Under production contracts, farmers and ranchers agree with agricultural contractors on the production of commodities. These arrangements help each side control risks and reduce uncertainty. Common terms in agricultural production contracts include the parties, the price and method of payment, the quantity and quality of the goods, and production practices.
Contractors use production contracts to gain a measure of control over the production process, making their products more consistent and more attractive to consumers. They also can control their supply of a commodity, which allows them to manage the costs of labor and equipment for processing it. Since production contracts usually define producers as independent contractors, the contractor does not face liability for events during the production process. For example, they will not be responsible for the environmental impact of production methods. On the other hand, a contractor bears the risk of any changes in the market price of a commodity, since they are paying the producer a set price.
How Production Contracts Affect Farmers and Ranchers
Producers benefit from the set price mentioned above, which shields them from fluctuations in the open market. They can rest assured that they will have a buyer for their products. In some cases, a contractor may provide a producer with technology or other support that helps them produce a commodity more efficiently, cheaply, or effectively. (Contractors often protect these forms of technology under intellectual property laws.) In addition, the contractor may provide resources to a farmer or rancher, such as seeds or livestock. This can reduce the capital investment required of a producer. Financing may be easier to find, since lenders may be more willing to issue loans to farmers or ranchers who receive steady income through production contracts. Sometimes a producer might be able to get funding directly from the contractor.
However, production contracts hold certain disadvantages for farmers and ranchers. Some producers prefer greater control over their operations, including their farming practices. A production contract may tie a farmer or rancher to technologies or materials that they must purchase from the contractor. A producer also may need to build certain facilities on their property to comply with the contract terms. They may not be able to easily repurpose these facilities or recover the cost of building them if the contractor terminates the contract. A producer may not receive payment as soon as they would if they sold their commodity on the open market, and this debt may not be secured if the contractor faces financial trouble. In some cases, a contractor has the discretion to determine whether a commodity meets its quality requirements. This may affect the level of payment issued to the producer.
Unequal Bargaining Power
The relative lack of competition among contractors means that they may have substantially greater bargaining power than farmers and ranchers. As a result, production contracts may be weighted in favor of contractors.
Rules Governing Production Contracts
Federal and state laws protect the rights of producers entering into these contracts. For example, the federal Farm Security and Rural Investment Act of 2002 does not allow production contracts to contain confidentiality clauses under certain situations. Also at the federal level, the Perishable Agricultural Commodities Act protects producers of fresh fruits and vegetables, while the Packers and Stockyards Act provides certain rights to livestock producers. The Agricultural Fair Practices Act prevents contractors from discriminating against producers that join producer associations or contract with them.
State laws governing production contracts vary, but some common requirements include:
Disclosure of material risks
Honesty and good faith in negotiations
Cooling-off period of three days, during which the producer can cancel the contract without penalties
Ban on retaliation or discrimination against producers for whistleblowing or exercising other statutory rights of producers
Priority liens for producers against the processed commodity, funds received from it, or the assets of the contractor
Private right of action for producers to sue for violations of state law
Alternative dispute resolution, such as mediation, before going to court to resolve a dispute over the contract
Liability of parent companies for subsidiary contractors
Outside specific federal and state statutory protections, producers may have standard rights under the Uniform Commercial Code. This is because production contracts often can be classified as sales contracts, which the UCC governs. A violation of a sales contract can open the door to UCC remedies.