Contract arrangements are a common part of the pork production landscape today. But even with experience under your belt, attention to contract preparation and content, especially when the economics are so challenging, can influence business survival.
At their baseline, these contracts have to spell out pork production and management responsibilities. A successful contract clearly defines who supplies feed inputs, facilities and equipment, labor, utilities, veterinary products and services, as well as the contract length. In most hog-finishing contracts, payment terms are based on available pig spaces, which can eliminate some of the variability experienced in the past.
Some contracts also may stipulate performance improvement incentives. These may be based on gains in feed efficiency in finishing-hog contracts or improved pigs per sow per year for farrow-to-finish contracts.
Production contracts offer contractors and growers an effective way to manage risk levels tied to both feed costs and hog prices. However, both parties also share in the risk that the other may fail its contract obligation.
Certain unforeseen risks such as rising interest rates on debt, utility rate increases, environmental regulation or nuisance complaints may result in one party being unable to complete its obligation. As a result, contingency plans that address unexpected problems need to be included in the contract language.
A contract also should spell out expectations. For example, a contract grower expects to be paid on time for the number of pig spaces stipulated in the contract. The grower also expects minimum downtime between pig groups. The health of the supplied animals and the quality of feed delivered also impact the grower’s ability to successfully produce the end product.
On the other side, the contractor expects properly maintained, sanitary facilities and equipment, as well as skilled labor to care for the animals. He or she also requires assurance that the grower will provide health and medical care for the pigs in a timely manner.
Contractors also depend on growers to maintain roads and facilities for feed delivery and loading and unloading pigs, including in adverse weather or at night.
Make Contracts Work for You
So, what do you need in a contract?
“A contract is whatever the two parties agree to,” says Eldon McAfee, attorney with Beving, Swanson and Forrest, Des Moines, Iowa. “It’s important to commit to the contract exactly what is expected of each party.”
A successful contract arrangement often boils down to the two parties’ ability to communicate and work with each other effectively. McAfee often hears clients exclaim, “they just can’t do that!” That’s why it’s important for the contract to spell out exactly what both sides expect of the other under any likely contingencies.
Force majeure clauses allow one party to not be bound to terms because they have been rendered impossible to perform. These issues have increased as the industry has faced profitability challenges.
An example of successful use of force majeure is if a building burns or is destroyed by a tornado. The fact that the contract is economically burdensome is usually not applicable. “In most contracts, market forces and disease are not considered force majeure events,” McAfee says.
A recurring problem he sees is failure to communicate when one party sees a potential problem developing. “If you see that you are going to have trouble fulfilling the contract agreements, the key is to sit down and talk as soon as possible,” McAfee says. “The best advice for all parties is to communicate, communicate, communicate.”
You have to know all the options provided by the contract if one party is unable to fulfill the agreement. “That way, if negotiation doesn’t work, you will be better prepared to use the options,” McAfee says.
In his experience, those who communicate well can typically avoid legal actions. Never give up on negotiations and keep trying to resolve the problem. “Even if legal proceedings have begun, don’t give up on the possibility of resolution,” he adds.
Increased Contract Scrutiny
When Congress passed the 2008 Farm Bill, new pork production contract requirements went into effect. As a result, the Grain Inspection, Packers and Stockyards Administration is taking a closer look at production contracts to ensure compliance with these new requirements.
The 2008 Farm Bill amended the Packers and Stockyard Act to require pork production contracts to:
Allow swine growers to cancel growing or production contracts for up to three days after signing, or any date specified in the contract or growing arrangement. The contract must disclose the cancellation method and deadline.
Include a disclosure statement on the first page that clearly states that additional large capital investments may be required of the grower during the contract term; and
Allow growers to opt out of arbitration provisions before entering a contract.
“These three items must be contained in contracts,” says Jay Johnson, GIPSA Midwest regional director. “As with any contract, we recommend both sides have their lawyers review the agreement before signing,” Johnson adds.
The contractor can be the packer or a producer owner, who contracts with others to grow hogs. “We (GIPSA) do not have jurisdiction over the grower side of the contract,” Johnson notes.
It’s worth noting that the legal forum to resolve any dispute between parties must be in the federal judicial district where the principal part of the contract performance occurs.
It’s wise to ensure that all contracts meet GIPSA requirements. The agency is seeking civil penalties of up to $11,000 per violation when it finds that swine contractors have not complied with the 2008 Farm Bill requirements. For more information on GIPSA, go to porkmag.com/business.
Additional Help Now Available
Rising input costs and product demand challenges at home and abroad have eroded pork production’s profit margins and economic returns. As a result, some companies and individuals who contract with growers to raise hogs and supply pork have closed processing plants, reduced pig placements and declined to renew contracts.
In some cases, it may have been less expensive to cancel old contracts and begin new ones with new growers supported by USDA Farm Service Agency loans. That left some growers with debt for their contract facilities but no contract to provide income and repay their USDA direct or guaranteed loan.
In response, FSA will issue additional guidance to county offices “to be considered as they make future lending decisions for loans to construct new buildings,” says André Kok, FSA public affairs specialist. You can find more about FSA loan guidance at porkmag.com/business.
Among the guidance, it will advise loan officers that contract terms on loans for new construction must include provisions for:
At least a three-year contract,
A requirement to include reasons for contract termination, and
A specified amount of annual income that is anticipated.
Because FSA is requiring those provisions, growers will be provided more leverage in protecting their investment when constructing new buildings. The goal is that growers who come to FSA for assistance will benefit by having loan officers who are better able to analyze risks unique to contract operations.
Remain open and ready for frank discussion and visits throughout the life of the partnership. In the end, there’s no substitute for understanding, clarity and communication for a successful contract arrangement.
Before You Sign
Eldon McAfee, attorney with Beving, Swanson and Forrest, Des Moines, Iowa, offers the following suggestions before you sign a contract.
Read every section and thoroughly understand what is required of you.
Have your consultants and legal advisors review the agreement.
Know the other party’s financial and other business history.
Make it clear that no contract exists until all the specifics are in writing and signed by all parties.
“Everything in a contract is negotiable, including whether to sign,” McAfee says. “If something is in the contract, you are obligated to perform. If it’s not in the contract, it isn’t part of the agreement.”
If changes or provisions are added, don’t settle for a verbal agreement. They may be binding, but they’re hard to prove. Any change must be added to the contract in writing.
If you suspect the other party may default, you can ask for written assurance he/she can perform under the contract. A party can terminate a contract if adequate assurance of performance is not provided within a reasonable period, not to exceed 30 days.
“In general, a buyer’s failure to pay for one group of pigs in a multi-group contract is not sufficient legal basis for a seller to terminate the contract,” McAfee says.
If a contract default occurs, other surprises may await you. While it’s impossible to think of every contingency, it pays to be aware of court precedents regarding payment and refunds. It can help each side fully realize the risks involved and save headaches and losses down the road.