Agricultural Contracts: Everything You Need to Know
Agricultural contracts are for academic economists' despite their urban affiliations. Farming had become the basic economic enterprise of mankind which developed into a bigger industry. 3 min read
Agricultural contracts are for academic economists' despite their urban affiliations. Farming had become the basic economic enterprise of mankind which developed into a bigger industry. This brought along terms such as landowners and tenant farmers in economic theory and eventually to the modern theory of contracts established on this topic.
Contracts now play a vital role in the aspect of agricultural production and marketing. These might take on any form such as leases, land agreements, production or marketing contracts.
Agricultural Contracts for Crops
Sometimes, market prices are dictated beyond your control because domestic economies are dependent, thus commodity prices are affected by the global supply and demand. With these unexpected movements and difficulty in predicting the prices, most producers need to deal with unclear prices and income. A way to control these uncertainties is with an agricultural contractual arrangement.
The Contractual arrangement has two types that agricultural producers commonly utilized: production contracts and marketing contracts.
- Production Contracts. With this agreement, the producers are getting paid to grow crops and livestock which simply means that the producer is the one providing services. Under this type, the producer has no ownership of the commodities. This also limits the producer in making inputs for the decision-making part of the process. In the context of the arrangement, the risk on the production and pricing is transferred to the buyers. Both parties will benefit from the contract because buyers can assure that they will get commodities that are fairly uniform while producers will have income stability on a guaranteed market price.
- Marketing Contracts. Conversely, the marketing contract dictates that the ownership of the commodities will stay with the producers. In general, this type of contract details the needed quantity, price, product specification, and delivery time and location. Oftentimes, price premiums are given when commodities exceeded the quality standards. Two types of marketing contract are widely used; forward marketing and futures contract. Forward marketing contracts are established before the planting and this will clarify terms of quality, quantity, and price aids. On the other hand, the futures market is used to hedge the price risk of the commodity.
Advantages of Production Contracts
There are few potential advantages when producers and contractors take a production contract into place. Here are few benefits to consider.
- More stable income because of the reduced traditional marketing expenses.
- Free technical advice, management expertise, and technological advances to be provided by the contractor.
- Provide a guaranteed market as long as commodities are in best quality.
- Increase the volume of the business even with a limited capital since the contractor provides the production inputs.
There are also a separate set of advantages for the contractors when a production contract takes effect.
- Having a contract will ensure a nice flow of uniform commodities with the contractor controlling the production costs.
- Presence of a contract also allows the contractor to better assess the changing market conditions.
- Investments and intellectual property rights of the contractor are protected.
Risks Associated with Production Contracts
Before someone engages with a production contract, they should look at any risks associated with having a production contract. Here are several risks the producer should pay attention to.
- Long-term Capital Investment. Some contracts require long-term capital investments which might incur additional capital for the producer for some installations, improvements, and equipment just to meet the standards and requirements detailed in the contract. If a large investment is needed in order to comply with the contract, the producer needs to make sure that the contract also provides enough protection in allowing him to recover his investment.
- Manner of Payment. It should be clear on how the payments will be made. Some contracts include formulas in computing the base payments and these formulas might include a comparison to other similar livestock. These formulas should be critically analyzed before a contract is signed.
- Assumed Risks. There are risks deemed to happen with or without a contract and these are casualty losses, adverse weather conditions, crop failure, among others. These risks should be detailed in the contract and how which of these will be absorbed by both parties.
- Risk of Non-Payment. In any contract relationship, the receiving party is always exposed to the risk of non-payment by the other party. The best way to avoid the risk of non-payment is to deal only with responsible contractors. Know their background before totally engaging with them on agreements and contracts.
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