A contract between buyer and seller can be negotiated, not broken

Jun 17, 2011
by DTN

Less than a year ago, $4 corn sounded sweet enough to sell. Many farmers forward contracted only to see futures prices balloon past $7. That’s increasing the temptation to default. Before you do, consider the legal and financial consequences.

Breaking a grain contract can get expensive. One Midwest farmer tried to get out of his multi-year contract with Cargill in 2008 and the case went to arbitration. In that case, the farmer received steel for grain bins to hold about 300,000 bushels of grain in exchange for selling Cargill that amount of corn in 2007, 2008 and 2009 at $2.40 per bushel. The case was finally settled last June. The arbitrators ruled in Cargill’s favor and the farmer owed Cargill almost $2 million in damages.

That producer wasn’t the only one who felt sellers’ remorse for a contract priced at half of market value. Wild market years often heighten contract issues. “Problem years were 1988, 1996 and 2008,” said Steve Beier, grain merchandiser for The Andersons in Maumee, OH. “The whole industry has gotten its act together better regarding process and procedure, so we are not seeing so many issues now.”

Some buyers have revamped their policies in response to defaults. Richard Carlisle and his sons Rick and Cameron, who farm in Bridgeville, DE, now face restrictions on how much of their corn they can forward contract even though they have never failed to deliver.

“Our buyer got burned when producers chose to sell somewhere else for more money, leaving the buyer with hedge losses,” Carlisle explained. “The buyer decided to put limits on how much they’ll contract with individual growers. After doing business with one buyer for years, if we want to forward price more than half our production, we need to find another buyer.”

“Chickens can’t eat paper; they need corn,” said Charlie Stubbs, from Tappahannock, VA. Stubbs is a grain merchandiser for Perdue AgriBusiness, which originates grain for Perdue poultry operations, the thirdlargest poultry producer in the U.S., and for sale to other end-users and export.

Perdue AgriBusiness has a network of elevators that reaches from New York to Florida, as well as Indiana and Kentucky. In the past, Perdue would allow producers to roll contracts into the next crop year, but they found some people abused that privilege by not wanting to deliver the second year either.

“We had people who swore they didn’t have a crop to deliver, then we’d see their truck headed down the road to a competitor,” said Stubbs. “Now we require they pay any difference in the futures price, although we don’t enforce basis differences.”

Those who don’t honor contracts are blacklisted. “We won’t do business with farmers who have burned us. Contracting is a privilege; we don’t have to do it,” Stubbs said.

“We also don’t contract more than half the average number of bushels an operation sold to us in the past two years for the nearby crop year and 25 percent for a year out (to protect against short crops),” Stubbs said. However, if an operation boosts acreage, it can make a case for more sales by providing mproof of planting such as a crop insurance policy or Farm Service Agency records.

“We have lost some business by limiting how much an operation can contract,” said Stubbs. “But we are not just protecting ourselves; we are protecting producers from over committing. If they go to another elevator, we can’t help that. Given price volatility today, at any given time, we have millions of dollars at stake in Chicago (on hedges against contracts). We just can’t afford nondeliveries.”

Negotiate, don’t walk away

“If people enter into an agreement and the facts move—such as a change in price—that is not an excuse to default on the contract,” advised Neil Hamilton, director of the Agricultural Law Center at Drake University.

If you have a weather-related issue, many grain buyers are willing to work with you to avoid cancelling a contract. However, DTN readers report some elevators are not as cooperative as in the past because they’ve been burned too many times—and revenue insurance helps farmers buy out of contracts when their production falls short.

“In terms of weather issues, we work with customers, and the Cargill Crop Insurance Agency has tools that help link insurance coverage and grain marketing plans,” said Mark Klein, media contact for Cargill. “Among other objectives, crop insurance can be used as replacement costs on contracts.”

In general, the sooner you communicate with your buyer about problems fulfilling your contract, the better for you both financially and legally, said Hamilton. “If it looks like you will not deliver on your contract (usually because of weather or other disaster), you may be able to limit your exposure by giving notice to the elevator of a pending breach of contract. If the elevator sues you, you’ll have to mitigate damages only up to that date of your notice, in most cases.” Once notified by phone and confirmed in writing, the elevator can go into the marketplace to protect itself from future damages.

In fact, many elevators are willing to help you adjust your contract to minimize the damage. “Our general policy is that if a producer can’t or won’t deliver, we monetize the commitment and they are responsible for any difference,” said Beier. “For instance, if they contracted corn at $5 and notify us they want to break the contact at $6, the $1 difference becomes a receivable. Timing of the farmer’s payment to us may be negotiable. A cancellation fee of 10 cents a bushel also usually applies. If they are willing to commit the same number of bushels for the next crop year, perhaps that 10 cents becomes negotiable.”

In cases when price is the issue, the producer might want to add an options feature to the contract, Beier noted. “Similar to buying a call option, there may be a fee involved but you would be able to capture any further price advance.”

Know the law

Some farmers think because no written contract was signed, they should be able to get out of their oral agreement. But that argument won’t work in most cases, Hamilton said. An oral contract is binding for “merchants,” and farmers are considered merchants because selling grain is something they do on a regular basis and it is part of their business.

Farmers new to grain marketing might get a break. “The courts do consider several factors in determining whether a particular farmer is a merchant,” explained Iowa State University ag economics professor Roger McEowen. These include how long the farmer has been engaged in marketing products from the farm and the degree of the farmer’s business skills, awareness of farm markets, and past experience or knowledge of practices unique to the marketing of the product sold.

But in strictly legal terms, a contract is meant to be a binding agreement—on both sides. — DTN