Production contracts are becoming commonplace in agriculture today. Certainly, they are now standard practice in the pork industry.
Whether you are a contractor or a contractee, it’s wise to sharpen your production contract skills to understand what to ask—or what kinds of questions you will get asked.
Here’s a quick look at what can happen when a contract goes bad.
One of my producers, and several other area producers, agreed to grow a specialty crop on contract. They planted the crop one year, with harvest occurring in the second year, but too late to produce another crop.
The contractor provided the growers with a letter detailing how the contract payments were to be calculated, tying those payments to production yields reported to the local FSA office.
The first year’s payments were made when due. However, the second year’s payment amount was higher than the contractor expected. Even though payment terms were spelled out, the contractor apparently decided the payments were not to his benefit.
One contract grower received a check for $1,500 less than the terms of his original agreement. Other producers, including my client, received no payment because they wouldn’t agree to the contractor’s new terms.
The episode eventually ended up in small-claims court for a resolution.
So, how can you avoid becoming a contract statistic?
First, do your research. Ask the contractor for references of other producers who raise crops or animals for him or her. Most importantly, check them out. Call the contractor’s neighbors and area input suppliers to determine his business reputation.
Ask how quickly the contractor pays his bills, and whether there have been problems with his contracts in the past.
Second, while this should go without saying, it’s worth repeating– get a written contract. Have your attorney and your financial consultant evaluate the contract’s details.
Get answers to the following questions before you sign:
1. How and when will you receive payment for the product?
2. Do the products you are growing/raising have a market other than directly with your contractor?
3. Are there quality levels that affect the final payment for your product?
4. Is your contractor the end-user of the product or is he merely a subcontractor who is responsible to another entity?
5. If your contractor is selling to another company, ask about terms and guarantees that he has with that company?
6. What happens if the crop that you are producing fails or the livestock die? Are you responsible for completing the contract even if you don’t have a product?
7. Is your contractor required to buy your product regardless of the outcome?
8. How are business disagreements resolved under the contract terms? Who is responsible for legal fees if there is a dispute?
9. Who is responsible if there are environmental or social disputes that arise?
10. Are you required to purchase inputs from specific suppliers?
11. What is the contract length, and what is the renewal process?
12. Does the contract require the purchase of capital improvements that may extend beyond the contract’s life?
Certainly there are other points needing answers, depending on the specific type of contract. For example, if it’s a pork production related contract ask your veterinarian or swine specialist for guidance. For crops, an agronomist would be a handy reference.
Don’t be shy about asking for financial data or guarantees from the contractor. His ability to pay is contingent on his financial strength. If the contractor doesn’t have a strong financial position, you may be at risk — especially if there are no other buyers for the product.
On large, multi-year projects or projects with substantial payment risks, you may want to secure performance bonds or a stand-by letter of credit.
Check with your state agriculture department to determine what guarantees you might have under the prevailing state laws.
In the end, if an arrangement sounds too good to be true, it probably is. Carefully investigate any contract prior to signing, and make sure that you understand the financial risks and rewards.
By Darrell Dunteman, an agricultural financial consultant and accountant with offices in Bushnell, Ill.