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title, section, order, summary

title	section	order	summary
When a Locked Co-op Goes Bankrupt	The Co-op	31	Federal bankruptcy law would override the lock, so a failed co-op could be sold whole to anyone, and this page lays out the amendment Congress would need to pass, modeled on how it already treats charities, along with what it costs creditors and how workers get a real chance to buy.

When a Locked Co-op Goes Bankrupt

The lock says a co-op funded by the bank can never be sold to conventional owners. That holds while the co-op is healthy. It can break at the worst moment, when the co-op fails and a bankruptcy court takes charge of what's left.

This page explains why, what Congress already does for a similar kind of organization, and what the amendment would say. A few terms first:

• The lock-holder is the independent organization that holds the co-op's lock share, a single share that pays nothing but can veto a sale (The Lock).
• A going concern is a business sold whole and still running, with its customers, contracts and trained staff. It's usually worth much more than the same equipment sold off piece by piece.
• Creditors are everyone the co-op owes: lenders, suppliers, workers, tax agencies, and anyone it has injured.

Why bankruptcy breaks the lock

When a business files for bankruptcy, everything it owns goes into a pool the court controls, called the estate, and is used to pay creditors as much as possible. There are three main routes:

• Liquidation (Chapter 7). A trustee sells what the business owns and pays creditors in order of priority. The trustee can keep the business running for a limited time if that helps sell it (11 U.S.C. § 721).
• Reorganization (Chapter 11). The business keeps running under a plan the court approves. Debts are cut or stretched out, and ownership often passes to creditors. Under the absolute priority rule, if a group of creditors votes against the plan, the old owners can't keep anything until those creditors are paid in full (11 U.S.C. § 1129(b)(2)(B)).
• Small-business reorganization (Subchapter V). A faster version of Chapter 11 for businesses owing no more than $3,424,000 (11 U.S.C. §§ 1182(1) and 101(51D), as adjusted in 2025). Here the absolute priority rule doesn't apply. If creditors don't agree to the plan, the owners can still keep the business by paying creditors all of its projected disposable income, what's left after the costs of running it, for three to five years (11 U.S.C. § 1191). Most locked co-ops would fit under that limit.

The lock can fail in four places:

1. The estate ignores limits on selling. The Bankruptcy Code says a business's property goes into the estate "notwithstanding any provision" in an agreement or in state law "that restricts or conditions transfer" of it (11 U.S.C. § 541(c)(1)). The lock is exactly that kind of provision.
2. The court can sell everything, "free and clear." A trustee can sell the estate's property outside the ordinary course of business, free and clear of other people's interests in it (11 U.S.C. § 363(b) and (f)). A court could treat the lock-holder's rights as one of those interests and pay them off in cash. In practice, a failed business usually goes to the highest bidder.
3. A reorganization plan can hand the firm over. A plan can sell the business, merge it or rewrite its charter "notwithstanding any otherwise applicable nonbankruptcy law" (11 U.S.C. § 1123(a)(5)). A standard plan cancels the old ownership and issues new shares to creditors. The Code also requires the reorganized company's charter to ban shares that carry no vote (§ 1123(a)(6)), while this model relies on outside money that carries no vote (Capital, After).
4. A lender can sell without going to court at all. A lender with a claim on all of a business's assets can sell them, or take them, after a default under state law (UCC § 9-610). No bankruptcy is needed.

So without a change in the law, a failed co-op's whole business could be bought by a conventional company. The lock would protect only healthy co-ops, which need it least.

What Congress already does for charities

Congress already keeps some organizations' property dedicated to its purpose in bankruptcy. The way it does it is simple: the Bankruptcy Code steps back and lets the ordinary law that governs those organizations decide.

• A charity's property can go to a non-charity "only under the same conditions as would apply if the debtor had not filed" for bankruptcy (11 U.S.C. § 541(f)). This covers tax-exempt charities.
• Court-approved sales by a nonprofit corporation must follow the law that governs its transfers outside bankruptcy (§ 363(d)(1)), and so must transfers under its reorganization plan (§ 1129(a)(16)). These three rules were added in 2005.
• Since 1978, creditors can't force a nonprofit into bankruptcy (§ 303(a)), and a court can't turn its reorganization into a liquidation unless it asks (§ 1112(c)).
• Also since 1978, valid limits on transferring a person's interest in a trust hold in bankruptcy (§ 541(c)(2)). That rule keeps some assets away from creditors, so it's a precedent for protecting a purpose at creditors' expense, not a neutral one.

A locked co-op isn't a charity. It's a business that makes and shares profits. The comparison is narrower: in both cases, assets are meant to stay dedicated to a purpose, not sold for private gain. So the amendment copies the technique: the Code defers to the law that governs locked co-ops, and that law, the bank's statute, says what can be sold to whom.

Is it constitutional? Bankruptcy laws must be "uniform." In 1982 the Supreme Court struck down a law written for the workers of one bankrupt railroad, calling it "nothing more than a private bill." But it said a bankruptcy law must "apply uniformly to a defined class of debtors," and that its ruling didn't impair Congress's ability "to define classes of debtors and to structure relief accordingly" (Railway Labor Executives' Ass'n v. Gibbons, 455 U.S. 457). A rule for every locked co-op, defined by what it is and not by name, is that kind of class. The parts that reach sales outside bankruptcy (point 9 below) rest on Congress's power over interstate commerce instead.

What the amendment does

Who it covers

1. Every locked co-op on the federal register. The bank's statute sets up a public register of locked co-ops. A co-op is covered while its lock is on the register. The register decides the question. A notice in the state filing system lenders already search (a UCC financing statement) points to it, but if that notice lapses, the co-op stays locked.

2. Old debts are protected. A lender already secured on the co-op's assets when the lock is registered has to consent in writing before registration. For a business that converts to a co-op, that's part of the buyout deal (When an Owner Wants to Sell to the Workers).

3. Creditors who never chose to lend are made whole for the lock's cost. Some creditors never had a chance to price the lock in: people the co-op injured, tax agencies, and creditors whose unsecured claims came before registration. If the lock makes them recover less than they would have from an open sale, the federation fund pays them the difference. For co-ops outside a federation, the bank pays it. Locked co-ops must also carry standard liability insurance, so injured people are mostly paid by insurers anyway.

What can be sold, and to whom

4. The Code defers to the lock. In every chapter, and in plan sales too, the lock's limits hold. The estate takes the co-op's property subject to them. A sale "free and clear" can't strip them. The lock agreements can't be rejected as ordinary contracts. And no plan can override them. The detailed sale rules live in the bank's statute, as the rules for charities live in state law.

5. Workers can keep the business running while it's sold. Argentina changed its bankruptcy law in 2011 to do this. The trustee must report within 20 days on whether the business can keep operating. Workers making up two-thirds of the staff can ask to run it as a co-op while the case goes on, with a plan due within 20 days. The judge decides, and sets a time limit that can be extended once (Law 26.684, amending articles 190 and 191 of the bankruptcy law). The amendment adapts this: workers can ask to run the business as a new co-op, under court supervision, while it's up for sale.

6. The whole business goes only to a qualified co-op.

• A qualified bidder is a locked co-op whose members do at least three-quarters of its work hours, and whose outside money meets the limits in Capital, After: no vote, at most 15 years. A co-op formed by the failed co-op's own workers qualifies from the start. So does the federation. A shell set up by a conventional company doesn't.
• The minimum price is what the assets would bring sold off piece by piece, set by an appraiser the court appoints. A higher floor, like the full value of a running business, could stop any co-op from buying and force a breakup, which is worse for workers and creditors both. The co-op bidders compete in open bidding, so the price is usually higher than the floor.
• No buying back your own failure cheaply. People who managed the co-op in the two years before it failed can't get bank financing to buy it (The Lock). In a reorganization where the members are running the case and also bidding, an independent officer runs the sale.
• The time limit is 90 days from when the sale is announced, or from when the workers' co-op files its plan, whichever is later. The court can extend it once if a qualified bidder is lining up financing.

7. Workers can pay with what they're owed. A secured lender can already bid using its claim instead of cash (§ 363(k)). Argentina lets workers do the same: a workers' co-op can count the wage and severance claims its workers voluntarily hand over toward the price, at their full amount, and the handover happens at a hearing before the judge (Law 26.684, article 27, adding article 203 bis). The amendment does this too, within limits:

• Only claims workers choose to hand over, in writing. Workers who don't join the new co-op keep their claims.
• At full value, up to the amounts bankruptcy law already puts first: unpaid wages and benefit contributions earned in the last 180 days, up to $17,150 per worker for wages (11 U.S.C. § 507(a)(4) and (a)(5)). That's a deliberate transfer from other creditors to workers, capped per person, as Argentina chose.
• The legal minimum is paid in cash, not handed over. Federal law requires minimum wage and overtime to be paid in cash or a cheque (29 CFR 531.27), "finally and unconditionally" (29 CFR 531.35), and workers can't waive them by private agreement (Brooklyn Savings Bank v. O'Neil, 1945). A stake in a new company isn't cash. Wage claims are bought and sold in bankruptcy, and handing one over at its full value isn't a discount, so this might be allowed. But the usual way a court blesses giving up wage claims is by approving a settlement of a real dispute over them (Lynn's Food Stores v. United States, 11th Cir. 1982), and there isn't one here. So the model doesn't rely on it.
  • The protected part is every unpaid hour at the highest minimum wage that applies, federal, state or local, plus all unpaid overtime at the worker's own overtime rate, taken from payroll records. For salaried staff whose hours weren't recorded, it's counted at 40 hours a week. Any damages the law adds for late wages stay with the worker.
  • Some states protect more. California bars employers from requiring a release of any wages due until they're paid, not just the minimum (Cal. Labor Code § 206.5), and no private agreement can get around its wage rules (§ 219). The bank's checked entry for each state (Owners Are Still Workers) says which wages can be handed over there. Where it's unclear, only severance and benefit contributions can be.
  • The pool pays first. The savings insurance pool pays up to eight weeks of each worker's unpaid wages in full, as it always does, and what it pays counts against the protected part first. Any protected wages beyond that stay the worker's own claim, and the court can't approve a bid that uses handed-over claims until the buyer has set aside cash to pay them.
  • Workers can hand over the rest: wages beyond what the pool paid that the protected part doesn't cover, benefit contributions and severance, within the cap above.
  • Handed-over claims buy savings, not votes. In the new co-op, they become credits in each worker's capital account. Votes stay one per member, so a manager with a larger claim doesn't get more say than an aide whose wages were paid by the pool.
• The insurance pool's claims count too. Normally, whoever pays a wage claim loses its priority (§ 507(d)). Without a fix, most low-paid workers' claims would be paid by the pool and couldn't be used to bid. So the pool keeps the priority, and when a qualified workers' co-op bids, it hands the claims it paid to that co-op for its bid. The new co-op repays the pool over time. Each worker's own claims use the $17,150 priority first, and the pool's claim for that worker only ranks after them.
• No last-minute claims. In the 180 days before filing, pay deferred by a vote, pay left unpaid for more than one normal pay period while others were being paid, and any increase in severance terms rank as ordinary claims, not priority ones, and can't be used to bid.

8. If no qualified co-op buys it, the pieces go to anyone, but not the whole. No buyer, together with anyone financially tied to it, may end up with substantially all of the business. The brand, the core technology or the main customer contracts count as substantially all, whatever their size, as the lock already says. A buyer of the pieces who hires more than a third of the members within two years owes the difference between what it paid and what the running business was worth, as set by the court's appraiser. The sale order says so up front. That money goes to the co-op's creditors, not the federation fund.

9. Lenders can't sell around it outside court either. The same rules apply to any transfer of substantially all of a locked co-op's assets because it can't pay its debts: a lender's sale or taking of its collateral, a state receivership, an assignment for the benefit of creditors, or a tax sale. The model state law writes these rules into state law too, and adds that a sale following these rules counts as "commercially reasonable" under the UCC, so lenders aren't penalized for following them.

When the co-op reorganizes

10. A reorganized co-op stays a co-op, and creditors are treated as they would be anyway.

• Only working members hold votes. A plan can give creditors new debt, or voteless claims on the terms in Capital, After, but never ownership, and no loan terms giving a lender approval over the co-op's management or strategy. The rule requiring a ban on voteless shares doesn't apply.
• Small co-ops follow the ordinary small-business rule. In Subchapter V, owners of any small business can keep it by paying creditors all of its disposable income for three to five years. A co-op gets the same deal, no better. To stop members shrinking that income by paying themselves more, disposable income is worked out with members' pay at the going rate (Investing for the Long Run), and raises in the two years before filing are reversed.
• Larger co-ops pay creditors the business's full value. If a group of creditors votes against the plan, they must get at least what the business would sell for on the open market, as if the lock didn't exist, in cash, new debt or voteless claims. That's what the absolute priority rule protects in any company. Members can keep a co-op they can't sell, but not at their creditors' expense.
• Members' own accounts go first. What members have in their capital accounts is wiped out before creditors lose anything. Members were taxed each year on those allocations, so this is a real loss, and it's the cost of being an owner (Member Capital Accounts).

Everything else

11. Former members are paid before current members. A former member's payout is a fixed debt the co-op owes (Member Capital Accounts). It ranks behind every other unsecured creditor, but ahead of current members' accounts. It isn't pushed down to the bottom as if it were a shareholder's claim (§ 510(b)). Anyone who left within a year before the failure has their balance recalculated first, as the insurance pool already does (Protecting Members' Savings).

12. The lock-holder can go to court, carefully. The lock-holder can take part in the case. If the trustee declines to challenge a deal the co-op made with insiders before it failed, the lock-holder can ask the court's permission to challenge it, and pays the other side's costs if the court finds the challenge frivolous.

What it doesn't do. Unlike charities, locked co-ops can be forced into bankruptcy by their creditors, and a failed reorganization can be turned into a liquidation. A business that can't pay its debts shouldn't be able to shelter behind the lock. The amendment only decides who can buy it, not whether it can fail.

What it costs, and who pays

• Lenders get back less when a co-op fails. The whole business can only go to a co-op, so it may sell for less than on the open market. Lenders who lend after the lock is registered know that, and they'll charge for it, in higher rates or more collateral.
• The bank bears it first. The bank is usually the biggest lender, so the pilot publishes its recovery rate on failed loans (The Pilot, in Numbers). That shows what the lock costs.
• The federation fund bears the rest. Creditors who never chose to lend are paid the lock's cost from the fund. That's a real call on money the co-ops put in.
• Other lenders may lend less, or not at all. Some banks will refuse locked co-ops, or lend only against equipment they can take back. Lenders willing to fund a failing co-op through a rescue may be harder to find, because they can't sell the business to anyone. That's a real cost, and it's part of why the model needs its own bank.
• Workers' claims come ahead of other creditors when workers bid. That's a choice to favor keeping a business running in its workers' hands. It's capped per worker, and it's paid for by other creditors.
• Low-paid workers bring less of their own to the bid. Their unpaid wages are mostly the legal minimum, which is paid in cash rather than handed over, so more of the bid rests on the pool's claims and on better-paid workers' claims. Whether the rule is needed at all depends on a legal question nobody has tested: whether a worker can freely hand over a wage claim at full value.
• Some viable businesses will still be broken up. When no co-op can buy a failed co-op whole, a conventional buyer who would have kept it running and kept the jobs can't. While the co-op sector is small, this will happen. Whether to allow a conventional buyer as a last resort, with any surplus going to the federation fund, is an open question (Open Problems).

Draft text

For readers who want to see what this could look like in the statute, here is a first draft of the core Bankruptcy Code changes. The detailed sale rules (points 5 to 9) go in the bank's own statute. This is a starting point for lawyers, not finished legislation.

Sec. 101 (new definition). The term "locked cooperative" means an entity entered, as of the date of the filing of the petition, on the register of locked cooperatives kept under [the bank's authorizing act].

Sec. 541(g). Notwithstanding subsection (c)(1) and any other provision of this title, property held by a debtor that is a locked cooperative may be transferred only as permitted by the nonbankruptcy law governing locked cooperatives, as if the debtor had not filed a case under this title.

Sec. 363(q). In a case in which the debtor is a locked cooperative, (1) the trustee may use, sell, or lease property under subsection (b) or (c), including under subsection (f), only in accordance with the nonbankruptcy law governing locked cooperatives; (2) the rights of a lock-holder under that law are not an interest that may be sold free and clear under subsection (f); and (3) section 365 does not permit rejection of any agreement required by that law.

Sec. 507(d) (amended). Insert at the end: "except that an insurance pool established under [the bank's authorizing act] that pays a claim of a kind specified in subsection (a)(4) or (a)(5) is subrogated to the holder's right to priority, but such priority is subordinate to any claim of the same individual under subsection (a)(4) or (a)(5) that the pool has not paid."

Sec. 1123(e). Notwithstanding subsection (a), a plan for a debtor that is a locked cooperative (1) may not provide for any transfer of property, merger, consolidation, or amendment of the debtor's charter except as permitted by the nonbankruptcy law governing locked cooperatives; and (2) need not comply with subsection (a)(6) as to any nonvoting interest permitted by that law.

Sec. 1129(a)(17). If the debtor is a locked cooperative, (A) all transfers of property under the plan are made in accordance with the nonbankruptcy law governing locked cooperatives; and (B) no equity security carrying voting power is issued to any entity other than members who work for the reorganized debtor.

Sec. 1129(b)(2)(B)(iii). In a case in which the debtor is a locked cooperative, membership in the reorganized debtor held by persons who work for it is not property received or retained on account of a junior interest, if each holder of a claim of the class receives or retains under the plan property of a value, as of the effective date of the plan, not less than the amount such holder would receive if all of the debtor's property were sold as a going concern without regard to section 541(g).

What this doesn't solve

• It needs Congress, and a later Congress can undo it. The lock's other layers hold if the bank's law is repealed. This one doesn't (Making It Last).
• Courts will test it. Treating membership as something other than property the owners keep is new in bankruptcy law. The draft ties it to paying dissenting creditors full open-market value, which answers the fairness point, but the first cases will still be fought.
• Reaching lenders' sales outside court is a federal reach into state law. It rests on Congress's power over commerce, not bankruptcy, and it will be challenged. States that adopt the model law make it much safer.
• Lenders can route around it. A co-op that leases its equipment, or sells its unpaid invoices to a lender, doesn't own those assets, so the lock doesn't cover them. Co-ops already report new leases to their members (Investing for the Long Run). How much of a co-op's business can sit outside the lock this way isn't limited.
• Workers still have to find the money fast. Keeping the business running and counting workers' claims toward the price help. But a new co-op still needs a lender within a few months, and whether the bank or federation will stand ready isn't settled.
• The register has to exist and be trusted. It's a new federal job, and every lender to a co-op will have to check it.