History of RECs: Lawsuit resources for co-ops & cooperative members & lawyers

History of Rural Electric Coops

The rural electric cooperative system began 72 years ago as a New Deal program.[1] The Rural Electrification Administration (REA) provided subsidized loans to locally organized electric cooperatives and most of them started business with almost 100% debt capitalization.

Many states adopted electric cooperative corporation statutes based upon three variants of a model that is believed to have been drafted initially by the REA. Most of the statutes do not define the term "cooperative" and require only nonprofit operation and a refund to members of revenues in excess of operating costs and certain reasonable reserves.[2]

What it means otherwise to be a cooperative is a matter left largely to cooperative economic theory given sanction by federal tax law and the bylaws of most cooperatives which require operation "on a cooperative nonprofit basis".

In 1937, about the time electric cooperatives began to be formed, a federal government report defined "cooperative" as an enterprise "which belongs to the people who use its services, the control of which rests with all the members, and the gains of which are distributed to the members in proportion to the use they make of its services."[3] The REA subsequently defined an electric cooperative as "a private, non profit enterprise, locally owned and managed, and incorporated under State law. It is owned by the members it serves, and each member has one vote in the affairs of the cooperative, regardless of the amount of electricity he uses."[4]

Another definition somewhat contemporaneous with the organization of electric cooperatives is "an association which furnishes an economic service without entrepreneur or capital profit and which is owned and controlled on a substantially equal basis by those form whom the association is rendering services."[5]

An electric cooperative industry task force report in 2005[6] defined a cooperative as "[a] business that returns its margins to the members through capital credits allocations and retirements," thus making the central issue in this case one of the defining attributes of a cooperative.[7]

Insofar as their capitalization, cooperatives are distinguished from investor-owned businesses by the absence of an entrepreneurial investment of capital and by the absence of a profit motive.[8] Profit is "the wage of the entrepreneur."[9] In a cooperative, there is no entrepreneur.[10] The members through the cooperative supposedly serve themselves and assume the risk of the enterprise.[11]

Nevertheless, many cooperatives, including electric cooperatives, require substantial amounts of capital, only part of which can be borrowed from lenders such as the REA.[12] For a cooperative to succesfully borrow from lenders, at least some of its capital must be furnished by the members. As a matter of cooperative economic theory and cooperative principles, the members furnish their portion of this capital through a revolving equity plan by which the members temporarily furnish the cooperative equity capital with the expectation that some or all of their money will be returned to them as new capital is collected from other members.

[1] On May 11, 1935 President Roosevelt signed Executive Order 7037 creating the Rural Electrification Administration (“REA”). The following year Congress authorized $410 million in appropriations for a ten-year program to electrify American farms. The rural cooperative model, which had been successfully employed in Pennsylvania, was adopted by the REA, with Congressional Representatives serving as the administrative liaisons for the formation of cooperatives within their districts.

The REA was essentially a government-financing agency providing subsidized loans to private companies, public agencies, or cooperatives for the construction of electrical supply infrastructure in rural regions. The loans were guaranteed by the federal government and had an attractive interest rate and a generous repayment schedule of twenty-five years. The interest rate initially matched the federal funds rate when the loan was executed, but after 1944 the rate was fixed at two percent. REA cooperatives quickly became one of the largest capital investment projects of the New Deal, and low-cost financing for construction of electrical supply infrastructure was the key provision of the program.

[2] Enabling statutes typically permit the accumulation of reasonable reserves for debt service, working capital, system improvements, extensions and replacements, contingencies and similar needs, but mandate refunds to patrons of revenues in excess of those required to pay current operating expenses and to establish such reasonable reserves. See e.g. Ala. Code § 37-6-20; Ark. Code § 23-18-327; Ga. Code § 46-3-340; Ind. Code § 8-1-13-17; Tex. Util. Code § 161-059; Tenn. Code § 65-25-212.

REA Bulletin 1-7 (Electric) set out a formula for establishing reserve funds of the sort contemplated by the statutes. See Shadow v. Volunteer Electric Cooperative, 223 Tenn. 552, 448 S.W.2d 416 (Tenn. 1969). The formula called for reserves not to exceed 15% of total physical plant (electric lines and other facilities), plus a cushion of two times annual debt service. Id.

Reserves in excess of those recommended by REA are excessive and a court will intervene if the electric cooperative fails to implement a program required by the statute to distribute revenues in excess of those required to pay operating expenses and establish the necessary reserves. Id, 223 Tenn. 522, 560. See also French v. Appalachian Electric Cooperative, 580 S.W.2d 565 (Tenn. App. 1978). Footnote continued following page.

The relationship between statutory “reserves” and the concept of member “equity” or capital credits, discussed below, is somewhat murky. As a matter of tax law and cooperative principles, all cooperative income in excess of operating expenses (margin) is the property of the members which they contribute to the cooperative for use as capital pursuant to a revolving equity plan. Therefore, all statutory reserves constitute member equity or capital credits. However, “reserve” implies a cash reserve rather than member equities re-invested in physical plant and other assets of the cooperative. Therefore, the statutory reserves would appear to be a sub-set of member equity. In other words, member equity is a combination of cash reserves and investments in other assets.

The statutory mandate to refund revenues in excess of operating expenses and reasonable reserves is satisfied through an annual “allocation” of margins to the members, the crediting of members with “capital credits” in the amount of their margin allocations and the eventual “retirement” of those capital credits pursuant to a revolving equity plan discussed infra. If an electric cooperative fails to adopt or implement a plan for returning member equities, it is in breach of the statutory mandate to return excess revenues to its members.

[3] Report of the Inquiry on Cooperative Enterprise in Europe (U.S. Gov’t Printing Office 1937) (emphasis added), cited in James A. Baarda, Current Issues in Cooperative Finance and Governance (USDA 2006).

[4] Rural Lines USA: The Story of the Rural Electrification Administration’s First Twenty-Five Years 1935-1960 (REA Publication 811 1960), p. 14 (emphasis added) [ “REA Publication 811 (1960)”].

[5] Israel Packel, The Law of the Organization and Operation of Cooperatives (Matthew Bender, 2^nd Ed. 1947), p.3 (emphasis added) [ Packel (1947)].

[6] National Rural Electric Cooperative Association [“NRECA”] & National Rural Utilities Cooperative Finance Corporation [“CFC”], Capital Credits Task Force Report (2005). [“NRECA & CFC, 2005 Task Force Report”]. See Appendix 4.

[7] The NRECA is the primary trade group that represents electric cooperatives in the United States. The CFC is a cooperative owned by cooperatives that is a major provider of financing to electric cooperatives in the U.S. Both were the moving force behind the 2005 Task Force Report. The NRECA is headed by former Oklahoma Congressman Glenn English.

[8] Packel (1947), supra, at 191.

[9] Id.

[10] Id.

[11] Id.

[12] The REA is now known as the Rural Utility Service (“RUS’) a department of the United States Department of Agriculture (“USDA”).

This page was last modified on Monday, January 11, 2010

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