Documents Required in a Cooperative Conversion
The documents required to convert a business to a cooperative are described below, although they will vary greatly depending on the form of business and the chosen process of conversion. Regardless of the process, there will likely be one large document that commits the parties to moving forward, outlining the entire conversion process in detail (we call this the “Conversion Agreement” below). Then, to fully execute the conversion, there will usually be a variety of smaller documents to create or convert any necessary entities, deed over real property, give parties necessary authority, and make the conversion official at closing. For Island Employee Cooperative, the time between executing the larger agreement (the “Stock Purchase Agreement”) and the closing of the sale (which required simultaneous execution of multiple documents) took approximately 6 months.
- A Rough Timeline and Summary of Documents
- Step 1 – Letter of Intent + Employee MOU – the “Ok, Let’s Do This” Documents
- Step 2 – The Conversion Agreement + Cooperative Governance Documents – the “Here is Exactly What Everyone is Going to Do” Documents
- Step 3 – Executory Documents – the “Now Everything is Final and Official” Documents
- Step 4 – A Few Final Formalities
A Rough Timeline and Summary of Documents
Here, we have grouped the required documents into three primary steps. Note that, in the first two steps, there will be two categories of documents: 1) Agreements between workers and owners, and 2) Agreements between workers.
Step 1 – Letter of Intent + Employee MOU – the “Ok, Let’s Do This” Documents
One or two relatively informal and loosely-binding documents can be used to launch the conversion process. Even before getting to this point, both the owners and the workers will have likely done a great deal of exploration and assessment of the viability of conversion. Having concluded that they should go forward, a Letter of Intent signed by participating employees and owners, can lay a rough road map of the process, and a Memorandum of Understanding (MOU) signed by participating employees can describe how employees will work together in negotiating the buy-out.
The Letter of Intent
The first roadmap document, which we’ll call “Letter of Intent,” outlines the terms and process that the parties are contemplating and states that each party will make a good faith effort to iron out the details in a more firmly binding and detailed agreement. This Letter of Intent might be between one and four pages and could consist of simple bullet points. Although it is a short document and not intended to be strictly binding, it would preferably give each party an obligation to go forward with the process and make a reasonable effort to carry it out. This helps each party feel secure to commit time, money, and effort to larger steps, such as forming an entity, applying for financing, and so on. At this point, the owners might make an exclusivity agreement – agreeing to negotiate exclusively with workers and not seek or entertain other offers to buy the business. The parties might also want to agree not to disclose the details of the negotiations, if any of the business information is sensitive. Each worker may sign the Letter of Intent as an individual party, or, if the workers have an MOU and have appointed a Steering Committee, it may be signed by one or more individuals designated to represent the workers as a group. The owners’ business entity (if any) should be a party to the agreement, and owners (as individuals) should likely also be parties, to the extent that individual owner consent will be necessary to complete the conversion.
Memorandum of Understanding (MOU) among Workers
The participating employees should all be on the same page about how to move forward, and they might want to form a “Steering Committee” to lead the cooperative conversion process on behalf of the employees. To officially appoint this committee to act on behalf of workers, the workers may want to execute an MOU, signed by all involved workers, describing their purpose, any commitments of time or money employees will pledge, powers granted to the Steering Committee, and how the workers will make decisions as a group. This could be a short and informal document, or, alternatively, it could mirror the Bylaws that the cooperative may eventually adopt, which has the benefit of giving the workers practice in operating as a cooperative and understanding Bylaws.
Step 2 – The Conversion Agreement + Cooperative Governance Documents – the “Here is Exactly What Everyone is Going to Do” Documents
When everyone is in agreement and ready to fully bind themselves to the conversion process, the owners and workers will likely execute a lengthy contract that we will call the “Conversion Agreement.” Additionally, if a new cooperative entity is to be formed, employees should execute Articles of Incorporation, Bylaws, and any other formation and governance documents for the cooperative. All of these documents are pivotal to the conversion process, and we strongly recommend that parties consult with a lawyer to make sure that the terms are fair, in compliance with the law, and that no important terms are omitted.
The Conversion Agreement
The Conversion Agreement is a detailed and formal document that binds all parties to complete various steps in order to eventually finalize the conversion. This document would contain the sale price, list of assets being transferred, information and assurances on which all parties are relying (representations and warranties), promises by each party to do or not do things (covenants), and various contingencies (conditions) that allow each party to back out of the deal if certain requirements are not met, such as confirming the necessary financing. This document would describe all other documents that must be properly executed to complete the conversion. Much like the purchase and sale agreement used in selling a house, there may be a variety of due diligence tasks and intermediate steps between the execution of the agreement and the closing of the sale. The Conversion Agreement might also be a called Buy/Sell Agreement, Sales Agreement, Purchase Agreement, Stock Purchase Agreement, or something similar. It will likely run between 5 and 40 pages, and include multiple attachments that represent samples of other documents to be executed before or at closing. Since this document will have many similarities to a buy-sell agreement used when selling any business, many samples of such a document are available.
Although the Conversion Agreement will contain many terms not described here, below are a couple terms worth describing in greater detail:
- Non-Compete Agreement and Non-Solicitation Agreement: Non-Compete Agreements and Non-Solicitation Agreements are often used in the sale of a business, since the selling owner(s) are well positioned to create a business that directly competes with or poaches employees from the sold business. A Non-Compete Agreement can specify a period of years and a geographical area in which the selling owners(s) are prohibited from starting a specified type of business. The Non-Solicitation Agreement can also state that the seller may not solicit or hire any of the cooperative’s employees to work for the seller.
- Consulting Agreement with Selling Owners: The knowledge and expertise of the selling owner(s) can greatly benefit a business, particularly in the months or first few years after transition to worker ownership. The Conversion Agreement could specify that the selling owner will provide ongoing advice and consulting services to the business. For example, the Island Employee Cooperative contracted with the prior owners to provide full-time consultation for a period of four weeks following the sale, and 500 hours per year for the subsequent two years.
Cooperative Formation and Governance Documents
If the workers plan to form a separate cooperative entity, then they will form the entity by executing and filing Articles of Incorporation and adopting Bylaws. If the cooperative chooses to form as an LLC, the workers would instead file Articles of Organization and adopt an Operating Agreement. If the cooperative will use a name that is substantially similar to the original business name, the original business may need to write a letter to the Secretary of State giving permission to the cooperative to file Articles using the name. The execution and filing of these documents would preferably take place prior to the execution of the Conversion Agreement, so that the new cooperative entity can be a party to the Conversion Agreement.
At formation, the Articles of Incorporation can specify that the Steering Committee will serve as the Cooperative’s first Board of Directors, and the Board may then adopt a resolution to adopt the Bylaws and admit members. To legally admit members, the Cooperative might also need to prepare a document providing certain disclosures to members, as is required in California. Membership certificates are generally not legally required, but could be used to give workers a more formal acknowledgment of their new ownership interest. The Cooperative need not receive capital contributions from members at this point, since doing so might first require some work to ensure that the Cooperative complies with securities laws, but the Bylaws may provide for a capital contribution required at a later date.
Since the decision to execute the Conversion Agreement is a major decision of the sort that cooperative members (as opposed to directors) are generally required to make, the Cooperative should then schedule a members meeting to officially vote on any resolutions necessary to validly execute the Conversion Agreement. All resolutions and meeting minutes should be kept with the Cooperative’s official records, and the initial resolutions and minutes may be provided to the business owners to give assurances that the Cooperative had the power to become bound to the Conversion Agreement.
If the workers do not plan to form a new entity, the Conversion Agreement should include an attachment representing the Amended Articles and Bylaws that would eventually be executed when conversion is complete. This is so that workers are fully informed of the nature of the entity that they will soon own, govern, and rely on for the livelihoods. This also provides assurances to the owners that they are indeed selling their business to a worker cooperative, and not to a group of workers who might turn around and sell the business to the highest bidder.
Step 3 – Executory Documents – the “Now Everything is Final and Official” Documents
To make the conversion final and official, a variety of documents will likely need to be executed. An escrow service may be used to facilitate the final execution of documents and transfer of funds, and many of the documents will be signed at a single closing meeting. One or more of the documents may be completed after closing, in situations where parties agree to take a specified action within a reasonable period of time after closing (such as changing trademark registration). Some of the documents needed before or at closing may include:
- Redemption Agreements: Where the Conversion Agreement does not provide for the automatic relinquishing of owners’ interests in the company upon the occurrence of certain conditions, the owners may sign a document at this point to officially relinquish their interests in the business.
- Promissory Notes: The cooperative will likely execute promissory notes representing the cooperative’s debt to the prior owners and/or to other lenders. A very basic sample promissory note is provided in the back of this handbook, though institutional lenders will often use their own form. If individual workers are receiving loans to finance their buy-in, workers will also need to execute promissory notes individually.
- Loan Agreements: Because promissory notes are generally short documents that simply describe the terms of promised payment, some lenders may require the cooperative to sign an ancillary Loan Agreement to provide for other obligations of the cooperative or lender. For example, the lender may require that the cooperative receive technical assistance from a specified provider, in order to ensure the financial viability of the cooperative.
- Inter-Creditor Agreement: In cases where multiple lenders collaborate to support a conversion, it may be necessary for the lenders to execute an inter-creditor agreement, committing each lender to provide financing and specifying the priority of repayment and the assets securing each loan. An Inter-Creditor Agreement was used in the conversion of the Island Employee Cooperative, as described in the case study later in this handbook.
- Share Certificates: The cooperative may prepare certificates evidencing the issuance of preferred shares, if any.
- Governing Documents: Where original business entity simply changes its structure, the new Articles and Bylaws may be officially adopted at closing.
- Leases, Lease Assignments, or Deeds: For businesses with a physical location, it will be necessary to execute documents ensuring that the cooperative has secure land tenure. This could involve the transfer of land by deed, the assignment of a lease (usually requiring the landlord’s permission), or the execution of a new lease if the prior business owner will retain ownership of the location and lease it to the cooperative. In cases where the original business entity simply converts to a new structure or new type of entity, it may not be necessary to execute any documents to transfer land title, since the land doesn’t change hands. However, since there may be a name change to add the word “Cooperative,” it would be a good idea to amend any deeds or leases to ensure that the owner/lessee name is up-to-date. Lastly, if ownership changes hands and there are other tenants at the location, the tenants should be notified of the change of ownership.
- Assignment of Contracts, Bank Accounts, and Insurance Policies: Since businesses tend to be parties to multiple contracts, including insurance policies, it may be necessary to obtain agreement from the other contract parties and insurance companies to assign the contracts and policies over to the new entity, if the cooperative is operating under a new entity. In addition, bank accounts will need to be closed, assigned, and/or renamed. Documents evidencing these assignments, contracts, policies, and accounts should be provided at closing, although some may, by necessity, need to be completed after the closing.
- Transfer or Licensing of Intellectual Property Rights and Trademarks: In cases where the individual business owners personally own the rights to any intellectual property rights or trademarks associated with the business, it will be necessary to transfer those rights to or license them to the cooperative. This may be done in the Conversion Agreement, itself, if the individual owner is a separate named party, or it may be done in an ancillary agreement. In the case of registered trademarks, copyrights, and patents, the registration will need to be changed.
- Consulting Contracts with Third Parties: While the Conversion Agreement may commit the prior owners to ongoing consulting with the cooperative, the Conversion Agreement may also require that the cooperative enter into separate contracts with other technical assistance providers. For example, the lenders that supported the conversion of the Island Employee Cooperative required that the cooperative enter into technical assistance and professional service contracts with three agencies, in order to receive support in grocery management, marketing, merchandising, business planning, cooperative governance and operations, and accounting.
- Letters and Resolutions Affirming Authority: Prior to closing, it is wise for the parties to collect documents that verify that all parties to the Conversion Agreement have the full legal authority to bind the entities and complete conversion. That way, it is unlikely that someone would later challenge the validity of the conversion on the basis that the parties did not have the necessary authority. For example, the attorney for the original business entity may write an opinion letter stating that the owners have made a valid decision to convert the business and that no laws or obligations to third parties prevent them from doing so. In addition, the cooperative can provide copies of Board resolutions and Member resolutions, signed by the Secretary, verifying that the cooperative has made legally binding decisions to commit to the conversion.
- Tax Clearance Letters: The business should provide evidence that it has filed all tax returns and paid all taxes. This evidence may take the form of a letter from an accountant or from the local, state, and/or federal taxing authority.
- Bill of Sale: In the case of an asset sale, a bill of sale – or multiple bills of sale – will officially transfer ownership of certain assets, such as intellectual property, client lists, inventory, equipment, files, records, and so on.
- Securities Offering and Registration Documents and/or No Action Letter: In some cases, when the cooperative receives capital contributions or loans from cooperative members, the cooperative may need to take additional steps to ensure that the receipt of capital from members complies with securities laws. See the financing chapter of this handbook for additional details on when securities law will be relevant, and what paperwork may be required.
- Final Valuation of Inventory: For businesses that maintain inventory, the value of the inventory can fluctuate on a day-to-day basis. The final value of the inventory will need to be determined as close to the date of final sale as possible, causing the business sale price to shift slightly.
- Deeds of Trust: If any loans will be secured by real estate, it may be necessary to file (or “record”) a Deed of Trust along with local property records, to ensure that the lender’s right to the property is protected in the event of a default on the loan, and to make prospective purchasers aware of the security interest.
- Resignation of Officers and Directors: Except in the case of an asset sale, the officers and directors of the original entity will need to submit their resignation. This is because the relinquishing of their ownership interests will generally not automatically result in removing them from governance and administrative roles.
Step 4 – A Few Final Formalities
After closing, the parties may have a handful of additional papers to prepare and file, particularly for tasks that cannot be completed until after closing. Tasks that may occur after closing might include changes to contracts with third parties, changes to bank accounts, changes to trademark registration, and any other action that is both contingent on successful closing and on third party action. Generally, the Conversion Agreement or other contracts executed at closing will bind the parties to completing these additional tasks as quickly as possible.
Additionally, the cooperative may need to file a Statement of Information or a similar document with the Secretary of State to provide an updated list of directors and officers. If it plans to do business under a name that is different than the entity’s legal name, it will usually need to file a Fictitious Business Name (“Doing Business As”) Statement.
In the case of an asset sale from one entity to the new cooperative, it is possible that the original entity will then want to dissolve, which requires a handful of formalities to wind up the business, file certificates of dissolution, final tax returns, and so on.