Understanding Crop Contracts: Benefits, Risks and Implications

Agricultural production contracts are agreements between producers, such as farmers, and contractors, such as agricultural companies, for agricultural commodities. These contracts typically outline the production practices that will be used, identify the party responsible for providing the necessary resources, and specify the quantity, quality and payment method of the basic product. Farmers and ranchers use production contracts as a tool to manage the risks inherent to agricultural production, while agricultural companies use them to control expenses. The legal implications of production contracts vary from jurisdiction to jurisdiction due to the law of each state governing their interpretation.

In addition, the variations in terms and language contained in individual production contracts make each one unique. Procurement is one way in which farmers can manage market and price risk. A variety of contracts can be used before, after delivery and before or after delivery to reduce or eliminate market and price risk. Grain buyers may have different names for the contracts they offer.

Producers should consult with each grain purchaser about the type and terms of the available contracts. Contract farming has significant benefits for both farmers and sponsors (investors). However, these benefits also come with problems. This chapter considers both the benefits and the problems from the point of view of the farmer and the sponsor.

Critics of contract farming tend to emphasize the unequal relationship and the stronger position of sponsors compared to that of producers. Contract farming is considered to essentially benefit sponsors by allowing them to obtain cheap labor and transfer risks to producers. However, this view contrasts with the growing attention that contract farming is receiving in many countries, as evidence suggests that it represents a way of reducing uncertainty for both parties. In addition, it will inevitably be difficult to maintain a relationship in which benefits are unfairly distributed between sponsors and producers.

The advantages, disadvantages and problems derived from contract farming will vary depending on the physical, social and market environment. More specifically, the distribution of risks will depend on factors such as the nature of the markets for both the raw material and the processed product, the availability of alternative income opportunities for farmers, and the extent to which relevant technical information is provided to contract farmers. Contract farming can help overcome many of these problems through bulk orders from management. Most small producers have difficulty obtaining credit for production inputs.

With the collapse or restructuring of many agricultural development banks and the closure of many export crop marketing boards (particularly in Africa), which in the past provided farmers with credit inputs, difficulties have increased rather than decreased. In many countries, a vicious circle has been created according to which low demand for inputs offers no incentive for the development of commercial distribution networks, which, in turn, affects the availability and use of inputs even more negatively. Contract farming usually allows farmers to access some type of credit to finance production inputs. In most cases, sponsors anticipate credit through their managers.

However, arrangements can be made with commercial banks or government bodies through levies guaranteed by the sponsor. When substantial investments are required from farmers, such as packing or sorting warehouses, tobacco barns, or heavy machinery, banks do not normally grant credit without guarantees from the sponsor. The tendency of some farmers to abuse credit agreements by selling their crops to buyers other than the sponsor (non-contractual marketing) or diverting inputs supplied by the administration to other purposes has led some sponsors to reconsider supplying most inputs and choose to provide only seeds and essential agrochemical products. The policies and conditions that control advances are normally described in the annexes to the contracts (Annex I). New techniques are often required to improve agricultural products for markets that demand high quality standards.

New production techniques are often needed to increase productivity and ensure that the product meets market demands. However, small farmers are often reluctant to adopt new technologies because of potential risks and costs involved. They are more likely to accept new practices when they can rely on external resources for material and technological inputs. However, successful introduction of new technologies requires a well-managed and structured agricultural operation.

Private agribusiness tends to offer technology more diligently than government agricultural extension services because it has a direct economic interest in improving farmers' production.