Understanding Crop Contracts (PCN Winter 2013) JAN 1 2013 | Consumers and Producers | Pulse Crop News
This article appeared in the Winter 2013 issue of Pulse Crop News.
Contracts are often seen as a necessary evil in a farm business operation. Though they can reduce risk for both parties, contracts are often complex legal documents that can impact the way a grower markets his grain. And because contracts are legally binding for both parties, producers must do their due diligence to make sure they sign the best agreement possible for their operation.
As it is with almost everything in agriculture, there is no one-size-fits-all approach to crop contracts. The type of contract you use to sell your crop will depend on the wants and needs of both your buyer and your operation. In general, though, crop contracts can be categorized in four ways:
Before-Delivery Contracts are used before the crop has been delivered. These include production contracts, where producers agree to deliver a certain amount of production from a specified number of acres and the buyer agrees to accept that delivery; and deferred delivery contracts, where producers agree to deliver a certain amount of production by a specified date and the buyer agrees to accept the delivery and pay a specified price. Production contracts reduce the risk of reduced delivery opportunities but not price risk, while deferred delivery contracts guarantee a price and a delivery option but, in turn, eliminate price or delivery flexibility for the producer.
Supply Contracts are used to guarantee the producer will supply a certain amount of the crop during an agreed-upon delivery month and the buyer will accept that delivery. Supply contracts can help reduce the risk of limited delivery opportunities, but they do not reduce price risk, as the price is agreed upon either at the time of delivery at the street price or prior to delivery through a deferred delivery contract.
After-Delivery Contracts are used after the crop has been delivered. Deferred pricing contracts, which allow producers to deliver their crop for a small up-front payment, are an example of After-Delivery Contracts. In deferred pricing contracts, producers agree on a price and payment deadline date for the remainder of their unpriced crop. Though deferred pricing contracts can reduce the need for on-farm storage and the risk of fewer delivery opportunities later, they can also increase price risk and even risk of nonpayment, as payment must be received within 90 days after delivery for bonding protection through the Canadian Grain Commission.
Before- or After-Delivery Contracts can be used either before or after the crop has been delivered. One example of this type of contract is a target-pricing contract, in which a producer defines the price they would accept for a certain amount of their crop. If the price reaches that number, the buyer pays that price automatically. This allows the producer to set his preferred price in advance, but doesn’t allow the producer to capitalize on good marketing opportunities that don’t meet the target price or on higher prices, as the producer would only receive the target price.
Each of these types of contracts have benefits and drawbacks, as well as particular conditions that must be met either by the producer or the buyer. More detailed information about the different types of crop contracts can be found at Alberta Agriculture and Rural Development’s website at www1.agric.gov.ab.ca/$department/deptdocs.nsf/all/sis10994.
Elements of a Crop Contract
No matter what type of contract you use, the following elements should be included in your crop contract:
- Clear language. Legalese is great, for lawyers. For the rest of us, contracts should use clear language when possible. If the contract is not written plainly, there is greater risk of misunderstanding or misinterpreting the terms of the contract.
- Rights and responsibilities of the producer and the buyer. Contracts should clearly define what both parties must do, as well as what both parties are entitled to. Contracts should also clearly state what will happen if one party fails to meet his or her obligations.
- Straightforward terms. Crop contracts should have clearly defined terms for things like quantity, grade, delivery date, delivery location, and price, if those provisions apply.
- Dispute resolution provisions and escape clauses. Ideally, dispute resolution provisions and contract escape clauses will never be used – but they’re good to have in the event that they are needed.
- Contract duration. Contracts should have a start date and an end date to ensure they do not go on indefinitely.
- Payment logistics. Contracts should describe when and how the buyer will pay the producer.
Reduce your risk in contracts
Contracts should help you reduce your risk on your operation – but contracts themselves can come with their own risks. Here are some things you can do to reduce your risk in contracts:
- Understand how the quoted price was developed, including whether it contains charges for things like freight or deductions for dockage or lower grades.
- Understand how “worst-case scenarios” (for instance, grade deficiencies or low production) will be handled.
- Ask questions about areas of the contract you don’t understand.
- Make sure the buyer is licensed through the Canadian Grain Commission. For a list of licensed buyers, visit www.grainscanada.gc.ca/licensee-licence/licensedagreees-eng.htm.
- Consult a lawyer about the legal implications of the contract and a financial advisor or accountant about the financial implications of the contract.