fair dealing with the cooperative and on the cooperative’s behalf.

Directors are often in a position

where they could violate the final aspect

of the duty of loyalty: that of confidentiality. Directors are privy to information about the cooperative that may not

be public. This is particularly the case

where directors have access to information about the affairs of other members

of the cooperative. Directors are under

strict prohibitions about either

divulging confidential information to

anyone else or using it for their own

benefit regardless of the harm to the

cooperative.

Generally, a violation of the duty of

loyalty, typically in situations referred

to as conflicts of interest, is the quickest and surest way to make a director

liable for wrongdoing.

6. The business judgment rule

Directors constantly exercise judgment on behalf of the cooperative, and

sometimes that judgment does not lead

to the best outcomes for the cooperative. Unexpected events can turn a

good plan bad. Or directors may simply

make a mistake in judgment. What

happens when directors’ actions lead to

losses or other detriment to the cooperative?

Normally, courts will not interfere

with the internal operations of a business to replace the judgments of the

directors with the court’s own judgment

on business matters after the fact. The

business judgment rule says that, absent

fraud or self-dealing, business judgments made by directors will not be

overturned by the courts and will not

lead to director liability. Directors do

not and cannot guarantee the success of

the cooperative or each decision made.

Courts have generally given three

reasons for the business judgment rule.

Few members would be willing to

serve as cooperative directors if they

faced personal liability for good faith

errors in judgments that results in

harm to the cooperative. Courts also

recognize that courts themselves are

ill-equipped to make business judgments for directors and that secondguessing board decisions is not an efficient way to monitor directors. Finally,

a cooperative cannot be managed efficiently if directors are not given wide

latitude in law to handle the cooperative’s affairs.

It is important to understand the limits of the business judgment rule. Courts

usually say that the authority of directors

is absolute when they act within the law,

and questions of policy and internal

management are—in the absence of nonfeasance, misfeasance or malfeasance—

left wholly to their discretion. The rule is

not a protection if the offending action

was an abuse of the board’s discretion,

was tainted with board member conflicts

of interest or was a result of the directors’

abdication of their duties to the cooperative. Courts will step in and hold directors liable for their actions when directors are guilty of willful abuse of their

discretionary powers, or bad faith, or of

neglected duty, or of perversion of the

purposes of the corporation, or when

fraud or breach of trust is involved. Otherwise, directors are not personally liable

for mistakes while exercising their

informed, best judgment.

7. Minimizing risk

An easy but inadequate suggestion

for avoiding problems as a cooperative

director is to understand and appreciate the responsibilities listed in the first

article in this series, know and adhere

to all standards of conduct in this article and make no mistakes that may be

detrimental to the cooperative. The

first two suggestions are in the control

of each director and are, in fact, the

best defenses to legal challenges to

director performance. 

Protection is best when a proactive

attitude is adopted by each director to

know the responsibilities and standards,

understand what it means for the director’s performance and identify particularly sensitive issues in the cooperative,

for the board of directors and regarding

Implementing exercise

Establish a schedule to consider—at board meetings or ancillary meetings—

each of the standards of conduct imposed on directors. Systematically consider

each standard and its requirements. At each meeting, thoroughly examine one

of the standards outlined in this article.

• What specifically does the board currently do to meet the standard?

• What are board’s weaknesses regarding the standard?

• Does each director have the skill, interest and time to consider and respond

to the standard’s requirements?

• Does the board have the knowledge and information necessary to meet the

standards?

• What specific steps can be taken to make the board meet every standard?

• Is there consensus on the board’s performance?

• Would members agree with the board’s self-assessment?

Even more than the board’s responsibilities, the standards are personal to each

director. Each director should individually address the issue and propose his or

her own solution to problems perceived about the standard of conduct under discussion. These sessions may be more effective if management is not present.

The board should also consider the mechanisms the cooperative has in place

to protect directors, such as indemnification provisions and D & O insurance.

Assessment of state law applicable to the cooperative and directors will be part

of the analysis.
Rural Cooperatives / September / October 2002 9

the director’s own personal performance.

Directors may also give attention to

several other actions and practices that

are beneficial to their performance.

Board structure, proper use of committees, effective board discussions and

leadership, flows of information from

management to the board and good

board-management relations can avoid

a number of problems. Directors may

rely on experts, advisors, employees,

and board committees, within certain

limits. Reliance does not relieve directors of their responsibilities but does

show care and diligence. 

Reliance on others must, of course,

be justified and cannot amount to abdication of responsibilities and duties.

Director training is key to effective

directorship. Effective training programs must go far beyond indoctrination by management about the cooperative’s business from management’s

viewpoint.

Compliance programs can be helpful, and in some cases are necessary, to

implement directors duties of care and

management monitoring. Compliance

programs are formalized internal programs to monitor certain types of

behavior to be sure neither the cooperative nor employees violate some law or

fail to take a required action. These

programs are typically designed around

legal requirements such as environmental issues, antitrust and securities laws,

financing issues, or special problems

that may be sensitive for a particular

cooperative. To be effective, the board

must insist on workable programs, must

monitor their implementation and

insist on full support by management at

all levels. In some cases, a poor compliance program is more likely to cause

problems than no program at all.

Legal audits are another technique

directors may use to assist them in

their duties. A legal audit can include

review of the cooperative’s legal structure and documents that govern the

cooperative internally as well as its

relationships with members and others, analysis of assets and liabilities,

evaluation of potential claims against

the cooperative, a thorough examination of procedures in place and recommendations for changes needed to

address weaknesses.

Whatever action is taken, the overall

attitude of directors should be active,

positive, creative and dynamic. The

great responsibilities imposed on cooperative directors and the associated

potential for liability should not lead to

a defensive posture.

Indemnification

Legal challenges to cooperative

directors and litigation involving directors cannot always be avoided. The

trauma of such actions against directors

is significant. In one regard, the burdens can be relieved somewhat in most

circumstances.

Legislation has been used in many

states to allow a corporation (and presumably a cooperative) to indemnify

directors who are subject to legal

action that requires expenditures of

sometimes substantial sums in defense.

Indemnification in this context simply

means that the cooperative pays for

costs incurred by a director who is

responding to legal actions for some

act as a director. 

In addition to authorizing indemnification and describing procedures for

indemnification, statutes usually establish standards of conduct permitting

indemnification. A cooperative may not

be permitted to indemnify a director

where the director’s conduct in question fails to meet certain standards of

conduct. For example, directors who

cause harm to the cooperative by selfdealing or fraud against the cooperative

cannot demand indemnification when

they are sued for such actions. When

contemplating indemnification, a board

considers not only the applicable statutory requirements and restrictions, but

also determines under what circumstances the cooperative should or

should not indemnify a director.

Insurance

Cooperatives can purchase insurance

to protect the cooperative and its directors in case costs are incurred defending

litigation against directors. Usually

called D & O insurance because it covers both directors and officers, the

insurance is often in the form of two

policies. One covers directors to the

extent the cooperative does not fully

indemnify them for their costs. The

other covers the cooperative itself for

the indemnification made to directors.

As with nearly any insurance

arrangement, each policy will be tailored to the needs of the cooperative.

Terms will be negotiated that include:

level of coverage, exclusions, claims or

occurrences methods, deductibles and

general claims procedures. ■
10 Rural Cooperatives / November / December 2002

By James Baarda, USDA/RBS

Economist

james.baarda@usda.gov

Editor’s Note: This is the third of

three articles dealing with issues facing

cooperative directors. The first installment

appeared on page 30 of the July-August

2002 issue while part two was on page 15

of the September-October 2002 issue.

These and other past issues of this magazine can be assessed via the Internet at:

http://www.rurdev.usda.gov/rbs/pub/

openmag.htm

ooperative directors regularly face problems that

directors of even the

largest and most complex

corporations need not

even think about. The tough issues don’t

depend entirely on cooperative size

either. Directors of small

cooperatives face many

decisions as difficult as

any confronted by the

largest cooperatives.

Special cooperative

director challenges require personal

wisdom and good collective decisionmaking abilities. In some ways, cooperative directors need to know

more—and think about issues more

carefully—than directors of other

kinds of businesses. Cooperative

boards certainly demand more time

and work. In addition, the dual role of

a director in a cooperative—as both a

director and a member—puts every

director in a sensitive position.

This article, the last in a series about

cooperative directors, identifies some

unique issues that cooperative directors

must consider on a regular basis. It

focuses on issues that are “in addition

to” the responsibilities expected of

directors of all businesses.

The character of the cooperative

Cooperatives are unique kinds of

businesses. Members justifiably expect

their cooperative to operate on a cooperative basis with the appropriate mix

of rights and obligations for everyone.

Members trust the board to fully support those expectations.

Sometimes cooperative characteristics are defined by law. In other situations they are just an inherent part of

the cooperative that members’ understand and expect. In any case, directors

have the ultimate responsibility to preserve the cooperative character of the

organization.

This responsibility presents some

hard questions for the board. Is the

organization truly operating on a cooperative basis? How do directors know it

is? What observable criteria can be

established to guarantee the integrity

of a cooperative’s implied promise to be

a cooperative? Are measures taken—

either on a periodic basis or in preparation for significant business changes—

to be sure that basic cooperative

principles are preserved? Has the board

established policies, operating procedures and internal controls to guarantee operation as a cooperative? Does

the cooperative have danger points in

its operations that require special monitoring and attention?

Although difficult, the directors’

role in maintaining the ability of the

cooperative to serve members in a

uniquely beneficial manner can be a

rewarding professional and personal

experience for directors. Each director

is a gatekeeper of the principles and

practices that empower members to

cooperate to create true value for

themselves and others.

Cooperative-based decisions

Cooperative boards of directors

make decisions not made by boards of

any other kinds of business. These

decisions are, for the most part, unusually difficult. They require directors to

have a clear understanding of financial

documents, performance measures and

the short- and long-term consequences

Cooperative directors face 

unique challenges

MANAGEMENT TIP

C

The Circle of Seven

Responsibilities

(As described in the previous article

in this series, see September-October

2002 issue, page 15.)

Directors:

1. Represent members

2. Establish cooperative policies

3. Hire and supervise management

4. Oversee acquisition and preservation of cooperative assets

5. Preserve the cooperative character

of the organization

6. Assess the cooperative’s performance

7. Inform members

Cooperative directors are responsible for

maintaining the cooperative character of the

organization.
Rural Cooperatives / November / December 2002 11

of decisions made and actions taken.

Situations may make the board a conflict-resolution body that balances

divergent and often deeply held interests among members. Some of these

involve business and financial issues,

while others are emotional in nature. 

Operating within proper authority was

mentioned in a previous article. The

cooperative’s authority and limitations

on that authority may be found in several places. The board’s authority may

be defined by the cooperative’s charter,

including the applicable incorporation

statute. The board of a cooperative

considers incorporation statutes, the

articles of incorporation and bylaws to

determine the obligations and limitations of the cooperative.

Laws that apply generally to all

businesses apply to cooperatives as

well, but sometimes in a different manner. Such laws mean that cooperative

boards must make decisions for the

cooperative based not only on generally applicable laws, but laws that are

especially applicable to cooperatives.

Examples include special tax laws that

apply to cooperatives, cooperative

antitrust laws that mandate or prohibit

certain business structures and behavior, and state cooperative incorporation

statutes that contain special requirements for cooperatives. 

A cooperative’s charter, its bylaws, its

contracts, membership agreements and

other binding agreements are all subject to review by directors as they establish policies and procedures to guarantee that the cooperative adheres to laws

and other legal obligations. Directors

may, of course, rely on counsel and

accountants to identify the rules, but

directors themselves make the decisions

and bear the responsibility for decisions

made.

Determining and allocating patronage

refunds is one of a cooperative board’s

major concerns. Of course, the board

does not make decisions about refunds

on the spur of the moment each year.

The system used to determine and calculate refunds should have been established in the bylaws and in written

policies, all of

which are subjects

of careful director

study and periodic

review. Decisions

about allocations

and distributions

are complicated by

short-term and

long- term implications as well as balances among those

who use the cooperative for different

purposes. All this

leads to possible

conflicts among

cooperative members. 

The cooperative may also face circumstances that weren’t contemplated

when the policies were established.

The board must decide what modifications can be made in response to special circumstances to recognize the

cooperative’s purposes.

Any patronage refund system has

many implications for the cooperative

and its members. These include fairness,

operation on a true cooperative basis, tax

implications, rules in state laws, interpretations of bylaws, members’ expectations and desires, and the very health

and survival of the cooperative. Successful solutions to sensitive issues ultimately

rest in the hands of an informed, deliberative board of directors.

Member qualification is important to a

cooperative, whether the qualifications

of applicants for new membership are

at issue or continued qualification of

existing members is in question. Directors should recognize the importance of

keeping good membership roles and

purging those who no longer deal with

the cooperative. The behavior of some

members may harm the cooperative

and therefore other members. Directors have the unenviable task of taking

appropriate action to protect the cooperative. Predetermined, neutral rules

that avoid ad hoc decisions about individual members will help avoid confusion and hard feelings.

Decisions with federal income tax consequences are pervasive. Directors are not

expected to be tax experts, but they do

need to appreciate the implications of

all of their decisions. Examples of decisions with direct tax implications

include use of qualified or nonqualified

notices of allocation, per-unit retains,

allocation of margins and losses and

most issues regarding calculating margins and distributions. 

Patron or non-patronage business

and the allocations and payment of

related net margins have direct income

tax implications. Added to the direct

effect on the cooperative is the impact

that any such decisions have on members or other patrons. A seemingly

simple business decision by cooperative

directors becomes one of balancing

many interests. 

Conflict of interest

Like other members, directors use

the services of the cooperative. This

means that directors deal personally

with the cooperative. They have their

own obligations toward the cooperative

and their own expectations of benefits

from it. Decisions that directors make

about the cooperative will affect them

as member-users just as they affect the

cooperative and other members.

The previous discussion of “duty of

loyalty” pointed out that the single action

most likely to impose personal liability

on a director is a conflict of interest. The

personal dealings that a director has with

the cooperative places the director in a

precarious position. What appears to be

innocent when done may in hindsight

look very bad for the director.

Many examples exist of directors’

dealings with the cooperative that will

Cooperative principles should be

familiar to every cooperative

director.

1. The User-Owner Principle: The people who own and

finance the cooperative are those who use the cooperative.

2. The User-Control Principle: The people who control

the cooperative are those who use the cooperative.

3. The User-Benefits Principle: The cooperative’s sole

purpose is to provide the distribute benefits to its users

on the basis of their use.
12 Rural Cooperatives / November / December 2002

affect both the director and the cooperative and pose possible conflicts of

interest. These include: 

• Price differentials or special concessions for large producers and

patrons.

• Directorship in both a local cooperative and the federated cooperative.

• Extension of credit to memberpatrons.

• Methods of obtaining capital.

• Allocation of patronage refunds,

especially when the cooperative is a

multi-functional cooperative and the

functions are not totally separated.

• Cash or non-cash patronage

refunds related to patron tax

brackets.

• Equity redemption decisions,

including when to redeem, financing methods and equity- building

programs.

Directors must make these and all

other decisions regardless of the shared

interests of directors and the cooperative. Cooperative incorporation statutes

recognize the problem, at least with

respect to the patronage relationship. A

typical provision says that “no director,

during his term of office, shall be party

to a contract for profit with the association differing in any way from the business relations accorded regular members or holders of common stock of the

association or others, or differing from

terms generally current in that district.” 

Directors should not have problems

if the conflict is clearly recognized,

decisions are made solely with the

interests of the cooperative foremost

and all questions are addressed openly

and honestly.

Financial matters

Directors must give careful attention

to the effective financial structure and

strong financial condition of the cooperative. Directors are entrusted with the

ultimate responsibility for the care of

the funds and property of the cooperative and its members. Although similar

general rules apply to non-cooperative

corporations, a cooperative’s directors

handle unusual issues because cooperatives have special techniques to finance

the organization. Because cooperatives

operate for the mutual benefit of the

members and not as purely profit-seeking organizations, they have financial

needs, opportunities and limitations not

found in other businesses. Ultimately,

the most difficult financial decisions are in the

directors’ hands.

Patronage refund distributions are closely related

to equity allocations in

most cooperatives.

Directors are involved in

the balance between current monetary returns to

members and additions

to the cooperative’s equity structure. For example, patronage refunds

may be paid in a combination of cash and written notices of allocations. The choice carries

major implications for

the long-term financial

health of the cooperative. At the same time,

members may expect

high cash payout as a return for their

involvement in the cooperative and

their own tax considerations. Allocations and choices of the income to allocate, equity vs. debt financing and

patronage-based vs. non-patronagebased sources of financing, are all part

of plans and strategies that boards of

directors establish.

Equity redemption is an integral part

of a cooperative financing system. It

can also be a source of dispute. Decisions about equity redemption are

often assigned specifically to the

board’s discretion. How is the board of

directors to exercise that discretion?

Do short revolving periods jeopardize

the cooperative’s financial health and

robustness? Do long revolving periods

show poor planning, do cooperatives

use former members’ money to generate benefits for the current users, and

does slow revolvement present fairness

issues? Courts usually support director

decisions on equity redemption in a

legal dispute, but the major challenge

for a board is to meet obligations of

past, present and future members with

fairness and forthrightness to avoid

unresolvable problems.

Special events

Directors bear added responsibilities

when the cooperative considers a major

change in its organization or in its relationships with other businesses. Mergers or establishing long-term, significant joint-venture arrangements with

other businesses are examples of events

where directors have a major responsibility for decisions that are of critical

importance to the cooperative. Such

events affect members’ interests in the

short run and in the long run. 

Decisions affect benefits that all parties involved will receive, including

financial obligations (past and future),

differential impacts among members

and planning horizons for all parties.

Directors not only assess overall costs

and benefits of such actions, they will

be required to address conflicts among

members about the action. 

A decision to dissolve a cooperative

is, of course, among the most difficult

the board will make. The process not

only occurs under typically unpleasant

circumstances; it challenges the abilities and dedication of all involved.

Directors will be well served by

making every effort to recognize how

Standards of conduct 

applicable to cooperative

directors include:

1. Duty of Obedience. Directors must ensure that they

or the cooperative do not engage in illegal or

improper actions.

2. Duty of Care. Directors are expected to act in

good faith at all times, exercise prudence, and

apply their best judgments for the benefit of the

cooperative.

3. Duty of Loyalty. Directors have a position of

highest trust and must avoid conflicts of interest,

self-dealing, actin in any other than the best interests of the cooperative or divulging confidential

information.
Rural Cooperatives / November / December 2002 13

standards of conduct discussed in previous articles in this series can guide

them. Adequate information about the

implications of the action, the mechanics of the process, impacts on members

and the future of the cooperative are all

critically important. Balancing member

interests and measuring the financial

and other needs of the cooperative will

guide directors’ decisions.

Assessing the cooperative’s success

Important decisions about the performance of management, success or

failure of strategic plans or specific

programs, and designing plans for the

future are all based on an accurate and

realistic assessment of the cooperative’s current performance. Such an

assessment is not necessarily easy

under any circumstances. 

As with any business, the “bottom

line” is critical. But unlike other businesses, for cooperatives the bottom

line is only the beginning of an assessment of its true success. Every director

needs to understand financial statements, organizational growth, project

plans, overall strategies and levels of

service offered. But more is required.

Difficult questions require additional board consideration. What was

the net benefit of an action to members,

including their share of savings and

margins? What was the tradeoff

between benefits distributed to members and the net income of the cooperative? What is the financial condition of

the cooperative and what are the trends

and expectations for future capital

needs? 

Were all members treated equitably

in distributions and financing obligations? Did the cooperative serve some

members at the expense of greater

returns to others? If so, is that practice

part of the cooperative’s greater purpose? What was the trade-off between

short-run and long-run needs, obligations and benefits? Are successes or

failures attributable to management,

board decisions, the economic environment or member actions? What can or

cannot be corrected about the cooperative’s performance?

Directors balance members’ interests

The cooperative’s fortunes are those

of its members, and if the cooperative

is not responsive to members’ needs,

the basic principles of member control

and user benefit are weakened. The

cooperative will simply cease to exist

and serve.

The membership of most cooperatives is not homogeneous. Each member has an interest in the cooperative.

These interests differ to some degree,

sometimes dramatically from other

members. Members may have differing

planning horizons, as would be the case

between someone just starting in the

farming business and someone contemplating imminent retirement. These

two members could have markedly different interests in financing, revolving

periods for patronage payments and

cash vs. non-cash payments. Members

may be in different tax brackets, which

has implications for the amount and

form of patronage refunds. 

Some members may be more concerned with price while others may find

certainty of supply or a market more

important. Producers of different products may have distinctly different needs

from the same cooperative. Disparity of

business volume among members may

lead to calls for differential pricing.

These and other variables make the

directors responsibility to represent

members quite different from decisions

for non-cooperative businesses.

Members, or prospective members,

may want more from the cooperative 

than the organization can provide and

still maintain its financial and operational integrity. Directors may actually

be put in a position of balancing some

members’ needs against the interests of

the cooperative itself. Diplomacy and

good communication are valuable, but

no easy resolution may be possible.

Board-management relations

A good working relationship

between the board of directors and

management is very important for

cooperatives. At the same time, the

relative responsibilities of the board

and management create natural tensions about roles and responsibilities.

The cooperative board has a distinct

role and make-up that places obligations of independence and leadership

on the cooperative board of directors that are not necessarily found in

other boards.

Does the board defer excessively to

a forceful manager? If so, what might

the consequences be? Does the board

interfere inappropriately in the cooperative’s management and day-to-day

operations? If so, what are the consequences? How does the board assess

management and what corrective

measures are in place in case of difficulties? Is there an effective chain of

communication and command between

the board and management? What

does management think of the board of

directors? If necessary for the good of

the cooperative, is the board of directors capable of making and executing a

decision to replace management?

The rewards

With all of the responsibilities

placed on boards of directors outlined

in the first article in this series, the

high standards of conduct required of

individual directors discussed in the

second article and the many difficult

decisions directors make as noted in

this article, why would anyone agree to

be a cooperative director? Individuals

can point to at least five reasons to

serve as a cooperative director.

The rules that apply to responsibilities, liabilities, duties and requirements

To be effective, board members must have a solid

grasp on co-op financial statements. Request to

meet with the co-op manager or accountant if you

need more background on how to read them.

USDA Photo by Ken Hammond 
14 Rural Cooperatives / November / December 2002

are pretty clear. With diligence and care,

a cooperative director has guidance to

avoid the many pitfalls suggested by a

cautious view of a director’s job. Though

a director may face unpleasant, and sometimes unexpected circumstances, adherence to high personal standards of conduct is excellent insurance against

personal problems.

Directors are part of a team. This

team is not only a source of support, it is

a reward in itself. Difficult issues are

discussed within the board before decisions are made; information is generated

and shared, and decisions are made as a

board. Responsibilities are shared with

others in a similar position. The team

concept includes not only the board of

directors, but management and, most

importantly, the cooperative’s members.

The opportunity to take an active role

in multiple constituencies is unusually

valuable for a cooperative director.

The sheer challenge of being a

cooperative director can be added as a

third source of reward. Directors see a

problem from its discovery. They

define the issues it raises for the cooperative and members, identify the

range of possible solutions, gather and

study the information needed to assess

the solutions, determine what the consequences of various courses of action

might be, make a decision, create the

policies and directives needed to implement the chosen solution, and assess

the consequences of the board’s decisions. The more difficult the problem,

the greater the rewards of finding an

answer. The more critical the issue is

to the success of the cooperative, the

more satisfying is the problem-solving

process.

Directorship presents an opportunity to serve others in direct and

important ways. Beneficiaries of a successfully guided cooperative include

members and patrons, the cooperative’s management and employees, the

individuals and businesses that deal

with the cooperative, the communities

in which the cooperative and its members and employees are located, and

the marketing and supply systems in

which the cooperative operates. Individuals considering being a director

should consider the significant

impacts they can have beyond the

boardroom and even on the cooperative.

Finally, board membership carries

personal prestige despite the many

duties and difficulties. Serving on a

cooperative’s board of directors is a worthy personal and professional goal.

Directorship should be a source of great

personal pride and satisfaction. ■

Implementing exercise

As a board, review the character of your cooperative:

• What is the stated purpose of the cooperative?

• What does this mean when balancing interests?

• Identify the “stakeholders”—those who have an interest in what the cooperative does and how the cooperative performs.

• Identify the principle things that make the organization a cooperative and

distinguish it from other kinds of businesses.

Revisit the cooperative’s vision statement, mission statement and objectives.

• Are they adequate, realistic and up-to-date?

• Did they come form the membership or were they devised as a boardmanagement exercise?

• Are members familiar with their cooperative’s vision, mission and purposes?

• What do the members think of them?

Set aside some time at a board meeting (after preparation) to discuss what measure of success the board should use to assess the cooperative’s performance, its

management, and the board of directors.

• Start with the broadest list and set priorities.

• Are some measures incompatible with others?

• If trade-offs are required, what decision rules can be devised?

• What would members think of the trade-offs and decision rules?

Make it personal—it already is!

• Identify the issues that you personally find to be the most uncomfortable,

those you’d really rather not have to make decisions about.

• Make a plan to share the burdens of the decision.

• List the factors you will consider in addressing the problem.

• Do you think others share your discomfort?
Rural Cooperatives / January/February 2002 15
16 January/February 2002 / Rural Cooperatives

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