Crop contracts – what to do if you are short of product
Contracting can be a useful way for farmers to market crop production and has become generally necessary to arrange delivery to a commercial buyer.
‘A crop sale contract is a legal business agreement between a seller and buyer,’ says Neil Blue, provincial crops market analyst with Alberta Agriculture and Forestry. ‘Signatories to a contract should read it carefully, consider all the “what ifs?” and clear up any uncertainties prior to signing. A producer may decide to have it first interpreted by a third party, such as a lawyer, before signing it.’
A crop purchase contract usually specifies price, quantity, quality or grade, the delivery location and date, and sometimes the transportation method. Grain companies are in the business of buying and selling crops, so when they sign a contract to purchase crop from a producer, at some point they will have a contract to sell that amount of crop and grade to a domestic or foreign buyer.
For that reason, when a producer is unable to fulfill the volume or quality of a contract, the grain company needs to either find a replacement source for that crop in shortfall or face default penalties on the contract with their buyer.
In most years, a good time to consider contracting crop to lock in price and delivery opportunity is during the growing season when prices often rally, at least temporarily, in response to weather concerns.
‘Usually, incrementally committing up to 25% of expected production prior to harvest is a safe practice, but sometimes a crop production shortfall may still arise. Weather events or conditions in some years may prevent enough crop of the contracted grade to be produced, resulting in a shortfall to fulfill the terms of the contract. In that case, the producer who signed the contract may be liable for damages,’ explains Blue.
If a producer realizes that it will not be possible to fill the terms of the contract, they should advise the crop buyer of that situation sooner rather than later. The buyer may have obligations in place for processing and selling that crop contracted by the producer, so the buyer also faces a potential loss.
If the buyer can easily replace the crop contracted with the producer at the same or lower price as the contracted amount, there may be minimal damages to a shortfall on the contract. However, if the crop price has risen from the time that the contract was signed, the producer may have to pay the price difference between the contracted price and “replacement” cost for the volume of crop in shortfall.
‘In some circumstances, a buyer may be able and willing to roll the crop contract to a subsequent production year, subject to a price adjustment. However, that is not so feasible this year with current prices high relative to those of post-harvest 2022.’
The crop buyer will want to maintain a good relationship with the producer. The most important considerations are early communication of the pending difficulty in fulfilling the contract, followed by honest, open and civil communication. Farm or field inspections by a buyer representative may be necessary. Some buyers are suggesting that the producer, after advising the buyer of a potential shortfall, wait until after harvest to deal with the contract.
‘Participants in AgriInsurance through AFSC may be eligible for a payout for a crop production shortfall below their coverage level. In addition, the Variable Price Benefit of that program may provide some additional relief if there is a crop insurance claim,’ says Blue.
A contract buyout charge will be an allowable expense for income tax purposes. A buyout cost (excluding penalties and interest) will also be an allowable expense under the AgriStability Program. There may be some relief following a contract buyout for participants in AgriStability.
For reference, the Canadian Canola Growers Association has an article titled “CCGA: What to Consider if Production Comes Up Short on a Deferred Delivery Contract”.