By Andrea Hilderman
Contracting is a way for growers to manage their marketing and pricing risks. An array of contracts are available and are, in theory, very simple. They are an agreement between two or more parties with consideration flowing both ways – in the case of a grain contract, the consideration that flows is usually grain production for money. Production contracts are a type of contract where the grower makes a commitment to deliver a specified amount of the production from a specified number of acres. On the other side, the purchaser agrees to take delivery of that specified production. Production contracts may or may not specify price or volume, but the exact terms can differ from contract to contract, from purchaser to purchaser. Production contracts generally specify the quality, or minimum quality specifications, of the contracted production and so, generally are more common with higher value crops. A production contract may also dictate certain crop husbandry practises be used, or not, depending on the final end use.
For the grower, the main advantage of a production contract is to eliminate the risk of restricted delivery for some or all of the crop. In some cases with what might be considered special crops, no minimum delivery may be required in the case of a crop failure, a so-called Act of God clause.
There are some limitations to a production contract for the grower. First, it doesn’t always deal with price risk, or basis risk if that is applicable. Another limitation can be the first-right-of-refusal requiring sale to the contracting company even if a higher price is achievable from another buyer.
According to Marvin Mills, a marketing advisor with FarmLink Marketing Solutions in Boissevain, Manitoba, there are a few rules of thumb for a grower to consider before signing a production contract. Those include who buys the production over and above that stated in the contract? And is there a price set for that overage? If there is a price when is it set and how is it determined? Still considering that overage production, can you get offers from competitors to ensure you are getting a fair deal?
Special crops include lentils, chickpeas, etc. In the case of these types of small acreage crop, if a crop failure occurs there can be little or no opportunity for the producer to find other production to fulfill his contract. The Act of God clause is used in these cases. Soybeans once fell into that category. “However, with the growth in acres of soybeans to over 1.3 million now, an Act of God clause is a rarity,” says Jonathon Driedger, senior market analyst at FarmLink Marketing Solutions.“Soybeans are now contracted very similarly to oats or canola, other commodity crops.” An Act of God clause removes the worry of production risks. There is no buyout or other penalty if the grower does not achieve the production stipulated in the contract. “Buyers use an Act of God clause to help encourage growers to plant the acres,” says Driedger. “If the volume of acres grows without this clause, then it’s not really needed in the same way. Also, the bigger production is allowing more companies to handle and market it in a similar manner to the other bulk commodity crops.”
The other terms in a production contract are generally very similar to any other mainstream contract and exist to protect both the seller and the buyer. “Typically, production contracts will spell out specification such as dockage and other quality parameters, payment terms, and delivery windows,” explains Driedger. “Like any other contract you might enter into, you need to do your due diligence to ensure your interests are protected.” Do you know the buyer? If not, then some research should be done to find out more about them. Are they harder on dockage than another buyer you might have dealt with? Do they take delivery when they say they will? Are they slow to pay?
“Growers can check to see if the buyer is licensed with the Canadian Grain Commission and they can ask for references from other growers the buyer might have done business with in the past,” says Driedger.
“Are they a publically traded company? What does their balance sheet look like? There’s a lot of information out there if you take the time to look for it.”
If the buyer is new to you and you have little familiarity with them, but you feel confident about their credibility, then the best way to establish a relationship is to start with a smaller transaction. “Get to know each other,” says Driedger. “That way, you can build up trust over a few transactions and build your business together.”
Sometimes a production contract can look very attractive – almost too good to be true even. “In that case the first thing to do is ask questions,” says Mills. “There is usually a reason why a contract would look so appealing – is there some inconvenience they are paying you for? In my experience, there is a reason why you are being compensated so richly.”
Here are some points growers can consider if they are thinking about entering into any contract:
- Carefully read and understand all the terms and conditions. Do not take anyone’s word for what the contract contains.
- Get advice if you are confused by any of the terms or conditions.
- Ensure the terms are accurate – volumes, delivery periods, etc.
- Ensure the buyer you are dealing with is licensed.
- Any pricing should stipulate how freight charges are dealt with.
- Double check all the quality specifications.
- Double check all the discount schedules, if there are any. What happens if your production does not meet spec?
- Are the discount schedules established at the time of contracting or during the season? Be wary if it is the latter.
- Who does the grading, and how are grade disputes to be settled?
- Examine the payment terms.
- Retain a copy of your contract.