The United States Court of Appeals for the Fifth Circuit recently allowed a “patronage capital” lawsuit to continue in federal court after deciding federal loan conditions and requirements may preempt state laws.
One of the agencies within the United States Department of Agriculture is the Rural Utilities Service (RUS). Among its other responsibilities, a primary role of the RUS is to provide loans to electric power cooperatives needing financial assistance. Like all loans, RUS’s loans contain significant restrictions and approval requirements that bind the actions of electric cooperatives. One such restriction controls the disbursement of “patronage capital,” or excess revenue not used by the electric cooperatives that is distributed to its members. The loans require electric cooperatives to obtain written approval from the agency before distributing patronage capital; however, the loans grant automatic approval of distribution if “[a]fter giving effect to the Distribution, the Equity of the Borrower shall be greater than or equal to 30% of its Total Assets.”
The present case arose when members of three rural power cooperatives in Mississippi alleged the cooperatives violated state law in refusing to refund excess patronage capital to their members. The members cited to relevant Mississippi law, which requires cooperatives to return excess revenues to its members, beyond what is needed for “operating and maintenance expenses and to the payment of such principal and interest and . . . to such reserves for improvement, new construction, depreciation and contingencies as the board may . . . prescribe.” Once filed, the cooperatives removed the cases to federal court, asserting federal officer removal jurisdiction under 28 U.S.C. § 1442. After the district court remanded the cases back to state court, the cooperatives appealed to the United States Court of Appeals for the Fifth Circuit, who consolidated the three cases.
The Fifth Circuit reversed the district court’s decision to remand the cases to state court. The court states that defendants seeking federal officer removal must show “(1) that it is a person within the meaning of the statute, (2) that is has a colorable federal defense, (3) that it acted pursuant to a federal officer’s directions, and (4) that a causal nexus exists between [its] actions under color of federal office and the plaintiff’s claims.” The three members only challenged the “colorable federal defense” element, though the court determined the other three elements were satisfied as well.
The standard for a colorable federal defense is not a high bar. The defense does not have to win a case or even be clearly sustainable; it only must not be immaterial, made solely for the purpose of obtaining jurisdiction, or frivolous. Here, the cooperatives used a federal preemption defense, arguing that Mississippi’s refund requirements conflict with Congress’s objectives as expressed in the RUS loan requirements.
The court decided that the preemption defense passes the low standard for removal. It notes that the circuit has not decided if a federal loan agreement can preempt conflicting state laws. However, previous cases suggest that the significant interest in recovering federal loans and ensuring the sustainability of rural power cooperatives may supersede state regulations. For example, the Supreme Court of the United States held in Arkansas Electric Cooperative Corp. v. Arkansas Public Service Commission that future RUS policymaking could preempt state regulation or that “[a particular state regulation] may so seriously compromise important federal interests, including the ability of [the cooperative] to repay its loans, as to be implicitly pre-empted. The Fifth Circuit reaffirmed this result, holding in City of Morgan City v. South Louisiana Electric Cooperative Ass’n that a state expropriation law hindered “the repayment of federal loans . . . the financial viability of federally financed electricity cooperatives, and ultimately . . . the maintenance of electricity service to rural areas.” Because it is possible that the RUS loan can either preempt or contribute to the preemption of a state law, the cooperatives’ defense is colorable, and the case belongs in federal court.
Although this case will be in federal court for some time, its eventual outcome may impact any rural electric cooperatives with RUS loans. The loan’s terms and conditions, along with future RUS policies, may preempt state regulations on distributing patronage capital, expropriation, rate supervision, and other areas affecting cooperatives. However, cooperatives should strive to comply with both state regulations and the RUS loan conditions until the court resolves this issue.
 Butler v. Coast Elec. Power Assoc., No. 18-60365 (5th Cir. 2019).
 See Richard P. Keck, Reevaluating the Rural Electrification Administration: A New Deal for the Taxpayer, 16 Envtl. L. 39, 45 (1985).
 See id.
 7 C.F.R. § 1717.617.
 Miss. Code § 77-5-235(5).
 Zeringue v. Crane Co., 846 F.3d 785, 789 (5th Cir. 2017).
 Butler, No. 18-60365 at 17-18.
 Zeringue, 846 F.3d at 789-90.
 461 U.S. 375, 385-89 (1983).
 49 F.3d 1074, 1075 (5th Cir. 1995) (per curiam), denying reh’g.
 The court also briefly reviewed a separate federal defense that federal law preempted the plaintiffs’ request for the remedy of placing the cooperatives under the control of a trustee or receivership, as this would also constitute default under the RUS loans. The court reiterated its uncertainty regarding the preemptive force of the RUS loan agreements, holding that this too could be a colorable federal defense.
Jeremy Fetty is a partner in the law firm of Parr Richey with offices in Indianapolis and Lebanon. Mr. Fetty is current Chair of the Firm Utility and Business Section and often advises businesses and utilities (for profit, non-profit and cooperative) on regulatory, compliance, and transactional matters.
The statements contained herein are matters of opinion and general information only and are not to be considered legal advice and should not be construed to form an attorney-client relationship. If you have any questions regarding this article, please contact an attorney.