Farmers have always known the power of working together, and today’s sustainable farm businesses are no different. Many farmers are exploring a wide range of options for working with other farm businesses in meeting shared objectives. Multiple farms might combine product for a single community- supported agriculture (CSA) program. Other farms might reach a broader base of buyers by cooperatively marketing their products. Some farms are interested in sharing the burdens of distribution by forming a company that delivers to multiple buyers. Still other farmers are forming collective enterprises to purchase equipment, manage labor resources and help educate the next generation farmers.
Although their objectives for working together may differ, any farm business that joins with another for common purpose faces a range of legal considerations. These are not necessarily barriers to cooperative efforts; they simply require conscious attention and decision-making.
The goal of this chapter is to help farmers identify some potential legal issues that emerge when farm businesses work together. Our emphasis is on concerns relative to choosing and organizing a business entity. Although plenty of other legal concerns exist, we encourage farmers to check out Farm Commons’ employment and insurance law guides to get a feel for those issues. Here, we identify and discuss unique concerns with “accidental partnerships,” joining a business as an individual or an entity, and the importance of thorough organization documents.
Key Factors to Consider When a Farm Operation Works with Other Farms
Farmers can accidentally form a partnership, leaving all partners exposed to elevated risks
Whether helping each other bale hay, sort livestock or deliver product, farmers work together all the time. We know that these acts of kindness are part of being a good neighbor and are essential for a less isolated and more enjoyable rural life. The law honors neighborly relations, and helping out another farmer does not necessarily mean that the two of you are at greater risk.
Yet, a couple of farmers who work together consistently to achieve a shared purpose may cross the line into forming a business together at some point. This is where our legal concerns arise. This distinction between simply helping each other out and forming a business enterprise matters. Businesses and individuals have different legal obligations; we need to know when a business exists and when it doesn’t. For example, we know from the sole proprietorships and general partnerships chapter of this Guide (Chapter 3) that partners in a legal “general partnership” are mutually responsible for each other’s obligations and liabilities. To know if the individuals have that shared responsibility (as opposed to individual responsibility for their individual actions only), we need to know if the individuals have formed a general partnership.
The answer to whether folks have formed a general partnership should be pretty easy, right? Did they sign documents to form one? Did they say they formed one? If only it were that simple! Because no formal action is required to form a general partnership, we don’t have any clear indicating factor when one has been formed. It’s all about whether the people involved are acting or representing themselves as if they are a business. Any time we have to evaluate behavior or representations, it can get pretty murky. What does it mean to “act” like you’ve formed a separate business with another farmer?
For better or worse, our legal system is all about drawing lines in the sand and forcing gray areas into black and white boxes. Whether two or more farmers have formed a separate business is precisely one of those gray areas that lawmakers and courts have tried to define as black and white. Generally speaking, people have formed a partnership when they 1) act like co-owners of a business and 2) intend to carry on the business for a profit (as opposed to intending to create a nonprofit). More specifically, the question is settled according to the laws of each state and the courtrooms that define state law. Still, we can generalize across all states. Each state relies on some version of the four main factors below.
Below, we explain each factor and use an example to help illustrate how a court might apply the factor to a farm business. Imagine for a moment that we have two hypothetical farmers joining together to market a CSA option. The first farmer, let’s call her Sally, raises poultry for meat and eggs. Our second hypothetical farmer is George; he grows vegetables. Sally and George offer a single CSA share that combines vegetables, eggs and chicken in one convenient plan. George and Sally haven’t done anything distinct such as signing a partnership agreement. Both operate their own farms and haven’t given much thought to whether their business is a partnership or two independent businesses assisting each other.
Factor: If individuals share profits from a common enterprise, a court is more likely to find that they have formed a partnership
Before we get further into this factor, let’s outline a few basics. We are using the accounting definition of profit: business revenues minus business expenses. Profit goes beyond simply gaining a benefit. If one farmer helps another bring in the hay, the hay producer has benefited because they have more hay to sell, sooner. That’s not the same as sharing in profit, though. The concerns of the individuals need to be economic, to an extent.
Profit must also be mutual. Let’s use our example of Sally and George to illustrate this. Sally and George might distribute a single sign-up form that requires CSA members to send in two checks, one to Sally for the eggs and chicken, and one to George for the vegetables. In this situation, it looks like Sally and George may not generate a mutual profit. Each will keep their own books where they post individual revenues, deduct individual expenses and earn a profit according to largely individual effort. This situation looks a lot less like a partnership.
By contrast, Sally and George might allow CSA members to write a single check, perhaps one written out to a farm name that is different from their own individual farm names. Sally and George might deposit this check into a separate bank account from which they both draw to cover their expenses in producing chicken, eggs and veggies for the CSA. At the end of year, Sally and George might split any profit that remains. This, of course, looks a lot more like sharing profits from the common enterprise! There’s still plenty of room to find that Sally and George have not formed a general partnership with this arrangement, but they are certainly closer than if they had taken separate checks.
Factor: If people intend, or appear to intend, to carry on a business together, a court is more likely to find they have formed a partnership
This factor is especially amorphous! What does it mean to “appear to intend” to do something? Although we can’t define it, we can spot a few illustrations of an intention. If folks create a business plan together that calls for generating a mutual profit, it looks like they’re intending to form a shared business. If they contribute investments to the business (or plan to do so), speak of each other as partners in their business and both enter into commitments on behalf of the enterprise, it looks like they intend to have a business. Not doing these things (like not entering into any commitments and not making any investments) doesn’t mean a business hasn’t been formed, but having done them can serve as evidence.
Factor: If individuals share profits from a common enterprise, a court is more likely to find that they have formed a partnership
Before we get further into this factor, let’s outline a few basics. We are using the accounting definition of profit: business revenues minus business expenses. Profit goes beyond simply gaining a benefit. If one farmer helps another bring in the hay, the hay producer has benefited because they have more hay to sell, sooner. That’s not the same as sharing in profit, though. The concerns of the individuals need to be economic, to an extent.
Profit must also be mutual. Let’s use our example of Sally and George to illustrate this. Sally and George might distribute a single sign-up form that requires CSA members to send in two checks, one to Sally for the eggs and chicken, and one to George for the vegetables. In this situation, it looks like Sally and George may not generate a mutual profit. Each will keep their own books where they post individual revenues, deduct individual expenses and earn a profit according to largely individual effort. This situation looks a lot less like a partnership.
By contrast, Sally and George might allow CSA members to write a single check, perhaps one written out to a farm name that is different from their own individual farm names. Sally and George might deposit this check into a separate bank account from which they both draw to cover their expenses in producing chicken, eggs and veggies for the CSA. At the end of year, Sally and George might split any profit that remains. This, of course, looks a lot more like sharing profits from the common enterprise! There’s still plenty of room to find that Sally and George have not formed a general partnership with this arrangement, but they are certainly closer than if they had taken separate checks.
Factor: If people intend, or appear to intend, to carry on a business together, a court is more likely to find they have formed a partnership
This factor is especially amorphous! What does it mean to “appear to intend” to do something? Although we can’t define it, we can spot a few illustrations of an intention. If folks create a business plan together that calls for generating a mutual profit, it looks like they’re intending to form a shared business. If they contribute investments to the business (or plan to do so), speak of each other as partners in their business and both enter into commitments on behalf of the enterprise, it looks like they intend to have a business. Not doing these things (like not entering into any commitments and not making any investments) doesn’t mean a business hasn’t been formed, but having done them can serve as evidence.
Going back to our example of Sally and George, let’s say that Sally and George discuss marketing efforts for their CSA. They agree that Sally will attend a CSA open house, distribute brochures and take payments. While she’s at the open house, Sally will also pick up some boxes from another farmer and pay for them with money George put into their shared bank account. In the meantime, George is meeting with a banker to talk about getting a modest loan for a distribution vehicle. Sally and George have agreed that George may sign a loan for up to $10,000 and that loan payments will be taken from the shared bank account. Each of these actions are signs that they think they are participating in business together. Both are acting on behalf of the other’s interests–one in the sale of product and the other for a loan payment. Both are indicating an intention to pool money, with the future goal of generating profit from their mutual efforts.
Keep in mind that whether an enterprise actually makes a profit, or even if the business plan has a reasonable chance of making a profit, isn’t relevant. People can and do form failing, profitless general partnerships all the time! It’s the plan and intention to work towards the profit together that reveals a general partnership.
Factor: If people share common ownership of property, a court is more likely to find they have formed a partnership
The common ownership of property is a pretty strong indication that two people have formed a partnership. For example, if Sally and George purchased the truck with shared funds, it’s more likely they have formed a partnership. Not having any common ownership of property doesn’t mean that a partnership hasn’t been formed, however. Many businesses don’t utilize property at all. Sally and George might form a marketing venture wherein they call restaurants on behalf of each other’s farm business and sell their product together. This wouldn’t require anything more than a phone. The court would look to other more relevant factors than common ownership of property to determine if Sally and George’s marketing venture is a partnership.
Factor: If people share control of the enterprise, a court is more likely to find they have created a partnership
In a legal sense, sharing control of an enterprise generally means a shared ability to influence significant decisions on behalf of the business. Entering into debt, making accounting and tax decisions, acquiring property and taking on investors or members are all significant decisions. When individuals have an opportunity to present their perspective and control the outcome of the significant decisions, they are more likely to have a partnership. This doesn’t mean each partner has to have the authority to make unilateral decisions or even an equal say in the decision. Each partner might get voting power over entering into debt, acquiring property, etc, in proportion to their stake in the business–that still qualifies as sharing control. In contrast, if one person has no say over a matter at all, they have an employee/manager relationship rather than a partnership relationship.
Why does it matter if you’ve formed a “partnership,” without fully realizing it?
Above, we outlined four different factors that a court will consider in determining if a partnership exists. But, have we fully explored what it means to have accidentally formed a partnership? If individuals don’t realize that they have formed a general partnership then they likely haven’t taken good risk management steps to accommodate their increased risk. Next, we will explore the increased risks and the management strategies farmers might adopt.
If you don’t realize you have a partnership you may not be managing the risk of joint and several liability
Earlier in this chapter we briefly discussed that if you have a general partnership, you can be held personally responsible for liabilities that your partner incurs. (We go into much more detail about how this “joint and several” liability works in Chapter 3 on general partnerships.) If you know that you may be potentially responsible for the decisions of your partner, you might act differently. For example, you might choose to keep your businesses separate and avoid a partnership. Or, you might be more diligent about following up on matters and allocating responsibility clearly. Perhaps you will take a closer look at your insurance policy and make sure that you have coverage for whatever might happen within the general partnership. The bottom line is that if you don’t know your current risks, you can’t manage them.
If you don’t realize you have a partnership, you might not have drafted a partnership agreement
A partnership agreement is a document that individuals create to outline their mutual obligations and business operation procedures. Our chapter on LLC operating agreements (Chapter 4) goes into full detail about the content of these types of agreements. We will summarize by saying that a partnership agreement is essential to identifying how decisions are made and how partners enter and exit the enterprise, and to outlining partners’ legal obligations to each other. When individuals haven’t acknowledged that they have a partnership, they probably haven’t thought about these decisions, let alone put them on paper.
Not having a partnership agreement gives individuals less control over their enterprise. If something goes wrong and a court is forced to make a decision about legal responsibilities, the court will rely on state law rather than the decision of both parties. The state law may or may not be best for the business.
If you don’t realize you have a partnership, you might not have insurance for your increased risks
Insurance is any business’s first line of defense against liabilities. It’s even more important than forming a business entity. The entity generally provides liability protection over personal assets, not business assets. The bottom line is, business assets are not protected if an enterprise doesn’t have insurance. When farmers start working with others, they may assume the other farmer’s insurance policy will cover them. These kinds of assumptions can come with terrible consequences if they are false. Any time a farm begins a new venture, the farmer should check with his or her insurance agent about coverage. Don’t immediately assume a new venture will cause rates to go up–the partnership might be covered under existing policies. Or, you might simply need to add the partnership as an “additional insured” to the policy. The best solution may depend on whether a separate partnership has been formed or not, so determining where you stand is an important first step.
If you don’t realize you have a partnership, you haven’t considered creating a different business entity such as an LLC
Given the opportunity, most farmers don’t choose to remain as a general partnership. The cost of creating a separate entity such as an LLC or a corporation is low compared to the benefits–primarily, insulation for personal assets from business liabilities. Perhaps the biggest drawback to not knowing that you have a partnership is not realizing that it is time to form a more optimal business entity. Farmers have a lot to gain from a conscious choice about which business entity to operate under.
Fundamentally, there’s nothing inherently wrong with having a general partnership and not realizing it. Problems occur if the increased risks to which the partnership is exposed materialize. Farmers can manage those risks. It’s all about making a conscious choice of whether and how to manage that risk. Choosing to draft a partnership agreement or forming an LLC or corporation could be the right choice, but there is no single correct answer; it’s all about the farmers’ situation and preferences.
Farmers should decide if they are participating in the co-venture as an individual or as a business
If you have read through this Guide already, you know that LLC members and corporation shareholders aren’t necessarily individual people. Other businesses can be members of an LLC or shareholders in the corporation as well. For farmers considering joining forces with other farmers, the question of whether to participate as an individual or business entity arises. Like so many legal questions, there’s no single correct answer. We have to assess several factors against the individual situation of those involved. To help illustrate the factors involved in making this decision, we will go back to our example of Sally and George and their cooperative CSA adventure.
If the new entity is an S corporation, the farmer must participate as an individual
The first factor is relatively straightforward. If the new collaborative venture is already organized as a corporation, options may be limited. As discussed in the C corporations chapter (Chapter 5), a corporation can either file taxes as a C corporation or as an S corporation. If the new venture isn’t planning on taking on outside investment or doing a public offering, it probably plans to file taxes as an S corporation. If an entity files taxes as an S corporation, all shareholders must be individuals. Other LLCs and corporations may not be shareholders in an S corporation. If the entity is already organized as an LLC and has already chosen to file taxes as an S corporation, the same applies.
Let’s return to our example of Sally Smith and George Merry, two farmers who are creating a co-owned venture to distribute Sally’s poultry and George’s vegetables as a single CSA share. Sally currently raises her chickens and her eggs under her existing business, Sally’s Farm, LLC. In her eagerness, Sally has already filed the paperwork to form the corporation Happy Peach Farm, Inc., the business under which she and George will market their CSA. Sally and George agree that Happy Peach Farm should file taxes as an S corporation; they want to avoid the double taxation of a C corporation. In this case, Sally can only join Happy Peach Farm, Inc. as Sally Smith. If she receives stock in Happy Peach Farm, Inc. in her capacity as a member of Sally’s Farm, LLC, Happy Peach Farm will lose its eligibility to be taxed as an S corporation. Sally can’t necessarily convert Happy Peach Farm, Inc. to an LLC, either. Depending on the business’s assets and accounting, doing that can have tax consequences. The best choice may be for Sally to join in her individual capacity as Sally Smith.
The farm or farmer should join the new venture in whichever capacity they will act in
Should a farm choose to join a multi-farm venture as the farm or as the farmer? Sometimes, this question can be answered with common sense alone. The farmer should ask him or herself in which capacity he or she will actually be participating in the business. Will the farmer be making decisions in the multi-farm venture on behalf of him or herself personally or on behalf of his or her existing farm business? Participation is on behalf of the existing farm business if it takes into account the farm’s overall business plan, growth strategy, financial situation, investor or partner preferences, or other business-specific factors. Participation is on behalf of a farmer personally if it considers personal objectives such as retirement plans, personal income, other actual or planned business ventures, purely personal objectives and other factors that aren’t related to the farm operation.
The question of personal or business capacity might seem pedantic, but it has real-world implications. As a participant in a multi-farm venture, you will have legal obligations to the venture. These obligations might be spelled out in an operating agreement or they might be traditional legal obligations that apply regardless. These obligations might require you to avoid competing with the multi-farm venture, to disclose certain information or to refrain from voting on certain matters when you have a conflict of interest. The member of an LLC or the officer/director of a corporation needs to be sure he or she understands these legal obligations and can fulfill them.
Anti-corporate farming laws may affect the farmer’s decision to join as an individual or as an LLC/corporation
If the new multi-farm venture will operate a farm, own farmland or lease farmland, and is located in Iowa, Kansas, Minnesota, Missouri, North Dakota, Oklahoma, South Dakota or Wisconsin, all potential members should look closely at the state’s anti-corporate farming laws. These laws restrict the ability of LLCs and corporations to control farmland or participate in farming under certain conditions. Many of these laws only allow LLCs or corporations where all members/shareholders are individual persons (and not other LLCs or corporations) from farming or controlling farmland.
Anti-corporate farming laws aren’t designed to trip up well-meaning collaborative farm ventures, but they can have that effect, especially if people aren’t aware these laws exist. The laws often have wide exceptions, so most businesses will still be able to conduct their operations. They just have to make sure they organize the business in certain ways or avoid titling farmland in the name of the business. Read our anti-corporate farming chapter (Chapter 10) for more information.
Joining as a business may make it easier to transfer ownership
If the member of an LLC or shareholder of a corporation is a business entity rather than a person, control of that membership follows the business rather than person. Farmers getting ready to transfer a business might find this convenient. For example, let’s say farmer Sally plans to retire in two years. She has a farm successor lined up and they are going through the process of transferring ownership and managerial authority. Sally’s successor is excited about the CSA opportunity and plans to continue working with George. If Sally joins Happy Peach Farm, Inc. as the member of her LLC, membership in Happy Peach Farm will transfer neatly to her successor along with ownership of Sally’s Farm, LLC.
Farmers may encounter other factors that affect their decision to join a multi-farm venture as an individual or as a business. Certainly, tax factors may play a role. Farmers should check with their accountant or tax preparer to understand any broader implications for the business’s financial situation. An attorney, insurance agent and other professionals can also be helpful in the decision.
Pay close attention to developing strong business organization documents
Farmers reading this Guide thoroughly will fully understand the role of strong business organization documents already! If you haven’t yet, please give a close read to our section on LLC operating agreements as you consider drafting a partnership agreement, bylaws or operating agreement (Chapter 4, Section 2). These documents are essential to setting up a strong working relationship between all partners in the business. Read the section on LLC operating agreements and review our sample document to pick up plenty of tips for preventing problems before they start.
Next Steps
Multi-farm ventures are the key to sustainable growth for many farm businesses. Production, marketing, labor and distribution ventures can all be made more efficient and more enjoyable when you join forces with others. These ventures can make the farm more resilient by opening up new markets and boosting profitability, but they can also make the farm more vulnerable. If farmers aren’t careful about forming business partnerships, they can create more risk than they intend. Also, if a farmer doesn’t carefully consider the nature of his or her participation, or the detailed ground rules in the organizing document, problems can emerge down the road. By the time that happens, it might be too late to effectively resolve legal problems that could have been prevented.