Details Make sure you are comfortable with both delivery and pricing provisions of the contract
Many farmers find contracting a useful method for marketing production. The most common type is a deferred delivery contract (DDC), an agreement by a producer to deliver grain to a buyer by a certain date. The contract usually specifies price, quantity, quality or grade, the delivery location and date, and sometimes the transportation method. Many farmers use a grain-pricing order or GPO to create a deferred delivery contract. With a GPO, the grain seller sets a target contract price that, if and when this price is “hit” it results in a deferred delivery contract being created with that buyer.
Advantages of a DDC
- It eliminates the risk of price decline on the contracted quantity.
- It provides delivery opportunity that may coincide with the need for cash flow.
- It requires no margin money as with a futures account.
- It is widely available.
Limitations of a DDC
- The quantity specified “usually” must be delivered.
- It restricts the choice of buyers.
- It restricts the ability to take advantage of a price rise.
“It is important to read and understand a contract before signing it,” says Neil Blue, market specialist with Alberta Agriculture and Rural Development. “Have the buyer’s representative explain the contract to you in detail. Then, read it carefully, consider the ‘what ifs’ and clear up any uncertainties that you may have. Contract concerns can usually be resolved by mutual agreement, but in cases of unresolved uncertainty, consider having it interpreted by a third party before signing it. Remember that all contracts are negotiable before signing.”
Items to consider
- Grade discounts or premiums — a contract specifies a base grade associated with the contract price, but not all contracts include a price schedule for delivered grades above or below that base grade. Producing a different grade than that specified in the contract usually does not remove the delivery commitment. The producer should completely understand how the final grade will be determined, and what implications a grade differential would have on product deliverability and price.
Note that base grades may differ between grain buyers, so when comparing contract prices, always check on the grade to which that price relates. The Canadian Grain Commission can provide a binding grade decision to producers who have a grading dispute with a licensed buyer.
- Delivering lesser or greater amounts than specified (i.e. underage/overage) — A production shortfall may result in a buyout penalty, usually equal to the volume shortfall multiplied by the current price that the buyer would have to pay to replace the product. If the current price is lower than the contract price, there may not be any further settlement requirement to that contract. An excess delivery to a contract usually only relates to a small amount of the last load. Unless specified, that excess could be priced at the contract price or at the current price.
- Transferability — some contracts could be filled by another producer, which provides a backup plan in case of a production or grade shortfall.
- Disaster (Act of God) clause — an Act of God clause in a contract would release a producer from the obligation to delivery on the contract in the case that weather or other natural event outside of the producer’s control causes a production shortfall. Note that if such a clause is contained in the contract, and the producer has a legitimate production shortfall, the amount produced may still be deliverable regardless of grade, but the shortfall would be excused.
- Timing of delivery — the contract should indicate the delivery period for the product. If a producer fails to deliver by a specified delivery date, will a penalty be levied? Does delivery delayed by the buyer past a certain date result in storage payments to the producer? Also, a delay in receiving payment from the buyer by a specified date should result in stated interest charges payable to the seller.
“Producers should carefully read and understand a contract before signing it,” says Blue. “Consider all the possibilities of production and price. Ask for clarification of any uncertain point. Remember that a contract should be valuable to both parties, so make your concerns known. A contract is still legal if written amendments are agreed to by both parties. If you have unresolved concerns about a contract being offered, you may wish to consult legal counsel or decide not to enter into that contract.”