The Role of Lawyers in Cooperative Conversions

The Need for Lawyers to Support Cooperative Conversions

While many conventional businesses operate and transact without much help from lawyers, cooperative conversions are perhaps uniquely in need of legal expertise and support. The reasons for this include:

• Cooperatives have unique governance, financial, and tax requirements that are not commonly understood by laypeople, banks, landlords, and other institutions and individuals vital to the business.
• Selling a business, under any circumstance, involves many steps, tax considerations, securities law considerations, and other technical details that are best handled by someone trained and experienced in handling such transactions.
• Business owners and employees have a lot at stake during a cooperative conversion, and each should receive independent advice.

Employees may be particularly vulnerable during the process of conversion, because they may be taking a risk with both their jobs and their personal assets. In an ESOP, a trust that manages the employees’ ownership interest has fiduciary duties to the employees; that is, it is obligated by law to act in the employees’ best interests, mitigating some of the risks of assuming ownership. By contrast, converting a business to a worker cooperative comes with fewer worker protections.

There will, for at least the next few years, likely be a gap between the demand for legal services and supply of lawyers competent to assist with cooperative conversions. There are simply very few lawyers in the U.S. with expertise on worker cooperatives. As such, this is also a call to action: Lawyers everywhere should learn about worker cooperatives and position themselves to be of service to the trend of cooperative conversions. Competence to advise on cooperative conversions entails basic knowledge of Subchapter T and Section 1042 of the tax code, of the processes and tax consequences of selling a business, of employment laws, of cooperative entity choices and structure, and of basic securities law.

In coming years, organizations like the Sustainable Economies Law Center and Democracy at Work Institute will likely begin to offer trainings for lawyers seeking to develop expertise in these areas. In the meantime, the U.S. Federation of Worker Cooperatives and the National Cooperative Business Association both maintain lists of professionals, including lawyers, accountants, and business strategists, able to assist cooperatives.

Roles of Lawyers

Lawyers generally assist with a wide variety of questions and tasks in the process of cooperative conversion, including:

• Helping to choose and structure the business entity and laying out a roadmap to the conversion process,
• Drafting most or all documents described in the Documents section of this handbook,
• Filing paperwork with governmental agencies,
• Ensuring that the transactions, financing arrangements, and membership structure comply with securities laws,
• Ensuring that the cooperative governance and financial structure comply with Subchapter T of the Internal Revenue Code,
• Advising on the impact of the conversion on employment law,
• Reviewing the financial statements and records of the business to ensure that there are no concerning liabilities,
• Advising on the details of the proposed cooperative Bylaws and advising the workers on their rights with regard to finances, voting, and influencing decisions,
• Reviewing the conversion transactions and explaining the tax consequences for the entities and individuals, and
• Verifying that the business is current on all filings and payment of taxes.

In some cases, financial or tax advisors might be more suitable to advising parties on some components of the conversion, particularly in assessing the financial viability of conversion and personal tax consequences. Lawyers are not necessarily good with numbers and may not know how to spot issues on financial statements. A financial or tax advisor could actually sit down and do math with a client in order to play out different financial scenarios and outcomes. This process is important, as it may reveal situations where an individual or entity is taking on too much debt or failing to budget for the payment of certain taxes.

Why Multiple Lawyers Will Likely Be Involved

A key question in the cooperative conversion process is: Which parties need their own lawyers?

While it may be convenient and cost-saving to have just one lawyer involved in the conversion process, a single lawyer cannot effectively consider and protect everyone’s interests simultaneously. Lawyers must follow professional ethical rules, which strongly urge, but do not absolutely mandate, that each party to a transaction be represented by independent counsel. This is to ensure that each party is fully advised of her rights, responsibilities, and risks when entering into a transaction, and that, when the interests of parties are in conflict, each party’s attorney can advocate for an ideal outcome for her client. It is common for business partners to seek separate counsel when forming a business and negotiating the terms of the partnership or operating agreement. After formation, however, it is typical for only one lawyer to work with and represent the business entity. Thus, once the conversion is complete, it is likely that most lawyers will drop out of ongoing involvement, and the cooperative will work with one lawyer to assist with legal needs going forward.

Even when multiple lawyers are involved in the conversion, the process need not be adversarial and may be highly collaborative. All parties might discuss the conversion openly and come to a general agreement about the plan for and terms of the conversion. When it comes to drafting the key legal documents, it is common for one lawyer to take the lead and prepare drafts, which other lawyers review.

In The Ideal Scenario: Everyone Would Get Independent Advice

During a worker cooperative conversion, each worker, each selling owner, and each entity is technically a separate party, and each might want to consider seeking independent advice on the financial and legal considerations, particularly when borrowing money, guarantying a loan, lending money, or contributing capital. A lawyer can help an individual or entity assess financial risks and goals, and make requests for changes to the legal documents in order to protect the client. In a perfect world, where lawyers would be affordable and where cooperative-specialized lawyers would be in abundant supply, the ideal scenario would be for every party – both individuals and entities – to get independent counsel.

If each employee does seek independent advice, it will ideally cost no more than $500. If legal services are more costly, it becomes decreasingly likely that an employee would seek independent counsel. As such, it will be important for lawyers to prepare themselves for advising a single employee on the legal implications of worker cooperative conversion, without creating undue cost for the employee. A lawyer could be prepared with a basic check-list of documents to review and matters to discuss with the client, in order to make the process quick and efficient.

Second Best Option: Involve at Least Two Lawyers

In reality, since it may be hard for each party to seek out independent legal advice, the best affordable option may be for one lawyer to represent the owner or group of owners selling the business (or the business itself) and a second lawyer to advise workers as a group. The lawyer advising the workers as a group would likely require that everyone sign a waiver to acknowledge the potential for conflicts of interest, such as situations where one worker is taking greater risks than others. If one individual plans to put substantially more capital at risk than others, that particular individual may wish to seek separate counsel.

For Simple Conversions: When One Lawyer Might Suffice

It has happened that businesses have converted to worker cooperatives with the help of only one lawyer representing the entity that is converted. When there is a shortage of affordable lawyers, this may be a viable option if the conversion does not require workers to take a significant financial risk, if the business has no debt or liabilities, and if the conversion does not affect the employment status of the new worker-owners. In such an arrangement, if there are very few risks for employees who become worker owners, it’s conceivable that no harm would be done if only one lawyer is involved. Nevertheless, it is always advisable to have someone looking out for the interests of the workers, conducting due diligence to ensure that there are no hidden risks and liabilities.