Abandoned Member Property Need Not Escheat to the State

Virtually every state has adopted a law similar to the Uniform Disposition of Unclaimed Property Act. 1 This article will outline how cooperatives have been affected by escheat laws and how one state, California, has passed legislation to exempt cooperatives from paying over to the state abandoned patronage dividends or shares.

The problem

If for five years any member does not either (1) claim a dividend, profit distribution or other sum owed by the cooperative to that member; or (2) correspond in writing or otherwise indicate an interest as evidenced by a memorandum or other record on file at the cooperative, then the property shall escheat to the state. 2

This is a big problem for cooperatives because they have so many members who become "lost" after a number of years. In one instance, a cooperative was forced to pay over $20,000 to the state as escheated property interests. Credit unions have also been surprised by the results of escheat audits by the state comptroller. Cooperatives most affected are those which issue patronage dividends and those with many transitory shareholders.

Escheated property means certain property held by corporations and financial institutions which remains unclaimed by its owner and thus is presumed to be abandoned by the owner after a set number of years. The state requires an accounting and then takes possession of the property forever on behalf of the owner unless the property is reclaimed by the owner. On the cooperative level, types of "proprietary interests" subject to escheat include the value of any membership, share certificates, accrued and unpaid dividends and patronage dividends.

Across the country, these escheat laws have been held to apply to cooperatives and have affected cooperatives in several ways. Multiple issues have arisen as to which property is escheatable. Unpaid wage claims, stock, dividends, including patronage dividends, and abandoned credit and bank accounts are subject to be paid to the state if unclaimed after a set period of time. Normally, the value must exceed $25,000, but in South Carolina an electric cooperative was assessed over $10,000 for unclaimed money or cash credits of former customers whose accounts, individually, were less than $25.00. 3

Although amendments to bylaws are generally binding upon old and new members, such a strategy may not be adequate in matters of escheated property. A cooperative-wide amendment may not be considered as evincing each member's intent to donate.4

The solution

Since 1986, a law has been in effect in California which permits consumer cooperative corporations to be an exception to the escheat rule. 5

The provision states in part that any proprietary interest that would otherwise escheat to the state shall instead become the property of the corporation. This law is set forth in full at the end of this article. A similar statute was passed for nonprofit Cooperative Agricultual Associations in 1987.6 In order to avail one's cooperative of this relief, however, the cooperative must keep records and then attempt to provide notice to the lost members.

Exception bylaw

The procedure set forth in the California statute is quite specific and must be carefully followed. The cooperative bylaws or articles must be amended to specifically provide for the transfer of ownership of otherwise escheated proprietary interests to the corporation.

The bylaw could retroactively apply to all proprietary interests not yet "abandoned" for five years as of the date the bylaw is adopted. As a sample bylaw, which should not be adopted without consulting an attorney, the following resolution is presented:

Gifts bylaw

Another possible solution may be to pre-empt the five year escheat law by adopting a bylaw whereby the members give their proprietary interests to the cooperative as gifts in the event the members cannot be found for two years. This was attempted by a cooperative in Utah, which won its case on other grounds.

The question remains open as to whether a giftgiving bylaw, by itself, would prevent escheat. Since notice is required in either a gift bylaw or the codified exception bylaw proffered above, the cooperative might want to follow the legislatively permissible route rather than one which may be subject to a court's unfavorable criticism.

Interestingly, since 1987 Intermountain Farmers, an animal feed supply cooperative, has been paying over its unclaimed property to the state while trying to change the law in Utah.

Tax question

If a cooperative meets the statutory requirements of Corporation Code §12446 and the value of the lost member's proprietary interest is transferred to the cooperative, the question arises whether that amount constitutes taxable income to the cooperative. Normally, release of corporate liabilities such as unpaid patronage or the value of stock would be income to the cooperative. If however, the cooperative members indicate their intent to give their unclaimed property as a gift to the cooperative, then the property received could possibly be characterized as a non-income donation. The taxing authorities may view a gift bylaw as too remote, so the cooperative may want to supplement such a bylaw by asking members to sign a membership agreement which contains specific language corroborating the members' intent.

This gift versus income issue is important, since the "proprietary interest" transfer takes place only on the cooperative's financial records. In reality, no new money is being received with which the cooperative will need to pay taxes if the transfer is characterized as income. Cooperatives considering the gift bylaw route should consult a tax lawyer to advise them about their particular situation. It should be noted that the two year period stated in the above hypothetical bylaw is not mandatory; the cooperative could insert any fixed term up to five years.

Conclusion

All California consumer and agricultural cooperatives might want to quickly take advantage of laws which permit them to keep unclaimed property. In order to do this, each California cooperative must amend its bylaws or articles and then follow the notice procedure.

Cooperatives not located in California might want to ask their state representatives to introduce legislation similar to the provisions presented below. This would handle the proprietary interests of past lost members. In order to attempt to minimize the tax effect of the transfer, the cooperative may want to add "gift" language to the bylaw/article and to the membership agreement.

The California cooperative statute is presented below in full. Since this law is unique, the application and interpretation of the statutes have not been tested.

California Corporations Code §12446. Proprietary interests; transfer to corporation; requirements.

(a) Subject to the provisions of subdivision (b), the provisions of Chapter 7 (commencing with §1500) of Title 10 of Part 3 of the Code of Civil Procedure shall not apply to any proprietary interest in a consumer cooperative corporation. Any proprietary interest which would otherwise escheat to the state pursuant to Chapter 7 (commencing with §1500) of Title 10 of Part 3 of the Code of Civil Procedure shall instead become the property of the corporation.

(b) Notwithstanding the provision of subdivision (a), no proprietary interest shall become the property of the corporation under this section unless the following requirements are satisfied:

(1) The articles or bylaws shall specifically provide for the transfer of ownership of the otherwise escheated proprietary interests to the corporation.

(2) At least 60 days prior notice of the proposed transfer of the proprietary interest to the corporation is given to the affected member by first-class or second-class mail to the last address of the member shown on the corporation's records, and by publication in a newspaper of general circulation in the county in which the corporation has its principal office. Notice given in the foregoing manner shall be deemed actual notice.

(3) No proprietary interest shall become the property of the corporation under this section if written notice objecting thereto is received by the corporation from the affected member prior to the date of the proposed transfer.

(c) For purposes of this section, a "proprietary interest" shall mean and include any membership, membership certificate, membership share, or share certificate of any class representing a proprietary interest in, and issued by, the corporation together with all accrued and unpaid dividends and patronage distributions relating thereto.

Historical note: §36 of Stats. 1986, c.766, provides: "The provisions of §12446 of the Corporations Code, as added by this act, shall apply to all proprietary interests which as of the effective date hereof have not yet been paid or delivered to the state controller pursuant to the provision of Chapter 7 (commencing with §1500) of Title 10 of Part 3 of the Code of Civil Procedure."

FOOTNOTES

1. 98 ALR 2d 304-314, UDUPA (and later case service).

2. States differ as to the number of years property needs to be abandoned.  In California, it is five years.

3. South Carolina Tax Comm. v. York Electric Cooperative, Inc., 270 S.E. 2d 626 (S.C. 1980).

4. See, "Cooperative Associations.  Validity and encorceability of bylaw amendment reducing benefits available to members," 61 ALR 3d 986-978 (1975).

5. California Corporations Code §12446(a).

6. California Food and Agricultural Code §54041.

Lottie Cohen is a Los Angeles attorney who represents cooperatives with their various tax, business, and real estate issues. This article is an expanded version of one published in the newsletter of the California Association of Cooperatives.