Conflicts of Interest in the Management of Co-ops

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Conflicts of interest are impossible to avoid within a co-op. Yet one of the best ways to tarnish your co-op’s reputation and bring suspicion to its operations, as well as invite a lawsuit or governmental investigation, is to mishandle conflicts of interest. Allowing a conflict to rise to the level of a breach of fiduciary duty could be devastating to your co-op, possibly subverting years of appreciated goodwill. However, managing conflicts to ensure that they are properly disclosed and grounded in good faith is fairly simple. 

The co-op structure can present novel issues and gray areas not encountered in the private corporate and nonprofit sectors. Nevertheless, implementing broadly applicable procedures to cover most circumstances and ensuring a high level of board and management involvement in particular conflict matters will prevent harm to your co-op and the individuals directly involved. This article will present the basic legal concepts and processes related to conflicts of interest, with the goal of assisting co-op board members, managers, and employees in properly discharging their duties.  

What is a conflict of interest?

A conflict of interest (COI) occurs when the financial or personal interests of a board member or co-op manager are, or may appear to be, inconsistent with the interests of the co-op. (For purposes of this article, "manager" includes members of the board of directors, corporate officers, employees, and any person serving a role in the co-op to which legal responsibilities attach.) Most COIs arise in the context of proposed co-op transactions with managers, family members of managers, or other organizations in which managers or their family members have a significant financial interest or managerial role. The variety and types of COIs are limited only by the complexity of modern business and personal relationships. 

COIs occur along a continuum. Some are clearly inappropriate, while others are less likely to be harmful yet still pose risks. For example, stealing cash from the co-op is an obvious COI, as well as a criminal act. A small freebie preferentially given to a manager may in itself present a fairly minimal conflict, yet if it initiates a pattern, it could become more serious. 

People elected or appointed as co-op managers serve in their position not to further their own interests but to further the mission and goals of the co-op for the benefit of the owners/
members. Managers need to focus on the concerns of the co-op, not on outside personal interests; otherwise their personal interests may interfere with the important decisions they make as managers. Thus, it is imperative that co-op managers be aware of all potential conflicts in order to head off the consequential ones. Large business enterprises are often affected by consequential and sometimes notorious COIs. Yet co-ops are not immune from such problems, despite the good intentions of co-op managers and the community-centered philosophy underlying cooperative enterprises. Here’s the bottom line: if humans and their business and personal interests are involved, COIs will arise and need to be addressed. (See Carolee Colter’s article, "Handling Emotional Conflict of Interest," in the May–June 2007 Cooperative Grocer for specific examples of conflicts that may arise in co-op management.)   

Most COIs are innocent, occurring quite naturally in business relations. When undisclosed, however, they can become particularly harmful. By not disclosing competing interests, a manager is, in effect, cheating. The co-op’s board of directors may believe that the co-op’s interests are being promoted in the transaction, but they may be very wrong. 

 Undisclosed COIs are likely to seriously compromise the decision-making process, preventing managers from having open and candid discussions and, in many cases, from acting in the best interests of the co-op. Large-scale or repeated COIs can threaten the co-op’s business and organizational goodwill and even lead to an overall breakdown of a co-op’s fundamental reason for existence: to create and maintain an autonomous association of persons of good faith who voluntarily cooperate for their mutual social, economic, and cultural benefit. 

Keep in mind the statement of cooperative values set forth by the International Cooperative Alliance in 1995, which include the values of honesty and openness. These values should directly guide co-op managers’ actions related to COIs. Co-op managers need to be open and forthright in disclosing conflicts and also honest about every detail of the co-op’s business. 

A useful rule of thumb for gauging the potential effects of a COI is the "front page" test. For any COI—even one that turns out not to be an actual breach of a co-op’s policies or a manager’s legal duties—the appearance of an inappropriate COI can sometimes be as damaging as an actual harmful conflict. Imagine how the conflict transaction, accurately described on the front page of your local newspaper or news website, would be received by co-op owners and the public generally. If it is likely to be controversial or misunderstood, you could save yourself some grief by foregoing the transaction. 

Preventing inappropriate conflicts

Heading off inappropriate COIs requires two initial steps by a manager. The first and most important step is disclosure—perhaps multiple instances of disclosure—and amending the disclosure if anything changes regarding the conflict. Disclosure should be made as soon as any conflict is discovered. The disclosure demonstrates that the person with the conflict understands both the potential problem and the possible need for a process to prevent any harm to the co-op. The second step is for the manager with the COI to entirely abstain from the co-op’s deliberation regarding the COI. The manager should refrain from participating in any discussions, lobbying, or other activity within the co-op’s processes related to the matter.

 When these two actions are taken, the manager with the conflict has "discharged" the COI, meaning the minimum has been accomplished to protect the manager from liability, generally irrespective of any action other co-op managers may take with respect to the COI. Action may then be taken by other managers on the disclosed COI to ensure that no legal duties are breached or serious appearance problems are presented. 

Conflicts of interest often present very touchy issues for a co-op (or any human institution), and any decision to waive a COI (that is, proceed with an action in spite of the COI) must be properly documented to establish the reasonableness of that decision. It is very important that the co-op’s corporate minutes and/or other formal business records accurately reflect the manager’s disclosure of a COI and any action taken by the co-op’s board or other members of the co-op management team. Public revelation of a co-op’s handling of a COI can go a long way in demonstrating the transparency of its processes, which will build owner confidence in the co-op. Having an accurate, formal record of the COI process also demonstrates the importance of the co-op’s minutes. 

Adopt a formal conflicts policy

An important tool used to manage conflicts and preemptively minimize the danger of potentially harmful conflicts is a COI policy. Every co-op—really, every organization—should have some form of written conflicts policy. Sometimes such policies are included in a more general code of conduct or ethics; sometimes COI-related policies are contained in a separate document. 

A COI policy cannot possibly define all types of conflicts that arise, but a good policy will accomplish the following:

  • Make managers aware of possible COIs and their potential dangers;
  • Educate managers about the situations and relationships that can give rise to COIs;
  • Cover most conceivable types of conflicts that might affect managers’ particular co-op or type of co-op;
  • Remind managers of their fiduciary duties and their need to protect the assets and reputation of the co-op, as well as the broader mission and goals of the co-op; 
  • Establish a routine process to follow when a conflict or potential conflict arises; and
  • Encourage managers to follow the process any time there might be the appearance or perception of conflict, even if it is not directly covered by the policy.

Such written policies not only assist in averting inappropriate COIs, but also demonstrate to the co-op members and the world that the co-op is serious about preventing COIs and that the co-op managers understand their fiduciary duties. Of course, your co-op must scrupulously follow the requirements of the policy. It’s also a good idea to reference the policy when noting such compliance in the co-op’s minutes or other corporate documents. Good examples of COI policies can be found through an internet search or from established co-ops.

Duties of co-op managers

The following is a short synopsis of the legal duties of co-op managers—usually stated as the duties of board members, but which apply equally to co-op officers and employees. Different states have varying laws and rules in this area, but the information below provides a generally applicable statement of a co-op manager’s corporate fiduciary duties. 

There are three general duties of co-op managers. These are the duty of obedience, adherence to the broad mission and specific goals of the co-op; the duty of due care or diligence, taking careful consideration in the execution of any action or in the failure to take action regarding the business of the co-op; and the duty of loyalty, remaining loyal to the business and operations of the co-op, particularly when presented with an opportunity from which the manager or a family member could benefit. 

As a legal matter, a COI is initially analyzed under the law relating to the duty of loyalty. The existence of a COI is not necessarily a breach of this duty, but the existence of a COI invokes further review under this duty. As mentioned above, properly disclosing the COI and taking no part in any deliberative process on the subject often fully discharges the COI, so nothing further may be required. But a COI that actually harms the interests of the co-op—even if fully disclosed and even if the manager with the COI has taken no part in the related deliberative process—may still result in a breach of the duty of loyalty by the manager with the COI. In addition, if the other managers vote to approve a transaction involving a harmful COI, they may thereby breach their duties of due care and possibly of loyalty. 

Many gray areas exist. For example, a co-op board may decide that an action which at first blush appears harmful to the co-op and only beneficial for the manager with the COI is actually the right course for some special or complex reason. This is an area fraught with danger since any such action may be difficult to adequately explain to co-op owners/members or governmental regulators.

One important point concerns the "business judgment rule." This legal rule protects business managers from liability or second-guessing in their decision-making process. The business judgment rule provides this protection if a decision is made in good faith, with the care that an ordinarily prudent person in a like position would exercise under similar circumstances and in a manner the manager reasonably believes to be in the best interests of the corporation. 

As you can see from this statement of the business judgment rule, a manager withholding disclosure of a COI that harms the co-op would not be protected (good faith not present). Even a manager properly disclosing a COI that then results in harm to the co-op may not be protected if it was reasonably expected that the harm would occur (neither good faith nor reasonable care present). A harmful disloyal act is not insulated from liability simply because it has been disclosed. The co-op managers voting for the harmful action could be held liable for failing to use due care in authorizing the action (due care and loyalty issues). 

Many—probably most—notorious corporate scandals started with some sort of COI, and many of those began innocently enough but then spiraled out of control into major breaches of fiduciary duties. An extreme example of a co-op (an electric co-op in this case) that over many years became embroiled in serious conflicts and other improprieties is described in this 50-minute documentary: www.youtube.com/watch?v=KIJHRMCxbrM. (For a short trailer, see www.vimeo.com/21828817.) The documentary concentrates on the subversion of the co-op’s mission and operations caused by the scandal. 

The legal implications of approving an action involving an underlying COI may require detailed analysis by an attorney. If anyone involved in a proposed action related to a COI has concerns, the best or easiest course may be to disapprove the action. That’s not always possible, and if concerns linger on any issue involving a COI, seek good legal advice on the issue. 

Remember co-op principles, values

The values of honesty and openness aren’t the only co-op precepts relating to COI management. The values of social responsibility, caring for others, democracy, equality, solidarity, organizational self-help, self-reliance, and self-responsibility also ultimately rely on the good faith and forthrightness of co-op managers and all co-op participants. That co-ops are based on community-centric principles and values does not make them immune from scandal and corruption, but co-ops are certainly less likely to encounter large-scale, greed-based breaches of fiduciary duty. Careful management policies and practices will significantly help protect your co-op from potential harm caused by conflicts of interest. 

See other articles from this issue: 165 April 2013