Reading the fine print in agricultural contracts: conventional contract clauses, risks and returns.

One distinguishing feature of ongoing structural change in agriculture is increasing vertical coordination between agricultural producers and processors, much of which has come through agricultural production and marketing contracts. Agricultural economists, extension agents, legal aid groups, and others have sought to provide farmers with information that enables them to make informed decisions regarding contract use. While all sensible advice begins with suggesting that a farmer consult his or her attorney and accountant before signing, numerous outreach publications provide information regarding specific contract provisions. (See, for example, Holman, Feuz, and Baltensperger 2006; Kunkel and Larison 2006; Office of the Illinois Attorney General 2005.)

In contrast to the relatively comprehensive analysis in such outreach efforts, agricultural economists' theoretical analyses of specific agricultural contract provisions have tended to focus on contractual provisions regarding compensation, and, to some extent, on input provision. When comparing the average theoretical model to an actual agricultural contract, there are pages of the contract that do not appear in the model at all.

Much of the material omitted in theoretical analyses of agricultural contracts is "boilerplate." Boilerplate is standardized contract terms that are used in multiple contacts. These terms are usually not subject to bargaining and typically are presented on a "take it or leave it" basis (Farnsworth 2001). Boilerplate reduces risk for the drafting party in several ways: economies of scale allow greater care and expertise to used in drafting, boilerplate typically states which states' law will apply, and boilerplate reduces uncertainty about judicial interpretation by using language already tested in that state's courts. But boilerplate can work to the disadvantage of the other party. To an extent constrained by competition and law, boilerplate will usually be drafted to the advantage of the drafter (Farnsworth 2001). The non-drafting party is usually relatively unfamiliar with the form and may have little opportunity to review it thoroughly. Boilerplate has been characterized as "at least formulaic, probably legalistic, and possibly unfair" (Bast 1994).

Most people know boilerplate from consumer sales contracts. But it is also used in contracts between large, sophisticated commercial parties, such as auto manufacturers and parts suppliers (Ben-Shahar and White 2006). And it plays a prominent role in agricultural contracts. We discuss four types of boilerplate provisions and their implications for farmers' returns and risks: the treatment of farmers as merchants, arbitration and mediation clauses, warranties, and legal and regulatory compliance clauses. We then explore potentially fruitful directions for future research. Our discussion draws on the law and economics literature regarding boilerplate. Due to space limitations, we do not examine other related work, some of which will be addressed elsewhere in this session.

We motivate our discussion with examples of boilerplate provisions from specific agricultural contracts. We limit our examples to publicly available contracts. While in many instances this means that the quoted contracts are no longer in effect, confidential review of other, more recent, contracts suggests that the quoted material is still relevant, as are terms of recent contracts included in this discussion. Our selection of examples is in no way intended to be a statistically valid sample: while such a sample would be ideal, it is not available. Our more modest goal is to provide illustrations of contract terms in use and some guidance regarding their value.

Farmers as Merchants

The Uniform Commercial Code (UCC) introduced the concept of holding merchants to higher standards than consumers into U.S. law in the 1970s (Farnsworth 2001). Most states have adopted the UCC with minor variations. The UCC defines a merchant as:

A person who deals in goods of the kind or

otherwise by the person's occupation holds

that person out as having knowledge or skills

peculiar to the practices or goods involved in

the transaction. UCC[section]2-104(1).

Merchants are presumed to be knowledgeable regarding the implications of contract terms. Consumers are presumed to be relatively uninformed regarding the implications of standard legal clauses, and often to have not even read them (Gilo and Porat 2006). Merchant status is important because it removes some statutory protections provided consumers (National Agricultural Law Center 2006).

Jurisdictions vary widely on farmers' status as merchants (National Agricultural Law Center 2006). Some courts have ruled that farmers have specialized expertise, while others have defined specific conditions under which farmers are merchants (Hamilton 1995). Section Two of the UCC applies to sales of goods, but not services, yet some jurisdictions define it to apply where the contractor retains title to the crop or livestock (Hamilton 1995). Some contracts contain explicit statements about farmers' status as merchants:

GROWER and DuPont Specialty Grains

are experienced and knowledgeable in the

cultivation of corn and business transactions

involving corn. DuPont Specialty Grains

(2001)

Merchant status can significantly affect the outcome of a contract dispute. Merchants are expected to be familiar with the meaning of contract terms as well as basic contract law provisions, such as conditions under which oral agreements are binding. Merchant status can affect how a court rules on the "unconscionability" of a specific contract provision. Courts may refuse to enforce unconscionable contract provisions or contracts containing them (Farnsworth 2001). Courts have tended to interpret unconsionability as requiring both procedural unfairness, such as "unreasonably hard-to-read print," and substantive unfairness that noticeably favors one party (Swanson 2001).

In economic analysis of agricultural contracts, merchant status can be modeled as a full rationality actor with full information. Consumer status can be modeled as a rational, but not fully informed, economic player. This modeling choice can have important consequences for evaluating policy options. For example, the social value of regulations intended to level the informational playing field depends on whether or not there is an information asymmetry in the first place.

Recent legislation suggests recognition that some growers may not have the knowledge and sophistication of the larger entities with whom they are increasingly entering long-term production contracts. For example, Illinois Public Act 93-522, implemented in 2005, safeguards growers against unfair contracting practices and facilitate their understanding of contract terms (Office of the Illinois Attorney General 2005). Requirements such as the readability requirement of a Flesch-Kincaid Grade Level score of twelfth-grade level or lower suggest that lawmakers did not consider growers to be merchants. The requirements also can be interpreted as prohibiting some types of procedural unfairness that can contribute to a ruling of unconscionability.

Dispute Resolution, Arbitration, and Mediation

Dispute resolution clauses specify how the parties will manage disagreements. Choice of law and venue provisions decrease uncertainty for contractors, but may increase it for growers who may find themselves governed by unfamiliar state law. Arbitration and mediation provisions require parties to rely on a neutral third party as part of an alternative to the court system. Under arbitration, the parties agree that the decision of the arbitrator(s) will be final. Under mediation, the decision of the mediator(s) is not binding, and either party can pursue the matter in court. At a minimum, arbitration and mediation clauses specify who will arbitrate or mediate, who will pay the associated fees, and, in the case of mediation, whether or not it must be attempted prior to a court filing:

The parties agree to the use of mediation to

attempt to resolve any dispute between the

parties arising out of or relating to this Agreement.

The mediator shall have no authority

to impose a settlement of any such dispute.

Jennie-O Turkey Store, Inc. (no date)

Optimum and GROWER agree that all disputes

and differences arising between Optimum

and GROWER out of or relating in

any way to this Agreement, the construction,

meaning and operation of this Agreement, or

breach thereof, shall be settled in arbitration

in accordance with the rules and regulations

of the National Grain and Feed Association

pursuant to such Association's grain arbitration

rules. Optimum Quality Grains, L.L.C.

(2000)

While arbitration and mediation were originally advocated as ways to decrease dispute settlement costs, there are ways in which they may increase costs for one other party. The standard rule in U.S. civil litigation is that each party pays their own litigation costs (Dobbs 2000). Some arbitration clauses require the losing party to compensate the winner for the costs of the arbitration.

Any dispute under this Agreement shall

be resolved by arbitration in Santa Ana,

California pursuant to the rules, then obtaining,

of the American Arbitration Association

and the prevailing party shall be

entitled to reasonable attorney's fees and all

costs. Calavo Growers, Inc. (2003)