I want to start out by apologizing to the members for the proposal that I put forward at the last board meeting regarding the General Reserve. While our bylaws require that we establish a general reserve to retain the annual surplus. The bylaw also allows us to establish a minimum level for the reserve: but it must be set at a percentage of total assets. We have yet to establish such a reserve. At last month’s meeting, I proposed that we create a general reserve and to set a minimum for that reserve. Without a minimum, no money can be transferred from the general reserve. The minimum reserve level should be set at a low enough rate that it would never serve as a barrier to the transfer of the surplus to the capital reserve. This is why I suggested a minimum reserve of .1 percent of total assets. However, the committee rejected my proposal to set a minimum percentage. Without having set a minimum we cannot transfer money to the replacement reserve and be bylaw compliant.

I am not asking the committee to accept my original proposal. The more I have considered it, the more I have come to realize that the solution that I proposed has its own internal problems. The more appropriate, although more time-consuming solution, would involve amending our bylaws.

I want to lay out the issues in greater detail.

I am going to start in an odd place, namely, “What constitutes our operating surplus?”

What constitutes the surplus?

In our discussions, we tend to speak of the surplus as the money left over after the transfer to the reserve. That is because we have trained ourselves to view those transfers as operating expenses. But, from the perspective of the auditors (both MNP and the Exchange Group), our budgeted contribution to the capital replacement reserve is not an operating expense. Instead, they treat the contributions to the replacement reserve as part of the operating surplus. This can be seen from the statement of operations for both 2022 and 2021: the reserve transfers are shown on the line below net operating income. Similarly, our lender, ACU, views the money that we place in the capital reserve as part of our surplus. That is why they allow it to be included in determining our 1.1:1 debt service coverage ratio that is required in our mortgage. (ACU requires that we have an operating surplus that is equal to ten percent of the sum of the principal and interest paid in any one year. In 2022 this was $470,517. Therefore, we had to have a surplus of $47,051 in that year—which we achieved by budgeting a contribution of $47,303 to the replacement reserve.) In other words, each year we budget for a significant surplus, which we transfer on a monthly basis to the capital reserve.

The Co-operative Housing Federation’s Asset Management Plan also excludes the contribution to the replacement reserve from operating costs and treats it as a surplus. This is also the way it is displayed in the consolidated statement that we provide every month and in the budget summary that is presented to the members annually.

This is important to bear in mind when one looks at what the bylaws say about the general reserve. In other words, we budget each year for a surplus of over $45,000.

What the bylaws say about the reserve

General Reserve and Other Reserves
7.01 The Co-operative must establish and maintain a general reserve to retain the annual surplus, if any. The Co-operative must maintain such other reserves as may be required by agreements made with funding agencies or that the Co-operative may choose to establish.

Minimum Reserve
7.02 The board may set the percentage of the total assets of the Co-operative, as reported in the year-end financial statements, which must be retained as a general reserve.

Allocation of Surplus
7.03 At the end of a financial year, after the Co-operative has complied with reserve requirements, including general reserve, the board may determine how to use the balance of the surplus, if any.

Significance of the above: 

These three provisions are in effect saying that the operating surplus(is to go to the General Reserve and be retained there. Funds can be taken out of the surplus if a minimum reserve (as a percentage of total assets) has been set. Decisions are made about what to do with the surplus at the end of the year. In reality, we have no general reserve and no set minimum as a percentage. Every month, rather than once a year, we transfer a portion of the operating surplus to the replacement reserve.

What does the Co-operatives Act state?

The Co-operatives Act makes no specific reference to a general reserve.

A number of articles discuss reserves.

Article 4 (1) states that operating surpluses can be directed to reserves. We do direct our operating surplus to a reserve, just not to a general reserve.

Article 278 (1) states that a housing co-operative’s bylaws must include “a provision for the establishment of adequate reserves.” We have established a replacement reserve and have a funding plan to ensure its adequacy.

Article 52 states that co-operatives can only pay dividends or patronage returns to members if the reserves are at their minimum levels (or a membership resolution has been passed) and if deficits have been paid. This is the general purpose of a General Reserve for most co-operatives. Retail co-operates, for example, generally provide their members with a patronage return at the end of the year. They are not allowed to do this unless the reserves are at the minimum level. General Reserve provisions like the ones in our bylaws make sense for these sorts of co-operatives. But they do not make sense for us, because of Article 286 in the Co-operatives Act.

Article 286 singles out not-for-profit housing co-operatives and states that they cannot distribute assets (including the surplus) to members. It then provides for two groupings of exceptions. 1. It can be done by giving members a break on the coming year’s housing charges. 2. The co-op can pay members (or ex-members) what it owes them either for shares, for loans, for work or goods provided or to resolve a dispute. There is no reference in this section to a requirement that reserves be funded to minimum levels before making these payments. In other words, for a housing co-operative, a general reserve is largely irrelevant. Most non-housing co-ops have it to make sure that dividends are not paid unless the General Reserve is healthy. But as a housing co-op, we are prohibited from making patronage dividends.

What do the auditors say?

When I spoke about this issue with both MNP and The Exchange Group, they could see no purpose for a general reserve in our situation and recommended changing the bylaw. Maria Vaiaso of the Co-operative Housing Federation concurred. They believe that the replacement reserve is the only reserve we need.

The Asset Management Plan recommends that we transfer all surpluses to the replacement reserve, which again renders a general reserve unnecessary.

The challenge

1. We want to be bylaw compliant.
2. To do this we can either create a general reserve and operate according to the bylaws or change our bylaws.
3. Changing the bylaws is a challenge in that the changes must be approved by the Companies Branch and the branch will not provide prior guidance as to what it will accept.
4. But even if we had done what I had suggested, we would still have to deal with the fact that we place a portion of the surplus into the replacement every month, even though the bylaws say that we should leave it in the general reserve until after the audit. The alternative would be to establish a separate fund into which we place this year’s reserve and transfer it next year. In other words, marinate the money in the general reserve for one year and transfer it the next. This guarantees the lowest possible interest on our money and is completely illogical. Trying to be bylaw compliant with our current bylaws requires us to engage in inexplicable contortions.

 

Amending the bylaw.

In consultation with Maria Vaiaso of the Co-operative Housing Federation of Canada, I drafted the following proposed bylaws to replace our language. I propose that we discuss this proposal at our next meeting. I have tried to mirror the current language as much as possible while also having the bylaw reflect our actual practice—and our actual practice is prudent. The definition of the purpose of the replacement reserve comes from our current Financial Management Policy.

Reserves

7.01 The Co-operative must establish and maintain a replacement reserve and any other reserves as may be required by agreements made with funding agencies or that the Co-operative may choose to establish. The purpose of the replacement reserve is to have sufficient capital invested for the replacement of capital expenditure items as needed from time to time.

Non-discretionary contribution to replacement reserve

7.02 In its operating budget, the board will mandate an annual non-discretionary contribution to the replacement reserve from the projected budget surplus for the coming year.

Allocation of Surplus

7.03 At the end of a financial year, after the Co-operative has complied with reserve requirements, including the replacement reserve, the board may determine how to use the balance of the surplus, if any.