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Corn+Soybean Digest

15 Questions About Grain Contracts

Like most people, farmers usually don't read the fine print of contracts. Unfortunately, some don't read much of the big print, either.

"Farmers, as well as their bankers, don't always read what they sign," says Steve Turner, an attorney with Baird Holm, Omaha, NE. His clients include financial institutions that service all levels of the food chain from the farm to the factory.

"They have a general understanding of what they think the deal is," says Turner. "But they sign without looking at the specific language and the implications of it."

A classic example, which ended up in court, is a Nebraska farmer who signed a contract to sell a specific quantity of grain to a processor. When the farmer's crop dried up, he thought he could ignore the contract, since he hadn't produced any bushels. But the language of the contract stipulated that he had to provide the designated bushels, whether he grew them or not.

The court ruled in the buyer's favor, resulting in a judgment against the farmer. He had to pay the difference between the original contract price and the higher market price that existed at the time he was supposed to deliver the grain.

"Farmers need to be diligent when considering contracts," warns Texas A&M ag economist Danny Klinefelter. "Too many farmers assume contracts are just pieces of boilerplate that cover general terms of the contract. It's a legal instrument that's binding.

"The companies that write those contracts have a large enough legal staff to make sure they protect themselves. Farmers need to do the same. You need to have somebody who knows what he's doing read the contract before you sign it."

Turner says: "Without question, the producer should consult with an attorney to review and explain the details of the production contract. Bankers should be asking the same questions."

In fact, there are quite a few questions you need to know the answers to before you ever sign a marketing or production contract. Turner suggests the list of questions from the Farm Finance Review, below right, as a guide.

"One of the issues that farmers need to realize is that their risk changes when they enter a production contract. Instead of market risk they now have buyer risk," says Turner. "If that buyer is ConAgra or ADM, they don't need to worry. But if it's Uncle Charlie's Bean Processing, farmers need to make sure that company is financially viable."

You may lose more than just your contract, points out Klinefelter. "I've seen cases where farmers get geared up with special equipment for production with an intermediate- or small-size processor who then goes belly up," he says. "You lose your capital investment as well as the contracted crop."

Ownership of the crop is another issue that farmers need to clearly understand. You need to know if you own the crop and sell it, or if you're just getting paid to grow it for a processor. If you don't own the crop, it could affect crop insurance coverage, financing and rental agreements, Turner says.

"In a typical, simple contract for the sale of goods, title to the goods doesn't pass to the buyer until delivery," he says.

"However, in some contracts the title to the crop may remain with the non-producing party throughout the term of the contract. In these cases the producer may in fact be just a "bailee" who is paid to just grow and care for the crop.

"In bailment contracts, the producer may not be able to pledge the growing crop as collateral to a lender. And he may not be able to obtain conventional crop insurance," he says. "Worse yet, in the event the buyer becomes insolvent, the producer may not be able to stop delivery to the buyer, or reclaim delivered goods, even if the buyer owes him money."

The biggest issues farmers need to understand about contracts are what they're getting paid for and when they'll get paid, Turner says.

"Farmers are better off if they can negotiate acres of production, rather than bushels. Otherwise, they can be legally obligated to deliver the bushels, whether they grow a crop or not. In either case, farmers need to know what and when they'll get paid and when they'll deliver the bushels. They also need to understand if the payments are tied to delivery and if that is negotiable."

Those aren't exactly small details, although they're likely written in the small type of the contract. You need to find them before you sign.

Even when everything goes right, premiums paid for contract crops don't last long.

"Premiums usually have about a three-year life. So as soon as you get one contract, you need to start working on several more," says Klinefelter. "Premiums go down because competing farmers are willing to grow the same crop for less. I know some guys who are working on 10 to 14 contracts so they always have something new coming on where the premiums are still in place."

But there are more reasons to contract crops than just price premiums, the ag economist believes.

"As we move toward more coordinated production systems, the farmers who are already working with those companies will be the first in line for new technology. Long term, these relationships are just like a marriage. You have to be careful to make the right choice the first time."

Dawson County, NE, extension educator Dave Stenberg has seen some of those marriages work quite nicely. "We had one farmer this year who contracted white corn for $2.42 and received a 30 cents premium for quality. The LDP and additional government payments added another 44 cents."

New contracts available in 2000 will give farmers in his area plenty to think about as well.

"One company is offering farmers $400/acre interest-free to grow corn. In return, the farmer has to buy all his crop inputs from the company and follow its crop consultant's recommendations," he says. "It looks good up front, but if you don't follow the contract, then you do have to pay interest on the loan. The company also wants to buy the crop, although the farmer isn't obligated to sell to it."

Stenberg also recommends to his farmers that they take a copy of any contract to their banker and attorney before signing it.

One overlooked advantage to contracts, he points out, is that they make farmers better marketers.

"When you sign a contract that says when you're going to sell and how much you're going to receive for it, it makes you start to think about what you're doing with the rest of your grain. Ideally, you should have a good marketing plan before you ever sign a contract. But it's a chicken and egg situation. Either one can happen first."

For more about production contracts, contact the Minnesota Department of Agriculture for a free copy of A Producer's Guide to Production Contracts. Call 800-967-2474 or write Commissioner's Office, Minnesota Dept. of Ag, 90 W. Plato Blvd., St. Paul, MN 55107

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