Bongards' Creameries, No. 3956 (October 11, 1994) Docket No. SIZ-94-6-28-85 UNITED STATES OF AMERICA SMALL BUSINESS ADMINISTRATION OFFICE OF HEARINGS AND APPEALS WASHINGTON, D.C. SIZE APPEAL OF: ) ) Bongards' Creameries ) ) Docket No. SIZ-94-6-28-85 Appellant ) ) Application for ) Recertification ) DIGEST An application for recertification as a small business will be denied where the applicant, an agricultural cooperative, has failed to show that it is not organized for profit. DECISION October 11, 1994 BLAZSIK, Administrative Judge: Jurisdiction This appeal is decided under the Small Business Act of 1958, 15 U.S.C. 632 et seq., and the regulations codified at 13 CFR Part 121. Issue Whether the Regional Office correctly denied an application for recertification of an agricultural cooperative. Facts On September 10, 1990, the Dallas Regional Office of the Small Business Administration (SBA) issued a formal size determination finding Bongards' Creameries (Bongards or Appellant) to be an other-than-small business for purposes of solicitations employing 500 or fewer employees. The applicable Standard Industrial Classification (SIC) code was SIC code 2021 (Creamery Butter); SIC code 2022 (Natural, Processed, and Imitation Cheese); and SIC code 2023 (Dry, Condensed, and Evaporated Dairy Products); all having a 500 or fewer employees size standard. These SIC codes were used because Bongards, an agricultural cooperative, produces these products. The Regional Office's determination was predi cated on a finding that Bongards was a not-for-profit organiza tion and thus did not meet the definition of a business concern that is eligible for assistance as a small business pursuant to the definition set forth at 13 CFR 121.403(a). The determination was sustained by this Office in Size Appeal of Excel Enterprises Inc., No. 3392 (1990). On August 20, 1993, Bongards filed an application with the Dallas Regional Office for recertification as a small business. Bongards submitted copies of its amended Articles of Incorporation adopted March 24, 1994, as well as the language of an earlier amendment dated March 2, 1992, to demonstrate that the cooperative came within the purview of the "for profit" portion of the definition of a small business as set forth by 13 CFR 121.403(b).1 Additionally, Bongards submitted its SBA Form 355 showing that, alone, Bongards has fewer than 500 employees. The amended language of Article 2, Section 1 of Bongards Articles of Incorporation adopted March 2, 1992, supra, reads as follows: The purpose of this association shall be to market the agricultural products of its members and other producers and to procure farm supplies and equipment for its members and other producers only to the extent that such purchasing is incidental to the marketing function. Such purchasing shall be provided only [as] a convenience to its members and other producers, and to enhance its marketing function. All of the association's activities shall be conducted strictly upon the cooperative plan for the purpose of marketing the products of members and other producers and turning back to them the proceeds of sales. less the necessary marketing expenses on the basis of either the quantity or the value of the products furnished by them. No financial gain or profit shall accrue or be paid to any member solely by reason of his or her membership in this association. [Emphasis added in the original to show the changes adopted.] The Article was amended on March 24, 1994. The current Article 2 reads as follows: Section 1. The purposes of this Association shall be to market the dairy products of its members and others and to procure farm supplies and equipment for its members only to the extent that such purchasing is incidental to the marketing function. Such purchasing shall be provided only as a convenience to its members and to enhance its marketing function. All of the association's activities shall be conducted upon the cooperative plan for the purpose of marketing dairy products and turning back to its members the proceeds of sales, less the necessary marketing expenses, on the basis of either the quantity or the value of the products furnished by them. No financial gain or profit shall accrue or be paid to members solely by reason of their membership in this association. Section 2. The general nature of its business shall be: to receive, purchase, store, handle, grade, preserve, dry, process, pack, ship, market, sell and otherwise deal in, utilize, and act as commission merchant with reference to, the diary products in order to remit to its members the largest possible net returns; and to purchase, manufacture, process, sell, store, handle, ship, distribute, and otherwise deal in, supply, and procure farm supplies and equipment for its members at the lowest possible net cost to them; and to finance any of the above enumerated activities. Such purchasing function shall be conducted as a service to members in order to enhance and compliment the cooperative's marketing function and will be conducted, to the extent possible, on a "break-even" basis. Article V, Section 3(a) was also amended as follows: Section 3. Common Stock: (a) Members and Eligibility. The members of this association shall be the holders of one or more fully paid shares of its common stock. The common stock of this association may be issued or transferred to or held by those who supply dairy products to the association, and who have been approved by the Board of Directors. When ever any member shall cease to be eligible to hold said common stock or shall fail to patronize this association for a period of twelve consecutive calendar months, or shall intentionally or repeatedly violate any By-Law, or shall breach any contract between him and this association or shall willfully obstruct the purposes or proper activities of this association, then in any such event, the Board of Directors may declare the common stock of such member forfeited and shall refund to him the par value of his common stock, or in case the book value of said stock shall be greater or less than the par value, the member shall be paid the amount of the book value of the stock, and such refund may be made either in cash, or in non- voting stock (if any then be authorized) at par, or in revolving fund credits at face value. The Regional Office issued its determination on May 25, 1994. In the determination, the Regional Office noted that: In its Opinion Digest No. 57 issued on May 11, 1965, the General Counsel for SBA addressed the issue [whether cooperatives are organized for profit] as it pertained to eligibility for assistance under the Agency's loan programs. The case at issue [there] also involved a dairy cooperative. In that instance, the cooperative was engaged in the production of dairy products, but the bulk of the raw materials were acquired from non-members. The Counsel questioned whether under such an arrangement, the entity was actually engaged in performing as a coop or whether it was basically performing as a corporation or other business organization.... ...[t]he Agency has definitely ruled that two classes of cooperatives are non-profit and thus ineligible [for SBA assistance]. These are consumer cooperatives and cooperatives organized by unions for the benefit of providing services and supplies to their members and not for the benefit of the cooperative as a pecuniary enterprise.... The Counsel devised five tests which a cooperative must meet in order to be eligible. It must (1) conduct a business activity, (2) be organized on a for profit basis, (3) operate for the benefit of itself as an entity and the business interests of its members, (4) it may not be an eleemosynary, charitable, or religious organization, and (5) it may not be a consumer cooperative. The Regional Office also noted that in a later opinion, the General Counsel concluded that the individual members of a cooperative must themselves qualify as small businesses. Based upon the above, the Regional Office found that Bongards meets four of the five tests, but remained unconvinced that the operation of Bongards, as described in its Amended Articles of Incorporation, reflects a "for profit" structure as required by SBA regulations. However, in view of the General Counsel opinion that members of a cooperative must themselves be eligible as small business, the Regional Office observed that in the case of Bongards, the record showed that there are a total of 1,058 stockholders. When the employees of each member are aggregated to Bongards' number of employees, the resulting figure exceeds the 500-employee size standard. Accordingly, the Regional Office concluded that Bongards is still an other-than-small business and denied recertification. Bongards received the Regional Office determination on May 25, 1994, and timely filed an appeal from that determination postmarked June 22, 1994. See 13 CFR 121.1705(a)(1). Bongards argues that, contrary to the Regional Office deter mination, it is a for-profit corporation, meeting all the tests enunciated by the General Counsel Opinion No. 27, supra. To support this argument, Bongards notes that Bongards operates in such a way as to "show a profit for itself" because it is only by showing a profit as an entity that Bongards is able to keep and attract patrons. Bongards asserts that nearly every decision made by its Board of Directors and General Manager is analyzed on the basis of "how it will impact Bongards' profitability." Bongards argues that, in reaching its conclusion that Bongards is not a for-profit entity, the Regional Office relied in part on its "misconception" that Bongards must distribute all of its profits." Bongards argues that this "misconception" is erroneous for two reasons: First, Bongards is not prohibited from retaining profits for use in its business operations and, in fact, does retain profits. Second, a profit-making business such as Bongards is not a nonprofit organization merely because it distributes profits, or because the distribution of its profits is made on the basis of patronage rather than on the basis of equity ownership. Bongards asserts that it has the authority to retain accumulated profits for its business purposes because it is authorized to maintain a reserve for permanent surplus equal to 50 percent of its paid up capital; 2 it is authorized to retain "reasonable amounts for expense evaluation reserves for any necessary operating purposes..."; 3 and it is authorized to maintain a "Patrons' Revolving Fund" of not more than one hundred million dollars. 4 Bongards concludes from these factual assertions that it is permitted to retain accumulated profits for use in its business operations. Bongards further argues that Bongards is a "for-profit" organization under SBA regulation because, although prior to 1994, Bongards operated as an "exempt farmers' cooperative" for purposes of Federal tax law, in 1994, Bongards amended its Articles of Incorporation and bylaws and began operating as a non- exempt cooperative. Thus, Bongards must now pay Federal income tax on its nonpatronaged sourced income, regardless of whether Bongards distributes such income to its members. Finally, Bongards argues that the Regional Office was in error in finding that Bongards exceeded the applicable 500-employee size standard on the basis that its 1,058 member patrons should be considered "affiliates" whose employees had to be aggregated with the employees of Bongards. Bongards argues that this finding is in direct conflict with the conclusions expressed in Size Appeal of Elk Rapids Packing Co., No. 2037 (1984), where the Panel found that a cooperative is not affiliated with its members if the members have no connection with the cooperative except by virtue of the terms and conditions of membership and through their membership on the Board of Directors, provided that the coopera tive is controlled by its officers or Board of Directors and exercises its sales and marketing independently of its members. Bongards asserts that its members' only connection with Bongards' Board of Directors is by virtue of the terms and conditions of their membership and through their membership on Bongards' Board of Directors. Bongards is controlled by the Board of Directors, and exercises its marketing activities independently of its members. Therefore, argues Bongards, it is not affiliated with its members for purposes of determining eligibility under the SBA's size regulations. Discussion Appellant's argument that it is a "for profit" entity is unpersuasive. An examination of Appellant's Articles of Incorporation indicates that, in spite of the 1994 amendments, its activities are still to be conducted cooperatively and on a non-profit basis. In this regard, in Size Appeal of Excel Enterprises. Inc., id., the Panel scrutinized this Appellant's status as a "for-profit" entity and found that it was not organized for profit under the definition set forth at 13 CFR 121.403(a). A similar conclusion is warranted here since the 1994 amendments Appellant enacted to its Articles of Incorporation fail to change its status. For example, as shown above, the language of Article 2, Section 1 from both the 1992 and 1994 versions states that "[A]ll of the association's activities shall be conducted...upon the cooperative plan for the purpose of... turning back to its members the proceeds of sales, less the necessary marketing expenses...." This language clearly indicates a cooperative association, not an entity organized "for profit." Also, regarding the purchase of farm equipment and supplies, Section 2 of Article II, as amended in 1994, states that "[S]uch purchasing function shall be conducted as a service to the cooperative's marketing function and will be conducted, to the extent possible, on a "break-even" basis." These stated aims and purposes of operation do not demonstrate conclusively that the organization is run as a "for profit" business entity. In fact, the principal distinction between the amended Articles of Incorporation and the original is that the current Articles of Incorporation have eliminated the phrase found in Article 2, Section 1 that "...the association shall not engage in any activity with a view to financial gain or profit for its own account." Further, Appellant's argument that, because as a result of its amendments it now has to pay Federal income taxes on its "nonpatronaged sourced income" rendering it "for profit," is not persuasive. While this is a factor in determining whether an entity is organized for profit, the totality of circumstances does not warrant treating Appellant as a "business entity organized for profit" within the meaning of 13 CFR 121.403(a). For these reasons, Appellant is not a business entity organized for profit pursuant to the above-quoted regulation. In view of this conclusion, it is unnecessary to consider whether the Regional Office correctly found that Appellant is-affiliated with its members for size determination purposes. Conclusion The Regional Office's determination is AFFIRMED. The appeal is DENIED. This constitutes the final decision of the Small Business Administration. See 13 CFR 121.1720(a), (b), and (c). ___________________________ Gloria E. Blazsik Administrative Judge ________________ 1 That regulation states: A business concern eligible for assistance as a small business is a business entity organized for profit, with a place of business located in the United States and which makes a significant contribution to the U.S. economy through payment of taxes and/or use of American products, materials and/or labor. 2 Bylaws, Article V, Section 1(b); Bylaws, Article VI. 3 Bylaws, Article V, Section 3(d). 4 Articles of Incorporation, Article V Section 1.