Farmers are getting involved in written contracts more and more every day. Some of these contracts bind farmers into long-term relationships and have significant dollar implications associated with them. Some examples of such contracts are solar and wind contracts, cell tower leases, manure biogas contracts, and commodity purchase or sale contracts. Farmers should consider the following before entering into such contracts:

Proper contract review. Lawyers often hear the same question from their clients: “Would you mind quickly looking at this contract?” The truth is that it takes a great deal of time for a lawyer to understand, review and further negotiate a contract. Remember, the litigation lawyers make a lot more money on the back end of a contract than the business lawyers do on the front end of a contract.

Escape clause. Information is power. Often, a party who has completed the financial projections or secured the long-term financing for a project would like the farmer to sign a long-term contract. However, the contract might be a bad deal for the farmer. A good lawyer should always look for provisions in a contract so their client can get out of the contract if it is a bad deal.

Mandatory arbitration. Big companies often include mandatory arbitration clauses in their contracts. At first glance, such clauses seem like a good way to get a quick resolution to a dispute. However, in arbitration, the parties have to pay for the judge (arbitrator). The process is often very pricey. The big company has the most money and is most likely to be the one to get sued. As such, inclusion of an arbitration clause in a contract is often to the company’s advantage and should be avoided.

Who is signing the contract. When a farmer meets with a company, he or she should be aware that the company might merely be a broker, developer or subsidiary of a larger company. As such, farmers could be signing a contract with an entity with no assets to back up the contractual obligations. A personal guaranty or financial disclosure may sometimes be warranted.

The Rule of 72. Long-term contracts often provide farmers with payments, either upfront or over many years. When looking at these payments, farmers should keep in mind a couple of financial principles.

Albert Einstein once said: “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.” When a farmer borrows money, he or she knows that a portion of the loan payments go to principal and a portion to interest. If a farmer borrows $200,000 over 30 years at 5% interest, the monthly payment would be $1,073.64. However, if the farmer was not charged interest, the monthly payment would be $555.55. The reason is compound interest.

Another way to understand the power of compounding is something called the Rule of 72. If an investor had $100,000 to invest and is guaranteed a 10% annual return, the investor would double his or her money in 7.2 years. In another illustration of the Rule of 72, if an investor was promised that his or her $100,000 investment would double in three years, then the party would be paying an interest rate of 24% (72 divided by 3 equals 24%).

Many contracts provide for rents or payments either upfront or over a period of time. Using the Rule of 72, you can determine how quickly such payments will double and whether an upfront payment is advantageous.

Inflation. A company seeking to pay a farmer rents or payments over a long period of time will often include provisions for flat increases. However, with the return of inflation in the economy, the use of an increase based on the Consumer Price Index should be considered. The CPI is a set of indexes generated by the Bureau of Labor Statistics that measures “the prices paid for urban consumers for a representative basket of goods and services.”

When the CPI is used, the parties will need to decide which index is used. For example, there are different indexes based on different population groups and item categories. Also, when a CPI clause is used, the parties will need to decide on the base year of adjustment, the timing and frequency of adjustment, and whether there should be caps on any increases or decreases.

Conclusion

Companies often put tremendous pressure on farmers to sign contracts quickly. However, before a farmer signs a long-term contract, he or she should take the time to read and analyze all of its terms. Remember, bad contracts are like bad marriages — they are easy to get into but can be pricey to get out of.