Managing Cash and Futures Contracts*

12/2000 Update: From the Commodity Futures Trading Commission. CFTC changed the rules in 1994 so that Summary Proceedings now can be filed for claims up to $30,000. For more information, see the CFTC Web site at www.cftc.gov

 BOZEMAN --The past decade has witnessed many innovations in grain contracting. Particularly since the adoption of options on futures contracts, grain merchants and farmers use contract arrangements to increase flexibility, reduce downside price risk, take advantage of upside price movements, and arrange timely delivery. Contemporary farmers are faced with a bewildering array of contracting opportunities. Some more popular contracts are deferred pricing, deferred delivery, basis, no-price-established, minimum price, flex, and hedged-to-arrive. They establish all, part or none of the price in advance. Some have added service charges; others are offered as a courtesy. Regional variations in types and terminology abound, and more complicated contracts include both cash market and futures market components. It's incumbent on each farmer and merchant to fully understand what he or she is getting into before signing or agreeing to any contract.

Current grain market conditions have upset the contracting apple cart. Some farmers have found themselves over contracted and unable to deliver the volume contracted. Others have second thoughts about delivering at previously agreed to prices that are below current levels. Some merchandisers face large margin calls on grain hedged on behalf of their farmer suppliers. Others are squeezed between previously contracted purchase and sale prices and reduced margins resulting from the tight supply and strong demand. The media is taking notice, and the term "high risk contracts" is becoming a buzz word in The Wall Street Journal and elsewhere. Lawsuits are starting to appear, so it's more important than ever to proceed cautiously.

MANAGING CASH MARKET CONTRACTS

Farmers who enter contractual arrangements must first understand that contracts are legally binding documents requiring performance. Failure to perform on the contract can be costly and can result in legal action. Before entering into any contract, it's crucial to understand exactly what is required of all parties. Fixed-price contracts normally specify quantity, quality, price, and delivery requirements. Price-later contracts dontt spedfy the transactions price, but usually include other requirements. Almost all have "fine print " that clarify the specifications and requirements.

The enforceability of contracts, and performance on them, may be defined by specific Uniform Commercial Code (WCC) provisions. The Covering Rule says that if a seller fails to deliver, the buyer can "cover" by purchasing substitute goods and charging the net cost back to the seller (UCC Section 2-712). A written contract between merchants is enforceable in this respect, but the courts are not in agreement that farmers are considered merchants:

• A person is a merchant if "by his (sic) occupation (he) holds himself out as having knowledge or skill peculiar to the practices or goods involved in the transaction" (UCC Section 2-104);
• One interpretation is that farmers are merchants because they deal in the kinds of goods involved;
• The opposing view is that ordinary farmers are not considered merchants.

In the event of a crop failure, if the farmer is not considered to be a merchant, the UCC Section 2-615 may provide some justification for nonperformance due to the crop failure. However, some specific action may be required:

• Delivery of all available production in partial fulfillment;
• Delivery of old crop in partial fulfillment;
• The farmer should establish that:
  • He or she did the best possible job (under the circumstances) in growing, harvesting, and delivering the crop;
  • He or she planted enough acres to cover the contract, and used sufficient inputs to achieve a normal crop yield;
  • Occurrence of the problem was not contemplated in the contract;
  • He or she is a grower and not a merchant or broker.

Contract management methods include specifying in the contract that the farmer is a grower ("This is a Grower's Contract") or a merchant ("This is a Merchant's Contract"), and inclusion of an "Act of God" clause that excuses delay or nonperformance due to circumstances beyond the reasonable control of the seller. Verbal contracts should be verified in writing quickly, and notice of objection to the contents of the written confirmation should be given within ten days of receipt of the contract. Resolving Cash Contract Related Problems

Avoid or minimize potential contract problems in advance by understanding and fine tuning the contract provisions and specifications before signing it. In the event that nonperformance on the contract may become a reality, the farmer should:

NOTIFY the other party to the contract early if a potential problem exists. It may be possible to renegotiate delivery to a later time, or the other party may be able to find alternate sources of supply. If cancellation of the contract is a mutually acceptable alternative, a penalty may be assessed.

DELIVER all harvested production in partial fulfillment, or use old crop, if possible.

BUY BACK the contract at prevailing prices. This may require the use of crop insurance funds, disaster payments or funds from other sources.

CONSULT a knowledgeable attorney to determine the exact status and the legality, validity, or enforceability of the contract. Arbitration or litigation may be necessary.

AVOID the mistake of assuming that a crop disaster relieves the responsibility of performing on a valid contract. 'Walking away" from a contract could result in legal action for breach of contract with associated costs for both parties.

MANAGING FUTURES MARKET CONTRACTS

Farmers who plan to use futures and options contracts have the responsibility to develop and manage their own game plans. This includes choosing the broker and lender, defining the types of futures and options contracts and trades they want to use, and placing orders to initiate and offset their futures market positions. Dr. Dick Shane at South Dakota State University has prepared a fact sheet on choosing a commodity broker: Producer Marketing Management Fact Sheet #13, Selecting a Commodity Broker, NCR Extension Publication 217.

The Commodity Futures Trading Commission (CFTC) has some educational materials available which treat the issue of self protection. The CFTC publishes a listing of reparation sanctions in effect that can be used to learn if particular firms or individuals have been sanctioned. The CFTC has another publication called Questions & Answers About How You Can Resolve A Commodity Market-Related Dispute. It includes a copy of the forms necessary to initiate a reparations hearing.

The National Futures Association (NFA) is a self-regulatory group, based in Chicago, which all futures related firms must belong to. The NFA has several commodity fraud pamphlets available: Before You Say Yes; Understanding Opportunities & Risks in Commodities Trading; Investment Swindles: How They Work & How to Avoid Them; and Investors' Bill of Rights.

Farmers should also have clear price goals and specific intentions before placing their futures or options trading orders. The use of limit orders may reduce unpleasant surprises, although it's important to know in advance the mechanics and limitations of using buy and sell "stop" orders, "market-if-touched " orders and other types of limit orders. Farmers can challenge the broker or account executive to verify the fill price and the time of transaction reflecting the daily or half hour trading price range if they suspect that their fill price was inappropriate.

Resolving Futures Related Problems

Three separate methods of resolving commodity futures and options trading problems or disputes are available.

CFTC REPARATIONS can be sought if the customer suffered a monetary loss because the Commodity Exchange Act or CFTC regulations or orders were violated, and if the responsible firm or individual was registered with CFTC at the time the alleged violation occurred. Several reparations procedures are available through the CFTC and are defined in Questions & Answers About How You Can Resolve a Commodity-Market Related Dispute, CFTC P-111 (7-86). Three CFTC reparations methods exist:

• Voluntary Decision - It requires the presentation of a written case before a CFTC judgement officer, who renders a decision without explanation. No appeal procedure exists. It requires a nonrefundable filing fee.
• Summary Decision - For claims of $10,000 or less, a written, oral, or telephone presentation of the case is made to a CFTC judgement officer, who offers brief statements of factual findings and conclusions along with the judgement. It is appealable to the CFTC and to the U.S. Court of Appeals. It requires a nonrefundable filing fee.
• Formal Decision - For claims over $10,000, this requires written or oral testimony before an administrative law judge who issues findings of fact and conclusions. This is also appealable to the CFTC and to the U.S. Court of Appeals, and it also requires a nonrefundable filing fee.

ARBITRATION is possible through many sources. They include the American Arbitration Association, most of the commodity exchanges, and the National Futures Association, which has a mandatory arbitration provision for its members. The NFA has a brochure entitled Arbitration: A Way to Resolve Futures Related Disputes that defines the NFA's procedure. Choosing a particular type of arbitration may require the farmer to waive his or her right to other methods of arbitration, or even to other remedies (e.g., CFTC or civil action) for the problem or the dispute, unless all parties agree otherwise in advance.

LITIGATION is the third alternative. Persons or firms, even if not registered with the CFTC, can be sued in federal court for violations of the Commodity Exchange Act or of CFTC regulations or orders. While more expensive and time consuming than reparation or arbitration procedures, litigation provides more extensive rights to obtain and prepare evidence. It is possible, in some instances, to file a claim in state court relating to common law fraud, or state consumer protection laws even if the Commodity Exchange Act or CFTC regulations or orders were not violated. Regardless of the circumstances, legal counsel is imperative.

Contracting is rapidly becoming an important way of doing business. As contracts become more prevalent and ever more complex and sophisticated, both farmers and merchandisers need to fully understand their rights and their responsibilities before entering into any type of contractual arrangement.

A common denominator in managing change in terms of market and price risks and opportunities is expanded levels of knowledge and information, and expanding the capacity to apply them to individual circumstances. A prominent Midwest livestock producer recently observed:

"Production agriculture has evolved through three eras. In the first era, hard work was the key to success. In the second era, it was important to produce - the right product, efficiently and in volume. Today, we are in a third era, an era in which business plans involving limited liability companies, multiple sources of financing, and long-term price-setting contracts with suppliers and processors are increasingly important if one is to compete."

Not all market and price risks can be controlled. But farmers can deal with them through greater understanding of the risks and opportunities they face and greater knowledge of how to adapt to them. Farmers need risk management strategies that best fit their own situations, and they need access to expertise needed to implement these strategies. The need for improved knowledge and its application is never complete. It expands over time, and the penalty for inadequate progress is to become obsolete and fall behind domestic and international competitors.

Please send questions or comments to Carol Flaherty, MSU Communications Services, Bozeman, MT 59717. 

You are the 12582nd person to access this page.