What to Consider in Special or Minor Crop Contracts Charles H. Rust Revised 2/96 Keywords: specialty crops, licensing, buyer, seller, pricing, risk, discounts, grades, premiums, contracts, payment, quality, seed, act of God, federal crop insurance, storage.

Specialty or new crops are often not accommodated by regular marketing channels. In many situations, it is desirable to have an advance contract with price determined prior to planting. To contract profitably, growers will have to carefully estimate their anticipated production costs.

Even with a contract, there are risks of non-performance or misinterpretation. These risks can be minimized by carefully reviewing the terms of the contract and the credibility of the buyer. Both buyer and seller need to understand all terms of the contract before signing the agreement.

The following is a check list of things you should keep in mind when deciding on a contract. Remember: There's more to a contract than just price! Contracts are binding on both parties.

Licensing and Bonding: Is the company a licensed commodity dealer, bonded with the State? The bond ensures that some minimal financial standards have been met.

Buyer and Seller: Each should be named and identified as to their contract position.

Pricing Choices: What are the pricing choices? Understand exactly what the pricing terms you have chosen will mean. Examples of common pricing options are:

 
• Fixed price on the entire contract production
  
• Fixed price on a set number of pounds, bushels, tons or cwt per acre
  
• Guaranteed minimum, with possible final payment at the going market price where delivered
  
• Pooling, where the price is negotiated by the pool or association and final price may be established prior to planting or anytime up to delivery
  
• Open price (price fixed at some point after the signing of the contract, usually upon delivery of the crop)

There is nothing mysterious about pricing choices&emdash;just be sure you understand the implications of the one you choose!

Risk-Taking: The proper decision on pricing choices depends on how the individual views risk. Farmers tend to have three basic attitudes towards risk:

 
• Risk aversion - the decision maker prefers a certain prospect of an amount of money over an uncertain prospect of the same amount of money.
  
• Risk neutral - the decision maker is indifferent between certain and uncertain prospects of the same amount of money.
  
• Risk seeking - a decision maker prefers an uncertain prospect over a certain prospect for the same amount of money.

The remainder of this discussion is based upon the assumption that the producer wants to minimize risk.

Growers who want to minimize risk will prefer a contract in which all crops are priced out. This will protect him or her from a drop in the market. But it also limits a grower who then cannot benefit from a rise in the market either.

Those who are willing to take risks will tend to prefer open prices or pooling. These provide little or no downward price protection; while, on the other hand, they allow more upward price movement, especially with open pricing.

A medium risk position is taken with a contract which contains a fixed price on a set amount of the crop. Part of the crop is priced, protecting it against a drop in the market; then any production over the minimum can be priced out later, possibly at a better price&emdash;or at a decrease in price.

Before negotiating an agreement on price in any of the choices or combination reviewed here, the producer needs to know his or her production costs. Any price agreement should at least cover estimated costs of production.

Pricing Basis: Does the contract price include delivery to the plant or is it F.O.B. the farm price? If F.O.B., the buyer is responsible for transportation costs. But, if not, the grower pays the trucking costs to a facility of the buyer's choice, either in his own truck or with a commercial trucker. Remember: If the crop is priced delivered to the plant, determine what the freight cost will be. If the crop is priced F.O.B. farm, what is the price compared to delivery at the plant? Then determine which will be most profitable to you, the grower.

Discounts for Lower Grades: Are the discounts for lower grades or qualities stated in the contract? Grades for many alternate crops do not exist. But where there are grades established, these points are critical.

Premiums: Are there premiums for better than minimum acceptable quality?

Lower Grades: Does the contract guarantee to take delivery of lower grades or qualities? If yes, at what discounts? Who decides?

Delivery Date: Does the contract guarantee to take delivery by a certain date? Does the guarantee apply to all grades and qualities or only to top grades?

Delivery Point: What is the delivery point? Who pays for transportation to the delivery point, and by what method?

Unpriced Portion: Are there options for selling the unpriced portion of the contract? Under some contracts the entire crop must be delivered, even though only a portion has been priced at sign-up time. If so, are there provisions for the company taking the unpriced portion at „contract¾ or „market¾ price? With some, the grower can market the unpriced part where he/she will.

Other Contracts: Will the contract allow you to sell a portion of your crop to another company? Does it allow for uncontracted acres?

Payment: What are the provisions for payment? Is there a pre-payment when you sign the contract? What share of the production costs are covered in the pre-payment? How soon will payment be received after delivery/pickup?

Quality: Returns are based on net product after dockage and shrink. Who decides on quality factors, dockage, moisture, etc.? In the event of a dispute, what provisions are stated for arbitration? Are identical back-up samples retained at the delivery points, and for how long?

Can the company refuse the crop completely because of poor quality? If yes, who decides?

Seed: Some contracts include the supply of seed. However, it is wise to check the price and payments agreement.

• Where is seed located for pick-ups?
  
  
• What are the payment arrangements for seed?

  - Cash only at the time of pick-ups?

  - Deferred and deducted from the first fall delivery settlement?

  - Is interest charged on deferred payment, and at what rate?

Act of God: Is there a provision for crop failure? This is commonly known as an Act of God clause. (Make sure the contract is clear on this point.) Unusual circumstances such as insects (i.e., grasshoppers) and mid-to-late-season drought or hail, where the crop may not be totaled but is adversely affected, are often considered Acts of God. (If unclear, check with your legal counsel.)

Federal Crop Insurance: If you are seeking Federal Crop Insurance, be advised that this is sometimes a lengthy process. For details on a specific crop, contact your local agent or the Federal Crop Insurance Office.

Identify All Partners: Don't forget to identify all parties to the contract. They should be named and identified as to their contractual positions.

Storage: What about storage in case the firm can't take delivery as agreed to in the contract? Where? Who Pays?

Remember: If you sign a contract, but at harvest time another buyer offers you a higher price, you must still deliver on the contract.

Charles H. Rust is a member of the Western Extension Marketing Committee and an Extension Marketing Specialist at Montana State University.

Return to Marketing Concepts Index

Return to the Western Extension Marketing Committee

This site is hosted by the Department of Agricultural & Resource Economics, University of Arizona
Questions regarding content: Russell Tronstad
Send all other questions and feedback to: arecweb@ag.arizona.edu

Document located at http://ag.arizona.edu/ext/wemc/papers/SpecMinorCrop.html