Agricultural Contracts: What Should I Consider?

Why is contract use increasing?

Marketing's 4 P’s

• Product

• Place

• Price

• Promotion (Channeling)

New Dynamics

• New Relationship between Buyer and Seller

• Cooperative rather than adversarial• Loss of managerial control?

• Buyers tend to write agreements.• Set the terms.• Evaluate the performance.• Make the payment.

• The 5 P’s of Contract Evaluation.

Contract Classification

• Sales Contracts

• Bailment Contracts

• Personal Service Contracts

• Pool Contracts (New

Generation)Sources: Kunkel and Larison, Hamilton

Sales Contract

• Sales Contracts: An agreement to accept or deliver a specified quantity of grain or soybeans with a minimum content of a specified physical trait, chemical trait, or produced using a specified management contract.– These contracts subject to provisions of the Uniform

Commercial Code.

Bailment Contract

• Bailment Contracts: A bailment is a legal relationship which exists when someone else is entrusted with the possession of property, but has no ownership interest in it.

– Provides the contractor with protection of unauthorized distribution of seed.

Personal Service Contract

• Personal Service Contracts: Contractor supplies most of the non-land inputs, an may be closely involved with management.– In essence, the grower receives compensation for land,

labor and machinery.– Typically, the producer does not own the commodity.– In general, the UCC provisions for the sale of

commodities will not be applicable to personal service contracts.

Pool (Next Generation) Contract

• Delivery by producer to a closed “New Generation” cooperative jointly owned and operated by a group of producers.– Purpose of the cooperative is to add value to the

raw commodity.– Growers purchase equity instruments in proportion

to the producer’s right and commitment to deliver.

Contract Checklist

A few things to consider in terms of risk management ...

Why write contracts?

•

•

•

Why sign a contract ?

•

•

•

Specific Contract Concerns

Price Determination ...• Clarity: Are the terms of payment clearly

written?

• Timing: When is the crop/livestock priced?Is the schedule of payments firmly set?Does the schedule meet cash flow

requirements?

• Premiums/Bonuses: How are premiums/bonuses calculated?

When are premiums paid?Can you examine the premium/bonus

calculations?

• Taxes: How is tax liability affected by contract type?

Investment

• Facilities and Equipment– Invest in additional equipment of facilities?– Special drying, storage (IP), irrigation?– Is the equipment certified?– Who owns the facility? Exclusivity of use?

• If More Investment ...– Does contract duration cover investment?– Contract termination before cost recovery?– Who get permits and pays fees?

Production

• Costs: What are the production costs?

Where are cost estimates available?

Don’t forget additional managerial time!

• Inputs: Must inputs come from a particular source?

Are inputs more expensive than normal?

Who provides feed? Balanced rations?

Livestock Particulars• Feed: If produce own, how is it priced?

Who sets rations?• Health: Who’s responsible for livestock health?

How is death loss handled?• Facilities: Who owns the facilities? Exclusive Use?

How are repairs made?Liability insurance required?What are the depreciation costs?

• Manure: Who handles manure?

Crop Particulars• Yield: What is the expected yield?

“normal”Yield penalty? (Gross

Revenue!)Yields more variable with

inclement weather?• IP: Use preservation practices?

Additional record keeping?

Segregation in field?

Crop Condition

• What are condition requirements? Reasonable?• Who conducts quality tests? When?• How are quality disagreements resolved?• If a portion of the crop does not achieve quality

rating, is the entire crop penalized?• If the specialty grain is rejected, can it be sold on

the open (generic) market? Are there discounts?

Amount Produced ...

• Quantity requirement:Is there a set quantity requirement?Penalty if the quantity requirement is not met?Does the grower find supplies if short?Is the grower responsible for unforeseen events?Can location and quantity be adjusted for bad planting weather?

Delivery Site and Date• Where is delivery to be made?

• Are there special handling procedures?

• Who pays for delivery to the site?

• When does delivery occur?

Is the date in the contract? If not, who sets the date?

• Is there a penalty for late/early delivery?

What if late delivery is beyond your control?

Managerial Control?

• Know Yourself: AbleAble to meet contract specifications?

Willing to meet contract specifications?

• Know the Relationship:– Authority to enforce obligations?– Can contractor enter land and work on crops? – Do other parties (e.g., spouse) need to approve? – For unforeseen circumstances, who retains

control over the decision making process?

Counter Party Risk

• Has the other party provided financial statements?

• Have references been provided?

• Is the contractor bonded for this type of obligation?

• Is the contractor committed to the region? Made fixed investment? Is this the buyer’s core business?

Dispute Resolution• Does the contract provide for dispute

resolution? A mediator? Arbitration?– Alternative dispute resolution is cheaper than

litigation!

– Mediation is negotiation between the

contractor and grower facilitated by neutral

third party.

– Arbitration requires third party to evaluate issues and render a decision (usually binding).

Choice of Law/Venue

• If the contractor is from another state -- does the contract specify the state law that applies? Is the choice of law fair?

• Does the contract set a location for any lawsuits that might be filed? Is this location fair?

• Does the contract permit renegotiation or nullification if the laws governing the contract changes?

Termination Clauses• Under what conditions does termination

occur?– Who determines if conditions are met?– Are the conditions objective or at the

contractor’s discretion?– Can the contract be terminated for minor

breaches?– When can the grower terminate the contract?

• Is the grower given the opportunity to correct the problem?

• How much notice is given?

Consult With Others ...• The Attorney ...

to check out legal terms and obligations.

• Financial and Technical Experts … to explore the financial and tax

consequences of the contract process.

• Other Producers and Buyers …good advice from those that have been

there.

References

• Foster, K. 1993.“Production and Marketing Contracts in the Pork Industry.” Purdue University Cooperative Extension Service Publication EC-675.

• Hamilton, Neil D. 1995. A Farmer's Legal Guide to Production Contracts, Farm Journal, Inc., Philadelphia, PA. 1995.

• Kunkel, P. and S. Larison. 1998. “Agriculture Production Contracts.” University of Minnesota Extension Service Publication FO-7302-GO. St. Paul MN. www.extension.umn.edu/distribution/businessmanagement/DF7302.html

• Swanson, B. 2002. “Specialty Grain Contract Production: Check List of Important Considerations.” Illinois Specialty Farm Products Web Site. web.aces.uiuc.edu/value/contracts/contracts.htm

• Swinton, S and L. Martin. 1997. “A Contract on Hogs: A Decision Case.” Review of Agricultural Economics. Vol. 19. No. 1:207-218.

• USDA. Contracting in Agriculture: Making the Right Decision. www.ams.usda.giv/contracting/contracting.htm

Strategic Business Planning for Commercial Producers