Wednesday, July 18, 2018
Next month, Washburn Law School and Kansas State University (KSU) will team up for its annual symposium on agricultural law and the business of agriculture. The event will be held in Manhattan at the Kansas Farm Bureau headquarters. The symposium will be the first day of three days of continuing education on matters involving agricultural law and economics. The other two days will be the annual Risk and Profit Conference conducted by the KSU Department of Agricultural Economics. That event will be on the KSU campus in Manhattan. The three days provide an excellent opportunity for lawyers, CPAs, farmers and ranchers, agribusiness professionals and rural landowners to obtain continuing education on matters regarding agricultural law and economics.
This year’s symposium on August 15 will feature discussion and analysis of the new tax law, the Tax Cuts and Jobs Act, and its impact on individuals and businesses engaged in agriculture; farm and ranch financial distress legal issues and the procedures involved in resolving debtor/creditor disputes, including the use of mediation and Chapter 12 bankruptcy; farm policy issues at the state and federal level (including a discussion of the status of the 2018 Farm Bill); the leasing of water rights; an update on significant legal (and tax) developments in agricultural law (both federal and state); and an hour of ethics that will test participant’s negotiation skills.
The symposium can also be attended online. For a complete description of the sessions and how to register for either in-person or online attendance, click here: http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/continuingeducation/businessofagriculture/index.html
Risk and Profit Conference
On August 16 and 17, the KSU Department of Agricultural Economics will conduct its annual Risk and Profit campus. The event will be held at the alumni center on the KSU campus, and will involve a day and a half of discussion of various topics related to the economics of the business of agriculture. One of the keynote speakers at the conference will be Ambassador Richard T. Crowder, an ag negotiator on a worldwide basis. The conference includes 22 breakout sessions on a wide range of topics, including two separate breakout sessions that I will be doing with Mark Dikeman of the KSU Farm Management Association on the new tax law. For a complete run down of the conference, click here: https://www.agmanager.info/risk-and-profit-conference
The two and one-half days of instruction is an opportunity is a great chance to gain insight into making your ag-related business more profitable from various aspects – legal, tax and economic. If you are a producer, agribusiness professional, or a professional in a service business (lawyer; tax professional; financial planner; or other related service business) you won’t want to miss these events in Manhattan. See you there, or online for Day 1.
July 18, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Wednesday, June 20, 2018
Contracts are a fundamental part of life. We all enter into various contracts on many occasions. But, sometimes a deal doesn’t live up to expectations. It’s those times that we might attempt to back out of the deal. But, is that possible? When can a deal be negated if the other party or parties to the agreement don’t want to cancel the deal?
Rescinding a contract – that’s the topic of today’s post.
Rescission refers generally to the cancellation of a contract. Rescission can occur as a result of innocent or fraudulent representation, mutual mistake, lack of legal capacity, an impossibility to perform a contract not contemplated by the parties, or duress and undue influence. Rescission may be mutual – all of the parties to the agreement agree (in writing) to terminate their respective duties and obligations under the contract. Rescission may also be unilateral – where one party to the agreement seeks to have the contract cancelled and the parties restored to the position they were in economically at the time the agreement was entered into.
An innocent as well as intentional misrepresentation may serve as the basis for a unilateral rescission of contract. To be successful on such a claim, the plaintiff must have justifiably relied on a false statement, which was material to the transaction. The rule prevents parties who later become disappointed at the outcome of their bargain from capitalizing on any insignificant discrepancy to void the contract.
Duty to investigate? There is a split of authority regarding a buyer’s duty to investigate a seller’s fraudulent statements, but the prevailing trend is toward placing a minimal duty on the buyer. With respect to land sale transactions, the general rule is that a seller’s defense that the buyer failed to exercise due care is disallowed if the seller has made a reckless or knowing misrepresentation. See, e.g., Cousineau v. Walker, 613 P.2d 608 (Alaska 1980); Fox v. Wilson, 211 Kan. 563 (1973). However, the defense is typically allowed if the buyer’s fault was so negligent that it amounted to a failure to act in good faith and in accordance with reasonable standards of fair dealing. So, in general, a purchaser of land may rely on material representations of the seller and is not obligated to ascertain whether such representations are truthful.
Illustrative case. In a 2006 New York case, Boyle, et al. v. McGlynn, et al., 814 N.Y.S.2d 312 (2006), the plaintiff bought the defendant’s farm (including the residence) and later sought to have the sale contract rescinded based on the seller’s alleged fraud and misrepresentations for not disclosing that plans were in the works for the construction of large aerogenerators on an adjacent parcel. The plaintiffs submitted the affidavit of a neighbor of the defendant who detailed two conversations with the defendant that occurred months before the defendant put his farm on the market during which the wind energy development project was discussed. The defendant, at that time, stated that the presence of commercial aerogenerators on the adjacent tract would “force” him to sell his farm. When the plaintiff sought to rescind the contract, the defendant claimed he had no duty to the plaintiff and that the doctrine of caveat emptor (“buyer beware”) was a complete defense to the action.
The appellate court affirmed the trial court’s denial of the defendant’s summary judgment motion. The appellate court noted the plaintiff’s claim that the defendants were well aware of their desire to buy a property with a scenic view that was free of environmental controversy and land use battles, and that the status of the land where the aerogenerators were planned was specifically discussed with the defendant before the contract closed. The appellate court also noted that during this same conversation, the defendant told the plaintiff that the property was “protected.” In addition, the sale brochure for the property stated that the property as “backing up to one of the largest areas of undeveloped land in the County.” The defendant also apparently told the plaintiff that “what you see if what you get” and that the area was “secluded and protected.”
The appellate court further noted that while there was an article in a local paper about the development project before the purchase offer for the property was made, the appellate court also noted that the plaintiff did not live in the area. Likewise, no public documents concerning the project were filed with the local planning board until a month after the parties’ closing.
It is important to note that the purchaser's claims in Boyle were based on the purchaser's allegations of unclear oral conversations between the purchaser and the seller, and a statement in a real estate brochure used to market the property. The principle in Boyle could be applied in similar agricultural land sale transactions where plans are being made for the development of any activity that could be considered a nuisance. In addition to the wind energy development project at issue in Boyle, known future development of a large-scale animal confinement operation, ethanol plant or similar activity that produces odors, obscures view or could create unreasonably objectionable noise, light or traffic, may need to be disclosed to a buyer to avoid a rescission action.
Thursday, February 22, 2018
Leasing is of primary importance to agriculture. Leasing permits farmers and ranchers to operate larger farm businesses with the same amount of capital, and it can assist beginning farmers and ranchers in establishing a farming or ranching business.
Today’s post takes a brief look at some of the issues surrounding farmland leases – economic; estate planning; and federal farm program payment limitation planning.
Common Types of Leases
Different types of agricultural land leasing arrangements exist. The differences are generally best understood from a risk/return standpoint. Cash leases involve the periodic payment of a rental amount that is either a fixed number of dollars per acre, or a fixed amount for the entire farm. Typically, such amounts are payable in installments or in a lump sum. A flexible cash lease specifies that the amount of cash rent fluctuates with production conditions and/or crop or livestock prices. A hybrid cash lease contains elements similar to those found in crop-share leases. For example, a hybrid cash lease usually specifies that the rental amount is to be determined by multiplying a set number of bushels by a price determined according to terms of the lease, but at a later date. The tenant will market the entire crop. The landlord benefits from price increases, while requiring no management or selling decisions or capital outlay. However, the rental amount is adversely affected by a decline in price. The tenant, conversely, will not bear the entire risk of low commodity prices, as would be the case if a straight-cash lease were used, but does bear all of the production risk and must pay all of the production costs.
Under a hybrid-cash lease, known as the guaranteed bushel lease, the tenant delivers a set amount of a certain type of grain to a buyer by a specified date. The landlord determines when to sell the grain, and is given an opportunity to take advantage of price rises and to make his or her own marketing decisions. However, the landlord must make marketing decisions, and also is subject to price decreases and the risk of crop failure. For tenants, the required capital outlay will likely be less, and the tenant should have greater flexibility as to cropping patterns. While the rental amount may be less than under a straight-cash lease, the tenant will continue to bear the risk of crop failure.
Another form of the hybrid-cash lease, referred to as the minimum cash or crop share lease, involves a guaranteed cash minimum. However, the landlord has the opportunity to share in crop production from a good year (high price or high yield) without incurring out-of-pocket costs. For a tenant, the minimum cash payment likely will be less than under a straight-cash lease because the landlord will receive a share of production in good years. The tenant, however, still retains much of the production risk. In addition, the tenant typically does not know until harvest whether the tenant will receive all or only part of the crop. This may make forward cash contracting more difficult.
Under a crop-share leasing arrangement, the rent is paid on the basis of a specified proportion of the crops. The landlord may or may not agree to pay part of certain expenses. There are several variations to the traditional crop-share arrangement. For example, with a crop share/cash lease, rent is paid with a certain proportion of the crops, but a fixed sum is charged for selected acreage such as pasture or buildings, or both. Under a livestock-share leasing arrangement, specified shares of livestock, livestock products and crops are paid as rent, with the landlord normally sharing in the expenses. For irrigation crop-share leases, rent is a certain proportion of the crops produced, but the landlord shares part of the irrigation expenses. Under labor-share leases, family members are typically involved and the family member owning the assets has most of the managerial responsibility and bears most of the expenses and receives most of the crops. The other family members receive a share of yield proportionate to their respective labor and management inputs.
Estate Planning Implications
Leasing is also important in terms of its relation to a particular farm or ranch family's estate plan. For example, with respect to Social Security benefits for retired farm-landlords, pre-death material participation under a lease can cause problems. A retired farm-landlord who has not reached full retirement age (66 in 2018) may be unable to receive full Social Security benefits if the landlord and tenant have an agreement that the landlord shall have “material participation” in the production of, or the managing of, agricultural products.
While material participation can cause problems with respect to Social Security benefits, material participation is required for five of the last eight years before the earlier of retirement, disability or death if a special use valuation election is going to be made for the agricultural real estate included in the decedent-to-be's estate. I.R.C. §2032A. A special use valuation election permits the agricultural real estate contained in a decedent's estate to be valued for federal estate tax purposes at its value for agricultural purposes rather than at fair market value. The solution, if a family member is present, may be to have a nonretired landlord not materially participate, but rent the elected land to a materially participating family member or to hire a family member as a farm manager. Cash leasing of elected land to family members is permitted before death, but generally not after death. The solution, if a family member is not present, is to have the landlord retire at age 65 or older, materially participate during five of the eight years immediately preceding retirement, and then during retirement rent out the farm on a nonmaterial participation crop-share or livestock-share lease.
Farm Program Payments
Leases can also have an impact on a producer's eligibility for farm program payments. In general, to qualify for farm program payments, an individual must be “actively engaged in farming.” For example, each “person” who is actively engaged in farming is eligible for up to $125,000 in federal farm program payments each crop year. A tenant qualifies as actively engaged in farming through the contribution of capital, equipment, active personal labor, or active personal management. Likewise, a landlord qualifies as actively engaged in farming by the contribution of the owned land if the rent or income for the operation's use of the land is based on the land's production or the operation's operating results (not cash rent or rent based on a guaranteed share of the crop). In addition, the landlord's contribution must be “significant,” must be “at risk,” and must be commensurate with the landlord's share of the profits and losses from the farming operation.
A landowner who cash leases land is considered a landlord under the payment limitation rules and may not be considered actively engaged in farming. In this situation, only the tenant is considered eligible. Under the payment limitation rules, there are technical requirements that restrict the cash-rent tenant's eligibility to receive payments to situations in which the tenant makes a “significant contribution” of (1) active personal labor and capital, land or equipment; or (2) active personal management and equipment. Leases in which the rental amount fluctuates with price and/or production (so-called “flex” leases) can raise a question as to whether or not the lease is really a crop-share lease which thereby entitles the landlord to a proportionate share of the government payments attributable to the leased land.
Under Farm Service Agency (FSA) regulations (7 C.F.R. §1412.504(a)(2)), a lease is a “cash lease” if it provides for only a guaranteed sum certain cash payment, or a fixed quantity of the crop (for example, cash, pounds, or bushels per acre).” All other types of leases are share leases. In April 2007, FSA issued a Notice stating that if any portion of the rental payment is based on gross revenue, the lease is a share lease. Notice DCP-172 (April 2, 2007). However, according to FSA, if a flex or variable lease pegs rental payments to a set amount of production based on future market value that is not associated with the farm’s specific production, it’s a cash lease. Id. That was the FSA’s position through the 2008 crop year. Beginning, with the 2009 crop year, FSA has taken the position that a tenant and landlord may reach any agreement they wish concerning “flexing” the cash rent payment and the agreement will not convert the cash lease into a share-rent arrangement.
There are many issues that surround farmland leasing. Today’s post just scratches the surface with a few. Of course, many detailed tax rules also come into play when farmland is leased. The bottom line is that the type of lease matters, for many reasons. Give your leasing arrangement careful consideration and get it in writing.
Friday, February 2, 2018
On April 16, 1677, the English Parliament passed the “Statute of Frauds.” The new law required that certain contracts for the sale of goods be in writing to be enforceable. In the United States, nearly every state has adopted, and retained, a statute of frauds. Most recently, state legislatures have had to amend existing laws to account for electronic communications and specify whether those communications satisfy the writing requirement.
A type of contract that must be in writing to be enforceable is one that involves the sale of goods worth $500 or more. Obviously, this type of contract will involve many contracts involving the sale agricultural commodities and other agricultural goods. But, there are exceptions to the writing requirement for contracts that would otherwise have to be in writing to be enforceable. One of those exceptions turns on whether a farmer is a merchant or not, and the rule involving the matter is known as the “merchant’s confirmatory memo rule.” It often comes up in situations involving the sale of grain under a forward contract.
That’s the focus of today’s post – the merchant’s confirmatory memo rule.
The Writing Requirement and the UCC
The writing requirement for sales of goods is found in a particular state’s version of § 2-201 of the Uniform Commercial Code (UCC). The official version, adopted by most states, is applicable only when the goods have a price of $500 or more. In addition, under UCC § 1-206, there is an overall statute of frauds for every contract involving a contract for the sale of personal property having a value in excess of $5,000. Thus, for personal property except “goods” a contract is not enforceable beyond $5,000 unless there is some writing signed by the party against whom enforcement is sought.
Contracts involving merchants. As indicated above, a contract for the sale of goods for $500 or more is generally not enforceable unless there is some writing signed by the party against whom enforcement is sought sufficient to indicate that the contract had been made between the parties. For contracts between merchants, it is common for one merchant to send the other merchant a letter of confirmation, or a pre-printed form contract. This confirmation will be signed by the party who sent it, thus leaving one party at the other party’s mercy. The UCC remedies this situation by providing that unwritten contracts between merchants are enforceable if a writing in confirmation of the contract is received within a reasonable time unless written notice of objection to the contents of the writing is given within ten days. UCC § 2-201(2); see also Topflight Grain Cooperative, Inc. v. RJW Williams Farms, Inc., No. 4-12-1079, 2013 Ill. App. Unpub. LEXIS 1753 (Ill. Ct. App. Aug. 13, 2012).
Thus, the effect of this “merchants” exception is to take away from a merchant who receives a writing in confirmation of a contract the statute of frauds defense if the merchant does not object to the confirmation. In any event, the sender of the written confirmation must still be able to persuade a jury that a contract was in fact made orally, to which the written confirmation applies.
Consider the following example:
In December of 2017, Jesse telephoned his local elevator for a price quote on wheat. During their telephone conversation, Jesse and the elevator agreed that Jesse would sell the elevator 25,000 bushels of wheat at a specified quality at the December price next June, with performance to be completed no later than June 30, 2018. The elevator sent Jesse a written confirmation asking that it be signed and returned within ten days. Jesse did not sign the written confirmation. Because of unexpected market conditions, the June 2018 wheat price was substantially higher than the December 2017 price. Jesse refused to perform in accordance with the forward contract, preferring instead to sell his wheat crop at the higher current market price. The elevator sued to enforce the forward contract. Jesse asserted the statute of frauds as a defense – because they didn’t have a written contract, he didn’t have to deliver.
If Jesse is a merchant with respect to the kind of goods contemplated in the forward contract (wheat), he will be bound by the oral contract. If Jesse is not a merchant, the elevator might be able to recover if it can establish that it changed its position in reliance on Jesse’s conduct, that Jesse knew or reasonably should have known the elevator would sell the forward contract, or can demonstrate that Jesse’s nonperformance was based on his desire to benefit from a higher market price.
When Is A Farmer a Merchant?
A “merchant” is defined as one who deals in goods of the kind being sold, or one who by occupation holds himself or herself out as having knowledge or skill peculiar to either the goods involved or the practice of buying and selling such goods. Courts are divided on the issue of whether a farmer or rancher is a merchant, with the outcome depending on the jurisdiction and the facts of the particular case. See, e.g., Huprich v. Bitto, 667 So.2d 685 (Ala. 1995); Smith v. General Mills, Inc., 968 P. 2d 723 (Mont. 1998); Brooks Cotton Co., Inc. v. Wilbine, 381 S.W.3d 414 (Tenn. Ct. App. 2012).
Unfortunately, in many instances, farmers and ranchers cannot know with certainty whether they are merchants without becoming involved in legal action on the issue. Courts consider several factors in determining whether a particular farmer is a merchant. These factors include (1) the length of time the farmer has been engaged in marketing products on the farm; (2) the degree of business skill demonstrated in transactions with other parties; (3) the farmer’s awareness of the operation and existence of farm markets; and (4) the farmer’s past experience with or knowledge of the customs and practices unique to the marketing of the product sold. For a couple of courts opinions on the issue of whether a farmer is a merchant that reached different outcomes, see Nelson v. Union Equity Co-Operative Exchange, 548 S.W.2d 352 (Tex. 1977) and Harvest States Cooperatives v. Anderson, 217 Wis. 2d 154 (Wis. Ct. App. 1998)
Whether a farmer is a merchant or not is the key to determining whether an oral conversation involving the sale of goods is enforceable. Just another one of those interesting aspects of agricultural law – with its roots dating back to 1677.
Thursday, November 2, 2017
The Uniform Commercial Code (UCC) holds merchants to a higher standard of business conduct than other participants to sales transactions. In every sale by a merchant who deals in goods of the kind sold, there is an implied warranty that the goods are merchantable. The warranty of merchantability exists even if the seller made no statements or promises and did not know of any defect in the goods.
What are the rules for merchantable goods?
What are Merchantable Goods?
In order for goods to be merchantable, they must be goods that:
- pass without objection in the trade under the contract description;
- in the case of fungible goods, are of fair average quality within the description;
- are fit for the ordinary purposes for which such goods are used;
- run, within the variations permitted by the agreement, of even kind, quality and quantity within each unit and among all units involved;
- are adequately contained, packaged, and labeled as the agreement may require; and
- conform to the promises or affirmations of fact made on the container or label if any.
Requirements (a) through (c) above are most often encountered in agricultural sales, with much of the focus on whether the goods are fit for the ordinary purposes for which they are used. For instance, as to the fair average quality requirement, one court held that beetle infestation exceeding an acceptable level of contamination for fungible flour made the flour unmerchantable. T.J. Stevenson & Co., Inc. v. 81,193 Bags of Flour, 629 F.2d 338 (5th Cir. 1980). As for the requirement that the goods be properly packaged, the warranty is breached when defective packaging results in damage to the product or personal injury, when the package does not adequately warn about dangers with the product, and when misleading packaging inhibits subsequent resales. See, e.g., Agricultural Services Association, Inc. v. Ferry-Morse Seed Co., Inc., 551 F.2d 1057 (6th Cir. 1977).
The ordinary purpose standard is breached when goods are not reasonably safe or when they cannot be used to meet their normal functions. For example, in Latimer v. William Mueller & Son, 149 Mich. App. 620, 386 N.W.2d 618 (1986), the Michigan Court of Appeals ruled that bean seed was unfit for its ordinary purpose when the purchaser discovered, after planting, that the seed was infected with a seed-borne bacterial disease. This defect, the court held, invalidated the label provisions that attempted to disclaim warranties for merchantability and fitness. Likewise, in Eggl v. Letvin Equipment Co., 632 N.W.2d 435 (N.D. 2001), the court found that a tractor sold with defective O-rings was not fit for the ordinary purpose for which it was intended and, thus, breached the warranty of merchantability.
Requirement (d) involves bulk purchases and specifies that goods sold in bulk must be of an even kind, quality and quantity. Requirements (e) and (f) pertain to goods that are sold in containers or packaging, and reflect an overlap between express warranties and the implied warranty of merchantability. They are especially important in sales of labeled goods, such as feed, seed or pesticides. Some courts have suggested that statements on labels or containers create both an express and an implied warranty.
Merchantability also involves the standard of merchantability in the particular trade. Usage of trade is defined as “any practice or method of dealing having such regularity of observance in a place, vocation or trade as to justify an expectation that it will be observed with respect to the transaction in question.” UCC § 1-205(2). If a product fails to satisfy industry standards, an implied warranty of merchantability may arise. For example, in one case, the Pennsylvania Supreme Court held that feed for breeding cattle normally does not contain the female hormone stilbestrol because it is known to cause abortions in pregnant cows and sterility in bulls. Kassab v. Central Soya, 432 Pa. 217, 246 A.2d 848 (1968).
Even if a particular farmer does not qualify as a “merchant,” known product defects must be disclosed to a potential buyer. Every seller with knowledge of defects must fully disclose defects that are not apparent to the buyer on reasonable inspection. This duty arises out of the underlying rationale behind the implied warranty of merchantability, which is to assure that the buyer is getting what is being paid for, and the UCC’s requirement that market participants operate in “good faith.”
The UCC warranty provisions also apply to sales transactions involving livestock. In a series of cases in the 1970s, courts applied the UCC implied warranty provisions to the sale of livestock as goods. See, e.g., Vorthman v. Keith E. Myers Enterprises, 296 N.W.2d 772 (Iowa 1980); Holm v. Hansen, 248 N.W.2d 503 (Iowa 1976); Ruskamp v. Hog Builders, Inc., 192 Neb. 168, 219 N.W.2d 750 (1974); Hinderer v. Ryan, 7 Wash. App. 434, 499 P.2d 252 (1972). The livestock industry strongly reacted and successfully lobbied for an exclusionary provision limiting the application of implied warranties in livestock sales. Some version of the statutory exclusion now exists in about half of the states, especially those states where the livestock industry is of major economic importance. The statutes are of three general types: those that exempt sellers from implied warranties in all situations, those providing that no implied warranty exists unless the seller knew the animals were sick at time of sale, and those providing an exemption if certain conditions are met.
The statutory exclusion of warranties in livestock sale transactions applies only to implied warranties; express warranties are not affected. Express warranties can still be made in livestock transactions and may be particularly important in transactions involving breeding livestock. Many sellers tend to make statements that might rise to the level of an express warranty in order to induce buyers to conclude the sale. Such statements can become a part of the basis of the bargain and create an express warranty enforceable against the seller.
The typical statutory exclusion also is inapplicable in situations where the seller “knowingly” sells animals that are diseased or sick. However, it is likely to be difficult for a livestock buyer to prove that the seller knew animals were diseased or sick at the time they were sold. Under the UCC, a seller “‘knows’ or ‘has knowledge’ of a fact when the seller has ‘actual knowledge’ of it.” UCC § 1-201(25). Thus, in order to overcome the statutory exclusion, the buyer must prove (most likely by circumstantial evidence) the seller’s actual knowledge regarding the animal’s disease or sickness.
Under most state exclusionary statutes, the meaning of “diseased or sick” is unclear. For instance, in breeding animals, the failure to provide offspring may result from recognizable diseases or from defects, often genetic, that historically have not been considered diseases. It is uncertain whether the statutory exclusion of implied warranties applies in circumstances involving genetic defects. Presently, no court in a jurisdiction having the exclusion has addressed the issue. Similarly, uncertainty exists with respect to the application of the exclusion to the sale of semen or embryo transfers, which are increasingly common in the livestock industry. Arguably, the livestock exclusion does not apply to semen sales since semen is not “livestock.”
The implied warranty of merchantability arises in many sales transactions involving agricultural goods. The rule for merchantability have produced some very interesting cases over the years.
Thursday, October 5, 2017
Not all contractual transactions for agricultural goods function smoothly and without issues. From the buyer’s perspective, what rights does the buyer have if the seller breaches the contract? That’s an important issue for contracts involving agricultural goods. Ag goods, such as crops and livestock, are not standard, “cookie-cutter” goods. They vary in quality, size, shape, and moisture content, for example. All of those aspects can lead to questions as to contract breach.
So, what rights does a buyer have if there is a breach? A basic review of those rights is the topic of today’s post.
Right of Rejection
A buyer has a right to reject goods that do not conform to the contract. Under the Uniform Commercial Code (UCC), a buyer may reject nonconforming goods if such nonconformity substantially impairs the contract. A buyer usually is not allowed to cancel a contract for only trivial defects in goods. For example, in a 1995 New York case, a manufacturer of potato chips rejected shipments of potatoes for failure to conform to the contract based on the color of the potatoes. The court held that the failure to conform substantially impaired the contract and justified the manufacturer’s refusal to accept the potatoes. The defect was not merely trivial. Hubbard v. UTZ Quality Foods, Inc., 903 F. Supp. 444 (W.D. N.Y. 1995).
Triviality is highly fact dependent. It will be tied to industry custom, past practices between the parties and the nature of the goods involved in the contract.
Right To “Cover”
The traditional measure of damages for a seller’s total breach of contract is the difference between the market price and the contract price of the goods. For example, in Tongish v. Thomas, 251 Kan. 728, 840 P.2d 471 (1992), the seller breached a contract to sell sunflower seeds to a buyer. The buyer recovered damages for the difference in the market price and the contract price. The UCC retains this rule, (UCC § 2-713(1)) but also allows an aggrieved buyer to “cover” by making a good faith purchase or contract to purchase substitute goods without unreasonable delay. UCC § 2-712(1). The buyer that covers is entitled to recover from the seller the difference between the cost of cover and the contract price. UCC § 2-712(1).
Most of the agricultural cases concerning “covering” focus on the difference between the goods purchased as cover and the goods called for in the contract (cover goods must be like-kind substitutes), and the timeframe within which cover was carried out (there must be no unreasonable delay). On the timeframe issue, a Nebraska case serves as a good illustration of how the courts analyze the issue. In, Trinidad Bean and Elevator Co. v. Frosh, 1 Neb. App 281 494 N.W.2d 347 (1992), a navy bean producer was able to terminate a contract without penalty, even though prices had doubled by harvest (the delivery date specified in the contract). The farmer notified the elevator in May, when market prices were identical to the forward price, that the farmer would not fulfill the contract later that fall. The court noted that under the UCC when a seller repudiates a forward contract before delivery is required, the buyer is entitled to the difference between the contract price and the price of the goods on the date of repudiation if it is commercially reasonable for the buyer to cover at that time. The court ruled that the elevator was not entitled to damages because it could have filled the contract at the forward contract price at the time it was notified of the seller’s contract repudiation.
Right Of Specific Performance
If the goods are unique, the buyer may obtain possession of the goods by court order. This is known as specific performance of the contract. Contracts for the sale of real estate or art work, for example, are contracts for the sale of unique goods and the buyer’s remedy is to have the contract specifically performed. Monetary damages can be awarded to a contracting party along with specific performance if it can be shown that damages resulted from the other party’s failure to render timely performance. See, e.g., Perry v. Green, 313 S.C. 250, 437 S.E.2d 150 (1993).
A buyer has a right before acceptance to inspect delivered goods at any reasonable place and time and in any reasonable manner. The reasonableness of the inspection is a question of trade usage and past practices between the parties. If the goods do not conform to the contract, the buyer may reject them all within a reasonable time and notify the seller, accept them all despite their nonconformance, or accept part (limited to commercial units) and reject the rest. Any rejection must occur within a reasonable time, and the seller must be notified of the buyer's unconditional rejection. For instance, in In re Rafter Seven Ranches LP v. C.H. Brown Co., 362 B.R. 25 (B.A.P. 10th Cir. 2007), leased crop irrigation sprinkler systems failed to conform to the contract. However, the buyer indicated an attempt to use the systems and did not unconditionally reject the systems until four months after delivery. As a result, the buyer was held liable for the lease payments involved because the buyer failed to make a timely, unconditional rejection.
The buyer’s right of revocation is not conditioned upon whether it is the seller or the manufacturer that is responsible for the nonconformity. UCC § 2-608. The key is whether the nonconformity substantially impairs the value of the goods to the buyer.
A buyer rejecting nonconforming goods is entitled to reimbursement from the seller for expenses incurred in caring for the goods. The buyer may also recover damages from the seller for non-delivery of suitable goods, including incidental and consequential damages. If the buyer accepts nonconforming goods, the buyer may deduct damages due from amounts owed the seller under the contract if the seller is notified of the buyer’s intention to do so. See, e.g., Gragg Farms and Nursery v. Kelly Green Landscaping, 81 Ohio Misc. 2d 34; 674 N.E.2d 785 (1996)
Timeframe for Exercising Remedies
The UCC allows buyers a reasonable time to determine whether purchased goods are fit for the purpose for which the goods were purchased, and to rescind the sale if the goods are unfit. Whether a right to rescind is exercised within a reasonable time is to be determined from all of the circumstances. UCC §1-204. The buyer’s right to inspect goods includes an opportunity to put the purchased goods to their intended use. Generally, the more severe the defect, the greater the time the buyer has to determine whether the goods are suitable to the buyer.
Statute Of Limitations
Actions founded on written contracts must be brought within a specified time, generally five to ten years. For unwritten contracts, actions generally must be brought within three to five years. In some states, however, the statute of limitations is the same for both written and oral contracts. A common limitation period is four years. Also, by agreement in some states, the parties may reduce the period of limitation for sale of goods but cannot extend it.
Most contractual transactions for agricultural goods function smoothly. However, when the seller breaches, it is helpful for the buyer to know the associated rights and liabilities of the parties.
Thursday, September 21, 2017
Understanding warranties with respect to contracts is important. One important aspect concerns their creation. There are various types of warranties that are recognized by the law. One type, an express warranty, generally results from explicit statements made by the seller and are the most common way of imposing liability on sellers of agricultural products. Once an express warranty has been made, it is very difficult to disclaim and, in general, an express warranty cannot be limited. Under the Uniform Commercial Code (UCC), an express warranty can be created in three ways. In each case, it is important that the event creating the express warranty occur at a time when the buyer could have relied upon it.
Today’s post looks at express warranties and ag contracts.
The first way an express warranty can be created is for the seller to make “ any affirmation of fact or promise” that relates to the goods and becomes part of the basis of the bargain. The warranty is that the goods will conform to the affirmation or promise. Oral or written statements concerning the goods that the buyer relies on in purchasing the goods can create an express warranty. In agricultural sales, express warranties usually involve the seller’s oral or written statements concerning the goods. If the statements become “part of the basis of the bargain,” that is, if they tend to induce the buyer to make the purchase, they may be considered express warranties. But, statements do not create an express warranty if they are statements of opinion, honestly held, or merely commendation of the goods (“puffing talk”). See, e.g., American Italian Pasta Co. v. New World Pasta Co., 371 F.3d 387 (8th Cir. 2004). For example, in a South Dakota case, a seller’s statement that allegedly defective seeds were “good seed” created no express warranty. Schmaltz v. Nissen, 431 N.W.2d 657 (S.D. 1988). Similarly, in a North Carolina case a seller’s statement that a herbicide would “do a good job” also did not create an express warranty. Tyson v. Ciba-Geigy Corp., 82 N.C. App. 626, 347 S.E.2d 473 (1986). Also, in a Wisconsin case, Fulton v. Vogt, 583 N.W.2d 673 (Wis. Ct. App. 1998), a broker’s statement that “there is no reason that this property cannot be a successful sod farm” did not create an express warranty.
However, at some point a statement moves from being merely an opinion and becomes an express warranty because the buyer reasonably understands that only an opinion is involved. For example, a statement by the seller that “all of my cows are bred,” or “all of my hay is of the highest quality” creates an express warranty that the goods (cows or hay) will conform to the particular affirmation or promise. See, e.g., Smith v. Bearfield, 950 S.W.2d 40 (Tenn. Ct. App. 1997); Reilly Construction Co., Inc. v. Bachelder, Inc., 863 N.W.2d 302 (Iowa Ct. App. 2016); Smith v. Penbridge Associates, Inc., 440 Pa. Super. 410, 655 A.2d 1015 (1995). Likewise, statements contained in product labels may be deemed to create express warranties.
An express warranty can also be created if the seller provides “any description of the goods” that becomes part of the basis of the bargain. The warranty is that the goods will conform to the description. Similarly, an express warranty can be created if the seller displays a “sample or model” of the goods. If the sample or model becomes part of the basis of the bargain, the warranty is that all of the goods will conform to the sample or model. See, e.g., Dakota Grain Co., Inc. v. Ehrmantrout, 502 N.W.2d 234 (N.D. 1993). The UCC creates a presumption that any sample or model is intended to become a basis of the bargain. UCC §2-313, Comment 6. To prevent a sample or model from creating an express warranty, the presumption must be rebutted by the seller. See, e.g., Sylvia Coal Co. v. Mercury & Coke Co., 151 W. Va. 818, 156 S.E.2d 1 (1967).
In general, express warranties are not subject to exclusion or modification and, once made, are very difficult to disclaim or limit. The UCC requires that “[w]ords or conduct relevant to the creation of an express warranty [be construed as consistent with] words or conduct tending to negate or limit warranty...wherever reasonable...[and] negation or limitation is inoperative to the extent that such construction is unreasonable. UCC § 2-316(1).
Disclaiming An Express Warranty
While it is difficult for an express warranty to be disclaimed once created, it may not be created if it doesn’t become a basis of the bargain between the parties. For example, the statement by a tractor seller that the tractor was in “excellent condition” and “field ready” did not become a basis of the bargain with the buyer because the buyer inspected the tractor, determined it was in need of some repairs and was familiar with tractors based on his experience.
Other Related Issues
Parties to sales contracts should exercise caution when reducing oral agreements to writing with the intent of making the written contract the final agreement between the parties. Oral statements may inadvertently be omitted from a later writing, but could have served as the basis of the bargain. As such, an express warranty could have been created orally, but eliminated by a subsequent writing omitting the relied upon oral statements. The best approach may be to ensure that all previously negotiated terms are included in any subsequent written agreement.
Any representations made by a company, its employees, consultants or agents pertaining to a product, whether oral or written, can potentially be treated as express warranties. Thus, an important part of any loss prevention program is to closely monitor any representations made and provide training concerning appropriate representations.
When entering into contracts for ag products, statements and conduct can create an express warranty. That can have legal implications. Care must be taken to make sure only what is intended to be warrantied occurs. It can be easy to create an express warranty, but difficult to disclaim. Take care when contracting.
Tuesday, August 22, 2017
On September 18, Washburn School of Law will be having its second annual CLE conference in conjunction with the Agricultural Economics Department at Kansas St. University. The conference, hosted by the Kansas Farm Bureau (KFB) in Manhattan, KS, will explore the legal, economic, tax and regulatory issue confronting agriculture. This year, the conference will also be simulcast over the web.
That’s my focus today – the September 18 conference in Manhattan, for practitioners, agribusiness professionals, agricultural producers, students and others.
Financial situation. Midwest agriculture has faced another difficult year financially. After greetings by Kansas Farm Bureau General Counsel Terry Holdren, Dr. Allen Featherstone, the chair of the ag econ department at KSU will lead off the day with a thorough discussion on the farm financial situation. While his focus will largely be on Kansas, he will also take a look at nationwide trends. What are the numbers for 2017? Where is the sector headed for 2018?
Regulation and the environment. Ryan Flickner, Senior Director, Advocacy Division, at the KFB will then follow up with a discussion on Kansas regulations and environmental laws of key importance to Kansas producers and agribusinesses.
Tax – part one. I will have a session on the tax and legal issues associated with the wildfire in southwest Kansas earlier this year – handling and reporting losses, government payments, gifts and related issues. I will also delve into the big problem in certain parts of Kansas this year with wheat streak mosaic and dicamba spray drift.
Weather. Mary Knapp, the state climatologist for Kansas, will provide her insights on how weather can be understood as an aid to manage on-farm risks. Mary’s discussions are always informative and interesting.
Crop Insurance. Dr. Art Barnaby, with KSU’s ag econ department, certainly one of the nation’s leading experts on crop insurance, will address the specific situations where crop insurance does not cover crop loss. Does that include losses caused by wheat streak mosaic? What about losses from dicamba drift?
Washburn’s Rural Law Program. Prof. Shawn Leisinger, the Executive Director of the Centers for Excellence at the law school (among his other titles) will tell attendees and viewers what the law school is doing (and planning to do) with respect to repopulating rural Kansas with well-trained lawyers to represent the families and businesses of agriculture. He will also explain the law school’s vision concerning agricultural law and the keen focus that the law school has on agricultural legal issues.
Succession Planning. Dr. Gregg Hadley with the KSU ag econ department will discuss the interpersonal issues associated with transitioning the farm business from one generation to the next. While the technical tax and legal issues are important, so are the personal family relationships and how the members of the family interact with each other.
Tax – part two. I will return with a second session on tax issues. This time my focus will be on hot-button issues at both the state and national level. What are the big tax issues for agriculture at the present time? There’s always a lot to talk about for this session.
Water. Prof. Burke Griggs, another member of our “ag law team” at the law school, will share his expertise on water law with a discussion on interstate water disputes, the role of government in managing scarce water supplies, and what the relationship is between the two. What are the implications for Kansas and beyond?
Producer panel. We will close out the day with a panel consisting of ag producers from across the state. They will discuss how they use tax and legal professionals as well as agribusiness professionals in the conduct of their day-to-day business transactions.
The Symposium is a collaborative effort of Washburn law, the ag econ department at KSU and the KFB. For lawyers, CPAs and other tax professionals, application has been sought for continuing education credit. The symposium promises to be a great day to interact with others involved in agriculture, build relationships and connections and learn a bit in the process.
We hope to see you either in-person or online. For more information on the symposium and how to register, check out the following link: http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/continuingeducation/businessofagriculture/index.html
August 22, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Monday, July 31, 2017
Today's post is a deviation from my normal posting on an aspect of agricultural law and tax that you can use in your practice or business. That’s because I have a new book that is now available that you might find useful as a handbook or desk reference. Thanks to West Academic Publishing, my new book “Agricultural Law in a Nutshell,” is now available. Today’s post promotes the new book and provides you with the link to get more information on how to obtain you copy.
The Nutshell is taken from my larger textbook/casebook on agricultural law that is used in classrooms across the country. Ten of those 15 chapters are contained in the Nutshell, including some of the most requested chapters from my larger book – contracts, civil liabilities and real property. Also included are chapters on environmental law, water law and cooperatives. Bankruptcy, secured transactions, and regulatory law round out the content, along with an introductory chapter. Not included in this Nutshell are the income tax, as well as the estate and business planning topics. Those remain in my larger book, and are updated twice annually along with the other chapters found there.
The Nutshell is designed as a concise summary of the most important issues facing agricultural producers, agribusinesses and their professional advisors. Farmers, ranchers, agribusinesses, legal advisors and students will find it helpful. It’s soft cover and easy to carry.
Rural Law Program
The Nutshell is another aspect of Washburn Law School’s Rural Law Program. This summer, the Program placed numerous students as interns with law firms in western Kansas. The feedback has been tremendous and some lawyers have already requested to be on the list to get a student for next summer. Students at Washburn Law can take numerous classes dealing with agricultural issues. We are also looking forward to our upcoming Symposium with Kansas State University examining the business of agriculture and the legal and economic issues that are the major ones at this time. That conference is set for Sept. 18, and a future post will address the aspects of that upcoming event.
You can find out more information about the Nutshell by clicking here: http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/agriculturallawnutshell/index.html
Tuesday, May 30, 2017
A basic rule of contract formation is that an offer for specific goods must be made and the offer must be accepted. The Uniform Commercial Code (UCC) as adopted by a particular state also helps define when an offer is accepted and a enforceable contract is formed.
In the context of an auction, what’s an offer and when does acceptance occur? That’s the focus of today’s post.
An auction sale contract is enforced, as is true of any other contract, according to its terms. In general, the owner of property sold at auction has the right to prescribe, within reasonable limits, the manner, conditions and terms of sale. That means a buyer, for example, will be bound by a written sale brochure provision stating that announcements made day of sale would control terms of sale.
Many agricultural goods are sold at auction. In an auction sale, the auctioneer is the seller’s agent. The auctioneer is selected by the seller, is remunerated by the seller, is to act in the seller’s interest and, to a degree, is subservient to the seller’s wishes. Until the auctioneer signals that the sale has been consummated, the auctioneer is exclusively the seller’s agent and functions in a principal-agent relationship. The auctioneer’s authority and liability depend upon the nature and extent of the agency conferred on the auctioneer by the seller. If the auctioneer exceeds the scope of authority, the auctioneer does not bind the owner of the property.
As an agent of the seller, the auctioneer must exercise ordinary care and skill in the performance of duties undertaken. An auctioneer may be held accountable to the seller for any secret profits received by the auctioneer as a result of the sale which are not disclosed to the seller. But, there is no auctioneer liability if the auctioneer never becomes a party to a contract with the bidder. See e.g., In re Wilson Freight Co., 30 B.R. 971 (Bankr. S.D. N.Y. 1983).
Offer and Acceptance
The fundamental rule at common law and under the UCC is that a bid at an auction constitutes an offer to buy. Other than for judicial sales, a contract is formed when the auctioneer signals acceptance by the fall of the auctioneer’s hammer or by some other act. If a bid is made while the hammer is falling in acceptance of a prior bid, the auctioneer has the discretion to reopen the bidding or declare the goods sold. A bidder may retract a bid until the auctioneer’s announcement of completion of the sale. UCC § 2-328(3). But a bidder’s retraction does not revive any previous bid. UCC § 2-328(3).
Auctions may be held either “with reserve” or “without reserve.” UCC § 2-328(4). These terms relate to the seller’s right to withdraw the goods if dissatisfied with the bids received. In an auction conducted “with reserve,” the seller or the auctioneer has the right to reject all bids if desired. In an auction conducted “without reserve,” the seller does not have the right to withdraw goods and the goods must be sold to the highest bidder even if only one bid is made. An article or lot cannot be withdrawn unless no bid is made within a reasonable time.
“With Reserve” Auction
Under the UCC, all auctions are presumed to be “with reserve” unless it is expressly announced to the contrary. For auctions conducted without reserve, the seller is committed to the sale once a bid has been entered, regardless of the level of bidding or the seller’s notion of the property’s true value. In a without reserve auction, the seller is the offeror, the bidder is the offeree and a contract is formed when a bid is made, subject only to a higher bid being made. For auctions conducted with reserve, a bid is an offer, and a contract is formed when the seller accepts the bid. Acceptance in a with-reserve auction is usually denoted by the fall of the auctioneer’s hammer, but UCC § 2-328(2) states that a sale may be completed “in any other customary manner.” This permits a seller to reject the highest bid even after the auctioneer’s hammer falls or the auctioneer otherwise ends the auction. See, e.g., Bradshaw v. Thomson, 454 F.2d 75 (6th Cir. 1972); Johnson v. Herman, No. CX-98-946, 1998 Minn. App. LEXIS 1390 (Minn. Ct. App. Dec. 22, 1998).
Seller Bidding on Own Goods?
At an auction, a seller may bid on the seller’s own goods only if the right to do so is reserved in advance. Except at a forced sale, if the auctioneer knowingly receives a bid on the seller’s behalf or the seller makes a bid, and notice has not been given that liberty for such bidding is reserved, the buyer may at the buyer’s option void the sale entirely or take the goods at the price of the last good-faith bid before the completion of the sale. UCC § 2-328(4). However, the seller must have an obligation to sell to the highest bidder before the bidder has a right to take the goods at the price of the last good-faith bid.
In some instances, the consequences of a seller not giving notice of an intention to bid can go beyond the bidder’s remedies of avoiding the contract or taking the goods at the price of the last good-faith bid. If the seller acts with a malicious intent to inflate the bids and injure other bidders, punitive damages may be awarded. See, e.g., Nevada National Leasing Co. v. Hereford, 36 Cal. 3d 146, 680 P.2d 1077 (1984).
What About Real Estate Auctions?
While Article 2 of the UCC does not apply to real estate sold at auction, some courts have applied by analogy the various rules of Article 2 to real estate auctions. For example, Well v. Schoeneweis, 101 Ill. App. 3d 254, 427 N.E.2d 1343 (1981) involved an action for specific performance of a sale of farmland brought by the highest bidder at a public auction against the seller. The court, while noting that Article 2 did not apply to real estate auctions, stated that the rules for real and personal property were identical and that the lower court did not err in relying on Article 2 for arriving at its judgment. Similarly, in Pitchfork Ranch Co. v. Bar TL,615 P.2d 541 (Wyo. 1980) the court noted that even though Article 2 did not apply to real estate sales, its auction sale provisions were useful.
As noted earlier, many agricultural goods are sold at auction. It is helpful to know the basic contract rules that apply in an auction context. So, enjoy the next farm auction you attend or conduct, and don’t get surprised by an unexpected rule application.
Wednesday, February 15, 2017
A question that I sometimes get involves an interesting aspect of farm lease law (although it’s probably not unique to agriculture) when the land is co-owned. The question is whether, when co-owned farmland is leased, must all of the co-owners agree to lease the property? On the flip side, must all of them agree to a termination of the lease? Those are interesting and important questions.
A few years ago, I discussed these issues with the former Dean of the University of Iowa College of Law who had written a bit on the matter in the 1960s. Today’s blog post is loosely based on that conversation (and an initial article that my staff attorney Erica Eckley, and myself authored in 2013 – the original article is available at www.calt.iastate.edu).
While most of the caselaw on the issue is relatively dated, there is a recent case from Ohio on point. In H & H Farms, Inc. v. Huddle, No. 3:13 CV 371, 2013 U.S. Dist. LEXIS 72501 (N.D. Ohio May 22, 2013), a married couple owned a tract of farmland. Over a period of time, they transferred undivided fractional interests in the farmland to a son – the defendant in the case. The wife eventually died, with the husband remaining in the farm home. At the time the case was filed, the son owned an undivided 94 percent interest in the farmland and his father owned 6 percent. The plaintiff had been the tenant on the property for a number of years and was the father’s grandson and nephew of the son. The father entered into an 11-year lease with the plaintiff for $150/year. However, the son did not consent to the lease and claimed that it was unenforceable and that the plaintiff would be trespassing if he attempted to farm the land. The plaintiff sought a declaratory judgment regarding the legal sufficiency of the lease, and the son filed a motion to dismiss. There was only one issue before the court - whether a legally plausible claim had been alleged.
The court addressed the legal standard for possession when tenants in common lease real estate. In Ohio, tenants in common each have a distinct title and right to enter upon the entire tract of real estate and take possession of it even if the ownership share is less than other tenants in common. If a tenant in common is not in possession of the real estate (i.e., an absentee landlord), that co-tenant is entitled to receive the reasonable rental value of the property from the co-tenant in possession consistent with the (absentee) co-tenant’s ownership interest. The court also noted that, under Ohio law, when an owner conveys property via a lease, the owner retains the fee simple interest in the property. Ohio courts have held that the possession of the tenant is synonymous with the lessor’s possession. Thus, tenants in common have a present possessory interest in the property. So, the father’s possession under the facts of the case was also the co-tenant’s possession.
The son’s motion to dismiss was based on the argument that a tenant in common cannot convey, encumber, or divest the rights of a co-tenant. The court disagreed because of the principle that a lease does not divest the possession of the land from the co-tenant. The court held that because the son’s possessory rights were not divested, there would be no need for him to approve the lease. Thus, the court declared that the plaintiff had stated a claim for which relief could be granted, and the motion to dismiss would not be granted.
The court, however, went on to state that it believed that when a six percent owner leases a farm to a third party for 11 years, it would be inequitable for the lease to remain with the land following a partition sale. But, that statement was merely dicta because it was not germane to the issue before the court and the motion to dismiss.
So, the tenant’s possessory interest is strong and cannot be disturbed. That also can mean that, absent a provision in a written lease, the landowner doesn’t have the right to hunt the leased ground absent the tenant’s permission. Of course, not allowing the tenant to hunt the ground will likely result in the tenant being terminated as soon as possible under state law.
Accounting for rents. Some states, such as Iowa have a statutory provision on this issue. Iowa Code § 557.16 explicitly states that a co-tenant in possession is liable for the reasonable rent to the co-tenant not in possession. See, e.g., Meier v. Johannsen, 47 N.W.2d 793, 242 Iowa 665 (1951).
Partition action. Because the tenant’s right of possession during the term of the lease is strong and cannot be interfered with, that can mean that once there is a valid lease, the tenant’s rights probably cannot be dislodged by a partition action. Similarly, property that is subject to a life estate cannot be partitioned. Redding v. Redding, 284 N.W. 167, 226 Iowa 327 (1939).
Termination of lease. In Dethlefs v. Carrier, 64 N.W.2d 272, 245 Iowa 786 (1954), a tenant had a written lease on 40 acres of farmland. The land was owned by a brother and sister as tenants in common and the lease was entered into between the tenant and the sister. The brother did not sign the lease. Upon the sister’s death, the brother became the sole owner, but did not follow state law to terminate the lease. The brother claimed that the sister’s death terminated not only her interest in the land, but also terminated the lease and eliminated the requirement that he give notice to terminate the lease. The court disagreed on the basis that, in such a situation, a presumption arises that the lease was made with the knowledge and consent of each co-tenant. There was no evidence to overcome the presumption
Similarly, the tenant’s possessory interest also is an issue when the landlord dies during the term of the lease and a growing crop exists. Entitlement to the crop is fairly clear when the landlord owns a fee simple interest in the leased land — the landlord’s heirs succeed to the landlord’s share of the crop. However, if the landlord owns less than a fee simple interest in the leased land (such as a life estate), the outcome may be different. The question is whether the deceased landlord’s estate or the holder of the remainder interest is entitled to the landlord’s share. In two 1977 Kansas cases, Finley v. McClure, 222 Kan. 637, 567 P.2d 851 (1977) and Rewerts v. Whittington, 1 Kan. App. 2d 557, 571 P.2d 58 (1977), the landlord owned only a life estate interest in certain farm ground and leased it on shares to a tenant. The landlord died before the growing wheat crop was harvested, and the court held that the landlord’s crop share was a personal asset of the landlord, entitling the landlord’s estate to the landlord’s crop share on the basis that growing crops are personal property. The remainderman takes nothing. The Nebraska Supreme Court has reached a similar conclusion. Heinold v. Siecke, 257 Neb. 413, 598 N.W.2d 58 (1999). However, the Colorado Supreme Court has held that the remainderman was entitled to the landlord’s share on the basis that the language in the deed creating the reserved life estate in the decedent had divested the estate of any rights to profits from the crops. Williams v. Stander, 143 Colo. 469, 354 P.2d 492 (1960).
Whenever farmland is owned by multiple parties or the ownership interests include a life estate, a partition action is likely not possible, but an absentee co-tenant may not be required to consent to a lease. It may be that a presumption arises that the lease was made with each co-tenant’s knowledge and consent. An issue also arises if the landlord owns less than a full fee simple interest. If you encounter these issues, consulting legal counsel would be a good idea.
Thursday, January 26, 2017
Many farmers and ranchers produce agricultural products under a production contract for someone else. These contracts generally provide for the raising of livestock, birds or crops with the farmer supplying the facilities and labor and the integrator supplying the livestock, birds or seeds and the feed and other supplies. The integrator generally retains title to the livestock, birds or crops and the contract generally establishes the amount paid to the farmer by the quantity and quality of the final product. Many of these contracts are forms drafted by the integrator, with no terms negotiated by the parties. That feature, by itself can raise an issue about fairness. Other issues can include the economic impact of production contracts.
But what about insurance? Does a farmer’s comprehensive general liability policy cover losses sustained by livestock produced under contract? The insurance angle is the focus of today’s post
As noted above, it’s not uncommon for livestock (particularly hogs) and poultry to be produced under contract. But, with livestock raised in a farmer’s barns that are owned by someone else, which party is responsible for any loss that occurs to the animals? The producer or the supplier? Typically, the party that has the control over the livestock (or poultry) produced under contract is the liable party. Indeed, production contracts commonly state that, even though the supplier owns the livestock/poultry, the producer is responsible for any death loss.
In that event, it is important that the producer has insurance coverage for any losses to the livestock or poultry. But, the standard farm comprehensive liability policy probably does not cover losses if that loss can in any way be attributed to the negligence of the producer to animals in the “care, custody or control” of the producer.
There are numerous cases involving the question of insurance coverage for livestock and poultry produced under contract. In many of those cases, the producer has even identified in advance that they needed additional coverage for livestock and/or poultry raised on contract and, as a result, has sought additional coverage. The additional coverage that is purchased is typically in the form of a “custom feeding endorsement” that says that if “the bodily injury or property damage arises from the activities of care or raising of livestock or poultry by an insured person for any other person or organization in accordance with a written or oral agreement…” the policy provides coverage. But, what does that language mean? One recent Iowa court decision illustrates the problem that faces contract growers.
In the Iowa case, Schulz Farm Enterprises, Inc. v. IMT Insurance, No. 15-1960, 2017 Iowa App. LEXIS 11 (Iowa Ct. App. Jan. 11, 2017), the plaintiff farming operation contracted with a company to custom feed hogs that the plaintiff owned at a third party’s site. The company was to take delivery of 50-pound hogs and raise and care for them until they reached 275 pounds. The plaintiff owned the hogs, but they were under the care of the company. The company contacted its insurance agent to get coverage for the custom feeding of the hogs, telling the agent that the company neither owned the hogs nor the facility in which they were raised, but that the company was responsible for the care and feeding of the hogs and building maintenance. The agent recommended a liability policy, and a custom feeding endorsement for an additional $118 annually. The custom feeding endorsement extended coverage for custom feeding and deleted exclusions in the liability policy that pertained to custom feeding. The ventilation system in the building failed when an electrical breaker tripped and 837 hogs died. The company filed a claim with the defendant for coverage, and the defendant denied coverage. The company then assigned its claim to the plaintiff who sued the defendant, the insurer.
The trial court granted the defendant’s motion for summary judgment. On appeal, the plaintiff claimed that because the endorsement deleted the exclusions pertaining to custom feeding, the death of the hogs produced in the custom feeding operation was a covered loss. However, the court determined that the custom feeding endorsement functioned only to remove the exclusion for bodily injury or property damage arising out of the insured’s performance of, or failure to perform, relating to the custom feeding of the hogs. In other words, by removing that exclusion, the company had coverage for bodily injury or property damage to others or the insured as a result of the custom feeding operation (i.e., damage caused by the hogs). But, the court determined that the endorsement did not eliminate the exclusion of coverage for damage to the hogs. Damage to the building caused by fire, smoke or explosion was a covered loss. The court reached this conclusion because the company paid only $118 annually for the endorsement which the court believed did not correspond to the additional risk of insuring the hogs. The court believed that the $118 annual charge did reflect the additional risk of damage caused by the hogs. The court provided no data for its conclusion (I don’t know whether there was data in the record) and no analysis of the endorsement language, instead merely citing a 2013 opinion of the state (IA) Supreme Court where the Court held that a custom feeding endorsement did not cover the loss of 535 feeder pigs that died due to suffocation.
Pointers for Producers
Contract growers seeking insurance coverage for the potential loss of the livestock or poultry produced under contract should take several common-sense steps to protect themselves. It’s a good thing to start with a general review of the comprehensive farm liability policy. Is there a custom farming exclusion? Is there exclusionary language involving “care, custody or control”? There likely is. If so, then a custom feeding endorsement to the policy should be acquired. But, that endorsement should contain language that specifically addresses both of those exclusions and specifically overrides them. So, it’s really important to know exactly what the policy covers and that it covers what it needs to cover. That is the case even if the owner of the livestock/poultry has coverage under their own policy. It’s even a good idea try to get a written opinion from the insurance company delineating the specific types of death loss events that are covered under the policy.
Uncovered losses for contract-produced livestock/poultry can result in significant financial problems for the producer. It’s not only the producer that could face severe financial hardship. A lender that provides financing for the producer is also at risk if that borrower defaults. So, both the producer and the lender have a vested interest in making sure that losses to the animals/poultry are covered. There are specific endorsements that exist that cover specific losses such as death loss of livestock by suffocation (such as when a building ventilation system fails). Indeed, in one case about four years ago, the court upheld an insurance company’s denial of a $24,075 claim filed by a small farming operation that was raising hogs on contract when the hogs died as a result of suffocation. After the litigation ended, the company started selling another endorsement covering livestock death by suffocation.
So, endorsements do exist that can cover the type and causes of losses that a producer needs coverage for. Producers, and their counsel, should be very careful to ensure that the coverage that is obtained is precisely what is needed.
Just another thing for contract grower to think (and worry) about.
Friday, January 6, 2017
Today we continue our look this week at the biggest developments in agricultural law and taxation during 2016. Out of all of the court rulings, IRS developments and regulatory issues, we are down to the top five developments in terms of their impact on ag producers, rural landowners and agribusinesses.
So, here are the top five (as I see them) in reverse order:
(5) Pasture Chiseling Activity Constituted Discharge of “Pollutant” That Violated the CWA. The plaintiff bought approximately 2,000 acres in northern California in 2012. Of that 2,000 acres, the plaintiff sold approximately 1,500 acres. The plaintiff retained an environmental consulting firm to provide a report and delineation map for the remaining acres and requested that appropriate buffers be mapped around all wetlands. The firm suggested that the plaintiff have the U.S. Army Corps of Engineers (COE) verify the delineations before conducting any grading activities. Before buying the 2,000 acres, the consulting firm had provided a delineation of the entire tract, noting that there were approximately 40 acres of pre-jurisdictional wetlands. The delineation on the remaining 450 acres of pasture after the sale noted the presence of intact vernal and seasonal swales on the property along with several intermittent and ephemeral drainages. A total of just over 16 acres of pre-jurisdictional waters of the United States were on the 450 acres – having the presence of hydric soils, hydrophytic vegetation and hydrology (1.07 acres of vernal pools; 4.02 acres of vernal swales; .82 acres of seasonal wetlands; 2.86 acres of seasonal swales and 7.40 acres of other waters of the United States). In preparation to plant wheat on the tract, the property was tilled at a depth of 4-6 inches to loosen the soil for plowing with care taken to avoid the areas delineated as wetlands. However, an officer with the (COE) drove past the tract and thought he saw ripping activity that required a permit. The COE sent a cease and desist letter and the plaintiff responded through legal counsel requesting documentation supporting the COE’s allegation and seeking clarification as to whether the COE’s letter was an enforcement action and pointing out that agricultural activities were exempted from the CWA permit requirement. The COE then provided a copy of a 1994 delineation and requested responses to numerous questions. The plaintiff did not respond. The COE then referred the matter to EPA for enforcement. The plaintiff sued the COE claiming a violation of his Fifth Amendment right to due process and his First Amendment right against retaliatory prosecution. The EPA refused the referral due to the pending lawsuit so the COE referred the matter to the U.S. Department of Justice (DOJ). The DOJ filed a counterclaim against the plaintiff for CWA violations.
The court granted the government’s motion on the due process claim because the cease and desist letter did not initiate any enforcement that triggered due process rights. The court also dismissed the plaintiff’s retaliatory prosecution claim. On the CWA claim brought by the defendant, the court determined that the plaintiff’s owner could be held liable as a responsible party. The court noted that the CWA is a strict liability statute and that the intent of the plaintiff’s owner was immaterial. The court then determined that the tillage of the soil causes it to be “redeposited” into delineated wetlands. The redeposit of soil, the court determined, constituted the discharge of a “pollutant” requiring a national pollution discharge elimination system (NPDES) permit. The court reached that conclusion because it found that the “waters” on the property were navigable waters under the CWA due to a hydrological connection to a creek that was a tributary of Sacramento River and also supported the federally listed vernal pool fairy shrimp and tadpole shrimp. Thus, a significant nexus with the Sacramento River was present. The court also determined that the farming equipment, a tractor with a ripper attachment constituted a point source pollutant under the CWA. The discharge was not exempt under the “established farming operation” exemption of 33 U.S.C. §1344(f)(1) because farming activities on the tract had not been established and ongoing, but had been grazed since 1988. Thus, the planting of wheat could not be considered a continuation of established and ongoing farming activities. Duarte Nursery, Inc. v. United States Army Corps of Engineers, No. 2:13-cv-02095-KJM-AC, 2016 U.S. Dist. LEXIS 76037 (E.D. Cal. Jun. 10, 2016).
(4) Prison Sentences Upheld For Egg Company Executives Even Though Government Conceded They Had No Knowledge of Salmonella Contamination. The defendant, an executive of a large-scale egg production company (trustee of the trust that owned the company), and his son (the Chief Operating Officer of the company) pled guilty as “responsible corporate officers” to misdemeanor violations of 21 U.S.C. §331(a) for introducing eggs that had been adulterated with salmonella into interstate commerce from the beginning of 2010 until approximately August of 2010. They each were fined $100,000 and sentenced to three months in prison. They appealed their sentences as unconstitutional on the basis that they had no knowledge that the eggs at issue were contaminated at the time they were shipped. They also claimed that their sentences violated Due Process and the Eighth Amendment insomuch as the sentences were not proportional to their “crimes.” They also claimed that incarceration for a misdemeanor offense would violate substantive due process.
The trial court determined that the poultry facilities were in poor condition, had not been appropriately cleaned, had the presence of rats and other rodents and frogs and, as a result, the defendant and his son either “knew or should have known” that additional salmonella testing was needed and that remedial and preventative measures were necessary to reduce the presence of salmonella. The appellate court agreed, finding that the evidence showed that the defendant and son were liable for negligently failing to prevent the salmonella outbreak and that 21 U.S.C. §331(a) did not have a knowledge requirement. The appellate court also did not find a due process violation. The defendant and son claimed that because they did not personally commit wrongful acts, and that due process is violated when prison terms are imposed for vicarious liability felonies where the sentence of imprisonment is only for misdemeanors. However, the court held that vicarious liability was not involved, and that 21 U.S.C. §331(a) holds a corporate officer accountable for failure to prevent or remedy “the conditions which gave rise to the charges against him.” Thus, the appellate court determined, the defendant and son were liable for negligently failing to prevent the salmonella outbreak. The court determined that the lack of criminal intent does not violate the Due Process Clause for a “public welfare offense” where the penalty is relatively small (the court believed it was), the defendant’s reputation was not “gravely” damaged (the court believed that it was not) and congressional intent supported the penalty (the court believed it did). The court also determined that there was no Eighth Amendment violation because “helpless” consumers of eggs were involved. The court also found no procedural or substantive due process violation with respect to the sentences because the court believed that the facts showed that the defendant and son “had reason to suspect contamination” and should have taken action to address the problem at that time (even though law didn’t require it).
The dissent pointed out that the government stipulated at trial that its investigation did not identify any corporate personnel (including the defendant and son) who had any knowledge that eggs sold during the relevant timeframe were contaminated with salmonella. The dissent also noted that the government conceded that there was no legal requirement for the defendant or corporation to comply with stricter regulations during the timeframe in issue. As such, the convictions imposed and related sentences were based on wholly nonculpable conduct and there was no legal precedent supporting imprisonment in such a situation. The dissent noted that the corporation “immediately, and at great expense, voluntarily recalled hundreds of millions of shell eggs produced” at its facilities when first alerted to the problem. As such, according to the dissent, due process was violated and the sentences were unconstitutional. United States v. Decoster, 828 F.3d 626 (8th Cir. 2016).
(3) The IRS and Self-Employment Tax. Two self-employment tax issues affecting farmers and ranchers have been in the forefront in recent years – the self-employment tax treatment of Conservation Reserve Program (CRP) payments and the self-employment tax implications of purchased livestock that had their purchase price deducted under the de minimis safe harbor of the capitalization and repair regulations. On the CRP issue, in 2014 the U.S. Court of Appeals ruled that CRP payments in the hands of a non-farmer are not subject to self-employment tax. The court, in Morehouse v. Comr., 769 F.3d 616 (8th Cir. 2014), rev’g, 140 T.C. 350 (2013), held the IRS to its historic position staked out in Rev. Rul. 60-32 that government payments attributable to idling farmland are not subject to self-employment tax when received by a person who is not a farmer. The court refused to give deference to an IRS announcement of proposed rulemaking involving the creation of a new Rev. Rul. that would obsolete the 1960 revenue ruling. The IRS never wrote the new rule, but continued to assert their new position on audit. The court essentially told the IRS to follow appropriate procedure and write a new rule reflecting their change of mind. In addition, the court determined that CRP payments are “rental payments” statutorily excluded from self-employment tax under I.R.C. §1402(a). Instead of following the court’s invitation to write a new rule, the IRS issued a non-acquiescence with the Eighth Circuit’s opinion. O.D. 2015-02, IRB 2015-41. IRS said that it would continue audits asserting their judicially rejected position, even inside the Eighth Circuit (AR, IA, MN, MO, NE, ND and SD).
In 2016, the IRS had the opportunity to show just how strong its opposition to the Morehouse decision is. A Nebraska non-farmer investor in real estate received a CP2000 Notice from the IRS, indicating CRP income had been omitted from their 2014 return. The CP2000 Notice assessed the income tax and SE Tax on the alleged omitted income. The CRP rental income was in fact included on the return, but it was included on Schedule E along with cash rents, where it was not subject to self-employment tax. The practitioner responded to the IRS Notice by explaining that the CRP rents were properly reported on Schedule E because the taxpayer was not a farmer. This put the matter squarely before the IRS to reject the taxpayer’s position based on the non-acquiescence. But, the IRS replied to the taxpayer’s response with a letter informing the taxpayer that the IRS inquiry was being closed with no change from the taxpayer’s initial position that reported the CRP rents for the non-farmer on Schedule E.
On the capitalization and repair issue, taxpayers can make a de minimis safe harbor election that allows amounts otherwise required to be capitalized to be claimed as an I.R.C. §162 ordinary and necessary business expense. This de minimis expensing election has a limit of $5,000 for taxpayers with an Applicable Financial Statement (AFS) and $2,500 for those without an AFS. Farmers will fall in the latter category. In both cases, the limit is applied either per the total on the invoice, or per item as substantiated by the invoice. One big issue for farmers and ranchers is how to report the income from the sale of purchased livestock that are held for productive use, such as breeding or dairy animals for which the de minimis safe harbor election was made allowing the full cost of the livestock to be deducted. It had been believed that because the repair regulations specify when the safe harbor is used, the sale amount is reported fully as ordinary income that is reported on Schedule F where it is subject to self-employment tax for a taxpayer who is sole proprietor farmer or a member of a farm partnership. In that event, the use of the safe harbor election would produce a worse tax result that would claiming I.R.C. §179 on the livestock.
An alternative interpretation of the repair regulations is that the self-employment tax treatment of the gain or loss on sale of assets for which the purchase price was deducted under the de minimis safe harbor is governed by Treas. Reg. §1.1402(a)-6(a). That regulation states that the sale of property is not subject to selfemployment tax unless at least one of two conditions are satisfied: (1) the property is stock in trade or other property of a kind which would properly be includible in inventory if on-hand at the close of the tax year; or (2) the property is held primarily for sale to customers in the ordinary course of a trade or business. Because purchased livestock held for dairy or breeding purposes do not satisfy the first condition, the question comes down to whether condition two is satisfied – are the livestock held primarily for sale to customers in the ordinary course of a trade or business? The answer to that question is highly fact-dependent. If the livestock whose purchase costs have been deducted under the de minimis rule are not held primarily for sale to customers in the ordinary course of the taxpayer’s trade or business, the effect of the regulation is to report the gain on sale on Part II of Form 4797. This follows Treas. Reg. §1.1402(a)-6(a) which bars Sec. 1231 treatment (which would result in the sale being reported on Part I of Form 4797). In that event, the income received on sale would not be subject to self-employment tax.
In 2016, the IRS, in an unofficial communication, said that the alternative interpretation is the correct approach. However, the IRS was careful to point out that the alternative approach is based on the assumptions that the livestock were neither inventoriable nor held for sale, and that those assumptions are highly fact dependent on a case-by case basis. The IRS is considering adding clarifying language to the Farmers’ Tax Guide (IRS Pub. 225) and/or the Schedule F Instructions.
(2) TMDLs and the Regulation of Ag Runoff. Diffused surface runoff of agricultural fertilizer and other chemicals into water sources as well as irrigation return flows are classic examples of nonpoint source pollution that isn’t discharged from a particular, identifiable source. A primary source of nonpoint source pollution is agricultural runoff. As nonpoint source pollution, the Clean Water Act (CWA) leaves regulation of it up to the states rather than the federal government. The CWA sets-up a “states-first” approach to regulating water quality when it comes to nonpoint source pollution. Two key court opinions were issued in 2016 where the courts denied attempts by environmental groups to force the EPA to create additional federal regulations involving Total Maximum Daily Loads (TMDLs). The states are to establish total maximum daily TMDLs for watercourses that fail to meet water quality standards after the application of controls on point sources. A TMDL establishes the maximum amount of a pollutant that can be discharged or “loaded” into the water at issue from all combined sources on a daily basis and still permit that water to meet water quality standards. A TMDL must be set “at a level necessary to implement water quality standards.” The purpose of a TMDL is to limit the amount of pollutants in a watercourse on any particular date. Two federal court opinions in 2016 reaffirmed the principle that regulation of nonpoint source pollution is left to the states and not the federal government.
In Conservation Law Foundation v. United States Environmental Protection Agency, No. 15-165-ML, 2016 U.S. Dist. LEXIS 172117 (D. R.I. Dec. 13, 2016), the plaintiff claimed that the EPA’s approval of the state TMDL for a waterbody constituted a determination that particular stormwater discharges were contributing to the TMDL being exceeded and that federal permits were thus necessary. The court, however, determined that the EPA’s approval of the TMDL did not mean that EPA had concluded that stormwater discharges required permits. The court noted that there was nothing in the EPA’s approval of the TMDL indicating that the EPA had done its own fact finding or that EPA had independently determined that stormwater discharges contributed to a violation of state water quality standards. The regulations simply do not require an NPDES permit for stormwater discharges to waters of the United States for which a TMDL has been established. A permit is only required when, after a TMDL is established, the EPA makes a determination that further controls on stormwater are needed.
In the other case, Gulf Restoration Network v. Jackson, No. 12-677 Section: “A” (3), 2016 U.S. Dist. LEXIS 173459 (E.D. La. Dec. 15, 2016), numerous environmental groups sued the EPA to force them to impose limits on fertilizer runoff from farm fields. The groups claimed that many states hadn’t done enough to control nitrogen and phosphorous pollution from agricultural runoff, and that the EPA was required to mandate federal limits under the Administrative Procedure Act – in particular, 5 U.S.C. §553(e) via §303(c)(4) of the CWA. Initially, the groups told the EPA that they would sue if the EPA did not write the rules setting the limits as requested. The EPA essentially ignored the groups’ petition by declining to make a “necessity determination. The groups sued and the trial court determined that the EPA had to make the determination based on a 2007 U.S. Supreme Court decision involving the Clean Air Act (CAA). That decision was reversed on appeal on the basis that the EPA has discretion under §303(c)(4)(B) of the CWA to decide not to make a necessity determination as long as the EPA gave a “reasonable explanation” based on the statute why it chose not to make any determination. The appellate court noted that the CWA differed from the CAA on this point. On remand, the trial court noted upheld the EPA’s decision not to make a necessity determination. The court noted that the CWA gives the EPA “great discretion” when it comes to regulating nutrients, and that the Congressional policy was to leave regulation of diffused surface runoff up to the states. The court gave deference to the EPA’s “comprehensive strategy of bringing the states along without the use of federal rule making…”.
Also, in 2016 the U.S. Supreme Court declined to review a decision of the U.S. Court of Appeals for the Third Circuit which had determined in 2015 that the EPA had acted within its authority under 33 U.S.C. §1251(d) in developing a TMDL for the discharge of nonpoint sources pollutants into the Chesapeake Bay watershed. American Farm Bureau, et al. v. United States Environmental Protection Agency, et al., 792 F.3d 281 (3d Cir. 2015), cert. den., 136 S. Ct. 1246 (2016).
(1) The Election of Donald Trump as President and the Potential Impact on Agricultural and Tax Policy. Rural America voted overwhelmingly for President-elect Trump, and he will be the President largely because of the sea of red all across the country in the non-urban areas. So, what can farmers, ranchers and agribusinesses anticipate the big issues to be in the coming months and next few years and the policy responses? It’s probably reasonable to expect that same approach will be applied to regulations impacting agriculture. Those with minimal benefit and high cost could be eliminated or retooled such that they are cost effective. Overall, the pace of the generation of additional regulation will be slowed. Indeed, the President-elect has stated that for every new regulation, two existing regulations have to be eliminated.
Ag policy. As for trade, it is likely that trade agreements will be negotiated on a much more bi-lateral basis – the U.S. negotiating with one other country at a time rather than numerous countries. The President-elect is largely against government hand-outs and is big on economic efficiency. That bodes well for the oil and gas industry (and perhaps nuclear energy). But, what about less efficient forms of energy that are heavily reliant on taxpayer support? Numerous agricultural states are heavily into subsidized forms of energy with their state budgets littered with numerous tax “goodies” for “renewable” energy.” However, the President-elect won those states. So, does that mean that the federal subsidies for ethanol and biodiesel will continue. Probably. The Renewable Fuels Standard will be debated in 2017, but will anything significant happen? Doubtful. It will continue to be supported, but I expect it to be reviewed to make sure that it fits the market. Indeed, one of the reasons that bio-mass ethanol was reduced so dramatically in the EPA rules was that it couldn’t be produced in adequate supplies. What about the wind energy production tax credit? What about the various energy credits in the tax code? Time will tell, but agricultural interests should pay close attention.
The head of the Senate Ag Committee will be Sen. Roberts from Kansas. As chair, he will influence the tone of the debate of the next farm bill. I suspect that means that the farm bill will have provisions dealing with livestock disease and biosecurity issues. Also, I suspect that it will contain significant provisions crop insurance programs and reforms of existing programs. The House Ag Committee head will be Rep. Conaway from Texas. That could mean that cottonseed will become an eligible commodity for Agricultural Risk Coverage (ARC) and Price Loss Coverage (PLC). It may also be safe to assume that for the significant Midwest crops (and maybe some additional crops) their reference prices will go up. Also, it now looks as if the I.R.C. §179 issue involving the income limitation for qualification for farm program payments (i.e., the discrepancy of the treatment between S corporations and C corporations) will be straightened out. Other federal agencies that impact agriculture (EPA, Interior, FDA, Energy, OSHA) can be expected to be more friendly to agriculture in a Trump Administration.
Tax policy. As for income taxes, it looks at this time that the Alternative Minimum Tax might be eliminated, as will the net investment income tax that is contained in Obamacare. Individual tax rates will likely drop, and it might be possible that depreciable assets will be fully deductible in the year of their purchase. Also, it looks like the corporate tax rate will be cut as will the rate applicable to pass-through income. As for transfer taxes, President-elect Trump has proposed a full repeal of the federal estate tax as well as the federal gift tax. Perhaps repeal will be effective January 1, 2017, or perhaps it will be put off until the beginning of 2018. Or, it could be phased-in over a certain period of time. Also, while it appears at the present time that any repeal would be “permanent,” that’s not necessarily a certainty. Similarly, it’s not known whether the current basis “step-up” rule would be retained if the estate tax is repealed. That’s particularly a big issue for farmers and ranchers. It will probably come down to a cost analysis as to whether step-up basis is allowed. The President-elect has already proposed a capital gains tax at death applicable to transfers that exceed $10 million (with certain exemptions for farms and other family businesses). Repeal of gift tax along with repeal of estate tax has important planning implications. There are numerous scenarios that could play out. Stay tuned, and be ready to modify existing plans based on what happens. Any repeal bill would require 60 votes in the Senate to avoid a filibuster unless repeal is done as part of a reconciliation bill. Also, without being part of a reconciliation bill, any repeal of the federal estate tax would have to “sunset” in ten years.
January 6, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Wednesday, January 4, 2017
This week we are looking at the biggest developments in agricultural law and taxation for 2016. On Monday, we highlighted the important developments that just missed being in the top ten. Today we take a look at developments 10 through six. On Friday, we will look at the top five.
- Court Obscures Rational Basis Test To Eliminate Ag Exemption From Workers' Compensation Law. While this is a state Supreme Court decision, its implications are significant. Most, if not all, states have a statutory exemption from workers’ compensation for employers that are engaged in agriculture. The statutory exemption varies in scope from state to state and, of course, an employer that is otherwise exempt can choose to be covered by the statute and offer workers’ compensation benefits to employees. In this case, the plaintiffs claimed that their on-the-job injuries should be covered under the state (NM) workers' compensation law. One plaintiff tripped while picking chile and fractured her left wrist. The other plaintiff was injured while working in a dairy when he was head-butted by a cow and pushed up against a metal door causing him to fall face-first into a concrete floor and sustain neurological damage. The plaintiffs' claims for workers' compensation benefits were dismissed via the exclusion from the workers' compensation system for employers. On appeal, the appellate court reversed. Using rational basis review (the standard most deferential to the constitutionality of the provision at issue), the court interpreted Sec. 52-1-6(A) of the New Mexico Code as applying to the primary job duties of the employees (as opposed to the business of the employer and the predominant type of employees hired), and concluded the distinction was irrational and lacked any rational purpose. The appellate court noted that the purpose of the law was to provide "quick and efficient delivery" of medical benefits to injured and disabled workers. Thus, the court determined that the exclusion violated the constitutional equal protection guarantee. The court further believed that the exclusion for workers that cultivate and harvest (pick) crops, but the inclusion of workers that perform tasks associated with the processing of crops was a distinction without a difference. The appellate court made no mention that the highest court in numerous other states had upheld a similar exclusion for agriculture from an equal protection constitutional challenge. On further review, the state Supreme Court affirmed. The Court determined that there was nothing to distinguish farm and ranch laborers from other ag employees and that the government interest of cost savings, administrative convenience and similar interests unique to agriculture were not rationally related to a legitimate government interest. The court determined that the exclusion that it construed as applying to ag laborers was arbitrary discrimination. A dissenting judge pointed out that the legislature’s decision to allow employers of farm and ranch laborers to decide for themselves whether to be subject to workers’ compensation or opt out and face tort liability did not violate any constitutionally-protected right. The dissent noted that such ability to opt out was a legitimate statutory scheme that rationally controlled costs for New Mexico farms and ranches, and that 29 percent of state farms and ranches had elected to be covered by workers’ compensation. The dissent also noted that the majority’s opinion would have a detrimental economic impact on small, economically fragile farms in New Mexico by imposing an additional economic cost of $10.5 million annually (as projected by the state Workers’ Compensation Administration). On this point, the dissent further pointed out that the average cost of a claim was $16,876 while the average net farm income for the same year studied was $19,373. The dissent further concluded that the exemption for farming operations was legitimately related to insulating New Mexico farm and ranches from additional costs. In addition, the dissent reasoned that the majority misapplied the rational basis analysis to hold the act unconstitutional as many other state courts and the U.S. Supreme Court had held comparable state statutes to satisfy the rational basis test. The dissent pointed out forcefully that the exclusion applied to employers and that the choice to be covered or not resided with employers who predominately hired ag employees. As such there was no disparate treatment between ag laborers and other agricultural workers. Rodriguez, et al. v. Brand West Dairy, et al., 378 P.3d 13 (N.M. Sup. Ct. 2016), aff’g., 356 P.3d 546 (N.M. Ct. App. 2015).
- 9. COE Jurisdictional Determination Subject to Court Review. The plaintiff, a peat moss mining company, sought the approval of the Corps of Engineers (COE) to harvest a swamp (wetland) for peat moss to use in landscaping projects. The COE issued a jurisdictional determination that the swamp was a wetland subject to the permit requirements of the Clean Water Act (CWA). The plaintiff sought to challenge the COE determination, but the trial court ruled for the COE, holding that the plaintiff had three options: (1) abandon the project; (2) seek a federal permit costing over $270,000; or (3) proceed with the project and risk fines of up to $75,000 daily and/or criminal sanctions including imprisonment. On appeal, the court unanimously reversed, strongly criticizing the trial court's opinion. Based on Sackett v. Environmental Protection Agency, 132 S. Ct. 1367 (2012), the court held that COE Jurisdictional Determinations constitute final agency actions that are immediately appealable in court. The court noted that to hold elsewise would allow the COE to effectively kill the project without any determination of whether it's position as to jurisdiction over the wetland at issue was correct in light of Rapanos v. United States, 547 U.S. 715 (U.S. 2006). The court noted that the COE had deliberately left vague the "definitions used to make jurisdictional determinations" so as to expand its regulatory reach. While the COE claimed that the jurisdictional determination was merely advisory and that the plaintiff had adequate ways to contest the determination, the court determined that such alternatives were cost prohibitive and futile. The court stated that the COE's assertion that the jurisdictional determination (and the trial court's opinion) was merely advisory ignored reality and had a powerful coercive effect. The court held that the Fifth Circuit, which reached the opposition conclusion with respect to a COE Jurisdictional Determination in Belle Co., LLC v. United States Army Corps. of Engineers, 761 F.3d 383 (5th Cir. 2014), cert. den., 83 U.S.L.W. 3291 (U.S. Mar. 23, 2015), misapplied the Supreme Court's decision in Sackett. Hawkes Co., Inc., et al. v. United States Army Corps of Engineers, 782 F.3d 984 (8th Cir. 2015), rev'g., 963 F. Supp. 2d 868 (D. Minn. 2013). In a later decision, the court denied a petition to rehear the case en banc and by the panel. Hawkes Co., Inc., et al. v. United States Army Corps of Engineers, No. 13-3067, 2015 U.S. App. LEXIS 11697 (8th Cir. Jul. 7, 2015). In December of 2015, the U.S. Supreme Court agreed to hear the case and affirmed the Eighth Circuit on May 31, 2016. The Court, in a unanimous opinion, noted that the memorandum of agreement between the EPA and the Corps established that jurisdictional determinations are “final actions” that represent the Government’s position, are binding on the Government in any subsequent Federal action or litigation involving the position taken in the jurisdictional determination. When the landowners received an “approved determination” that meant that the Government had determined that jurisdictional waters were present on the property due to a “nexus” with the Red River of the North, located 120 miles away. As such, the landowners had the right to appeal in Court after exhausting administrative remedies and the Government’s position take in the jurisdictional determination was judicially reviewable. Not only did the jurisdictional determination constitute final agency action under the Administrative Procedure Act, it also determined rights or obligations from which legal consequences would flow. That made the determination judicially reviewable. United States Army Corps of Engineers v. Hawkes Company, 136 S. Ct. 1807 (2016).
- 8. Proposed Regulations Under I.R.C. §2704. In early August, the IRS issued new I.R.C. §2704 regulations that could seriously impact the ability to generate minority interest discounts for the transfer of family-owned entities. Prop. Reg. – 163113-02 (Aug. 2, 2016). The proposed regulations, if adopted in their present form, will impose significant restrictions on the availability of valuation discounts for gift and estate tax purposes in a family-controlled environment. Prop. Treas. Regs. §§25.2704-1; 25.2704-4; REG- 163113-02 (Aug. 2, 2016). They also redefine via regulation and thereby overturn decades of court decisions honoring the well-established willing-buyer/willing-seller approach to determining fair market value (FMV) of entity interests at death or via gift of closely-held entities, including farms and ranches. The proposed regulations would have a significant impact on estate, business and succession planning in the agricultural context for many agricultural producers across the country and will make it more difficult for family farm and ranch businesses to survive when a family business partner dies. Specifically, the proposed regulations treat transfer within three years of death as death-bed transfers, create new “disregarded restrictions” and move entirely away from examining only those restrictions that are more restrictive than state law. As such, the proposed regulations appear to exceed the authority granted to the Treasury by Congress to promulgate regulations under I.R.C. §2704 and should be withdrawn. A hearing on the regulations was held in early December.
- 7. Capitalization Required For Interest and Real Property Taxes Associated with Crops Having More Than Two-Year Preproductive Period. The petitioner (three partnerships) bought land that they planned to use for growing almonds. They financed the purchase by borrowing money and paying interest on the debt. They then began planting almond trees. They deducted the interest and property taxes on their returns. The IRS objected to the deduction on the basis that the interest and taxes were indirect costs of the “production of real property” (i.e., the almonds trees that were growing on the land. The Tax Court agreed with the IRS noting that I.R.C. §263A requires the capitalization of certain costs and that those costs include the interest paid to buy the land and the property taxes paid on the land attributable to growing crops and plants where the preproductive period of the crop or plant exceeds two years. I.R.C. §263A(f)(1) states that “interest is capitalized where (1) the interest is paid during the production period and (2) the interest is allocable to real property that the taxpayer produced and that has a long useful life, an estimated production period exceeding two years, or an estimated production period exceeding one year and a cost exceeding $1 million.” The corresponding regulation, the court noted, requires that the interest be capitalized under the avoided cost method. The court also noted that the definition of “real property produced by the taxpayer for the taxpayer’s use in a trade or business or in an activity conducted for profit” included “land” and “unsevered natural products of the land” and that “unsevered natural products of the land” general includes growing crops and plants where the preproductive period of the crop or plant exceeds two years. Because almond trees have a preproductive period exceeding two years in accordance with IRS Notice 2000-45, and because the land was “necessarily intertwined” with the growing of the almond trees, the interest and tax cost of the land is a necessary and indispensable part of the growing of the almond trees and must be capitalized. Wasco Real Properties I, LLC, et al. v. Comr., T.C. Memo. 2016-224.
6. No Recapture of Prepaid Expenses Deducted in Prior Year When Surviving Spouse Claims Same Deduction in Later Year. The decedent, a materially participating Nebraska farmer, bought farm inputs in 2010 and deducted their cost on his 2010 Schedule F. He died in the spring of 2011 before using the inputs to put the spring 2011 crop in the ground. Upon his death, the inputs were included in the decedent’s estate at their purchase price value and then passed to a testamentary trust for the benefit of his wife. The surviving spouse took over the farming operation, and in the spring of 2011, took a distribution of the inputs from the trust to plant the 2011 crops. For 2011, two Schedule Fs were filed. A Schedule F was filed for the decedent to report the crop sales deferred to 2011, and a Schedule F was filed for the wife to report the crops sold by her in 2011 and claim the expenses of producing the crop which included the amount of the inputs (at their date-of-death value which equaled their purchase price) that had been previously deducted as prepaid inputs by the husband on the couple’s joint 2010 return. The IRS denied the deduction on the basis that the farming expense deduction by the surviving spouse was inconsistent with the deduction for prepaid inputs taken in the prior year by the decedent and, as a result, the “tax benefit rule” applied. The court disagreed, noting that the basis step-up rule of I.R.C. §1014 allowed the deduction by the surviving spouse which was not inconsistent with the deduction for the same inputs in her deceased husband’s separate farming business. The court also noted that inherited property is not recognized as income by the recipient, which meant that another requisite for application of the tax benefit rule did not apply. Estate of Backemeyer v. Comr., 147 T.C. No. 17 (2016).
Those were developments ten through six, at least as I see it for 2016. On Friday, we will list the five biggest developments for 2016.
January 4, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Monday, January 2, 2017
This week we will be taking a look at what I view as the most significant developments in agricultural law and agricultural taxation during 2016. There were many important happenings in the courts, the IRS and with administrative agencies that have an impact on farm and ranch operations, rural landowners and agribusinesses. What I am writing about this week are those developments that will have the biggest impact nationally. Certainly, there were significant state developments, but they typically will not have the national impact of those that result from federal courts, the IRS and federal agencies.
It’s tough to get it down to the ten biggest developments of the year, and I do spend considerable time going sorting through the cases and rulings get to the final cut. Today we take a quick look at those developments that I felt were close to the top ten, but didn’t quite make the list. Later this week we will look at those that I feel were worthy of the top ten. Again, the measuring stick is the impact that the development has on the ag sector as a whole.
Almost, But Not Quite
Those developments that were the last ones on the chopping block before the final “top ten” are always the most difficult to determine. But, as I see it, here they are (in no particular order):
- HRA Relief for Small Businesses. Late in 2016, the President signed into law H.R. 6, the 21st Century Cures Act. Section 18001 of the legislation repeals the restrictions included in Obamacare that hindered the ability of small businesses (including farming operations) to use health reimbursement arrangements (HRAs). The provision allows a "small employer" (defined as one with less than 50 full-time employees who does not offer a group health plan to any employees) to offer a health reimbursement arrangement (HRA) that the employer funds to reimburse employees for qualified medical expenses, including health insurance premiums. If various technical rules are satisfied, the basic effect of the provision is that, effective for plan years beginning after December 31, 2016, such HRAs will no longer be a violation of Obamacare's market "reforms" that would subject the employer to a penalty of $100/day per affected person). It appears that the relief also applies to any plan year beginning before 2017, but that is less clear. Of course, all of this becomes moot if Obamacare is repealed in its entirety in 2017.
- More Obamacare litigation. In a somewhat related development, in May the U.S. District Court for the District of Columbia ruled in United States House of Representatives v. Burwell, No. 14-1967 (RMC), 2016 U.S. Dist. LEXIS 62646 (D. D.C. May, 12, 2016), that the Obama Administration did not have the power under the Constitution to spend taxpayer dollars on "cost sharing reduction payments" to insurers without a congressional appropriation. The Obama Administration had argued that congressional approval was unnecessary because the funds were guaranteed by the same section of Obamacare that provides for the premium assistance tax credit that is designed to help offset the higher cost of health insurance as a result of the law. However, the court rejected that argument and enjoined the use of unappropriated funds due insurers under the law. The court ruled that the section at issue only appropriated funds for tax credits and that the insurer payments required a separate congressional appropriation. The court stayed its opinion pending appeal. A decision on appeal is expected in early 2017, but would, of course, be mooted by a repeal of Obamacare.
- Veterinary Feed Directive Rule. The Food and Drug Administration revised existing regulations involving the animal use of antibiotics that are also provided to humans. The new rules arose out of a belief of bacterial resistance in humans to antibiotics even though there is no scientific proof that antibiotic resistant bacterial infections in humans are related to antibiotic use in livestock. As a result, at the beginning of 2017, veterinarians will be required to provide a “directive” to livestock owners seeking to use or obtain animal feed products containing medically important antimicrobials as additives. A “directive” is the functional equivalent of receiving a veterinarian’s prescription to use antibiotics that are injected in animals. 21 C.F.R. Part 558.
- Final Drone Rules. The Federal Aviation Administration (FAA) issued a Final Rule on UASs (“drones”) on June 21, 2016. The Final Rule largely follows the Notice of Proposed Rulemaking issued in early 2015 (80 Fed. Reg. 9544 (Feb. 23, 2015)) and allows for greater commercial operation of drones in the National Airspace System. At its core, the Final Rule allows for increased routine commercial operation of drones which prior regulations required commercial users of drones to make application to the FAA for permission to use drones - applications the FAA would review on a case-by-case basis. The Final Rule (FAA-2015-0150 at 10 (2016)) adds Part 107 to Title 14 of the Code of Federal Regulations and applies to unmanned “aircraft” that weigh less than 55 pounds (that are not model aircraft and weigh more than 0.5 pounds). The Final Rule became effective on August 29, 2016.
- County Bans on GMO Crops Struck Down. A federal appellate court struck down county ordinances in Hawaii that banned the cultivation and testing of genetically modified (engineered) organisms. The court decisions note that either the state (HI) had regulated the matter sufficiently to remove the ability of counties to enact their own rules, or that federal law preempted the county rules. Shaka Movement v. County of Maui, 842 F.3d 688 (9th Cir. 2016) and Syngenta Seeds, Inc. v. County of Kauai, No. 14-16833, 2016 U.S. App. LEXIS 20689 (9th Cir. Nov. 18, 2016).
- Insecticide-Coated Seeds Exempt from EPA Regulation Under FIFRA. A federal court held that an existing exemption for registered pesticides applied to exempt insecticide-coated seeds from separate regulation under the Federal Insecticide, Rodenticide Act which would require their separate registration before usage. Anderson v. McCarthy, No. C16-00068, WHA, 2016 U.S. Dist. LEXIS 162124 (N.D. Cal. Nov. 21, 2016).
- Appellate Court to Decide Fate of EPA’s “Waters of the United States” Final Rule. The U.S. Court of Appeals for the Sixth Circuit ruled that it had jurisdiction to hear a challenge to the EPA’s final rule involving the scope and effect of the rule defining what waters the federal government can regulate under the Clean Water Act. Murray Energy Corp. v. United States Department of Defense, 817 F.3d 261 (6th Cir. 2016).
- California Proposition Involving Egg Production Safe From Challenge. California enacted legislation making it a crime to sell shelled eggs in the state (regardless of where they were produced) that came from a laying hen that was confined in a cage not allowing the hen to “lie down, stand up, fully extend its limbs, and turn around freely.” The law was challenged by other states as an unconstitutional violation of the Commerce Clause by “conditioning the flow of goods across its state lines on the method of their production” and as being preempted by the Federal Egg Products Inspection Act. The trial court determined that the plaintiffs lacked standing and the appellate court affirmed. Missouri v. Harris, 842 F.3d 658 (9th Cir. 2016).
- NRCS Properly Determined Wetland Status of Farmland. The Natural Resource Conservation Service (NRCS) determined that a 0.8-acre area of a farm field was a prairie pothole that was a wetland that could not be farmed without the plaintiffs losing farm program eligibility. The NRCS made its determination based on “color tone” differences in photographs, wetland signatures and a comparison site that was 40 miles away. The court upheld the NRCS determination as satisfying regulatory criteria for identifying a wetland and was not arbitrary, capricious or contrary to the law. Certiorari has been filed with the U.S. Supreme Court asking the court to clear up a conflict between the circuit courts of appeal on the level of deference to be given federal government agency interpretive manuals. Foster v. Vilsack, 820 F.3d 330 (8th Cir. 2016).
- Family Limited Partnerships (FLPs) and the “Business Purpose” Requirement. In 2016, there were two cases involving FLPs and the retained interest section of the Code. That follows one case late in 2015 which was the first one in over two years. In Estate of Holliday v. Comr., T.C. Memo. 2016-51, the court held that the transfers of marketable securities to an FLP two years before the transferor’s death was not a bona fide sale, with the result that the decedent (transferor) was held to have retained an interest under I.R.C. §2036(a) and the FLP interest was included in the estate at no discount. Transferring marketable securities to an FLP always seems to trigger issues with the IRS. In Estate of Beyer v. Comr., T.C. Memo. 2016-183, the court upheld the assessment of gift and estate tax (and gift tax penalties) with respect to transfers to an FLP because the court determined that every benefit allegedly springing from the FLP could have been accomplished by trusts and other arrangements. There needs to be a separate non-tax business purpose to the FLP structure. A deeper dive into the court opinions also points out that the application of the “business purpose” requirement with respect to I.R.C. §2036 is very subjective. It’s important to treat the FLP as a business entity, not put personal assets in the FLP, or at least pay rent for their use, and follow all formalities of state law.
These are the developments that were important, but just not big enough in terms of their overall impact on the ag sector to make the list of the “top ten.” The next post will take a look at developments ten through six.
January 2, 2017 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Thursday, October 6, 2016
In the 1990s when ag production contracts were more in the ag law news than they are now, I remember visiting with Washburn Law School Professor Jim Wadley on the subject because I was getting numerous calls from farmers about perceived (and real) contract abuses. I wanted Jim’s thoughts on the issue so that I could respond to the inquiries and also because I was beginning my research for what would become my college/law school text on agricultural law. Jim was a big help in framing the issues for me. He was working on a book on Kansas ag law at the time with Sam Brownback (now the Governor of Kansas) and many of his thoughts ended up in his book. I dusted off my notes from that original conversation the other day and also revisited the topic in the contracts chapter of my book after getting a couple of new emails on the issue. So, today’s blog post focuses on the issue and also illustrates how relevant Jim’s thoughts from two decades ago remain.
Crop farmers and livestock producers often enter into contracts with a vertically integrated processor to raise animals for the processor that meet a particular quality requirement. These contracts are known as “production contracts.” They are different from forward contracts. Forward contracts are entered into for tax and marketing purposes, but production contracts largely form the entire foundational basis for the farming operation. A producer may enter into a production contract if there is a belief that the market for his production isn’t stable either in terms of buyers or in terms of price.
Pros and Cons
So, what are the primary advantages and disadvantages of a production contract? They do tend to reduce the capital investment requirements, and economic returns tend to be more predictable. Similarly, less operating capital is required, and better use of available labor and facilities might result. Conversely, the big disadvantages include the producer losing control over management, and a limit on the return from the operation. Also, the facility use is not guaranteed and economic returns may not equal facility costs or replacement costs. Another possible negative factor is that the producer does not own the animals, but the producer could be liable for any death loss.
Many ag production contracts authorize the processor or an agent to inspect the producer’s facilities at any time and require any changes the processor deems necessary. Those changes can include such things as material changes in the facility (without any assurance or guarantee of a future contract); processor control over feeding rations and medication; and delivery at a particular time irrespective of market price at that time.
When it comes to a production contract, what should a producer know? The following are suggested items that a producer should have information on before the contract is signed:
- Which party is responsible for the cost of production inputs such as feed, medicine, transportation, facility upkeep, water, labor and utilities, and marketing costs;
- The extent of the processor’s right to enter and inspect the premises and require changes in the facilities;
- The extent of the producer’s control over the health and quality of the animals that the processor delivers to the producer;
- The extent of the producer’s control of the daily activity of raising the animals and whether there will be field employees of the processor who will serve as supervisors of the producer’s activity;
- How payment is to be made? There are various ways that the economic structure can be set up - flat fee per animal; the number of days that it will take to raise the animals; the final weight of the animals; a guaranteed price that is tied to cost per pound; or a profit-sharing arrangement;
- The manner in which marketing decisions are to be made and the party that is to make them;
- The circumstances and conditions under which the contract may be broken and the resulting consequences if there is a breach;
- The party that controls the quality and quantity of feed;
- Whether the processor will receive any liens on the property of the producer as a result of the contract.
Broder Economic Concerns
Clearly, very few farmers have anywhere near the level of bargaining power that the contracting firm (such as a seed supplier, livestock supplier or meatpacker) has. Consequently, the contracting firms can be expected to capture most of the yield premium as the division of revenue shifts over time to the party that has market power. The likely result is that less revenue, in the long run, will go to the producer, resulting in less compensation to producers and less to capitalize into land values. The contracting firm will receive more revenue and control of the rights to any associated technology, with more revenue capitalized into corporate stock. A key point is that the party holding the rights to any technology involved will capture the majority of the revenue, not the producer. Also, as indicated above, the contracting firm is likely to negotiate for ownership of the product involved with the producer only having the right to receive a contract payment for labor services rendered. But, while the producer receives only compensation under the contract, the producer still bears significant economic and legal risk.
Clearly, a producer thinking about entering into a production contract should have legal counsel examine any proposed contract and go through the issues listed above. Contract production of agricultural commodities is very important and comprises a great deal of agricultural production. It’s also important to get the best deal that you can and get fairly compensated for the risk that you are bearing.