Risk Management, Legal, Southern Report Arleen Boyd – September 2016 Combined Risk Management, Bylaw and Policy Committees Meeting on Governance Issues – Red Lodge Office August 10, 2016. Committee members present: Frank Willett, Burt Williams, Charles Sangmeister, Janet Lulof, Sharlene McComas, Dave Alberi, David Peterson, Bill Pascoe, Roxie Melton, Arleen Boyd. Board members and staff present: Julie Lindgren, Dan Dutton, Wade Hirschi. Present by telephone: Laurie Beers, Larry Martin, Jim Webb. Attorney Larry Martin outlined the legal framework for corporate governance based on laws, bylaws, policies and organizational values that drive expectations and behavior and are incorporated in bylaws and policies that reflect a corporate culture. Co-op law differs in Montana and Wyoming. One example is the difference between Montana law that requires member approval of bylaw changes while Wyoming law allows co-op boards to change bylaws without member notification or vote. Bylaws are a contract with members and the bylaws for BEC and LVE differ significantly. In a merger there is one “surviving cooperative.” In a merger between LVE and BEC the surviving co-op would be LVE whose bylaws and policies would govern the former BEC members as would Wyoming law. Counsel has found no legal precedent for merger issues between a Montana co-op and an out-of-state co-op and no evidence that such a merger has occurred. Counsel will need to review further how proposed governance documents and a merger process would meet requirements of Montana law. Counsel advised developing a memorandum of understanding (MOU) or similar document to outline the provisions a contract would provide: anticipated savings in expenses, operational plans, goals and plans for rate setting and governance plans. A memorandum could be developed once the committee and board had the data to evaluate the likelihood of proceeding toward a merger recommendation. Counsel noted that under Montana law members would need to be fully informed of the documents and provisions surrounding the merger. Jim Webb agreed with the consensus of the committee that members would have to know the “whole story” of a proposal, including its full terms and ongoing provisions. An initial list of documents for members to review before a vote on a merger would include: articles of incorporation, bylaws, policies, memorandum of understanding and contract. Policy and risk management committee members raised questions about whether a merger could be reversed after a period of time. Counsel’s response: if merged, BEC no longer exists, so there would be no organization to reconstitute and action on any exit would be a consideration by LVE under LVE bylaws and Wyoming law. Sharlene McComas read a statement she had prepared questioning why a merger would be considered at all when BEC would disappear, “a little fish swallowed by a big fish.”

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The committees decided not to review the bylaws as planned, but to ask Arleen to take input from committee members and list significant issue differences between the LVE and BEC bylaws that should be reconciled or noted for the board and its working group as not reconcilable. There was agreement that the BEC bylaws are more protective of member rights and involvement and transparency and that the two primary BEC values are member involvement and transparency. Committee consensus was that the board’s plan to have board members meet by phone with representatives of the LVE board on September 11 include the committee’s recommendation that a requirement for merger would be that the BEC bylaws reflect BEC values and that Arleen would draft a list of bylaw provisions to be addressed for a potential merger understanding that review of policies would follow. Arleen was asked to report BEC bylaw primary values to the boards’ governance working group meeting scheduled for September 11. Jim noted the objective discussed by the board and risk management committee for the working group: identify issues, propose potential solutions, and identify potential sticking points The committee members understood that the governance issues and financial forecast/advantages that are yet to be defined would be weighed by the board before deciding on a recommendation and ultimately weighed by the members. All recommendations of the working group and the suggestions from Jim Webb and Richard Peck would be reviewed and acted upon by the respective boards. Meeting on the 11th report attached – next steps Jim and Arleen – Jim and Peck -- Meeting adjourned at 3:00. Risk Management -- The risk management committee members present at the combined meeting agreed that the next meeting to review the seven-year financial forecast should be scheduled after a date is set for completion of the forecast by Wade Hirschi. Next steps for risk management are:

Define scope of work and reach agreement with GDS to perform phase two of the board-approved analysis: risk management/due diligence evaluation of merger/standalone comparison

Review seven-year merger forecast Compare standalone and merger numbers Scope rate and rate-setting analysis and engage consultant Review legal analysis of merger issues and Montana law

Legal Report – In addition to the advice above which will be presented to the board on September 24, counsel will report on:

Contract with Richard Peck to perform specific representing the BEC board’s perspective in projects defined by the board relating to merger requirements

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Legal discussions at Southern Montana Electric regarding YVEC inquiries regarding distribution of Schedule 3 Transmission refund from NorthWestern Energy

Southern Montana Electric – Yellowstone Valley Electric Cooperative has initiated discussion of NWE refunds with Southern Montana Electric. BEC has received its defined share of the refund to Southern. Larry will give an update on legal discussion of the YVEC issue. Larry also will report on the fire/insurance memorandum prepared for the audit.

August 11 BEC and LVE Working Group Meeting LVE board member Rod Jenson conducted the BEC/LVE meeting. Working group on the phone included: LVE board members Rod Jensen, Fred Brog, and Dean Lewis; BEC board members Dick Nolan, Julie Lindgren, Dan Dutton, and Arleen Boyd; Gay Petersen, Jim Webb and Richard Peck. Rod stated that the goal was to address issues identified at the discussion before the June28 BEC board meeting which Rod and Fred attended and address bylaw, policy and other governance issues. Arleen reported (as the committees and board members present at their August 10 governance meeting suggested) that the BEC bylaws reflect values and seem more recent and positive that the LVE bylaws – and that the suggestion had been made at the committees meeting that they could use our bylaws. The statement was acknowledged, along with the BEC primary values of transparency and member participation Rod reported that the LVE bylaws were redone in 2010 in line with NRECA reference documents. Both parties understand that legal review of governance issues relating to Montana and Wyoming law will be addressed by the co-op attorneys. Rod proposed that Jim and Richard meet to suggest solutions for as many as possible of the governance issues. Arleen is to identify bylaw issues (and additional governance concerns) and work on the lists with Jim. There is no commitment to decide by December that the issues are resolved. Rod called for a vote to endorse a goal to complete the work on suggested solutions for governance issues and identify sticking points by November 30. Attendees voted to approve.

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The report found no holes in our approach to evaluating alternatives and affirmed the approach (not data and assumptions) of studies BEC has used to help make decisions.

Highlights and opinions: Management agreement is good faith effort delivering expected benefits Continuing management agreement, even at higher cost to BEC might be

beneficial If merger occurs 2 LVE board members from BEC could be justified – BEC

would represent 22% of a 9-member board Reducing line losses that are out of line with industry standards should be a

priority The MOU between Fall River and LVE does not address BEC and should BEC

and LVE move toward merger an MOU specific to the two should be developed

The EES consolidation analysis does not address rates For a merger proposal the BEC board needs overall revenue requirements

that would indicate rate levels for the legacy area for a merger proposal and an agreement that the rate concept would not be altered later

The E3 economic analysis of the LVE/FREC consolidation is difficult to interpret and does not at this time incorporate effects on BEC

An E3 model or other solid approach to estimating rates under a merger is necessary

Three-way consolidation could leave BEC out regarding governance issues – board membership and management shift not in BEC best interest

The decision to end discussions of an acquisition by NorthWestern Energy was based on appropriate analysis and declining the acquisition proposal was in the best interest of members

Strategic Alliances can consolidate operating functions and reduce costs without requiring co-ops to lose identity and individual governance

Conclusions In terms of having the ability to compare rate levels to BEC consumers under each scenario considered, the simplest approach would likely be to use the CFC Compass Forecast and first prepare a Base Case, that would reflect a BEC stand-alone operation, and then progressively test the impact of alternatives, based on the savings produced, to the extent such savings can be accurately estimated. Ultimately, an allocated cost study may be necessary, as part of the consideration of merger options, to better understand the allocation of costs, particularly legacy costs associated with each participating cooperative, in the developing of rates for consumers in each legacy area. As outlined in Section 6.0, above, there may well be other opportunities available to BEC to achieve operational cost savings through alliances. With all options considered, though, the BEC will need to identify costs savings and be able to assure that outages will be minimized and responded to immediately when they do occur,

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what the rate levels will be, what services and programs will be available to BEC members, etc. And governance issues cannot be overlooked either, such as Board representation, bylaws, etc. BEC’s ultimate decision will have long-term ramifications, though, and whatever decision is made should be based on the best available information, including independent reviews of that information

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Governance Review Issues for LVE and BEC Committees and Boards Legal issues

Review bylaws for compliance with Montana law Review governance issues as needed Confirm position on BEC voting on merger in both Wyoming and Montana What will be (is required to be) distributed to members before a merger vote

(articles, bylaws, policies?)? Larry answered the committee question about having a timeframe for

undoing the merger and a member group like a board in the Beartooth district saying there would be no co-op or any corporate structure to go back to because Beartooth would no longer exist and there would be no Montana electric supplier in the

Governance issues Beartooth region/district at LVE

Could there be a committee for the distant Beartooth district – no board power, but a Beartooth focus and reporting function?

State law issues/differences need to be defined and shared with members Representation on LVE board – is it one or two? Consultant comment

suggested two. Review the process for election of representative(s) from Beartooth region --

the distance argues for election in the district where BEC area members will not be outnumbered by voters who do not know the candidates.

Rate setting policy/process for Beartooth region has to be defined and shared with members. Statements have been made about a COSA process that would set revenue and expense numbers annually to calculate rates. We are not yet clear about what expenses are contemplated to be shared and what expenses are proposed to stay in a calculation of the BEC region’s responsibility. BEC has a different power supply and so likely will have different rates, but the COSA suggestion that would result in a policy confirming different distribution costs seems unusual for a merger that one could anticipate as creating one new co-op with shared expenses (and in most cases shared rates). A logical question from members is why a merger is required when so much remains separate? If a rate setting were to occur annually it would have to be reviewed in detail there would have to be an open meeting the district before it was recommended for approval by the LVE board. There should be a goal for shared distribution expenses.

Need to define what material members must have (and will want) before considering a vote and when the materials will be completed – new bylaws, policies, articles of incorporation)

Add items from Rod’s memo/list Beartooth Values reflected in policies and amended bylaws: transparency, member involvement, due diligence and financial accountability

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Policies need review. The area immediately apparent is the member involvement value statement represented in BEC Policy 211 that deals with committees. To some members committees seem unwelcome at LVE. Committees were created at BEC to enlist expertise from membership to help/advise the board in order to better inform decision-making and to promote member/community involvement. BYLAWS -- Beartooth bylaws designed to protect member rights while LVE bylaws are more protective of the organization. Many things that caused the turnover of the Beartooth board would once again be possible under LVE Bylaws. Article I, Section 1 – BEC bylaw requires the co-op to notify a person being rejected for membership of the reason for rejection within 30 days of deciding to reject the person – if no notification, the person is accepted for service and membership. Article I, Section 2 – BEC deliberately declared that “any two persons receiving electric services from the Cooperative at the same location” may apply for joint membership. LVE kept the traditional “husband and wife” requirement. The “spouse” language continues through the provisions of Section 3. We do not need to know about their marital status – members have the right to privacy and may chose to take on the responsibility of joint membership if they choose. We have members who are not married, yet have joint memberships. Article I, section 5 in LVE bylaws says, “Production of energy by a member on a member’s premises, regardless of facilities, shall be subject to appropriate regulations as shall be determined by the Cooperative.” Is this even legal? If someone has a solar camp stove or a gasoline generator it sounds as if the co-op can tell them what they may do with it. If they are not exporting energy what right does the co-op have to determine regulations? Article I, Section 6 (a) in the LVE bylaws allows the board or management to cancel service if a member does not purchase power for six months after it is available to him/her. At BEC where many members do not purchase power for extended periods and many just keep a meter in place for future use, Section 6 A allows termination only after someone has not paid what is due for six months – this could be the base charge, requiring no “energy purchased.” Only by 2/3 vote of the board may termination be approved (no management prerogative as in the LVE bylaws). Article I, Section 7 in LVE bylaws (Section 4 in BEC bylaws) provides the same “may not” provisions for members using the membership list but BEC very carefully added positive provisions (rights) for members to use the list. BEC Article II, Section 4 A 2 says that the “Cooperative must provide the member a copy of the Membership List.” The only constraint is that the purpose for using the list be for “the Member’s interest as a Member.” This leaves the list available to candidates for

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the board and for members with petitions to challenge the board, on purpose while the LVE bylaw says a member may not use (negative again) the list for a purpose “unrelated to an Annual, Special Member Meeting, or matter within the jurisdiction of the Wyoming Public Service Commission.” Maybe the special meeting and PSC provisions are designed to leave everything justifiable as it is at BEC? Is state law for member initiatives the same in Wyoming and Montana? If a merger occurs it is unlikely that the Beartooth region ever could bring forward member initiatives because there would not be sufficient local membership to present one and the distance to other districts of LVE is too great to readily support circulating petitions. Article II, Rights and Liabilities of members This article is key to Beartooth values and has six sections compared to the three brief traditional sections in the LVE bylaws. Article II, Section 3 in BEC bylaws is “Access to Property” vs. “Grant of Property Rights” in the LVE bylaw which says that the member shall grant or convey to the cooperative a written easement, right-of-way, license, or other right or interest in the member property, and execute a document regarding this grant or conveyance, as prepared in the reasonable discretion of the cooperative. BEC very deliberately eliminated this provision which most of us said we would never sign -- and many customers were not members because they had refused to sign something similar in the past. With current management we are closer to this kind of agreement than many would be willing to agree to be. This violates what we have told members we would do, especially if it were used to grant access for adjacent property. The BEC provision says that access will be granted for what is necessary to operate the cooperative safely … and provide services to any real or personal property in which the member possesses a legal right – not his neighbors having a legal right to be served via his property. BEC Article II Section 5 defines clearly member rights to information and calls out many vehicles the co-op must use to inform members. Members have a right to all information relevant to the business of the cooperative that is not deemed proprietary or confidential by law, contract, policy or the bylaws. The right to information is repeated throughout the bylaws and the methods for providing it are repeated as well. Article II, Section 2 Special Meeting – the LVE bylaw seems to say a member may take action if the board secretary does not meet the special meeting requirements for calling the meeting, but that is not clear. BEC Article III, Section 2 B is very clear that a member may set the time place and give member notice of a special meeting if the cooperative fails to call the meeting within 45 days of receiving a both Much more management action at LVE – board gets responsibility and is held accountable at BEC.

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Article III Meeting s of Members – the two co-ops are similar. BEC Article III Section 7, C was added to ensure that the co-op or board could not see ballots or know what area returned mail-in ballots had come from before the count at the annual meeting. This was a strongly supported requirement from members to ensure fairness. A proposed amendment endorsed by the bylaw committee this year would have allowed counting of mail-in ballots before the meeting, but only by the auditor and with the requirement that the results of the pre annual meeting counting would be confidential and known only to the auditor. This amendment was to streamline the counting process at the annual meeting. It was not prepared for the 2016 annual meeting because counsel advised that, if a merger vote were to occur the change might be seen as an attempt to influence that vote. Article IV BEC and LVE differences relate to the board’s responsibility to ensure that member rights to information are respected (BEC Article IV, Section 1 C) and that any action to incur debt to build generation facilities over five megawatts capacity must be approved by 51 per cent of the members in a prescribed manner (BEC Article IV Section I D). Additionally, BEC Article IV, Section 1 G was added in 2013 to require member notification before the co-op approves long-term debt exceeding two years or power contracts exceeding two years. This was a critical requirement from members who did not want to be part of anything like the 40-year G&T contract they had with Southern Montana Electric or the millions of dollars in debt they had paid and secured for the Highwood Generating Station. A proposed change to require member notification and opportunity to comment on power contract “intent” instead of “proposals” was postponed by the board until after the decision regarding merger recommendation is made by the board. This provision may be foreign to LVE with its power contract with BPA a secure advantage, but BEC will continue to need power contracts whether it remains independent or merges – members at BEC placed high value on these notification provisions. BEC and LVE Article IV, Section 5 is critical. Both co-ops elect trustees by a vote of all members. There is concern among members that 1) the initial member or members of the LVE board, if there were a merger, must be elected by the current Beartooth co-op members (not appointed or elected by the board) and that members in the once-was-Beartooth district elect their LVE board representative(s) because only Beartooth people will know their local candidates, the distance is so great that neither area will have much opportunity to know or influence each other personally, and the BEC area will be outnumbered between four and five to one in voting for their representative at the distant co-op. Article IV, Section 9 seems similar for both although the BE version is easier to understand. LVE Article IV, Section 7 and BEC Article IV, Section 9 Trustee Compensation may imply the same thing, but BEC specifically says that there will be no “salary,” meaning no compensation except an amount for approved meetings and associated expenses. Members want to know how much a trustee receives and for what in

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order to understand whether compensation is a motivation for service (and in this case a motivation to vote for merger). What do LVE trustees receive and for what? I is there a requirement for member notification or approval of compensation changes or is it all at a board level? Insurance? Do they get to go to any meeting they choose? Article V -- Many provisions overlap in the two co-ops. The important difference is BEC Section 1 A. This is a value statement – ALL regular meetings of the Board shall be open to Members and the public …” BEC Article VI, Section 3 Removal of Officers and Agents by the Board – adds a provision that “… any Member of the Cooperative may bring charges against an officer …” Again, this was a value statement by members that they want control of their co-op accompanied by detail of how to accomplish that fairly. Article VI, Section 8 BEC and LVE are different and represent a member statement on the part of BE. BEC deliberately called out the “manager” rather than even a CEO. What is the “President” designation at LVE meant to add to the CEO title? Designating the board chair as chair rather than president as BEC does makes sense. LVE Bylaws VIII, IX, and X are much more comprehensive than BEC provisions and appear good. Looking them over would best be done by counsel to look for any conflicts with Montana requirements.

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