The Co-operative Reform Process


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    This document has been made available in electronic format
         by the International Co-operative Alliance ICA 
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                         August 1992


            ************************************* 
               The Co-operative Reform Process
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source : Janos Juhasz, Co-operatives in Eastern & Central
Europe, ICA Studies and Reports, Geneva, 1992, 62 pp. price 12
CHF


2.1  Government co-operative policies
*************************************

In the government's assessment the existing co-operatives, the
production and workers' types in particular, were not
established to serve the development of their members' private
property and bear only formal co-operative features. For that
reason the fundamental transformation of the structure is
necessary. 

The basic concept is that new co-operatives can only be
established on the basis of private property. To that end the
common property of existing co-operatives has to be made
divisible. Employment obligations and other socio-political
responsibilities of co-operatives should be abolished.
Furthermore, the members' rights and responsibilities should
be made clear, and should include members' financial
responsibility for the co-operative and its assets.

The transformation of co-operatives is foreseen as a gradual
process based on social consensus. Any kind of campaign-like
drive is to be avoided. The process should include the
establishment of new forms of co-operatives, the main function
of which is the promotion of their members' businesses. 

The co-operative transformation process will obviously entail
a certain degree of decentralization, above all in
agriculture. The over-large co-operative farms will most
likely separate to form smaller more localized enterprises.
Some areas of the large-scale farming co-operatives' work are
also expected to become independent, or to convert into other
company forms. Such processes are also promoted by the
agricultural policy. As to the transformation of the existing
structure of institutions in general, government policy puts
an emphasis on privatization and on the establishment of
company forms. Co-operatives are looked upon as one of the
types of potential economic business organizations needed in
the development process. However, no special privileges are to
be given to them and they should be able to stand competition. 

The fact is that no co-operative promotion programmes exist in
the country. Several factors would explain this. Above all,
co-operatives have a rather bad image in Hungary, just as in
other Eastern European countries. Their bad image is the
result of at least two factors. Co-operatives are identified
by the general public as a means of communist-forced
collectivization. This view, of course, is very simplified and
focuses on one single type of co-operative, neglecting both
the promotion co-operetives in Hungary and the achievements of
the international co-operative movement as a whole. It also
goes to show the low level of knowledge about co-operatives
outside the co-operative sector. 

There is, however, another factor which contributes to the
unfavourable image of co-operatives. A direct business
mentality has been developing that hopes the market economy
will remedy all economic problems within the shortest possible
period of time and to the fullest possible extent. The market
is considered an "omnipotent" power capable of overcoming all
the ills of economy and society alike. This approach has no
room for the concept of c-operation and does not believe in
those co-operative values which go beyond business efficiency. 

This is not meant to say that there is an oppressive climate
for co-operatives. No political power would declare an 
anti-c-operative policy. In present day Hungary this applies
to both the ruling and opposition political parties. All have,
in one way or another, declared their appreciation of a
genuine co-operative movement. Co-operatives are considered a
necessary sector of the economy and enjoy full moral support.
However, they are looked upon first of all as business
organizations and are expected to be economically viable and
profitable. Equal chances and equal conditions are promised
them, but no special treatment. Therefore no particular
incentives and no special promotion programmes are to be
introduced. Co-operatives, at least according to the present
state of affairs, are not going to have extra subsidies, tax
exemptions or tax reductions. This is partly the reaction to a
policy which upgraded c-operation to the level of state policy
and failed. It is also an indication of a pointedly normative
and neutral approach to various forms of economic activity. 

This is not a permanent  situation, of course. Intensive
lobbying, mainly on the part of co-operative managers and
co-operative federations, has already succeeded in easing some
of the scheduled provisions. For example, the first draft of
the banking law contained the same minimum capitalization
requirement for both business banks and savings and credit
co-operatives. This has now been reduced to half for
co-operatives. Similar examples however, cannot yet be given
for other co-operatives. 

2.2  Co-operative legislation 
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Until the beginning of 1992 a great number of laws and
regulations controlled the operation of co-operatives. The
basic law was Act No. A. of 1971 on Co-operatives. In
addition, co-operatives' business activities were regulated by
a number of relevant regulations. The whole co-operative
sector was, in fact, "over-regulated". The rules and
regulations, of course, reflected the approach of the old
socialist (communist) regime to co-operatives. Indeed, there
were certain legal measures that contained provisions which
put co-operatives in an unfavourable position. The
introduction of a new co-operative legislation has therefore
been supported by all parties concerned, and is considered a
precondition for the change to a social and economic paradigm. 

After a long preparatory work two acts were passed by
Parliament on 16 and 17 January 1992: The Unified Co-operative
Act and the so-called Co-operative Transition Act. The first
is meant to provide a legal framework for future co-operative
action embracing all types and models of co-operatives, while
the latter deals with the transformation of the existing
co-operative structure. 

Preparatory activities to draft the acts were carried out by
the Ministry of Justice on behalf of the Government. However,
the Ministry relied, to a great extent, on the contribution of
the co-operative movement itself. It requested the National
Co-operative Council to set up a special drafting committee
composed of the representatives of various co-operative
branches, the co-operative federations and co-operative
researchers. Each version of the Unified Co-operative Act and
the Co-operative Transition Act was discussed and commented on
by the drafting committee of the National Co-operative
Council. 

2.2.1     The unified co-operative act:

The unified legislation for future co-operatives was prepared
with the active involvement of the existing co-operative
structures. With some simplification, it can be stated that
whatever is included has the support and agreement of at least
the leaders of the movement. 

The government - and the drafting committee - has taken a
characteristic approach to the new legislation, which has been
followed throughout the preparatory procedure and is reflected
in the text of the law. This approach includes the requirement
of non-interference of the state and the full authority of
co-operative self-government. In addition, it aims to provide
opportunities for the establishment of various entrepreneurial
and working contracts and agreements between the co-operatives
and their members. Co-operatives are looked upon as joint
enterprises nased on the private property of members and, as
such, legislation should, to the largest possible extent, make
them similar to other economic associations.  Thereby, the
Hungarian co-operative legislation would be closer to European
practice. 

The basic features of the Unified Co-operative Act can be
summarized in the following: 

The law defines co-operatives as societies established in
accordance with the principles of free c-operation and
self-help, carrying out entrepreneurial and other activities
that serve the interest of the members and use the property
and personal contribution of members within the framework of
democratic self-government. Co-operatives are independent
legal entities. One of the new provisions of the law is that,
although it states that the members of co-operatives are
individuals, it allows for the membership of legal entities as
well. The rights and duties of the 'legal entity' members are
equal to those of individual members, except for some special
provisions such as personal contribution and eligibility for
office. The reason given for this possibility is that the
membership of legal entities may be needed, and useful, for
the co-operative's operation in various respects, first of all
from the point of view of capital formation. The involvement
of legal entities must not change the basic nature of
co-operatives as associations of individual members. 

A co-operative can be established by a minimum of 5 people.
Only the establishment of school co-operatives and credit
co-operatives requires at least 15 members. It is a further
new feature of the law that the co-operative will be
represented not only by its chairman or the designated member
of the board of directors but also by the "managing chairman"
and/or  managing director. Legal supervision of co-operatives
will be done by the Court of Registration just as in the case
of other economic associations. 

The law puts a very keen emphasis on the autonomy and
self-government of co-operatives. In accordance with the
principle of self-government the co-operative membership will
decide on 

-    all questions of operation, business and any other
activities serving the members' interests;

-    establishment through election of its corporate bodies;

-    creation of its own statutes and rules;

-    supervision of the operation of its organs, the
activities of its office bearers and employed managers. 

It is an important provision that any restrictions regarding
the co-operatives, their membership relations and property
rights in particular, can be made by legislation only. 

The general assembly remains the highest organ of
self-government of the co-operative. However all decisions
belonging to its sphere of authority can be relegated to the
delegates' meeting by the statutes. The only exception in this
respect is the decision on merger, separation, transformation
and cessation. The law maintains the institution of the
so-called partial general assembly. This means that, for
example, a co-operative that covers several villages may have
partial general assemblies in each village. Partial general
assemblies have the authority of the full general assembly. 

In the field of membership relations the law provides for the
application of the principle of open and voluntary membership.
No discrimination is allowed by race, colour, gender,
language, religion, political or other opinion, ethnic or
social background, property or other position. It is worth
mentioning that, among the rights of members, the law lists
the sharing of the income of the co-operative by the members
according to their contribution to capital as well, and not
only according to personal contribution. However, all the
organizational and personal rights of members are independent
of the size of contribution in terms of property.

An independent chapter of the law is devoted to the provisions
regarding the property relations between the members and the
co-operative. The act maintains the institution of
co-operative shares as well. Members joining the co-operative
will be obliged by law to buy at least one co-operative share.
The maximum number and value of co-operative shares will be
determined by the statutes. The shares are of the same value,
and are not negotiable. A dividend is due to the members on
their co-operative shares, and is payable from the net surplus
of the co-operative. 

The law introduces the so called 'business share' as a new and
significant form of property relations between the members and
the co-operative. The business share is different from the
co-operative share. 

It is not purchased by the members, but allotted to them from
the proceeds of the co-operative's business activity. The
general assembly is to decide annually on the distribution of
net surplus (profit) of the co-operative for dividends,
reserve fund and business share capital. The amount allocated
for the augmentation of the business share capital should be
distributed among the members in the form of business shares.
Members are to be provided with a certificated business share
made out in their names. In cases where the business share
capital is used to cover losses the nominal value of shares
will be decreased proportionately. It is a very special
provision of the law that the business shares of co-operative
members are not only inheritable but fully negotiable as well.
In addition, a dividend is paid on them, but no interest is
payable. If the business share is going to be sold to a
non-member, the co-operative and its members will have the
right of option. Furthermore, where the new owner of the share
is not a member of the co-operative, he/she will have no
voting rights at the general assembly. If a membership
relation ceases, the former member, or his/her heir, will be
eligible to receive the value of his co-operative shares only,
provided that the co-operative's share capital was not used to
cover loss. Only business shares existing in the form of
securities can be sold either to the co-operative or to
outsiders. 

The law retains the possibility for the co-operative to
provide financial support to its retired, disabled or sick
members. Conditions for this are to be defined in the statutes
of the co-operative. The agricultural and industrial
co-operatives are obliged by law to form a "solidarity fund",
the amount of which should make up 10% of total assets. It is
a new provision that members' fledgling enterprises may be
supported by the co-operative through the use of real estate
and/or means of production under certain conditions. 

As to the uconomic activities of co-operatives, any kind of
business may be carried out with the exception of those that
are the exclusive sphere of activity of other organizations or
institutions. Co-operatives are otherwise entirely free to do
their business and have full independence in the disposal of
their net profit i.e. the surplus after meeting their tax
obligations. However, for safety reasons the law makes it
possible, but not compulsory, for them to establish a reserve
fund. At least 10% of net profits should be allocated to this
until the reserves reach the amount defined by the statutes as
a proportion of the co-operative share capital.

There are new provisions regarding the working relationship of
the members and the co-operative. Above all, the obligatory
employment requirement of the co-operative has been abolished.
Since this was a unified act the provision applies to workers'
co-operatives, and also to the agricultural production
co-operatives. However, the law specifies two types of working
relations for the co-operative members. One of them is the so
called "entrepreneurial" type of work, which in practical
terms, means a contractual relationship between individual
members, or groups of members, and the co-operative. The other
one is the waged worker relationship, which is known from past
experience and from the experience of other enterprise forms.
Both require the written agreement of the co-operative and the
members concerned. 

The co-operative is liable for its debts, with its property
composed of the co-operative share capital, the business share
capital, the reserves and the free assets. Co-operative
members' liability does not extend over their private property
and salaries, i.e. it is rustricted to their co-operative and
business shares. Liabilities for damages between the
co-operative and its members is regulated by the Civil Code.
An exception may be the case of the waged worker relationship,
which is dealt with by the Labour Code and may mean a more
limited liability in the case of the employed members. 

Finally, the law confirms the right of co-operatives to
establish secondary organizations on regional or professional
grounds, and national organizations for safeguarding their
interests. Co-operatives have the right of merger, separation,
transformation and cessation as well. Co-operatives can be
transformed into both limited liability companies and share
holders' companies. However, savings co-operatives, credit
co-operatives and insurance co-operatives may be converted
into shareholders' companies only. Precondition for a
transformation into other company forms is the total division
of the co-operative's property among its members in the form
of securities. In case of cessation, the property should be
divided after having settled the co-operative's accounts. 

2.2.2 The co-operative transition act:

The Co-operative Transition Act is at least as important as
the Unified Co-operatives Act. All co-operatives should be
re-established in accordance with the provisions of the
unified act. This takes time and requires special rules for
the period of transformation. The transition law allows for a
6-month transition period (until 30 June 1992) in general, and
a 12-month transition period (until 31 December 1992) in the
case of agricultural co-operatives and industrial
co-operatives. 

In the course of these periods each co-operative is supposed
to submit its new statutes to the Court of Registration. Those
who fail to do this will be liquidated by force of law and
deregistered. In the course of the transition period four
important tasks are to be accomplished: personalization of the
property, organizational transformation, voting in of new (or
modified) statutes and election of leaders and officers. All
these areas are regulated by the Act. 

The term "personalization" of property has been created in
connection with the transformation of the existing
co-operatives, particularly the production (workers')
co-operatives. It is the conversion of joint co-operative
property into the private property of members. In other words,
it represents the means of privatization in the co-operative
sector, the major purpose of which is to make co-operative
joint enterprises based on the private property of members.
According to the concept of the transition law, this requires
the return of property to those who contributed to its
accumulation. Distribution of the property should be done in
the form of business shares. The whole process of dividing the
property of the "old", i.e. existing, co-operatives is called
property personalization.

As a general rule, the transition law provides for the
personalization of 100% of the co-operative's property.
However, this applies only to the production co-operatives,
i.e. the agricultural and industrial co-operatives. In the
general consumer co-operatives only 70% of the property must
be personalized, while the property of housing co-operatives,
savings co-operatives and school co-operatives should remain
indivisible. 

People eligible for restitution are those who:

-    were members of the co-operative in question on 1 January
1991 and were members on the day of the Co-operative
Transition Act coming into force,

-    had been members of the co-operative for at least 5 years
before the law came into force, or are heirs of people who
were, or

-    have restored their membership, or are the heirs of those
who would be eligible to restore their membership, with the
co-operative. 

Furthermore, the general assembly may decide to provide
business shares in the framework of the personalization
process to its employees, and to those family members who
participate in the work of agricultural co-operatives on a
regular basis. The quantities will be decided upon by the
general assembly taking into consideration the contribution of
the members to the accumulation of property. In practice, it
is usually the time spent in the co-operative, the position in
the work organization (salary) and the original property
transfer which are taken into consideration. 

The rules of property personalization in agricultural
co-operatives do not apply to land. The problem of the
privatization of land is much more complicated, and requires
different solutions for different groups of people. The
solutions, of course, should also be in harmony with related
legislation, above all with the compensation law.4

The first type of land is that which is owned by the
co-operative members but is in the common use of the
co-operatives. This is considered full private property and
should be surrendered to the members if requested. The second
case is that of those who are entitled to purchase land on the
basis of the provisions of the compensation law. This land
will be sold by auction to those who have such entitlement and
should be made available to the new owner at his/her request.
However, in both cases, owners have a free choice to maintain
the common use of the land, to cultivate it privately or to
join the co-operative as members and utilize the
co-operative's services. Both cases are regulated by the
compensation law. 

The third type of land is owned by the co-operative and is
also in the common use of the co-operative. This land, after
having met all compensation claims, should be distributed
among the members of the co-operative. The members' share in
terms of proportion and Golden Crown* value is to be entered
in the cadastral land register. The land allotted in this way
should be surrendered to the member on leaving the
co-operative. During the maintenance of membership, rent is
due to the member if the land is under co-operative farming. 

4 -  Act XXV/1991 on the Partial Compensation for Damages
Caused Unjustly by the State in the Property of Citizens in
Order to Settle Property Rights.

5 -  Golden Crown is a traditional unit of measure of the
quality of the land. At the time of its introduction, the
number of Golden Crowns corresponded to the net profit of a
land area of one yoke, i.e. 0.56 hectare. 

The transition law aims at an organizational transformation of
the existing co-operative structure. It is intended to give an
opportunity to the co-operative members to revise and correct
all those organizational developments which were unnecessary
and occurred without the support of the members, or even
against their will. This process is to be facilitated by
easing the conditions of merger, separation, transformation
and cessation during the transition period. During that time
all the listed motions can be decided upon by a two-thirds
majority of votes cast by members present at the general
assembly. Of course, after the transition period, when the
organizational set-up of the co-operatives has been resettled,
the rules provided for by the Unified Co-operative Act will
become effective. 

The transition law also makes possible the separation of one
single member and/or any small group of people from the
agricultural and the industrial co-operatives. This
measurement is also temporary. There is an important
restriction, however, for the general consumer co-operatives
and housing co-operatives. As to the consumer co-operatives,
separation is allowed only for those groups of members who
live in the same settlement. In the case of housing
co-operatives, separation is restricted to those groups who
have a common interest in a physically separable building or
other construction unit. The proportional share of property
should be surrendered to the separating individual or group. 

The legislation intends also to settle the problem of the
agricultural associations by the transition law. Agricultural
- and other - associations are considered unsuccessful from
the point of view of their legal construction. The fact that
they are not independent legal entities created a lot of legal
problems. Therefore, this form of co-operative association
will cease to exist by the end of the transitional period. The
transition law offers several options for the existing
associations. Members may join the mother co-operative.
Another option is that, after having settled accounts, the
association is liquidated and its members establish an
independent co-operative. This co-operative may join the
parent co-operative as a member. Finally, associations have
the option of transforming themselves into a new company or
society which, as an independent legal entity, may also join
the mother co-operative. If the members' conference of the
association does not decide upon any of the above options by
the end of the transition period it will be liquidated by
force of law. 

One of the most crucial and complicated questions related to
the organizational transformation of co-operatives is the
division of property. The transition law provides for their
division in physical terms. For that, any transformation
should be preceded by at least a simplified valuation of the
property. After setting the value of the indivisible part of
the property, the general assembly will decide on which
property items should undergo the division process
individually and in groups. It is an important provision of
the law that the assets and liabilities of the co-operative
shall be attached to definite property items and shall be
transferred to the new owner(s) in the course of the
procedure. A positive statement to that effect from the
potential new owner, and the approval of the creditors, are
preconditions of such a division of property. 

The division itself may be pursued in two ways. It can be made
by the resolution of the general assembly. This presupposes a
smooth and full agreement of all interested parties. If such
an agreement cannot be reached the property item in question
will be sold by auction. The auction itself will have three
phases. First a closed auction will be held with the
participation of those who have the "property bond" issued by
the co-operative in question. Both individuals and groups may
bid. The selling price must not go below the reserve price. If
this is unsuccessful, a second auction will be attended by the
same participants but the property item may be sold below
reserve price. The third, and last, possibility is the open
auction in which outsiders paying cash can also participate. 

In order to facilitate transformation, the law deals in depth
with the rules of procedure. Among other things, it enables
the holding of more than one general assembly in the course of
the transformation process specifying the issues to be dealt
with by each of them. 

In the context of procedures, one of the most important
provisions is that the assignment of present co-operative
office holders will cease at the time of the general assembly
approving the new statutes of the co-operative. The new
officers are to be elected by the same general assembly. This
motion is needed because the new Unified Co-operative Law
introduces a different set of management positions, and the
office bearers' liability is changing, too. It is reasonable,
therefore, to give the members a chance to elect new leaders
and to give the managers the choice of taking or refusing
responsibility under the new conditions. 


2.3  Tendencies towards "spontaneous" transformation
*****************************************************

As yet, no dramatic changes have occurred in the Hungarian
co-operative movement. The most significant tendency is the
transformation of traditional industrial co-operatives into
small co-operatives, as mentioned above. Another
characteristic process is the "personalization" of the
co-operatives' property  based on previous legislation. Some
50% of the property has been "personalized" in most of the
agricultural, industrial and consumer co-operatives. 

Various associations and joint ventures established among or
between co-operatives and other enterprises have long existed.
Most recently, international capital has shown an increasing
interest in creating business activities in Hungary. New joint
ventures are established with the participation of Hungarian
co-operatives and foreign investors. However, this process has
not been very fast so far because of the lack of co-operative
legislation. 

The really new forms of enterprise are joint-stock companies.
Both limited liability companies and share-holding companies
appeared only in 1989. The legal basis for their establishment
is provided by the company law. Although both are
non-c-operative organizations, the establishment of one or the
other indicates different processes and has a different, but
very strong, impact on the co-operative structure. In the
co-operative system, limited liability companies come into
being in two ways. The general assembly of a co-operative may
decide to transform one or more of its units (workshops,
branch offices, etc.) into an independent limited company.
Most often this is done with the capital contribution of
individual members. The co-operative contributes the assets
used by the unit. In some cases 'one-person' limited companies
are established in which the co-operative, as a legal entity,
is that 'person'. The other way of establishing such companies
is the traditional one, when an entirely new enterprise is
created with capital input from the co-operative and other
legal entities or individuals. The important feature of this
process is that, regardless of the means of establishment, the
newly created limited liability company does not abolish the
existence of the co-operative as a whole. It may decrease its
size of operation, but does not aim at changing the
institutional form of the entire co-operative. For example,
the units of non-farming activities, such as repair shops,
industrial workshops, etc., are frequently transformed into
limited liability companies in agricultural co-operatives.

The aim in establishing share-holding companies is usually
different. Some co-operatives or, to be more precise, some
co-operative managers feel the future of the co-operative, and
also their own future, would be safer in some other
organizational form. Legal regulations make it possible for
the general assemblies of co-operatives to transform their
co-operative into a joint-stock company. In a few recent
experiments the form of share-holding company has been
selected for that purpose. Based on the general assembly's
decision, a larger part of the co-operative property has been
distributed among the members and employees in the form of
fully-negotiable shares. For the purposes of social security
and social assistance, a foundation has been established by
setting aside the smaller part of the co-operative property.
This solution was legitimate according to the company law.
However, it was expected to clash with the new co-operative
legislations. For that reason a moratorium was imposed by the
Parliament on all co-operative conversions into other
organizational forms until the co-operative law has been
passed.