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@@ -72,6 +72,29 @@ A lock on the company is worthless if the business can walk out the side door. T
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- **Buying the assets and hiring the workers counts too.** If a buyer of the co-op's assets hires more than a third of its members within two years, the deal is treated as a sale of the whole business after the fact. The buyer owes the federation fund the difference between what it paid and the value of the business as a going concern. People are always free to change jobs. This rule makes a buyer pay full price for a whole business, even if it picks the business up in pieces.
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- **Subsidiaries are covered.** Any company a locked co-op controls is also locked, and its workers are covered by the membership rule. Otherwise a co-op could grow through an ordinary subsidiary and then sell it. That's the pattern behind Mondragon's non-member foreign subsidiaries. How that works, including when a co-op buys a company, is [below](#when-a-co-op-owns-another-company).
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- **No outside control through the back door.** The limits in [Capital, After](capital.md) (outside claims last at most 15 years, rank behind lenders, and carry no vote) apply forever, not just while a bank loan is outstanding. No investor, lender, supplier or licensee can hold a veto over the co-op's budget, hiring or management. No contract can give one outside party an exclusive claim on most of what the co-op produces for longer than five years.
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- **Insiders can't drain it through contracts.** Rent, fees and prices paid to insiders are checked for as long as the lock lasts, not just while the bank's loan is outstanding ([below](#deals-with-insiders)).
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## Deals with insiders
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While a co-op owes the bank, every contract with an insider is checked each year, and overpaying one is a breach of the loan ([The hidden boss](pilot-safeguards.md#the-hidden-boss)). Once the loan is repaid, that lever is gone. A founder who kept the building could simply wait, then raise the rent. The lock is meant to stop the firm's value leaving through the back door, and an inflated contract is a back door. So the check becomes part of the lock.
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Members take most of the profit, so they have every reason to refuse an inflated contract themselves, which a charity's donors don't. The danger is narrower: the insider controls what members see, or the co-op can't walk away. So the first defenses are telling members in advance and making sure they can leave a bad deal. Outside checking comes second.
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The rules borrow from how federal law polices charity insiders ([26 U.S.C. § 4958](https://www.law.cornell.edu/uscode/text/26/4958)), because the tax law has decades of practice drawing this line. A charity's assets are dedicated to its purpose much as the reserve is dedicated to the people who'll work at the co-op later.
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- **Who counts as an insider.** Anyone who in the last five years was a founder, board member, officer or manager, or was otherwise able to steer the co-op; their family; and any company they, together, own more than 35% of. The charity rule treats founding the organization as one sign of influence; this model counts founders and managers automatically, so it's broader. Anyone who signed a contract with the co-op while an insider stays one for that contract and its renewals, however long it runs, so stepping down and waiting five years doesn't work.
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- **Through a middleman counts.** If the co-op overpays a supplier who passes part of it on to an insider, it's an insider deal, as it is for charities ([26 C.F.R. § 53.4958-4(a)(2)(iii)](https://www.law.cornell.edu/cfr/text/26/53.4958-4)). So is a swap: if an insider of one co-op deals with a second co-op while an insider of the second deals with the first, both deals count.
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- **Members hear about it first.** Every insider deal worth more than $5,000 a year is sent to all members before it's signed, with the price, the terms and the evidence for them, and listed again in the yearly report to members and the lock-holder. Smaller ones are only listed.
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- **A fair process earns a presumption.** A deal is presumed fair if it's approved in advance by people with no stake in it, who had evidence of fair value and wrote down their reasons at the time ([26 C.F.R. § 53.4958-6](https://www.law.cornell.edu/cfr/text/26/53.4958-6)). Having no stake means not being the insider or their family, not working under them, not having one's pay set by them, having no money riding on the deal, and not having a deal of one's own that they approve. For pay, prices from three comparable employers nearby are enough in a co-op with sales under $1 million, as the charity rule allows for small organizations. For rent, buildings, equipment and licenses, the charity rule looks to an independent appraisal or real competing offers, and so does this one. Where a deal runs more than $5,000 a year, the appraiser comes from a list the lock-holder keeps, not one the insider picks, and the co-op pays. The accountant then checks the paperwork, not the price. A deal without that approval gets the full price check.
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- **When nobody is free to judge.** In a small co-op, everyone may work under the manager who owns the building. If there aren't at least three members with no stake, the deal needs an appraiser from the lock-holder's list, and the lock-holder checks the process.
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- **The co-op can always walk away.** Two of the pilot's rules become part of the lock too. Members can end any management or franchise contract by vote on short notice. And a co-op that leases something it needs to operate from an insider has an option to buy it at an appraised price ([The hidden boss](pilot-safeguards.md#the-hidden-boss)). A market price can still be steep, but an insider can't hold the co-op hostage at renewal.
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- **Overpaying costs the insider, not the members.** If a deal cost the co-op more than it would have paid a stranger, the insider repays the difference with interest, plus a quarter of it on top. If it isn't repaid within a year, they owe twice the excess on top instead. Charity law charges an insider those amounts as taxes (§ 4958(a)(1), (b)); here they go to the co-op. The insider and their company are both liable, so an empty shell company doesn't end it. The co-op can take what it's owed out of anything it owes the insider under any contract. The reserve's 30% comes out of what's recovered, not the members' profit pool. If nothing can be recovered after a real attempt, the loss is written off and falls on everyone, like any other bad debt. A member who's also an insider is covered by this rule, not by the pay rule, so the same money isn't charged twice.
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- **Approvers are liable only if they knew.** Board members who approved a deal knowing it was overpriced owe the co-op a tenth of the excess, up to $20,000 per deal, the share and limit charity law puts on charity managers (§ 4958(a)(2), (d)(2)), and their own payouts stop until it's paid. Following the process above, or relying on written, reasoned advice from a professional on the lock-holder's list, counts as not knowing, as it does for charity managers ([26 C.F.R. § 53.4958-1(d)(4)(iii)](https://www.law.cornell.edu/cfr/text/26/53.4958-1)). The federation's group insurance covers the cost of defending an approver who wasn't found to have known. Most worker-directors earn ordinary wages, and this is meant to deter insiders, not scare them off the board.
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- **The members can't wave it through.** Members can pay themselves whatever they decide, and [rule 1](the-long-run.md#the-rules) handles that. What they can't do is hand the co-op's money to someone outside it. An overpayment to an insider who isn't a member is an outside claim on the co-op, and outside claims are allowed only on the terms in [Capital, After](capital.md). An insider's investment in the co-op is an insider deal too: its share of profit has to be priced like a stranger's, and the lock-holder must approve it.
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- **Who checks once the loan is repaid.** The yearly insider test stays in the accountant's package. The lock-holder takes over the bank's part: it keeps the list of approved accountants and appraisers, gets the report, picks the samples and orders a check when [a warning sign](compliance.md#audits-by-lot-and-when-something-looks-wrong) appears, such as payments to insiders growing faster than sales, any insider's price rising faster than inflation, any renewal of an insider's lease, or when any member asks. Nobody tied to the insider can take part in the lock-holder's review of that co-op. A co-op with no insider deals over $5,000 a year isn't drawn. Among the rest, one in ten is drawn by lot each year for a check of its insider deals, not a full audit. The check is paid through the fees of co-ops with insider deals, and by an insider found to have overcharged. One in ten is a judgment. It's about what the charity rule's tax gives up: if a quarter on top is the penalty and the chance of being caught is at least one in ten a year, a long contract overcharged year after year is likely to be found before it pays.
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- **Who can go to court.** The same parties who can enforce the rest of the lock: the lock-holder, any member, any other locked co-op, the bank and the state attorney general. What's recovered goes to the co-op, and a member who wins has their legal costs paid out of it first.
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This is weaker than the check while the loan is out, because the bank's threat to call its loan was the strongest lever there was. An insider who has left and owns nothing the co-op can reach may never pay. A presumption can be gamed with a flattering appraisal. The charity rule has the same weakness, and the IRS can still rebut the presumption with better evidence. Here the lock-holder can too.
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## When a co-op owns another company
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Claude Opus 5.5