The Benefits of Indivisible Reserves and their Connection to Communities

The International Cooperative Alliance (ICA) issued a restatement of cooperative principles in 1995 that included the idea of indivisible reserves in its third principle as a discretionary option for cooperatives. When cooperatives build financial reserves, they may specify a certain share or all of it as indivisible, in other words, not transferrable to members. For cooperatives with indivisible reserves, closures of these businesses or acquisitions by private investors, would result in transfers of these designated capital funds to other cooperatives or to organizations supporting their communities.

The ICA’s inclusion of indivisible reserves has an implicit connection to its seventh principle, Concern for Community. The ICA had not included indivisible reserves nor concern for community in its previous articulations of principles in 1930, 1937 and 1966. Yet, these ideas were important to earlier cooperatives. A review of the benefits of indivisible reserves, their connection to community, and the early 19th century origin of these ideas are discussed in this article.
 

Three Benefits of Indivisible Reserves

Worker cooperatives in Mondragon, Spain, in the Emilia-Romagna region of Italy, and in France apply the principle of indivisible reserves (Corcoran). In recent years the application of indivisible reserves expanded in Quebec, Canada and in Slovenia (Avsec). For many of today’s cooperatives, especially start-ups and small organizations, indivisible reserves are often impractical. When financially feasible, there are three potential benefits from their use.

First, they create a disincentive for demutualization (conversion of a cooperative to investor ownership). Some investor-owned firms target cooperatives for acquisition. In other cases, demutualization is sought by retiring members when they have lacked individual retirement accounts. This was a significant problem among Yugoslavian worker cooperatives and plywood cooperatives in the US, as pointed out by David Ellerman.

He explains how member capital accounts can prevent demutualization. He also points out how the combination of indivisible reserves and member capital accounts, as used by the Mondragon cooperatives, supports the longevity of democratic-controlled businesses.

The second benefit occurs in the unfortunate event that cooperatives are either forced to close or are acquired by investors who are undeterred by having no access to indivisible reserves. All such reserves are transferred to either local cooperatives or to community development organizations. A cooperative that had to close from business losses is unlikely to have substantial reserves since they would be a source of capital to use in trying to sustain during economic hardship. However, that may not be the case for a highly successful cooperative that becomes a target of investor acquisition. Indivisible reserves may provide a substantial amount to be invested in the community.

The third benefit of indivisible reserves is their use as permanent capital to support cooperatives during temporary economic recessions. Permanent capital for most cooperatives is the equity that is not allocated to members. It can be used to manage risk and protect member equity and capital accounts from economic volatility. In addition, lenders prefer permanent capital to member equity as collateral.

Cecilia Navarra conducted research on how Italian worker cooperatives avoided layoffs and sustained their businesses during periods of economic duress. They used some of their indivisible reserves to sustain operations during recessions and replenished this source of permanent capital when business returned to normal. In recognition of this method of supporting employment, the Italian government taxes indivisible reserves at a low rate. The government of France requires worker cooperatives hold a minimum of 15 percent of their capital as indivisible reserves, yet French cooperatives hold on average higher percentages (Corcoran).

These benefits have a positive public impact, particularly by helping sustain businesses and employment. Making indivisible reserves tax exempt or taxed at low rates would incentivize US cooperatives to establish this form of permanent capital. There are some precedents in past US tax policy. Until the Revenue Act of 1951, farmer cooperative reserves were not taxed (Frederick). Although not indivisible, such reserves were regarded as important for supporting the early development of cooperatives to help farmers operate economically (Packel).
 

Buchez

Indivisible reserves were stated as a principle of worker cooperatives by Philippe Buchez in 1831. Buchez was a French physician and political leader (1796-1866). He had a critical role in the rise and fall of the revolution of 1848 (Chastain). Paul Lambert reprints an article by him and discusses his organizing principles for worker cooperatives.

During the early 1830’s he was involved in the organization of a cooperative for Parisian goldsmiths. When drafting their organization statutes, he established that 20 percent of annual savings be assigned as untransferable and therefore secured as an indivisible reserve.

Buchez had a special concern about the problem of retiring members depleting the capital reserves of a cooperative, as occurred in recent decades in Yugoslavia and in US plywood cooperatives. He asserted that without making the reserves untransferable, “…the association would become similar to any other business company; it would be useful only to the founders”.

He did not address the issue of what happens if a cooperative ceases to operate because of a protracted decline in earnings. If 20 percent of reserves were designated as untransferable to members, any remaining value would presumably be taken by some unit of the government when a cooperative is dissolved. This omission renders his principle of indivisible reserves incomplete because he assumes that cooperatives would never close or demutualize.

Most of today’s cooperatives specify that any remaining indivisible reserves after closure, or from investor acquisitions, are transferred to their communities. Buchez’s concern about retiring members depleting reserves is managed today in many cooperatives by having them indivisible along with capital accounts for individual members.
 

Connection to Community

Early 19th century writers and leaders generated numerous ideas and practices to elevate community life through cooperatives, such as Saint Simon, Robert Owen, Charles Fourier, and Dr. William King. Buchez was an early follower of Saint Simon and later blended that philosophy with Christian Socialism (Lambert). This period gave rise to the idea of building a cooperative commonwealth, that later cooperative leaders did not regard as a worthwhile goal for cooperatives.

Lambert points out that the Rochdale Equitable Pioneers’ Society hoped to create a cooperate communal society, but their primary focus was to establish principles for economically successful democratic enterprise. In 1844 they produced 34 organizational statutes that covered practical business operations as well as principles for cooperatives. They made substantial amendments and revisions in 1845 and again in 1854. Their concern for community was expressed in their first statute that in addition to establishing a cooperative in the interest of members, they would seek “… to establish a self-supporting home-colony of united interests or assist other societies in establishing such colonies.”

When the ICA established its first set of principles in 1930 it drew from the Rochdale statutes. It condensed them into seven principles although not specifically including Concern for Community until 1995. However, when the ICA established rules for its own organization, they emphasized that cooperatives would be organized in the interest of the whole community (Lambert).

Lambert also points out that concern for community was also articulated in the Rochdale amendments in 1854 where they address actions to be taken in the event of a dissolution. It states that “… the surplus (if any) of such property shall be applied by the trustees … to such charitable or public purposes as they think fit.”

Rochdale made the community connection that Buchez had neglected in his articulation of the principle of indivisible reserves. Nevertheless, he is recognized for originating the idea. As Lambert has carefully analyzed, the history of principles for creating cooperatives is a confluence of contributions from many groups and individuals.

References

Avsec, Fransi (2023) “Indivisible capital of cooperatives: Law and practice in Slovenia,” Journal of Co-operative Organization and Management, Volume 11, Issue 1.

Chastain, James G. (2004) Encyclopedia of Revolutions of 1848: Philippe-Joseph-Benjamin Buchez, https://sites.ohio.edu/chastain/ac/buchez.htm

Corcoran, Hazel and David Wilson (2010) The Worker Co-operative Movements in Italy, Mondragon and France. Canadian Worker Cooperative Federation.

Ellerman, David P. (2016) The Democratic Firm, www.ellerman.org/wp-content/uploads/2016/06/DEMOFIRM.pdf

Frederick, Donald A. (2005) “Subchapter T:Where We’ve Been & What Is The Future.” Cooperative Accountant, Summer.

Lambert, Paul (1963) Studies In The Social Philosophy of Co-operation. French edition published in 1959, English edition published by Co-operative Union, Ltd., UK and Cooperative League of the USA, Chicago.

Navara, Cecilia (2009) Collective Accumulation of Capital in Italian Worker Cooperatives: An Empirical Investigation on Employment Stability and Income Smoothing. Conference on Growth and Development Patterns: The Role of Institutions in a Comparative Perspective, Perugia, Italy.

Pachel, Israel (1970) The Organization and Operation of Cooperatives. Joint Committee on Continuing Legal Education of the American Bar Association, 4th edition.