Contract Farming Resource Centre

ISSUES TO ADDRESS WHEN DRAFTING AGRICULTURAL CONTRACTS: A CHECK LIST

What is contract farming?

At the heart of contract farming (CF) is an agreement between farmers and buyers - both partners agree in advance on the terms and conditions for the production and marketing of farm products. These conditions usually specify the price to be paid to the farmer, the quantity and quality of the product demanded by the buyer, and the date for delivery to buyers. Typically, the contract may also include more detailed information on how the production will be carried out or if any inputs such as seeds, fertilizers and technical advice will be provided by the buyer.

Purpose of the Check List

It is important that the contract regulating the contract farming operation is well drafted, complete and faithfully reflects the agreements reached between buyer and seller so that the relationship is mutually beneficial and sustainable in the long-term.

Usually, during the negotiation phase, the buyer provides an offer to an individual producer or association of producers, which outlines the conditions of the contract. Before signing a contract farming agreement, at a minimum, farmers should consider a series of issues and then decide if the contract agreement is acceptable to them.

This Check List provides a quick reference for farmers and those providing advice to them to avoid overlooking key aspects of a contract farming agreement. Buyers can also use this list to ensure that they include all the essential elements in the contract and adopt good practices that contribute to the success of their relationship with producers.

The Check List is primarily based on the findings of the UNIDROIT/FAO/IFAD Legal Guide on Contract Farming.

How to use the Check List?

It is advisable to review the offer received by applying the 15 points in this list to evaluate whether the contract proposal is correctly drafted and there are no major omissions. Otherwise, identify the missing or incomplete clauses and present a counterproposal.

1. Is the proposal accompanied by sufficient information that allow the producer to make an informed decision?

The process of developing a contract is important to build up a harmonious relationship between the parties.

  1. Contractors should consider providing producers with advance information about the contractor, what is expected from the contract, possible risks, and the rights and obligations of the producer.
  2. Prior to making a formal offer for acceptance by the producer, contractors should ensure that there is no vagueness or uncertainty in the proposed agreement.
  3. Farmers have been consulted and fully understand what they are being asked to agree to.
  4. In negotiations, the presence of a trustworthy person, like the leader of the farmers’ organization, a government extension officer or someone from a non-governmental organization, can be of much assistance in explaining the contract terms in detail to farmers.

2. Are the parties familiar with the relevant laws governing the contract farming agreement?

Contractors should familiarise themselves with all relevant laws governing contract farming agreements and also make these known to farmers or their representatives.

Relevant laws may be found in legislation on, among others:

    1. Laws of contract
    2. Agriculture
    3. Tax
    4. Corporate relations and competition.

Other legislation likely to affect the operation of contracts includes that on:

    1. Food safety
    2. Farm inputs (seeds, pesticides, fertilizers, etc.)
    3. Land tenure
    4. Labour (labour rights)
    5. Natural resources
    6. Human rights (worker health and safety).

3. Have the parties conducted negotiations in good faith?

Both managers and farmer representatives might have a responsibility to ensure that contract negotiations are carried out in good faith. Legal principles often dictate that acting in bad faith, abusing rights, failing to declare relevant information, and exploiting a stronger bargaining position are unacceptable.

4. Is the contract drafted in written and in a simple way?

  1. Contracts should normally be written and presented in an unambiguous and simple way, using terms that are understood by all.
  2. Where illiteracy is a problem farmers should be given an oral explanation.

5. Does the contract cover the following basic content?

It is in the interest of all parties to ensure that contracts are complete and detailed. Important components are:

  1.  The parties. The names and addresses of the signatories.
  2. The purpose. The reason for the contract.
  3. The production site. The size and location of the farming area, specified in as much detail as possible.
  4. Obligations of the parties. The contracting parties have obligations relating to the product, the process by which it is produced, the delivery of the product and the price and payment arrangements. What and how the farmer is expected to produce and deliver and what support the contractor is required to provide.
  5. Price and payment. The price to be paid or how it will be calculated. When and where payment will take place.
  6. Input provision. In cases where the buyer agrees to provide inputs or technical assistance, these inputs must be adequately described, including the time and place of their delivery, and eventual intellectual property rights associated with them. How repayment by the producer will be calculated and made and eventual obligations of the producer in case something goes wrong.
  7. Third parties. Relationships with others who may contribute to the contract’s success, such as input suppliers and financial institutions.
  8. Excuses. Acceptable justification for failing to comply with the contract, such as because of force majeure.
  9. Remedies. Ways in which one party can be compensated for the failure of the other to meet its obligations.
  10. Duration, renewal and termination. How long the contract is for, arrangements for extension or renewal, and how and why it can be ended.
  11. Dispute resolution. Ways of addressing potential disputes, including mediation, arbitration and judicial dispute resolution.
  12. Signatures. Parties should ideally sign in the presence of witnesses.

6. Does the contract clearly specify the product obligations?

  1. Product-related obligations that should be addressed in a contract include QUANTITY. The amount the producer undertakes to deliver and the contractor undertakes to purchase should be clearly specified either as an agreed weight or number or with reference to the area of production, a quota established following agreed procedures or some other agreed arrangement. Minimum and maximum quantities are sometimes specified.
  2. It is important that the contract specifies the QUALITY requirements in a clear way and that these are understood by farmers, with support from the contractor’s extension staff. To guarantee quality requirements are met, the contract should specify that all products must be produced by the producer, following agreed procedures. This is to avoid producers purchasing non-conforming products from a third party.

Process-related obligations include any agreement made regarding the INPUTS involved in the production of the good under contract.

Inputs can include:

  1. Land, installation and fixed assets required for the production of the good under contract.
  2. Physical elements, such as seeds, animals, fertilizers, pesticides, etc.
  3. Financing.
  4. Non-physical elements, such as technical assistance, training and intellectual property rights.

The contract could specify land, installation and fixed assets required for the production of the good under contract. Where land is leased or rented, confirmation of tenure arrangements and, sometimes, of the owner’s approval may be required.

Should the buyer require using specific physical inputs, the contract should specify:

  1. Producers should be obliged to handle and use inputs as specified by the contractor according to instructions provided, as noted in item 13).
  2. The prices charged by the contractor for inputs, or their method of calculation, should be clearly indicated.
  3. The time and place for input delivery should be identified and the consequence of late delivery or of the supply of defective inputs clearly spelt out.

When financing is provided, the contract should specify that financial advances should be used for contracted production and not any other purpose. Interest rates and other charges for financial advances and inputs should be specified as well as repayment arrangements.

Should the buyer provide technical assistance, it should be specified in the contract, as well as eventual intellectual property rights associated with inputs such as seeds.

 Services and advice provided by the contractor. The contractor can require the producer to follow prescribed production methods.

  1. Specific details about what the production method should be given in the contract to avoid confusion. Consequences of failure to follow the contractor’s requirements should be specified as should consequences for the contractor of providing faulty advice or other services. When the buyer agrees to provide technical assistance for the implementation of such production methods, the contract should specify the consequences of improper or inadequate technical assistance.
  2. Process monitoring and access to the production area. If the contractor wishes its staff to visit farmers’ fields (which is desirable) this should be specified, together with times for such visits. There are obligations on both producer and contractor to comply with such agreed times.
  3. Other process-related obligations may include:
    • Compliance with standards, certification and traceability
    • Avoidance of use of child labour
    • Hygiene requirements
    • Intellectual Property Rights (IPR), for example, regarding seeds provided.

8. Does the contract clearly specify the delivery obligations?

Delivery-related obligations are important, particularly for perishable products. They should be included in the contract to avoid arbitrary arrangements being made at a later stage and should cover:

  1. Place. Where the products are to be delivered or whether the contractor is responsible for collection.
  2. Period. The period when delivery will be accepted (although this should be flexible given the vagaries of agricultural production).
  3. Time. The time of day for harvesting and delivery to the contractor.
  4. Transport. Who is responsible for transport and who meets the costs. If there are obligations related to transport (e.g. use of cold chain facilities and pollution prevention), these must be specified in the contract.
  5. Weighing and quality assessment. Arrangements for carrying this out need to be specified in detail. The opportunity for the producer to attend or be represented also needs to be covered here.

9. Does the contract clearly specify the price and payment obligations?

Price and payment obligations are an essential component of any contract and failure to include them could make the contract unenforceable. Clauses in the contract should cover:

  1. Price calculation. If the contract does not specify the price that will be paid it is important to indicate how it will be calculated. This should be easy to understand by farmers or, if not, by their representatives.
  2. Deductions for advances. When advances are paid to farmers or inputs are supplied on credit the loans have to be repaid. In addition to interest and other charges the method whereby the loans will be repaid through deductions needs to be specified.
  3. Payment arrangements. Arrangements for paying the producer should be stated, including how long after delivery this will take place. Where certain steps need to be taken by the producer, such as opening a bank account, this should also be indicated.

10. Does the contract detail what to do in case of force majeure or changes of circumstances?

  1. Contracts should recognise that performance by producers may sometimes be impossible through no fault of their own, as a result of force majeure events or change of circumstances. They should specify how such failure will be treated.
  2. If force majeure or change of circumstances is included in a contract it is desirable to specify in detail all events that could qualify. This would normally exclude:
    • Events where the producer’s negligence has contributed to the loss, e.g. by failing to use appropriate pest control methods during an infestation.
    • Events considered within the contractor’s control, such as strikes by its employees. 
    • Changes in market conditions, such as major price falls.
  3. A contract may envisage force majeure in a number of ways:
    • It may excuse the producer from delivery because of force majeure.
    • It may indicate how repayment of advances will be treated.
    • It should clarify the extent of damage necessary for force majeure to apply.
    • It may address situations where delivery is possible but quality does not meet requirements.
    • It may consider how to share the potential risks. In many cases it will be in the contractor’s interest to continue the relationship with the producer after a force majeure event. However, this is likely to require some cost sharing by the contractor.
  4. Less frequently, contractors’ performances may also be subject to force majeure or change of circumstances.
  5. Renegotiation is often the solution of choice for a contractually defined change of circumstances.

11. Does the contract explain what to do in case of breach of contract?

  1. Contracts should include clauses relating to remedies that could be applied when one party fails to perform for any reason other than force majeure. Emphasis should be on arriving at mutually acceptable, cooperative solutions.
  2. Potential breaches of contract by producers that may lead to the application of remedies include:
    • Failure to carry out required land preparation.
    • Failure to use inputs as specified in the contract.
    • Delivery of products that do not meet agreed quality standards.
    • Failure to deliver all or part of contracted quantities.
  3. Potential breaches of contract by the contractor can include:
    • Failure to deliver inputs on time or inputs of the agreed type or quality.
    • Failure to take delivery at the time and location specified and in the agreed quantities and qualities.
    • Failure to pay.
  4. To avoid confusion concerning responsibilities, it is a good idea to include an annex in the contract setting out all contractual activities to be carried out in the sequence in which they should be carried out. Further, the need for remedies to be implemented can usually be reduced by ensuring maximum communication, so that both parties are aware of emerging problems at an early stage.
  5. If disagreements do occur, it is in the interests of both to find cooperative solutions and maintain the relationship. Remedies can take a range of forms, including:
    • Correction of the problem,
    • Withholding of subsequent performance by the aggrieved party, 
    • Reducing the price payable,
    • Restitution of loans and advances, 
    • Payments of damages and, 
    • Termination, as a last resort.
  6. Where the possibility of such remedies is envisaged they should be included in the contract but national laws are also likely to be very relevant.

12. What is the contract duration?

Contracts should clearly state the planned duration, which is likely to be related to the production cycle of the product as well as the level of investment required from the producer.

13. Does the contract say anything about its renewal?

Renewal of contracts is common and may be done automatically through a clause in the contract or by mutual agreement. Otherwise, the contract should indicate how renewal will be organized, and in case of changes in the contractual conditions (adaptation of the price according to the consumer price index), these must be clearly specified in the contract.

14. Does the contract say something about termination?

  1. With long-term contracts, one or other of the parties may, at some stage, wish to terminate the agreement. Ways of doing this need to be specified in the contract:
    • Giving formal notice should be required. Generally, the longer the contract the longer the period of notice that should be given.
    • Clauses giving the contractor the right to terminate unilaterally are not recommended, as they could result in substantial losses for the producer and may be illegal. 
    • Termination does not exclude the parties from existing liabilities for non-performance or from repayment of any debts.

15. Does the contract detail how to resolve disputes?

  1. Ideally contracts should be self-regulating through mutual collaboration. However disagreements do occur and their possibility should be assumed when contracts are drafted. Avoiding vaguely worded contracts is an important way of minimising disputes. When drafting contracts, the parties should also familiarise themselves fully with available dispute-resolution mechanisms in their country.
  2. Contracts should propose a sequential approach to dispute resolution. First, the parties should attempt to resolve difficulties on their own. If this does not work, mediation should be tried. Failure of mediation could then lead to arbitration or, the national courts.
    • Mediation involves a mediator who tries to help the parties to resolve their difficulties. The parties willingly agree to participate but make no commitment to accept the results unless they reach agreement, when that agreement becomes contractually binding. Most contracts include reference to mediation and in some countries it may be a legal requirement.
    • Arbitration is governed by domestic legislation. Participation in arbitration is voluntary but its inclusion in the contract indicates that consent to arbitrate if required has been given. It is carried out by a neutral third party whose decision is legally binding. Unlike mediation, the arbitrator must consider the dispute with reference to the law so contracts should clearly specify the institution that would be called upon to carry out the arbitration.
    • Law courts can be costly and time consuming and are not normally appropriate for resolving contract farming disputes. Arbitration is often a preferable alternative to law courts, and only rarely do the courts consider cases that have already gone through arbitration.

References and resources

FAO. 2013. Contract farming for inclusive market access. Edited by da Silva, C. and Rankin, M. Available at: http://www.fao.org/3/a-i3526e.pdf

FAO. 2012. Guiding principles for responsible contract farming operations. http://www.fao.org/docrep/016/i2858e/i2858e.pdf

GIZ. 2013. Contract farming handbook. A practical guide for linking small-scale producers and buyers through business model innovation. By Will, M. Available at: http://teca.fao.org/sites/default/files/technology_files/GIZ%20Contract%20Farming%20Manual_low%20resolution.pdf

UNIDROIT, FAO and IFAD. 2015. Legal guide on contract farming. Available at: http://www.fao.org/3/a-i4756e.pdf