Agricultural Contracting: A U.S. Perspective

1
Agricultural Contracting A U.S. Perspective

• Prof. Neil D. Hamilton, Dwight D. Opperman Chair
  of Law and Director, Agricultural Law Center,
  Drake University Law School

2
Issues and Lessons for India to Consider from the
U.S. Experience with Contracting

• Does the nation want to regulate the development
  and use of production contracts to protect
  growers and address the unequal bargaining power
  of the parties?
• If so it will be necessary to determine what
  level of government, federal or state
  authorities, are best equipped to develop,
  implement and enforce contracting rules.

3
Issues and Lessons for India to Consider from the
U.S. Experience with Contracting

• How do existing laws, such as the common law of
  contracts or other commercial rules, apply to
  contracting, e.g. what baseline protections
  exist?
• How do possible issues of constitutional
  relations and federalism affect the ability of
  states or local governments to develop production
  contract laws?
• There is a growing concern U.S. Supreme Court
  rulings on the dormant commerce clause may
  threaten state contracting laws.

4
Issues and Lessons for India to Consider from the
U.S. Experience with Contracting

• What is the desired nature of the relation
  between the contractors and farmers - independent
  contractor, employment or some other status?
• Are there existing sources of state or federal
  agricultural regulations, such licensing for
  markets or payment protections for growers, which
  might serve as the source for new contract
  regulations?
• What issues or conflicts might shape contracting
  relations in India payment terms, dispute
  resolution, requiring growers to fund
  improvements?

5
Opportunities for India in Developing Contracting
Laws

• India can learn from the U.S. experience and work
  to avoid the use of potentially exploitive
  contracts and help insure the risks and returns
  to producers are equitable, i.e. make contracts
  risk sharing not risk shifting
• If contracting is still in a formative period
  India has time to put in place guidelines for
  contracting practices, such as risk disclosure,
  protection for grower investments, fair dispute
  resolution procedures, and clear payment terms.

6
Opportunities for India in Developing Contracting
Laws

• There is an opportunity to determine at which
  level of government contracting rules should be
  set and who is best positioned to do any
  necessary regulation.
• Courts are not the best forum for resolving
  contracting disputes because they only respond to
  conflict, but judicial precedents can be valuable
  in setting the standards for the conduct.
  Forcing contract disputes into arbitration can
  avoid the development of fair and just
  precedents.

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Why consider the importance of production
contracts in agriculture?

• Production contracts are an exciting legal
  development which can have many important impacts
  for farmers.
• The increased use of production contracts means
  more farmers will be faced with deciding whether
  to enter such agreements.
• The sources of information about the subject are
  still limited.
• Most production agreements involve an inherent
  imbalance of power and information between the
  parties. Farmers are typically asked to sign a
  printed form contract with little or no
  opportunity to negotiate different terms.
• Such imbalances can create the opportunity for
  unfair advantage and increase the need for
  possible regulation.

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What farmers should consider before entering a
production contract

• Farmers should have four primary goals when
  deciding to enter a production contract
• a) making sure you know what you are getting
  into,
• b) insuring you get paid for what you sell or the
  services you perform,
• c) guarding to be sure you don't accept unknown
  or new legal or financial risks, and
• d) trying to guarantee the relation you are
  entering is informed and fair.

9
The value of good information and education.

• One key role of government is to educate and
  inform the parties involved in using production
  contracts. By providing good information to all
  parties it may be possible to minimize the
  misunderstandings or disputes, and in some
  instances even improve the contract terms.

10
Defining the term "Production Contract"

• There is no definition of "production contract"
  in the dictionary. But it is possible to develop
  one based on how the contracts work. The
  following is a legal definition, which covers
  most relations involving production agreements.

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An agricultural production contract is

• a legally binding agreement of a fixed term,
  entered before production begins, under which a
  producer, either agrees to sell or deliver all of
  a specifically designated crop raised on
  identified acres in a manner set in the
  agreement, to the contractor, and is paid
  according to a price or payment method, and at a
  time, determined in advance or agrees to feed
  and care for livestock or poultry owned by the
  contractor until such time as the animals are
  removed, in exchange for a payment based on the
  performance of the animals. Under the
  agreement, the producer may have no legal title
  to the crop or livestock but is a bailee, and the
  producer is declared to be an independent
  contractor and not an employee or joint venturer
  with the contractor.

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Elements of a Production Contract

• By considering how production contracting
  relations operate, the definition can be divided
  into several main elements
• 1) a legally binding agreement between two
  parties, the producer and contractor
• 2) the agreement is for a fixed term, either one
  crop year or so many production cycles
• 3) the agreement is signed or entered into before
  production begins

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Elements of a Production Contract

• 4) the contract calls for either the production
  of a crop or the care and feeding of animals, on
  land owned or controlled by the producer
• 5) all the animals or all of the crop from a
  designated number of acres, which may be
  specifically identified, will be delivered or
  sold to the contractor
• 6) the crops or livestock must be produced or
  cared for according to the terms of the
  agreement, to be acceptable

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Elements of a Production Contract

• 7) the producer will be paid an amount and at a
  time according to the agreed to schedule or term,
  which may include premiums or deductions for
  quality or performance
• 8) the producer generally has no legal title to
  the crop or livestock but is considered to be in
  a bailment relation with the contractor and
• 9) the producer is described as an independent
  contractor rather than an employee, partner, or
  other joint venturer with the contractor.

15
History of Production Contracts Freedom to
Contract

• Production contracts have been in existence in
  the U.S. for over sixty years. In 1946, Cleo
  Bauldry an Iowa hog farmer signed a contract with
  Farmers Hybrid Seed Corn Company to raise hybrid
  hogs on contract. One year later he filed for
  bankruptcy and claimed a personal exemption for
  all the hogs he owned under 6 months of age. But
  the Federal District Court ultimately decided he
  did not own any of the pigs instead they were
  owned by Farmers Hybrid. The Iowa court had to
  consider the nature of the relationship between
  the parties and ruled

16
Freedom of Contracts

• "It is well settled that unless prohibited by
  statute or by rules of law parties are free to
  enter into any type or form of contract that they
  wish and to have it contain such provisions as
  they wish." In re Bauldry, 78 F. Supp 412, 416
  (N. D. Iowa 1948).

17
Distinguishing Production Contracts from other
Contracts

• Production contracts are a unique type of legal
  agreement which creates a different relation
  between the parties and involve a much greater
  sharing of both control and risks, than do most
  traditional marketing tools. Other contracts
  used in agriculture include

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Distinguishing Production Contracts from other
Contracts

• a) forward contracts - the sale of a fixed
  amount of the actual commodity at a set price, at
  some point in the future
• b) marketing agreements - in which a farmer
  agrees to sell all of a particular commodity
  produced through an organization such as a
  cooperative and
• c) futures contracts - the sale or purchase of a
  standardized quantity of a commodity for future
  delivery on a regulated commodity exchange.

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What is Behind the Trend Toward Contract
Production?

• Many factors fuel the increased use of production
  contracts, including access to improved genetic
  materials, new technologies, and profitable
  markets. Another factor in modern agriculture is
  the issue of risk management. All parties in
  agriculture, from small farmers to the largest
  processors are looking for ways to reduce or
  manage their financial risks.

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What is Behind the Trend Toward Contract
Production?

• Production contracts have traditionally been used
  for seed production and for many vegetable and
  horticultural crops. In the last forty years
  most poultry production in the U.S. has been
  reorganized around production contracts by large
  vertically integrated operations. Today over 90
  of broilers produced in the U.S. are raised under
  contract, with the remaining share owned directly
  by processors who are vertically integrated,
  owning the bird from the time it is hatched until
  it is sold to the consumer. A similar shift is
  underway with swine production in the U.S.

21
Relation of Contract Production to the
Industrialization of Agriculture

• The use of contracting is part of the ongoing
  industrialization of agriculture. Tom Urban,
  former president of Pioneer Hi-Bred
  International, Inc., describes industrialization
  as the process whereby the production of goods is
  restructured under the pressure of increasing
  levels of capital and technology in a manner
  which allows for a management system to integrate
  "each step in the economic process to achieve
  increasing efficiencies in the use of capital,
  labor, and technology."

22
Trends in Grain and Livestock Production

• Several economic and agronomic forces are
  increasing contract production of grains and
  livestock. These include
• 1. Identity preservation. This term means crops
  for which the identity and thus unique
  characteristics are preserved from the time of
  production through marketing to processing and
  consumption. Identity preserved is most commonly
  used in connection with grains, such as uniquely
  altered genetics which give higher values, for
  example as better animal feed. In order to
  preserve the identity of the product, and its
  unique traits, identity preservation requires
  that significant steps must be made during
  production, harvesting, storage and processing to
  segregate the crop from other varieties.

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• 2. Specialty crop production. This term may
  relate to producing non-traditional varieties of
  grain such as waxy corn, white corn, or food
  grade soybeans or may refer to raising identity
  preserved crops. In either case, the attraction
  of specialty grain production is the ability to
  enter a new or niche market which will offer a
  price premium above that available in the public
  marketplace. Entry into the specialty crop
  market may depend on the producer's ability to
  find a buyer who is willing to pay a higher price
  to guarantee a supply for the alternative use.

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• 3. End use tailored varieties. This term is
  another way of describing the process of identity
  preservation, but here the focus is on the work
  of plant breeders or genetic engineers in
  specifically designing a crop to express a trait
  which can result in added value. The development
  of high-oil corn which has a higher value as an
  animal feed component is an example of an end use
  tailored variety.

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• 4. Vertical Integration in Meat Production - the
  most significant factor driving the expansion of
  contract production has been the trend toward
  vertical integration by processors and marketers.
  Vertical integration can happen in either of two
  primary methods. First, companies may begin as
  in-put suppliers, such as feed companies, but
  expand into production, either through direct
  ownership of facilities or through contracting
  with others to care and feed company owned
  animals. Second, a company which began as a
  processor or marketer of the commodity, may
  decide to integrate downstream to control the
  actual production of the animals. This model has
  been used extensively in the broiler industry and
  by some beef packers.

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Legal Significance of the Changes in Production

• Changes in the methods of producing and marketing
  grains and livestock are important developments
  for agriculture. It may result in new markets,
  higher prices, price premiums and even new ways
  of pricing and marketing commodities for farmers.
  But while the economic benefits may be real,
  there are also potential concerns with
  contracting. Important issues, such as access to
  contracting opportunities and their role in
  spurring concentration of production, are real.

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• The trend toward increased contract production
  raises challenging new legal issues for both the
  farming community and agricultural lawyers.
  Questions about the fairness of the contracts and
  the economic effect of vertical integration will
  trigger public debate and legislative proposals.
  Critics charge contracting can reduce farmers to
  low wage employees who assume most financial
  risks, without little potential for increased
  returns. Others say it is not contracting which
  is bad, it is bad contracts which are the
  concern.

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Reasons Why Agricultural Companies Will Use
Production Contracts

• 1. Quality Control - Contracts provide control
  over the production methods and inputs used, and
  help insure uniformity and quality making the
  commodity more suitable for preparing
  standardized consumer products.
• 2. Assuring Adequate Supply - Contracts offer a
  mechanism to control the quantity of crops
  produced and how they are marketed to processors
  and consumers, helping increase the price
  premiums obtained and prevent over-supplies which
  may decrease demand.

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Reasons Why Agricultural Companies Will Use
Production Contracts

• 3. Supply Management - Contracts lock in a
  guaranteed supply to meet potential needs but do
  so using pricing arrangements limiting the risk
  of having to acquire more than is needed. "Passed
  acres" clauses, common in vegetable contracts,
  allow the company to not harvest or purchase the
  crop, even if it meets contract standards. The
  producer is paid a portion of the contract price
  from a pool of funds established by a charge on
  all growers.
• 4. Marketing Related Technology - Use of
  contracts may require use of related technologies
  or production methods, also marketed by the
  company. This means contracting may provide
  opportunities for economic linkages, such as
  offering "packages" of seeds, chemicals, and
  marketing opportunities.

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Reasons Why Agricultural Companies Will Use
Production Contracts

• 5. Intellectual Property Protections - Contracts
  allow control over the release of the specialized
  crop and animal genetics creating the added-value
  trait, meaning the contracts serve as an
  additional form of intellectual property
  protection to control the unauthorized
  reproduction or sale of the crop.
• 6. Market Protection - Contracts protect
  confidentiality of the pricing and marketing
  arrangements for the commodity and of the
  identity of the end-user or purchaser. Buyer
  contacts can be very important in the specialty
  crop sector and protecting the identity of the
  end-user prevents producers from contacting the
  purchaser directly.

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Reasons Why Agricultural Companies Will Use
Production Contracts

• 7. Pricing Confidentiality - Contracts using
  non-public pricing and marketing conceal the true
  magnitude of any price premium gained for the
  special trait. This allows the company to obtain
  higher profits and limit the knowledge or ability
  of producers to bargain or negotiate for a larger
  share of the "added value."
• 8. Reduced Risks and Higher Profits- Contracts
  give companies investing in value added crop
  breeding and genetic engineering, a mechanism to
  project the companies financial interests, and
  thus potential returns, farther down the
  production process of the crop, without having to
  own the land or production facilities. The
  company can become involved directly in crop
  production without risking investments in
  farmland or buildings.

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Reasons Why Agricultural Companies Will Use
Production Contracts

• To a skeptic, the use of production contracts may
  illustrate the attitude, why own the farm if you
  can own the farmer and the crop. But to most
  agricultural economists the use of contracting is
  just one factor in the continuing evolution of
  the food production and marketing sector in the
  U.S. In their view contracting is how companies
  increase the efficiency of production and
  communicate market risks to producers

33
Benefits of Production Contracts A Form of Risk
Management

• Many farm economists portray the use of
  production contracts in agriculture as a form of
  risk management. The argument is contracts
  provide farmers with the opportunity to reduce
  the financial risks normally associated with
  traditional production and marketing by
  contracting with other entities in the food
  processing and marketing system. There are
  several obvious ways in which production
  contracts can be used as a form of risk
  management.

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• 1. Reducing financial risk - contracts can
  reduce financial risks by providing a guaranteed
  source of cash flow and reduce the need to borrow
  money. By raising hogs on contract a young
  producer does not have to finance purchasing the
  stock but instead can utilize available labor and
  feed caring for someone else's animals. Under
  the contract the producer is assured of a steady
  source of income in the form of contract
  payments, which may be at stable or predictable
  amounts. By insulating the producer from price
  swings in the market, the contract may provide
  more stable income.

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• 2. Access to capital - contracts can help make
  the producer a more attractive borrower. Because
  a contract may offer a steady source of cash a
  bank may be more willing to lend money, such as
  for constructing a new facility. Some of the
  companies involved in production contracting,
  have sources to offer financing for their
  producers.

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• 3. Access to new technologies - If a person is
  interested in raising a new form of grain, such
  as high-oil corn, the only way to access the seed
  may be to enter a production contract with the
  company owning the patent. Under some contracts
  the seed may be provided at no cost. By signing
  the contract a farmer may have access not just to
  the new technology and advice of the company but
  also to the higher value markets.

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• 4. Access to new markets - contracts can offer
  new sources of demand or higher prices. If a
  grower wants to produce and market food grade
  soybeans for export it may be difficult to
  personally make the contacts and arrangements for
  such sales. Instead, the most likely way to do
  so will be to sign a production contract with a
  company developing the market.

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• 5. Higher prices - contracts can provide higher
  prices or price premiums for raising new crops or
  for using certain production methods. A producer
  who wants to market organic produce or pesticide
  free grain may find it easier to do so is by
  entering a production contract. Linkages such as
  these make production contracts attractive to
  companies marketing specialty crops.

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New Risks Contracting Might Present Risk Sharing
or Risk Shifting?

• Most producers decide to use production contracts
  to increase income or marketing returns.
  Contracts can lead to higher returns and serve as
  a form of risk sharing, but this is not always
  true. In some situations, the language of the
  contract can make it more a form of risk shifting
  than risk sharing, with the producer assuming
  unexpected or new burdens. One rule to keep in
  mind is if the farmer is earning higher returns
  or gaining a benefit under a contract it is in
  exchange for something. Farmers earn the
  benefits they receive.

40
Considering the Economic Returns Offered by
Contracts

• When considering a contract, farmers should
  consider why the increased economic returns are
  being offered. Depending on the crop involved
  and the contract, the required action - in
  contractual terms - the "consideration" - from
  the producer, could be

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• - increased production costs associated with
  complying with contract requirements
• - reduced flexibility in how to farm
• - loss of control over pricing and marketing
• - compensation for lower yields, known as the
  "production penalty," which can result if the
  specialized crop is less productive than
  traditional varieties

• - compensation for the reduction in the quantity
  marketed due to the quality standards, i.e. not
  all the crop will be marketable at the price
  premium or
• - higher priced inputs, for example special
  seeds, required under the contract.
• The key with evaluating any production contract
  opportunity is penciling out the costs and
  expected returns and then determining if the
  extra trouble is worth the possible returns.

42
Considering the Legal Risks for Farmers in
Contracting

• Only by examining the language of the contract
  being signed, the legal issues and obligations
  established, and the nature of the relation
  created, is it possible to decide if a production
  contract is risk sharing or risk shifting.
  Consider these common examples of how production
  contracts may shift additional risks to
  producers. All have been the subject of U.S.
  court cases

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• 1. Long term investments, short term contracts -
  Under swine and poultry production contracts it
  is common for producers to build a new facility
  to company specifications. This usually requires
  borrowing significant amounts of money and
  placing a mortgage on the farmland. However,
  most contracts provide a much shorter contract
  period than the term of the financing. For
  example, most broiler contracts are for only one
  flock of birds. A short term contract can create
  serious risks if it is terminated before the
  building is paid off. This risk is especially
  real in areas where the contractor may be the
  only party marketing livestock or poultry in the
  area, so there is no one else with which to
  contract.

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• 2. Acquisition of specialized equipment - The
  production of some specialty crops, such as
  tomatoes, is done primarily under contract and
  may require expensive new equipment such as
  tomato harvesters. Producers buy equipment based
  on the expectation of raising the crop long
  enough to pay for the machines. But most
  vegetable production agreements are for one year,
  subject to renewal at the company's discretion
  meaning it is possible no new contract will be
  offered, leaving the farmer with no use for the
  expensive technology.

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• 3. Flexible quality terms - Production contracts
  often include very detailed terms on the quality
  of the crop or the methods for its production.
  Whether the crop meets these standards is usually
  determined solely to the discretion of the
  company. The company can vary the rigor with
  which such provisions are applied depending on
  the need for the production and the market price
  conditions. A producer may raise what appears to
  be a bumper crop only to have the price reduced
  for "quality reasons" or worse yet, have the
  company not buy it. There may be few
  alternative uses or markets for the crop.

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• 4. Risk of not being paid - Production contracts
  are a new form of marketing and the producer
  depends on the company to pay for the crop. The
  contract may provide for a significant portion of
  the payment to be made long after the crop is
  harvested and delivered to the company. Even
  though the legal title has passed, until the
  producer is paid, he is an unsecured creditor now
  financing the company. If a crop is sold in
  normal channels the producer may be protected by
  a public licensing system in case the company
  goes bankrupt. But under production contracts
  the producer may have no such protection.

47

• 5. Risk of loss in performance - Under many
  production contracts, the producer does not have
  any legal right or title to the crop being
  raised. This protects the financial interest of
  the company from claims by the farmers creditor.
  The producer is in reality performing the
  service of growing a crop for the company rather
  than selling the crop. However, most contracts
  provide the risk of loss of the crop, such as by
  weather or disease, rests with the producer. If
  you raise a crop the company owns it but if it is
  lost you own it and no compensation is earned.
  This is a classic example of contracting as a
  form of risk shifting, guaranteeing the company's
  right to the crop if it is produced but not
  exposing the company to any risks of production.

48

• Production contracts can be a useful tool or a
  risky proposition. The answer depends on the
  relationship between the parties, the language of
  the contract, and the performance of the
  agreement. It is correct to assume the company
  offering a contract has every intention of
  performing the agreement and has no interest in a
  legal dispute. But you can also assume the
  company received legal advice when drafting the
  contract and protected itself from risks.

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Hamilton's Twelve Basic Rules of Contracting

• Each experience with an agricultural production
  contract will be unique and depend on the
  relation between the parties, the terms of the
  contract, and their bargaining position.
  However, there are a number of common principles
  to keep in mind.

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Hamilton's Twelve Basic Rules of Contracting

• Remember the first rule of contracts -- whoever
  wrote the contract took care of themselves.
• There is no reason to assume the contract being
  offered is either fair or that your interests are
  protected. Even though you may trust the company
  you are dealing with, production contracts are
  arms-length business transactions and must be
  considered in this light. This rule is
  especially important because in most contracting
  situations you will be offered written contracts
  on a take it or leave it basis and given no real
  opportunity to negotiate or alter the terms.

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Hamilton's Twelve Basic Rules of Contracting

• 2. Read and understand any contract before
  signing it. Contract terms play a fundamental
  role in determining the rights and duties of the
  parties. A good example is the difference
  between a bushel contract, which commits to
  delivering a fixed amount regardless of the crop
  actually raised, and an acreage contract, which
  promises delivery of whatever amount is raised on
  a designated number of acres. If the terms of a
  contract are not clear you need to ask questions
  until you understand it. You should consider
  having your attorney review the contract,
  especially if it involves a sizable portion of
  your production or involves a long term
  relationship or investment. Legal advice is an
  investment not a cost when it resolves confusion
  and helps your avoid unfavorable economic
  consequences.

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Hamilton's Twelve Basic Rules of Contracting

• Compliance with contract terms is required before
  the contract is performed.
• The price premiums you are expecting won't be
  paid unless the terms of the contract are
  satisfied. Failure to comply with the contract
  may subject you not just to lower returns, but
  also to claims for damages to the other party,
  penalties for breach and other legal remedies. It
  is important to understand the contract
  provisions relating to default or breach of the
  agreement. Producers who, because of bad
  weather, are unable to satisfy a contract
  requiring delivery of a fixed number of bushels,
  might be surprised to learn they have to enter
  the market and buy higher priced commodities to
  satisfy the contract.

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Hamilton's Twelve Basic Rules of Contracting

• Never assume failure to perform the contract will
  be excused.
• Circumstances may arise in which you think it is
  reasonable to assume the other party will not
  require you to perform the agreement. You should
  never make this assumption, especially if your
  failure to perform can be expected to cause the
  other party damages. If you do not think you
  will be able to perform or if you would like to
  try to amend the terms of the agreement,
  communicate with the other party rather than
  surprising them.

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Hamilton's Twelve Basic Rules of Contracting

• Know the contracting party, their financial
  situation, and their performance history.
• This knowledge is essential in helping insure
  you will be paid for any crops you deliver. It
  is especially important if the contract calls for
  passing legal title when the commodity is
  delivered or when payment is delayed. Then you
  become the creditor of the other party, and in
  most situations your claim is unsecured other
  than by the contractual promise to pay. What
  happens if the buyer goes out of business or
  doesn't pay you should always be questions you
  consider before signing?

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Hamilton's Twelve Basic Rules of Contracting

• Weigh the advantages of the contract in terms of
  higher prices against any increased costs or
  risks.
• While a proposed production incentive, such as
  2.00 per bushel premium for growing a specialty
  crop, may appear attractive, it is important to
  calculate the real costs and risks presented by
  complying with the contract. Remember the
  additional revenue is in exchange for something.
  Perhaps the unique variety of grain being raised
  has a significant yield penalty

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Hamilton's Twelve Basic Rules of Contracting

• Proposed contracts are always subject to
  negotiation.
• While most production contracts will be printed
  or typed forms offered to you on a "take it or
  leave it basis" you do have the freedom to
  negotiate. Just because a term is in writing
  doesn't mean it can't be changed if both parties
  agree to do so. Your ability to obtain more
  favorable terms will depend on whether you have
  market power to negotiate with the company or
  whether there are other growers willing to sign
  the contract.

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Hamilton's Twelve Basic Rules of Contracting

• If changes are made in the agreement make sure
  they are in writing and separately signed by the
  company representative.
• Just because you believe a contract was amended
  it may not be true. Most contracts specifically
  provide the only terms enforceable are what is in
  writing. So, if you rely on changes you think
  were agreed, get them in writing.

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Hamilton's Twelve Basic Rules of Contracting

• 9. Do not rely on oral communications made by the
  company either before the contract is signed or
  during performance.
• If what is being communicated is important to
  the relation be sure it is reduced to writing,
  signed by both parties, and incorporated as an
  amendment to the contract. If you can not get it
  in writing be sure and keep copies of any
  documents, such as letters, payment sheets,
  checks, etc., which you can use to show what was
  agreed.

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Hamilton's Twelve Basic Rules of Contracting

• Keep good records of your performance.
• It is always a good idea to keep good records
  especially in the performance of production
  contracts. Keep a record of all communication
  with the contractor and keep a record of your
  actions in producing the commodity. It is also
  wise to keep samples of what was produced, if
  possible, and the results of independent quality
  tests. These records may come in very handy in a
  later dispute over your satisfaction of the
  contract terms.

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Hamilton's Twelve Basic Rules of Contracting

• Don't hesitate to ask questions if you don't
  understand what is happening.
• Remember you are committing to perform under
  the terms of the written agreement. If you have
  questions about what the language means or about
  how the procedure will operate do not hesitate to
  ask questions. The questions should be directed
  to the company representative or to your own
  advisors.

61
Hamilton's Twelve Basic Rules of Contracting

• Stay in communication with the other party to the
  contract.
• Communication can be very important in resolving
  uncertainty and in preventing misunderstandings
  from arising. By communicating with the other
  side as to your performance, questions, or
  concerns, you can help build a smooth productive
  relation. When long periods of time pass without
  communication it is possible for circumstances to
  have changed which put performance of the
  agreement in a much different light.

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Introduction Why Consider Legislation to
Regulate Contracting

• Do you want farmers to have the freedom to
  consider any sort of production contract a
  company may offer or should the state protect
  farmers from bad deals?
• Should companies be required to give farmers
  notice and reasons before terminating agreements?
  
• If farmers make long-term investments in
  facilities or equipment should the contract be of
  any equal length?
• These are the questions many state legislatures
  in the U.S. have tried to answer in recent years.
  
• oduction contracts

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Issues to Consider about Regulating Contracting

• When considering how agricultural contracts may
  be subject to legal regulation there are several
  basic issues to consider
• First, the arrangements are subject to existing
  contract and commercial laws - such as common law
  contract principles and any special legislation
  on commercial activity, such as the Uniform
  Commercial Code. In the U.S. issues of contract
  law are state law questions. There is not a
  federal law of contracting. This means state law
  - and state courts - are the primary sources of
  legal guidance on contracting.

64
Issues to Consider about Regulating Contracting

• Second, the arrangements may be subject to
  special laws enacted to address particular issues
  in the use of production contracts. This outline
  addresses examples of state laws enacted for this
  purpose.
• Third, one important legal issue in determining
  which law may apply - and in drafting remedial
  legislation - is the question of how to classify
  the parties relation. Agreements commonly are
  described as contracts and classify the farmer
  as an independent contractor. However the
  legal relations may be viewed in other ways, such
  as employment agreements, agencies, or even
  franchises. The status of the parties will
  determine their legal relation and their rights
  and obligations under the agreement.

65
Issues to Consider about Regulating Contracting

• Fourth, while contract law is primarily an issue
  of state law, there are ways the regulation of
  agricultural contracting can become a federal
  matter. The central question in application of
  federal law is existence of some form of
  regulatory jurisdiction over either the parties
  or the commodity being produced. For example,
  the Congress and USDA have long been involved in
  regulating the marketing of poultry and
  livestock, which is one avenue for potential
  federal regulation of contracting.
• Fifth, efforts to regulate contracting can
  implicate questions of federalism and states
  rights - as well as raise constitutional issues,
  such as the application of the dormant commerce
  clause.

ed
66
State Regulation of Contracting

• Several states, such as Arkansas, Illinois, Iowa,
  Minnesota, Wisconsin and Kansas have enacted laws
  regulating some uses of production contracts.
• While legislatures in many Southern states have
  chosen not to adopt laws designed to protect
  poultry growers, in 2005 Arkansas did adopt the
  Livestock and Poultry Contract Protection Act -
  at section 2-32-201 of the Arkansas Code.
• Legislation to regulate contracting is a
  controversial issue which will help determine the
  future of agriculture. The type of laws proposed
  and enacted have a strong influence on what type
  of production contract relations are developed
  and even where the practice is used.
• For an excellent review of these laws, see State
  Regulation of Production Contracts by Alison
  Peck, May 2006, A National Agricultural Law
  Center Research Publication, available at
  www.NationalAgLawCenter.org

67
State Contracting Laws

• In the U.S., state laws on contracting can be
  divided into two categories a) laws which create
  substantive rights for producers which can be
  enforced by private court actions and
• b) laws designed to regulate contract formation
  and performance with the goal of equalizing the
  barging power for the parties.

68
Direct regulation of contract production

• There are several different approaches states
  have considered.
• 1. Direct Prohibitions - this approach, found in
  Iowa's restriction on packer feeding of livestock
  or contracting for swine, attempted to ban the
  use of contract production by certain parties.
  It was struck down in federal court as an
  unconstitutional interference with interstate
  commerce.

69

• 2. Regulating Contracting Methods - this
  approach establishes minimum requirements for
  parties who engage in contracting and may require
  including certain terms in contracts being used.
  There are several approaches states follow
• A. Standardized contract - this approach
  establishes a standardized form for all
  production contracts used in a state. For
  example in 1990 the Iowa House of Representatives
  adopted a bill requiring the state to develop
  model livestock production contracts. Under the
  law, which was not enacted by the full
  legislature, the producer was to receive the
  model contract and be given 24 hours before
  signing the other contract being offered by
  contractor. If the producer was not given the
  model then the other contract was voidable.
  However, the law did not require companies to
  adopt any provisions of the model contract. The
  model contract was to be developed by the lawyers
  in the farm division of the Iowa Department of
  Justice. The bill provided that

70
Proposed Iowa Model Contract

• Each model contract shall provide terms
  expressing alternative methods of structuring an
  agreement, including but not limited to methods
  of compensation. A model contract shall not
  state a price to be paid under the contract. It
  shall provide for the division of expenses and
  losses. A contract shall include provisions
  relating to the following.

71

• The required provisions included
• 1. exchange of financial information, including
  any perfected security interests in the
  livestock. The contractor could grant the grower
  a security interest to secure the contractor's
  performance.
• 2. party responsible for insurance.
• 3. delivery of livestock to the feeder, including
  terms on notice, delays, and compensation for
  delays.
• 4. grower's right to refuse livestock when
  delivered, if it was in less than "normal"
  condition.
• 5. information on the payment of expenses related
  to feeding and sheltering the livestock.
• 6. term on the use of veterinary care.
• 7. any requirements relating to construction of
  capital improvements required.

72
Terms in Model Iowa Contract

• 8. term on death or loss of the livestock and
  who bears the risk. The law provided a shifting
  presumption related to timing of death from the
  date of arrival. The cost of disposal was to be
  shared.
• 9. procedures for contract termination,
  including
• a) the actions which can result in termination,
  but the contractor couldn't remove livestock
  merely due to a grower's refusal to agree to
  changes in the contract
• b) grounds for termination couldn't be based on a
  subjective evaluation of feeder's husbandry
  practices unless done by a person other than
  owner. The provision required a method for
  notice of termination and a minimum period of
  notice. Terms for automatic renewals were also
  to be provided.
• 10. compensation paid to the feeder, including
  the manner of compensation and when it is due.
  If the contract included profit sharing then
  information on the sale of the animals was
  required to be given to the feeder.
• 11. mediation or arbitration requirement for
  resolving disputes.

73

• B. Regulating the contract relation - this
  approach establishes requirements for contract
  production relations. Minnesota was the first
  state to enact a law setting mandatory terms for
  inclusion in contracts and for interpreting the
  agreements. The Minnesota law is described
  below.

74

• C. Mandatory dispute resolution A state may not
  want to regulate the terms of production
  contracts, but still require any legal disputes
  involving contracting to be submitted to
  mediation prior to filing a court action. Iowa
  enacted this law in 1990.
• D. Required Contract Terms The most common
  state law regulating contracting is to mandate
  inclusion of certain provisions such risk
  disclosure, methods of termination, and payment
  terms.

75

• 3. Registration of contractors - Another
  approach to regulating use of contracts is a
  system to register or certify entities engaged in
  the practice. Licensing would provide a
  mechanism to more directly control use of certain
  practices or to require use of standardized
  contracts, and could be the source of information
  through regular reports.

76
Indirect Regulation of Contract Production

• Another approach is to establish indirect methods
  to control use of contracts or to protect the
  producers who sign contracts.
• 1. Producer bargaining protections - increased
  use of contract production raises concerns about
  the ability of contract producers to organize to
  bargain for more favorable contract terms.
  Several states, including Maine and Washington,
  have enacted state "Agricultural Marketing and
  Fair Practices" acts to protect the interests of
  producers who form associations to bargain for
  better contract terms. See, Washington Wash.
  Rev. Code Ann. 15.83,005 - ,905 and Maine
  Me. Rev. Stat. Ann. tit. 13 1953, et seq.

77

• 2. Using contracts to impose environmental
  requirements - when Arkansas considered proposed
  regulations on the disposal of waste from poultry
  houses in 1992, a proposal was made by the
  integrators to include in their production
  contracts a requirement growers comply with all
  state environmental rules. The provision was
  criticized by growers who perceived it as a way
  for integrators to claim compliance with state
  environmental rules while shifting responsibility
  and costs for compliance to the growers. In 1994
  Kansas enacted such a provision for swine
  contracts.

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Minnesota Contracting Law

• In 1990 Minnesota was the first state to enact a
  law setting mandatory terms for inclusion in
  contracts and for interpreting the agreements.
• Minn. Stat. Ann 17.90-.98 and 514.945 (1993)
  
• The legislation was the result of a report
  prepared by the "Agricultural Contracts Task
  Force" created by the legislature in 1988 to
  explore the subject. The task force met fifteen
  times in preparing its final report which
  included a series of legislative proposals. The
  laws enacted as a result of the task force effort
  established a number of requirements for all
  "agricultural contracts.

79
Minnesota Contracting Law

• These include
• a) dispute resolution - The law requires a
  "contract for an agricultural commodity between a
  contractor and a producer must contain language
  providing for resolution of contract disputes by
  either mediation or arbitration."
• b) recovery of investments - When a producer is
  required by a contract "to make a capital
  investment in buildings or equipment that cost
  100,000 or more and have a useful life of five
  or more years," the contractor must not cancel or
  terminate the contract until

80
Minnesota Contracting Law

• "the producer has been given written notice of
  the intention to terminate or cancel the contract
  for at least 180 days notice before the effective
  date of the termination or cancellation" ...
  except when the producer abandons the contract
  or is convicted of an offense related to the
  contract business, and
• 2. "the producer has been reimbursed for damages
  incurred by an investment in buildings or
  equipment that was made for the purposes of
  meeting minimum requirements of the contract."

81
Minnesota Contracting Law

• c) right to cure - If the producer breaches the
  contract the contractor must still give the
  producer 90 days notice before terminating the
  agreement and must give the producer 60 days to
  correct the breach.
• d) parent company liability - Parent companies of
  subsidiaries licensed to purchase agricultural
  commodities are "liable to a seller for the
  amount of any unpaid claim or contract
  performance claim if the contractor fails to pay
  or perform according to the terms of the
  contract."
• e) implied promise of good faith - All
  agricultural contracts must be interpreted by the
  Minnesota courts as including an "implied promise
  of good faith." If the court finds there has
  been a violation of the implied promise of good
  faith, the court may allow the party to recover
  "good faith damages, court costs, and attorney
  fees."
• (f) return of prepayments - If a producer makes
  prepayments "for agricultural production inputs
  that include but are not limited to seed, feed,
  fertilizer, or fuel for future delivery, the
  producer may demand a letter of credit or bank
  guarantee from the provider of the inputs to
  ensure reimbursement if delivery does not occur."
  

82
Minnesota Contracting Law

• 3. Mandatory dispute resolution A state may not
  want to regulate the terms of production
  contracts, but still require any legal disputes
  involving contracting to be submitted to
  mediation prior to filing a court action. Iowa
  enacted this law in 1990.
• 4. Required Contract Terms One of the most
  common forms of state law regulating contracting
  is to mandate the inclusion of certain provisions
  such as risk disclosure, methods of
  termination, and clearn payment terms.

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Improved Minnesota Law - Required Risk
Disclosure

• In 2000 the Minnesota law was amended to include
  several important new requirements, including
• the contract be drafted in plain language using
  words and grammar that are understandable by a
  person of average intelligence, education and
  experience with the industry. Minn. State.
  17.943, subd.1., and
• All contracts entered after Jan. 1, 2001, be
  accompanied by a risk disclosure statement, which
  among other provisions must describe the material
  risks in the agreement and allow a three day
  right to cancel the contract once it is signed.

84
Indirect Regulation of Contract Production

• Another approach to regulating contracting is to
  use indirect methods of controlling their use or
  for protecting producers who sign contracts.
• 1. Producer bargaining protections - increased
  use of contract production can raise concerns
  about the ability of contract producers to
  organize to bargain for more favorable contract
  terms. Several states, including Maine and
  Washington, have enacted state "Agricultural
  Marketing and Fair Practices" acts to protect the
  interests of producers who form associations to
  bargain for better contract terms. See,
  Washington Wash. Rev. Code Ann. 15.83,005 -
  ,905 and Maine Me. Rev. Stat. Ann. tit. 13
  1953, et seq.

85
Federal Involvement in Contract Regulation

• Agricultural Fair Practices Protections
• Federal and state laws have been enacted to
  protect the rights of producer to organize and
  bargain in marketing commodities. The laws, in
  particular the Agricultural Fair Practices Act of
  1967, have been used by poultry producers to
  challenge the manner in which contracts were
  terminated. Congress passed the AFPA to protect
  the right of farmers and ranchers to join with
  other growers to form associations to bargain for
  better prices and terms with handlers and
  processors. The Act sets out a number of
  prohibited practices for handlers, which is
  defined to include persons engaged in
  "contracting ... with .. producers .... with
  respect to production or marketing of any
  agricultural product ... ." The act focuses on
  prohibiting handlers from discriminating against
  or intimidating producers because of membership
  in or exercise of the right to organize.

86
Application of Packer and Stockyards Act

• The Packers and Stockyards Act of 1921, 7 U.S.C.
  192, lists a number of "unlawful practices" for
  any packer or live poultry dealer or handler,
  including
• (a) Engage in or use any unfair, unjustly
  discriminatory, or deceptive practice or device
  or ....
• (e) Engage in any course of business or do any
  act for the purpose or with the effect of
  manipulating or controlling prices, or of
  creating a monopoly in the acquisition of ,
  buying, selling, or dealing in, any article, or
  of restraining commerce or
• (f) Conspire, combine, agree, or arrange with
  any other person (1) to apportion territory for
  carrying on business or (2) to apportion
  purchases or sales of any article or (3) to
  manipulate or control prices
• For these provisions to have any effect in
  connection with the use of contract feeding,
  federal officials would have to determine use of
  the practice caused a violation of the Act. Such
  a determination could either come in a specific
  complaint, or if the practice were widespread,
  the USDA could undertake rulemaking on the
  subject.

87
Information Sources on Production Contracts

• National Center for Agricultural Law Production
  Contracts Reading Room
• http//www.nationalaglawcenter.org/readingrooms/pr
  oductioncontracts
• Iowa Attorney Generals Office - Contract Data
  Base
• http//www.iowaattorneygeneral.org/working_for_far
  mers/contracts/index.html
• National Contract Poultry Growers Association
• http//www.ncpga.info/index.htm
• Farmer Legal Action Group (FLAG) - Publication
  list
• http//flaginc.org/topics/pubs/index.php