charges. The insurance companies charge enough for the insurance to cover all possible contingencies, with the idea of returning any surplus to policyholders at the end of a given period. Cooperative associations follow a like practice.

It has been said that

So-called dividends upon life insurance policies are not really "dividends," but are the return by a mutual company of the unearned portion of the premium for the past year, unearned because of saving in expected mortality, saving in expense loading, and increase in investment earnings over the expected 32 percent. To the extent of the combined savings due to these three elements, theoretically at least, the premiums paid in advance are regarded as having been excessive or unearned."

There is no magic or mystery about patronage dividends or refunds; they simply represent a practical means of achieving a given result, namely, the return to the members of an association of savings effected by it.

Inasmuch as the amount of patronage dividends arises either from "underpayments" by marketing cooperatives or "overpayments" to purchasing cooperatives, after operating costs and expenses have been deducted, it is clear that there is no basis for the payment of a patronage dividend on account of current operations unless an association has actually made a "net profit." It should be remembered that directors of an association act at their peril in authorizing the payment of dividends of any character unless the facts justify doing so.72

At common law the declaration of a dividend, whether patronage or otherwise, is a matter for action by the board of directors and not by the stockholders.73 But bylaws could provide for referring this matter to the members.78

In the absence of specific agreement or conditions to the contrary, dividends, whether patronage or otherwise, do not constitute a liability of an association until declared.75 Following the declaration of a dividend it represents a debt of the corporation.76

71 Atlantic Life Insurance Company v. Pharr, 59 F. 2d 1024, 1026.

72

Fawkes v. Farm Lands Investment Company, 112 Cal. App. 374, 297 P. 47; Ellis v. French-Canadian Co-operative Association, 189 Mass. 566, 76 N. E. 207; Towles v. South Carolina Produce Ass'n, 187 S. C. 290, 197 S. E. 305; Doss v. Farmers Union Co-op. Gin Co., 173 Okl. 70, 46 P. 2d 950.

73

Callaway v. Farmers Union Cooperative Association of Fairbury, 119 Neb. 1, 226 N. W. 802.

75

Fruit Growers' Supply Company v. Commissioner of Internal Revenue, 56 F.2d 90.

76 II Fletcher CYCLOPEDIA CORPORATIONS, Perm. Ed., sec. 5365.

Revolving-Fund Plan of Financing

THE problem of how equitably to capitalize a cooperative so that the capital furnished by a particular member will bear a direct relation to his patronage and ultimately will be returned to him is believed by many competent cooperative leaders to be solved best through use of the revolving-fund plan of financing."

Cooperatives commonly have begun business with a small amount of capital, which has been gradually increased from deductions or savings without giving to the respective patrons a clearly defined contingent right with respect to the sums that each by reason of his patronage has provided. Frequently, the early patrons of an association are largely responsible for building up its capital, while those who later become its patrons are not required to make comparable investments therein. Such inequalities are avoided by the revolvingfund plan of financing.

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

In marketing associations, under this plan, money for capital purposes is obtained principally from retains or deductions on a percentage or a unit basis, or from the sale of certificates of various kinds. In purchasing associations, the major part of the capital is usually obtained from earnings or savings. Such associations, instead of paying out patronage dividends in cash, pay them in some form of certificate evidencing the investment each member has thus made in the capital of the association.

The derivation of the name "revolving-fund plan" becomes more apparent when an association reaches the stage when the oldest investments of the patrons of previous years may be retired. It is only when an association reaches this stage that its revolving fund begins to revolve. Money which is thus furnished by the patrons of an association for capital purposes should be regarded by them as an investment in their own association and not as an additional expense. It cannot be overemphasized that it takes money to go into business. Farmers, when they form and operate a cooperative, are in business. and should supply the required capital.

77 Sanders, S. D. "RETAINS" THAT NOBODY FEELS. 3 News for Farmer Cooperatives 5-6. F. C. A. 1936; Sanders, S. D. ORGANIZING A FARMERS' COOPERAF. C. A. Circ. C-108, 42 pp. 1939.

TIVE.

There is a wide latitude with respect to the terms and conditions which may be adopted for the revolving-fund plan of financing.78

Accumulations or retains for capital purposes, under this plan of financing, should be at least recorded on the books of the association as credits in favor of the proper persons. Generally, associations issue certificates to evidence such funds. These certificates are sometimes referred to as "certificates of indebtedness," "revolvingfund certificates," "certificates of equity," or "certificates of interest." The terms and conditions of such certificates differ and the rights of the holders vary accordingly.

Some associations organized with capital stock issue "certificates of stock" to evidence investments that increase the revolving fund. From a legal standpoint there appears to be no reason why an association formed with capital stock, as well as one formed on a nonstock basis, may not issue certificates other than certificates of stock. If an association revolves its capital stock, at least one share of voting stock should be held at all times by producers who are to continue as members of the association. If an association is formed with common and preferred stock, the preferred may be revolved while the common-usually issued on the basis of one share to each producerwould not be affected.

If an association is to employ the revolving-fund plan of financing, its organization papers should clearly show how it is intended to function; nothing should be left to surmise or inference. If it is intended that interest be paid on such capital funds, definite provision should be made therefor. In some instances it is preferred to make the payment of interest optional with the board of directors and to provide only that interest may not exceed 6 percent per annum. It is believed that, as a rule, the certificates issued should not have due dates and should be subject to retirement only at the discretion of the board of directors. If such certificates have due dates, the status as capital, of funds which they represent, is at least somewhat impaired, because ordinarily a suit may be brought against the association by the holder of such a certificate just as in the case of any other legal claim.

It is believed to be the better practice for an association to acquire and maintain contingency reserves for the purpose of "insuring" that certificates issued or credits given for funds obtained for capital purposes will remain at par. Such reserves are, of course, expected to operate as a cushion to absorb losses which an association may suffer. Reserves which are set aside for the meeting of contingencies

"For suggested forms of bylaw provisions see pages 402 and 410.

should be allocated on the books of the association and revolved when circumstances warrant doing so. In case of losses, the interest of patrons in such reserves should be reduced on as equitable a basis as practicable and the bylaws of the association should so provide.

As previously indicated, a sharp line of demarcation should be drawn between operating and maintenance expense items, and investments which the members of an association make in their association. The revolving-fund plan of financing is believed to be the most practicable way of insuring that ultimately all the major contributions of patrons to the assets of an association may be returned to them. The fairness of the plan should make it easier for an association to obtain members and to build up adequate capital. It provides a means by which the capital of an association increases as its volume of business increases.

Many of the largest and most successful agricultural cooperatives use this method of financing." It is being adopted not only by new associations but by associations which have been operating for many years.

As pointed out, in the discussion of the exemption of cooperative associations from the payment of Federal income taxes (p. 255), it is highly important that the "contributions" of patrons to the capital of an association, whether as reserves or otherwise, should be allocated on the books. The revolving-fund plan of financing is adapted to meeting this condition for exemption from such taxes.80

The validity of the revolving-fund plan of financing has been specifically recognized.81 Yet it should be kept constantly in mind that a member of a cooperative association, like a member of any other business corporation, may be an ordinary creditor thereof. He may make an outright loan to a cooperative association and thus become a creditor in the sense in which that term is customarily used. Likewise, a member who supplies money to an association may provide

79 Washington Co-operative Egg & Poultry Association, Seattle, Washington; Dairymen's League Cooperative Association, Inc., New York, N. Y.

80

For a fuller discussion of the revolving-fund plan of financing see Farm Credit Administration Circular C-108, ORGANIZING A FARMERS' COOPERATIVE, by S. D. Sanders.

81 Reinert v. California Almond Growers Exchange, 9 Cal. 2d 181, 63 P. 2d 1114, 70 P. 2d 190; Adams v. Sanford Growers' Credit Corporation, 135 Fla. 513, 186 So. 239; Ozona Citrus Growers' Association v. McLean, 122 Fla. 188 165 So. 625; Proodian v. Plymouth Citrus Growers Association, 143 Fla. 788, 197 So. 540; Parker v. Dairymen's League Co-operative Association, Inc., 226 N. Y. S. 226, 222 App. Div. 341; Loomis Fruit Growers' Association v. California Fruit Exchange, 128 Cal. App. 265, 16 P. 2d 1040.

it subject to specific terms and conditions. In the absence of fraud, the courts will ordinarily enforce the terms of such agreements.

To illustrate, in a case 82 involving a cooperative association formed by retail grocers to operate a wholesale agency, it appeared that bylaws were adopted pursuant to which 1 percent was added to all statements for the purpose of creating a credit reserve fund "to guarantee the accounts of all members with the Association who receive credit." The bylaws further provided that the amount credited to each member's reserve account "shall be returnable with interest upon the member ceasing to be a member of the Association," less a pro rata percentage of losses sustained by the Association on account of credit extended to members. The funds thus accumulated were not held out as constituting part of the assets of the cooperative. The wholesale agency was placed in bankruptcy and creditors thereof contended that the members had no claims against the bankrupt on account of their contributions to the credit reserve fund, but the Court held otherwise. As agricultural cooperatives that use the revolving-fund plan of financing usually provide that the obligations of the association to the holders of certificates issued in connection therewith are junior and subordinate to the claims of other creditors, the opinion just discussed goes much further than a court ordinarily would be called upon to go in a case involving such a cooperative. The status of certificates which are junior and subordinate to other claims. is similar to that of the holders of stock certificates.

As showing that borrowed money may be borrowed under such terms and conditions that it may be considered as capital and, therefore, may not be required to be shown on the books of a corporation as a liability, a case 83 in which a cooperative automobile insurance company issued for its preferred stock so-called retirable guarantyfund certificates so as to enable the company to be exempt from the payment of Federal income taxes, is significant. It was held that the money evidenced by such certificates was borrowed money though the certificates had no fixed maturity dates and their holders "had no right to enforce payment of them" and that the certificates did not have to be carried "as a liability on its books and statements." Authority for the revolving-fund plan of financing is found in the

82 Warner v. Schoner, 90 F. 2d 579.

83 Commissioner of Internal Revenue v. National Grange Mutual Liability Company, 80 F. 2d 316. See also Island Petroleum Company v. Commissioner of Internal Revenue, 57 F. 2d 992; Luckenbach v. McCahan Sugar Refining Company, 248 U. S 139, 39 S. Ct. 53, 63 L. Ed. 170; Stephens v. Simpson, 87 N. Y. S. 1608, 94 App. Div. 298; Schachne v. Corporation of Chamber of Commerce, 102 Misc. Rep. 197, 168 N. Y. S. 791.