Because of a new California law that passed last year, starting January 1, 2017, any worker cooperative corporation with seven or more members must now obtain workers compensation insurance for its worker-owners, even when everyone serves on the Board of Directors.
Although Assembly Bill (AB) 2883 was framed as a bill to clean up ambiguities in the code, it failed to take into account its impact on Cooperative Corporations. Many worker cooperatives are now being hit with enormous insurance bills costing worker-owners as much as 20% of their income. Prior to AB 2883, worker-owners had a choice in how this money was spent, sometimes setting it aside instead for higher wages that are paid directly to workers, or using it to provide comprehensive medical insurance. AB 2883 effectively takes this decision-making power away from worker-owners, undermining worker self-determination.
This article provides background, steps that cooperatives can take to respond, and information about the worker cooperative community’s current efforts to change the law.
What did the law say before AB 2883?
Previously, under Labor Code 3351, managing owners of businesses were not required to obtain workers compensation coverage for themselves. While this remains true for LLCs and Partnerships, AB 2883 failed to preserve this rule for Cooperative Corporations. Prior to AB 2883, in Cooperative Corporations where all members (aka shareholders or owners) serve on the Board of Directors, it was not necessary to obtain workers compensation for those directors/members. That allowed many worker cooperatives to save tens or hundreds of thousands of dollars, which the cooperatives usually put toward higher wages and better insurance coverage (such as health insurance and long-term disability insurance).
What is the new law as of January 1, 2017?
The new Labor Code laws as passed under AB 2883 have three major implications.
Only Cooperative Corporations with 6 or fewer members can waive workers compensation: After the passage of AB 2883, workers compensation coverage can only be waived by an “officer or member of the board of directors [...] if he or she owns at least 15 percent of the issued and outstanding stock of the corporation.” (Labor Code 3352(p)). Although the law does not address the impact on cooperative corporations where there is no “stock,” arguably, in a cooperative with 7 members, each member only owns 14.3% of the business. This means that a cooperative with 7 or more members may not be able to waive workers compensation coverage. Cooperative corporations with 6 or fewer members can arguably still use the exemption if member-directors file a waiver with the cooperative’s insurance company.
Owner-managers of LLCs and Partnerships can still opt out of coverage, but they have to take steps to waive coverage: AB 2883 retained an exemption for LLCs and Partnerships (Labor Code 3352(q)), which is why some California worker cooperatives have converted or are considering converting to LLCs. In order to waive coverage, an owner must actively manage the business. If you have a hierarchical management structure, we suggest that you think twice before waiving coverage for everyone. People at the bottom of the hierarchy could get injured and bring a workers comp claim, and it’s quite possible that a court would find that they actually were not “managers,” and therefore could not have waived coverage. At Sustainable Economies Law Center, for a lot of reasons related to unequal distribution of wealth and power in society, we gently suggest that all businesses explore adoption of non-hierarchical structures.
Now coverage is automatic unless it is waived, which is awkward: AB 2883 made at least one other awkward change to the law, which is that coverage now applies automatically to all working members/shareholders of corporations, LLCs, and Partnerships, UNLESS the member/shareholder actively signs a waiver of coverage. This is in contrast to the previous law, where coverage was not automatic and it was not necessary to sign a waiver. The new law says:
“The waiver shall be effective upon the date of receipt and acceptance by the corporation’s insurance carrier and shall remain effective until the officer or member of the board of directors provides the insurance carrier with a written withdrawal of the waiver.”
This is extremely awkward for businesses that do not have a workers comp insurance carrier at all. Who would they file the waiver with? This is a problem not just for worker cooperatives, but also for any small business that has not obtained workers compensation in the past.
What a cooperative corporation should do:
If you are a cooperative corporation comprised of seven or more worker-owners, you need to either obtain workers compensation for all worker-owners or consider converting to an LLC, which can exempt all managers. Below is more information about how to convert from a cooperative corporation to an LLC. Note that a few downsides to converting to an LLC include: 1) California LLCs must pay a gross receipts tax, which could cost you between $900 and $11,790 per year. 2) You will not be allowed to use “cooperative” in your business name. 3) You lose access to a special financing option that some cooperatives use, which allows the cooperative to raise capital through sale of community investor memberships for up to $1,000 each (see section 25100(r) of the CA Corporations Code).
What all businesses – including cooperatives with fewer than 7 members, LLCs, partnerships – should do:
All managing owners wishing to waive coverage should sign a document waiving workers comp, and then file it with your insurance company. If you do not have workers compensation insurance for anyone in your company, it is unclear what insurance company you should file with. This is a major problem with the new law and we hope it will change soon. In the meantime, you could perhaps try creating your own waiver document and mail it to your general liability insurance provider or long-term disability insurance provider. Again, we know this is awkward. Because of the awkwardness, the absolutely safest thing to do is to obtain workers compensation for at least one worker-owner, then have the rest of the worker-owners provide the waiver to the workers comp insurance company. If you choose to create your own waiver document, here is some sample language you could try:
Pursuant to California Labor Code section 3352(q), I hereby certify, under penalty of perjury, that I am a general partner (if the insured is a partnership) or a managing member (if the insured is a limited liability company) of the above-named business. As a qualifying general partner or managing member, I elect to be excluded from workers’ compensation insurance coverage. I understand and agree that this written waiver will be effective until I provide a written withdrawal of this waiver. I understand and agree that by signing this waiver, I will not be entitled to workers’ compensation coverage if a work-related injury occurs.
Remember, we cannot confirm that this waiver will comply with the law if it is not sent to and accepted by an insurance company.
How to convert from a Cooperative Corporation to an LLC
At least one cooperative that we know of has converted to an LLC as a result of AB 2883. Here are steps involved:
Form a new LLC: We discovered that you can’t simply “convert” from a cooperative corporation to LLC, because the CA statute does not allow it (unlike with most other entities that need to file a fairly simple form to convert). Turns out that it’s necessary to create a new LLC, and then either merger the former cooperative with the LLC, or transfer all of the cooperative’s assets to the LLC. Merger may be the easiest option, so we describe those steps here. In a merger, one entity essentially swallows up another entity. In this case, the LLC will swallow the cooperative, and the cooperative will disappear.
Elect to be taxed as a corporation: File Form 8832 with the IRS to elect to be taxed as a corporation, which will allow you to continue to be subject to Subchapter T taxation (unless you get tax advice and find out that it would be ideal to be taxed like a “pass-through” partnership, which is the default for LLCs). Long story, but the main reason to choose Subchapter T taxation is that, if the cooperative has a collective account or indivisible reserve, the cooperative probably doesn’t want the IRS to perceive those funds to have “passed through” to members all of a sudden. In that case, the funds could look like the members’ income, even when it’s not the cooperative’s intention for members to ever receive those funds.
Structure the LLC to mirror the cooperative: One option is to take the cooperative Bylaws and make small changes so that it meets LLC requirements. An LLC actually has a LOT of flexibility with regard to what it puts in its main governing document, the Operating Agreement, but we recommend that you mirror the cooperative Bylaws as much as possible at the time of merger, for the reasons we explain in the next section.
Make sure that this merger will be considered a tax-free transaction: When a business reorganizes, merges, gets acquired, and so on, there are often tax consequences for the owners or the company. However, the IRS recognizes a few types of reorganizations that qualify as tax-free. Though it’s hard to be 100% certain, our research told us that when a cooperative merges into a nearly identically-structured LLC – one that adopts the same books of account, the same list of members, and the same tax category as the cooperative – the change is so insignificant that the IRS will barely bat an eye at it. We concluded that such a reorganization is likely tax-free under 368(a)(1)(F) of the Internal Revenue Code.
Prepare 4 merger documents: We hope to provide samples of these documents here soon, especially if we learn that many cooperatives are considering converting. The documents you should prepare include:
- A Certificate of Merger: This certificate should be on a form provided by the California Secretary of State. You will need to attach pages so that everyone can sign twice (once in their capacity as cooperative members and another time in their capacity as LLC members).
- A Plan of Merger: The plan should contain details about what will happen when you merge. Specifically, the plan should clarify that the LLC will adopt the books of the cooperative, and that all interests and governance structures will remain virtually identical.
- An Agreement of Merger: Since you’ll file this document with the Secretary of State (SOS), we suggest keeping it really simple and referencing a separate Plan of Merger. Otherwise, the SOS might force you to revise the Agreement if they are confused by any of the details in the Agreement.
- A Certificate of Approval of the Agreement of Merger: This is a short document to be signed by the Secretary and President of your cooperative, verifying that the requisite vote was held and that the Agreement of Merger was approved by the members.
Hold a big meeting: Check your Bylaws and find out what kind of vote is necessary to decide on the merger. Take very detailed minutes documenting that everyone approves the merger and merger documents in their capacity as both members and directors of the cooperative, and as members and managers of the LLC. We hope to provide sample minutes here soon.
File documents with the California Secretary of State: You will then need to mail or hire a courier to file three documents with the SOS – the Certificate of Merger, the Agreement of Merger, and the Certificate of Approval of Agreement of Merger.
Do a lot of other little things: There are a lot of small steps to transfer everything to the new entity, including: Obtain a tax ID number (EIN) for the new LLC, open a new bank account for the LLC, transfer over assets, transfer permits and license (or obtain new ones for the LLC), obtain permission from your landlord to assign your lease to the LLC, assign over insurance policies (often by asking your insurer to add what is called an endorsement to your policy), file your fictitious business name statement (unless you want to use your LLC’s legal name, which would require that you say “LLC” or “Ltd” all the time), etc.
And keep in mind, that was just a basic summary. Truthfully, there are a lot of little details to juggle in the merger process, so this hasn’t been an exhaustive list. The process could vary somewhat from cooperative to cooperative. The goal here was to give you a rough idea of the process, but we strongly suggest that you work with a lawyer to complete the process. If you are in the Bay Area, we welcome you to stop by our regular legal advice cafes, but cannot guarantee that you will get to talk to a lawyer with expertise in this area.
Minor note for LLCs:
For an LLC, only “managing members” may waive coverage. Oddly, the California LLC law (in a separate area of the code) defines “manager” as someone who manages a “manager-managed” LLC. Most LLC worker cooperatives that we know of are member-managed, not manager-managed. An LLC that wants to be extra cautious could become a manager-managed LLC, then appoint all current members as mangers in the Operating Agreement. The purpose is to ensure that there’s no question that all members would meet the definition of “manager.” However, we might be overly paranoid in recommending that. It’s hard to argue that members of a member-managed LLC are not “managing members.”
Help change this law!
The Sustainable Economies Law Center has helped to convene a working group (consisting of worker-owners from 8 worker cooperatives) to change this law. We need everyone to get behind the campaign to change this law. We are asking legislators to pass a “clean-up” bill effectively allowing cooperatives to waive coverage in the same way that LLCs and Partnerships may. We also hope to clear up the problem with the waiver. More information about the campaign to fix AB 2883 can be found here: www.theselc.org/workerscomp