Sector Workshop Blog Archive

Case Study: Pollock Harvesting in Seattle

Joseph Sullivan, of Mundt Macgregor in Seattle, is up next. (Joe used to be mayor of Bethel, Alaska!) He starts off by giving us a vocabulary update -- what we've been calling "sectors," he calls "cooperatives". What he calls "sectors" means something else. Differences in our fisheries exist, too -- the pollack fishery is a very clean fishery: single stock, for the most part. Figuring out how to manage mixed stock fisheries the way we are here is much harder.

He's been just working on a problem more like what we're facing in the New England region for the Bering Sea head and gut processor fleet. He promises to continue sharing documents, and wants this conversation to be the beginning, not the end, of a collaboration between folks working on these kinds of arrangements. His presentation is available here. Download university_of_maine_sector_agreements_workshop_outline_sullivan_103107.doc

(We're warned not to take anything Joe says as tax or legal advice. That's a good disclaimer for this whole blog, too. We all know better, I hope, but it's worth reminding folks. This is not legal advice!)

First, there's a major legal problem with cooperatives. It's against the law for market competitors to collaborate to allocate a share of resources or set prices. That's antitrust. You need an exemption from antitrust law, or a determination that the arrangement is more pro-competitive than anti-competitive. Exemption for fishermen might come under the Fisherman's Collective Marketing Act (15 USC 521??). More problematic are vessels that are 'vertically integrated' = owned by processors. The American Fisheries Act also seems to help those vessels. The courts seem to like these exemptions, but they're complex and should be dealt with fishery by fishery. You run into problems where there is cross-ownership and cross-management between members of sectors and processers, buyers, etc. Joe promises to send along some articles to provide more details. US v. High Note (covers catfish farmers who collaborated on price setting, and deals extensively with the vertical integration question.)

Where there's a hard TAC (total allowable catch), and it is consistently obtained, that's better for consumers than a collaboration among competitors that reduces the amount of product available (and would lead to higher prices). This makes it more likely that the DOJ will conclude that there's not a problem.

"USDA Rural Business Cooperative Service Cooperative Information Report No. 59 "The Story of the Capper-Volstead Act" is a great resource on antitrust issues. It does not go into the rule of reason analysis, but Joe promises another article about a DOJ rule of reason review. USDA also has a bunch of form documents that are good. [The Capper-Volstead Act, 7 U.S.C. ó 291, I am told by the law student sitting next to me, exempts agricultural producers from antitrust liability for collective production, and is applicable precedent for analyzing FCMA cases.] Joe's written an article about this, available here.

Now we're leaving anti-trust behind (well, not completely -- it is an issue we need to remember all the time) and we're going to talk about the specifics issues, documents, and agreements at play in the Bering Sea Pollack Fishery.

Vocabulary alert: In the North Pacific, a "sector" is a division between inshore folks (catcher vessels) and offshore folks (catcher-processors, vessels delivering to catcher/processors, and motherships). There was an 8 year battle between the offshore folks and the inshore folks about the allocation of the fishery among the participants, and who could be part of which group. It's an example of poor communications between regulators and fishermen -- poor decisions about eligibility conditions and licenses. There was a huge backlash in the region in 1998, at the time of this, against individual fishing quotas, and this was a backdoor means of creating quotas.

It's really important that the industry folks and the government regulators are talking all during the formation and establishment of cooperative fishing groups.

One issue: spillover from the rational fisheries into the non-rationalized fisheries (people kicked out of the Pollack fishery would go around the corner to the Gulf of Alaska groundfish or Bering Sea crab fishery). This creates the need for an inter-regional management system.

Another issue: what to do about distribution? Fishermen and lawyers have traditionally thought that was a shoreside, civil approach, but the truth is the distributional effects of the increase in efficiency has the potential to eat up all of the efficiency benefits promised by cooperative management. This needs to be approached from the beginning -- you've got to get the policy folks, the owners and operators, the processors, and the lawyers thinking about this right away. (Note: processors resist these cooperative arrangements among fishermen -- they see it as a disadvantage.) In the pacific northwest, there was a specific requirement that particular sectors deliver 90% of harvest to particular processors. The 10% play helped.

Structures of Pollack cooperatives: non-stock nonprofit corporations, formed under Alaska or Washington statutes, both of which have antitrust exemptions and some specific enforcement rights. The IRS has recognized these as 501(c)(5) "aquaculture associations" or 501(c)(6) "trade associations". There are restrictions on the ability of these corporations to pay dividends and to do any political lobbying. If you want the cooperative to share profits or have capital accounts for its members, there are some hard and complex workarounds, but Joe doesn't recommend it. Watch out for collaborations in marketing, sales, and distribution, or you may run afoul of the nonprofit restrictions. Buying/selling cooperatives should be separate. Joe recommends a harvesting arrangement for a sector (limited only to harvesting agreement arrangements), first and foremost, and a second entity for sales or marketing and branding. Keep it simple! If you try to encompass all of this in one organization, the monitoring and sales and processing and bargaining with processors issues are far more likely to impair the group's ability to form and get along (plus you're more likely to have antitrust issues with vertical integration, etc). Remember, antitrust rules don't just apply at the time of the formation of the sector, but throughout its life -- so changes in membership can put the whole sector in jeopardy.

These nonprofits have some documents associated with them: an Articles of Incorporation, Bylaws, and a Membership Agreement. The Articles and Bylaws establish membership eligibility and voting rights -- not as easy as it sounds. Ownership and control are a big headache, as any transactional lawyer knows. The membership agreement is a contract among members, dividing up the fish, and saying what happens to bad actors in the group. In the Pacific, harvest share enforcement takes the form of liquid damages ($$$$) for overharvest, updated each year.

Q: Can a sector be an LLC, with the bylaws above being an operating agreement? A: yes, it can be done. Here's why we don't. Fishermen generally want to have their independence running the business end of their arrangements. So they want separate financial operating units, and tend not to want to be in an LLC with connotations of a joint venture or a collaborative financial undertaking (no capital calls! no group ownership of the assets!). The entity is really all about dividing up the fish, monitoring, reporting, and enforcing -- no profit sharing or financial intertwining.

Issues: membership -- who decides whether an eligible vessel can join? In the Pacific, inshore applicants MUST be admitted -- a product of the regulatory scheme. Offshore applicants are admitted at the discretion of the cooperative. Note to regulators! This is a much easier regime to operate. Monitoring and enforcement issues are much harder when a cooperative is forced to include people who don't want to choose to be linked.

The corporate governance models range -- every member is on the board, or a centralized board with great authority to act on behalf of all members. Why choose one? Centralized and small board can act much more quickly, and that's sometimes necessary (change in fish restrictions, enforcement action to prevent overfishing, etc). This seems like a better and more adaptive structure. But the hard part is deciding which issues should require consensus, vs. member votes, vs. board of directors, vs. cooperative manager's authority? Phew! Joe has some ideas, but not time to talk about them all right now.

What's the duration of the cooperative? They should be built to last, because it's such a costly pain to set them up. But when people change their minds, there needs to be a way for them to withdraw and get out. At first, in the Pacific, these were one or two year terms, or two-year auto renewals. It's important, if there's a chance of the sector shutting down, for there to be lots of notice for the members so they can get out and make other arrangements.

Allocations: these are generally consistent with catch history proportions, but there are lots of negotiations and equitable adjustments (e.g. c'mon, guys, in one of the base years we're using to do the allocations, my boat didn't work, so you should adjust my allocation upwards, or, geez, guys, I used to be bad, but in the past two years I've outfished all of you guys, and in the next two years I'm going to do even better!). An alternative is you use the best five of the last six years (that hurts the steady guy who fished consistently all six years, unlike his turbulent or flaky buddies). As with any negotiations, this is a long tug of war. In the Pacific, the baseline database of catch history is confidential. That's a huge pain! A workaround to resolve disputes is having a third-party auditor -- Joe recommends we include that right from the start -- fishermen don't want to give one another their catch records, but don't mind giving it all to an auditor who will create an aggregate record.

Cooperative operations: remember antitrust law? This is important. Documents explicitly prohibit collaborative sales between and among members, so that the cooperative is limited to harvesting and catch share. (This is a new frontier, and worth pursuing, but first step is to set up the cooperatives in the first place, and that's really hard. Note that marketing to international export doesn't bother the DOJ, so that's the low-hanging fruit of joint marketing and sales. Then you can tackle the vertical integration and anti-trust problems of cooperative sales and marketing agreement.)

Enforcement: "Trust, but verify" is the name of the game. Everyone needs to know that there's real-time, credible, capable monitoring of everyone in the sector. It's got to be credible both to the fishermen, and the monitoring agency. In the Pacificm they use observer coverage -- two per catcher/processor, one per catcher vessel 125' and over, 30% coverage on catcher vessels, 100% coverage of deliveries to motherships. One problem for the Northeast -- we don't have an embedded observer system in place, here, and we need to think hard about how to establish that.

(Sea State, Inc (karl hafflinger, a fishery biologist and all-around smart guy) provides services for the cooperatives in the Pacific. We're going to need one of those here -- a trusted third party here. Who are we grooming to take this essential role?)

UH OH. What happens when someone stops complying? First, the monitoring agent identifies this. In the Pacific, each increment (metric tons, kilograms, any unit that makes sense) over the allowed amount is the basis for liquidated damages by the bad guys. Take the market price, then a multiplier (in the Pacific it's about 3 times) to take into account all the other bad stuff (3 times market?), and that's your liquidated damages. There's an opportunity cost formula, for secondary stocks.

In Maine, liquidated damages must bear a rational relationship to actual costs. This isn't an insurmountable hurdle, but we need to pay attention to Maine jurisprudence on penalties vs. contract damages. Joe points out that a huge value of cooperatives is record building -- the market value, the incremental value of the viability of the sector, and other supporting evidence for a higher value of stock that results from a sector allocation, which can be threatened by non-compliance of individual actors. [Possible analogy: tree trespass statute with treble damages; legislators had to cap the damages under that statute.] Joe suggests specific performance as a messy, complex, possible solution (but it doesn't cure an instance of overfishing that has already happened). In this regime, someone who looks like they are going to exceed the capacity, the manager got a temporary restraining order, and slapped it on the aggressively fishing vessel.

A single members' overfishing, that has not yet led to a sector violation, can be cured by a reallocation within and among the sector. Joe recommends market based transfers -- the violator goes outside the sector and buys up some fishing rights from another one to allocate to the remaining members of the sectors. To employ this, you need effective real-time monitoring and the ability to move fast. Another critical piece: members must indemnify the cooperative against everything that results from an individual breach. (If there's a substantial agency penalty for the sector, the teeth in the indemnification provision is a big deal for managers trying to rein in bad actors.)

We're running into a time limit -- Joe quickly touches on collateral for damages (it's hard to get), and transfer limitations (a right of first refusal, a requirement that any transferee assume the membership agreement obligations), etc.

Posted at 07:07 AM

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