Recommendations to the President’s Commission on Tobacco Concerning Agricultural Contracts


The use and regulation of contracts within agriculture is one of the critical issues before the President’s Commission on Tobacco. First, those tobacco farmers who want to continue to grow tobacco – regardless of the fate of the tobacco program – will almost certainly have to operate within a market dominated by contracting. Second, those farmers wishing to diversify will have few economically viable choices that do not involve contracting. While this is particularly true for farmers considering adding livestock or poultry operations on their farmers, markets for every commodity are experiencing an increase in the use of marketing and production contracts.

Today more than 1 in 10 farm operators reported income from contractual arrangements. According to the USDA's 1998 estimates, the value of products accounted for under contracting totaled $67 billion or 35 percent of the total value of commodities produced in the sector. These estimates do not reflect tobacco contracts which were introduced in 2000 nor the latest decline in independent hog production.

Unfortunately, these contract relationships are developed in an atmosphere in which processing companies have monopoly-like market power and farmers possess little legal protection to obtain fair returns on their investments of capital and labor. The result is a growing inequality between the family farmer and agribusiness corporations, an inequality that is depressing farm income and threatening the economic viability and environmental health of our rural communities.

Accessing the Impact of Contracting

While not all of the current contracts are negative for the farmer, it is important to note the difference between a market dominated by a few, integrated buyers and a market in which the large majority of transactions are still open and numerous buyers are available. Those farmers contracting for tobacco this past season received a good price for their production, largely because the companies were competing with the auction houses and the price support structure. It is highly unlikely, from a purely economic standpoint, that without the negotiated base price and the auction house competition the contracts would continue to be as profitable.

To assess the impact of contracting on tobacco and other commodities, members of the President’s Commission on Tobacco should look not at this initial honeymoon period but at the long term experience of contract farmers in general. Poultry, which has been dominated by contract production for decades, is the best case study for analysis.

Contracting: the Unbalanced Relationship

Under the poultry model, farmers make significant investments in sole-purpose buildings and equipment using their own capital, and sign contracts with large integrated, poultry companies. In the contracts, the farmer provides the labor, management, and facilities required to raise the company-owned chicks to the appropriate processing weight. Over the years, because of poultry industry consolidation and lack of market power on the part of the growers, the typical contract relationship between growers and the poultry companies has become very abusive.

Though the initial contract may seem profitable, within a few years growers are often offered a new contract - take-it-or-leave-it - with unfavorable terms. Ever larger debts and the absence of multiple processors (markets) within most regions means the farmer has little ability to challenge. The companies control all the production decisions, leaving the growers little if any autonomy in their farm operations. Growers are often forced to produce beyond the capacity of their land, and left by the companies to shoulder the environmental responsibility for manure and dead bird disposal.

Because of their lack of market power, growers have no leverage to negotiate better contracts, and often face significant retribution if they attempt to speak out against the abuses. The fear of retribution has become so severe in the poultry industry, that during a recent rulemaking, USDA permitted growers to send in comments anonymously, in recognition of the potential harassment they could face if their names were made public.

Recommendations

Fair contracts are impossible when individual producers have no power to negotiate terms or to protect themselves against fraud, retaliation or discrimination. Farm policy is needed at both the state and federal level that would help balance the contract relationship by protecting the right of certified farmer cooperatives to negotiate contract terms on behalf of their members. Such legislation would significantly enhance contract farmers’ ability to leverage a fair price for goods and services. As a minimum protection for all farmers farm policy is needed that sets basic contract standards and addresses the most blatant abuses.

While federal policy is called for to help level the playing field across the country and prevent states from being played against one another, any federal action should clarify it does not invalidate any existing or future State law dealing with these subjects. State legislation reflecting these policies is also effective and can be modified to address specific needs of a given region.

Bargaining Rights

"If farming continues to move toward contractual ‘supply chains,’ this could
be the most important farm law of the twenty-first century."
               -Dan Looker, Business Editor, Successful Farmer, August 1999

Congress should amend the Agricultural Fair Practices Act to empower farmer cooperatives to negotiate fair contracts with processors.

Specifically, the amendment should provide for:
*Mutual obligations for good faith bargaining between processors and cooperative associations of agricultural producers;

*Accreditation of voluntary producer associations by the Secretary of Agriculture;

*Investigative and enforcement authority for the Secretary of Agriculture.

Responding to the retaliatory practices of processors in the 1950’s and 1960’s, the Agricultural Fair Practices Act (AFPA) of 1967 was passed to ensure that family farmers could join together in authorized cooperative associations to market their produce without fear of interference or retribution from processors. Unfortunately, a loophole in the Act allows handlers to avoid bargaining in good faith with producer associations. In fact, while the Act prohibits processors from refusing to deal with producers simply because they are part of an association, it includes a disclaimer provision permitting the processors to refuse to do business with a producer for any other reason. This makes discrimination based on association membership extremely easy to disguise.

An amendment which eliminates the loophole and requires good faith bargaining will give marketing cooperatives the leverage to compel negotiations. It provides farmers a means of equal participation in contract negotiations with processors, participation reflective of the farmers’ substantial economic investments. The 1999 Family Farmer Cooperative Marketing Amendment to the Agricultural Fair Practices Act (HB 2830) and the Agricultural Producer Protection Act of 2000 (S3243) would both meet the above objective.

Several states, including California and Michigan have state legislation that recognizes the right of farmer controlled and owned cooperatives to negotiate contracts on behalf of their members. These measures have proven successful at enabling farmers to positively impact the contract. The bargaining associations have played an important role in stabilizing prices and perhaps more importantly, have participated in setting quality standards. In Michigan, farmers growing commodities with active bargaining organizations consistently receive better prices than like farmers in other states.

Minimum Contract Standards

Empowering producer associations to effectively participate in the development of agricultural contracts provides organized growers the opportunity to work with processors to eliminate unfair or unreasonable terms. However, building effective bargaining cooperatives takes time and all commodities in all regions are not likely to be organized or operating effectively at all times.

Therefore, in addition to protecting producers’ rights to negotiate fair contracts, congress should set basic agricultural contract standards that provide a minimum degree of protection to the individual farmer. Such minimum standards should include:

*Recapture of capital Investment - Production contracts can't be terminated capriciously or as a form of retribution if farmers made a sizable capital investment as a requirement of the contracts. If there is a not a breach of contract and the contractor terminates or fails to renew, the producer can collect damages based of the value of the remaining useful life of the facilities and equipment.

*Re-enforce the right to organize - This provision would ban unfair trade practices and clarify producers rights such as the right to join producer bargaining associations without fear of retaliation.

*Ban the use of "tournament competition" for a payment system – This provision would prohibit "tournament competition" (the ranking system) for payment. In the tournament system, farmer pay is based on how a group of farmers rank against each other, not on the individual farmer’s production. Since the final performance of any farmer is highly contingent on the quality of company supplied (or selected) inputs, this system has a history of corruption and unjust manipulation.

*Confidentiality clauses prohibited - Any confidentiality provisions - whether written or oral, express or implied - are void and unenforceable.

*Binding arbitration clauses prohibited – Any provisions calling for binding arbitration and eliminating the right of a farmer to take a complaint of unfair or abusive practices to court are void and unenforceable.

*An implied promise of good faith - The processor must present the contract to the producer with honest and accurate information. This applies to both written and oral communication.

*Plain language and disclosure of risks - The contract must be easy to read and understand, with a clear disclosure of the major material risks to the producer up front.

*3 day right to review - The producer has up to three after signing the contract to change his or her mind and cancel the agreement without penalty.

*First priority producer lien - The producer can register a lien, making the producer a primary and secured creditor. This provision significantly increases the producer's ability to be paid, even if the processor has financial problems.

*Private Enforcement – Producers who suffer damages because of a violation of these standards can be awarded by the court damages, prohibitory and mandatory relief (including temporary or permanent injunction) and attorney’s fees and costs.

The need for such basic standards is becoming increasing clear. The Agricultural Producer Protection Act of 2000 (S3243) was introduced this fall in the US Senate and includes these measures. Also this fall, sixteen State Attorneys General released a joint statement and model state legislation establishing minimum standards. In the joint statement the State Attorneys Generals argued that despite any benefits, "contracting poses serious risks for producers and, ultimately, for consumers." The joint statement noted the spread of contracts within highly concentrated agricultural markets and warned of the "greater and greater disparity between processors and farmers with respect to market information and bargaining power." The Attorneys General also noted, "Contracting can result in the unfair shifting of economic risk to farmers" and that contracts with confidentially clauses destroy market transparency, limiting the ability of farmers to negotiate a fair deal.