Producer’s Guide to Contracting (2000)

The National Pork Producers Council’s Guide to Contracting is designed to be used as background material by those involved in the preparation and negotiation of contracts for the production of hogs. The persons and entities responsible for preparation of the Guide to Contracting are not giving legal advice to any individuals or entities who use the book. Each party to a contract for production of hogs should be represented by independent legal counsel. No representation is made by those who prepared the Guide to Contracting as to how they should be used in the negotiation or preparation of a production contract. The parties to the contract should use the Guide to Contracting as background material and make adaptations in negotiating and drafting the production contract that fit their particular situation.

 

The swine industry continues to grow and change very rapidly. One of the most significant changes the industry has seen is that producers are contracting the production of pigs.

 

Production of agricultural products under contract is certainly not new to American agriculture. Contract production of fruits, vegetables, poultry, and eggs has been widespread for many years.

 

The original Guide to Contracting was developed in 1996 in response to the dramatic increase in contract production. This was due to the availability of financing through contract, the stability of contract returns and the desire to expand in the industry.

 

As a result, it is essential that both parties participating in a contract understand the benefits, costs and risks they may be taking. This guide has been developed to address the issues involved in contracting.

 

As contracting has become an integral part of the hog production there was a need to review and update the Guide to Contracting. This revised guide reflects changes in contracts since 1996 as well as addressing new contracts not offered in 1996.

 

Special thanks are due to several people who helped develop this document: Linden Olson (producer); Jon Caspers (producer); Lee Fuchs (AgriBank, FCB); Hugh Dorminy (Cargill, Inc.); Conley Nelson (Murphy Farms of Iowa); Brian Buhr (E-Markets); Gary Malenke (Sioux Preme Packing); Laura Cheney (Michigan State University); Dan Peregrin (Moore Stephens Frost); Kaye Whitehead (producer); Kristie Bray (NPPC); Jami Conn (NPPC).
Jeff Ward, Editor

 

INTRODUCTION

 

What is Contracting?
Contracting is a term describing a legal relationship between the owner of a group of pigs, referred to as a “contractor” in this text, and another party who is participating in the production and care of the pigs, referred to as a “grower” in this text. Contracts exist for every phase of the production process including breeding/gestation, farrowing, nursery and finishing operations and combinations of these activities.

 

As this text is designed as a ready reference for parties interested in contracting, it has been written to maximize access to information. Please note that chapter 5 details the basic aspects that need to be covered in any production contract. Chapters 6, 7 and 8 cover the same ground, but add specific information about farrowing, nursery and finishing contracts respectively.

 

A variety of contracts exists today and more are being added. Although some versions are more common than others, there is no such thing as a “standard” contract.

 

Contracting in the swine industry involves sharing the production and financial risks associated with producing pigs in a rapidly changing environment. The contract terms vary from one to 10 years, with renewal and cancellation provisions carefully stipulated.

 

In the most common form, the contractor provides the animals, transportation, veterinary care, feed, record system and some supplies. The contract farrower or grower provides and maintains the growing environment within the limitations required by the agreement. The environment includes the buildings, land, proper temperatures and physical care. In addition, the grower supplies labor, both for daily care and for load-in/load-out, record-keeping, access to the animals (including roadways on private property) and reporting functions. All manure management and dead animal disposal functions are normally the duties of the grower.

 

Key Elements of a Production Contract

 

A production contract includes several main elements:

1. Two parties, the contractor and the grower, make a legally binding agreement.
2. The agreement is for a fixed term, in years or in production cycles.
3. The agreement is signed or entered into before production begins.
4. The contract calls for the care and feeding of animals, on land owned or controlled by the grower.
5. All the animals are delivered to the grower.
6. To be acceptable, the livestock must be produced or cared for according to the terms of the agreement.
7. The grower is paid a set amount at a time according to the agreed schedule or term, which may include premiums or deductions for quality or performance.
8. The grower generally has no legal title to the livestock but is considered in a bailment relationship with the contractor.
9. The grower is described as an independent contractor rather than an employee, partner or joint venturer with the owner.

 

The importance of a production contract is that it is a legal agreement that creates a unique relationship between the parties.

 

The Business of Contracting: Sharing Risk and Return

 

There are several reasons for contracting in the swine industry, but all have a common root. Each party wants to gain some economic advantage, beyond his/her own resources, by cooperating with the other. Contracting is a form of interdependence or networking, and individual motivations depend on whether the party is the owner of the buildings or the owner of the pigs.

 

If pork producers are going to profit from the opportunities contract growers offer, their investments must be sound. Contracts must offer a reasonable and fair return for the resources contributed by both parties. Deciding what represents a reasonable or fair return is not always easy, so an economic analysis is in order.

 

To begin with, all of the inputs needed to produce hogs may be divided into four basic groups:

• land
• labor
• capital
• management/risk-bearing function

 

Each input must receive a fair compensation for its contribution to the finished product. The return to land is called rent; the return to labor is wages; the return to capital is interest; and the return to management/risk-bearing is profit. In a contract relationship, whoever owns and supplies each input is entitled to receive the return for its use.

 

In a typical finishing contract, the grower supplies:

• land
• labor
• some capital items, including the facilities, utilities, insurance/taxes, repairs and maintenance

 

The contractor supplies the remaining capital:

• hogs
• marketing/transportation
• feed
• medicines/veterinarian services
• management

 

A key advantage to contracting is sharing production risks. The contractor bears the price risk for capital items subject to risk, such as feed and replacement stock prices, and output price risk or hog prices. The grower bears the price risk associated with the capital items supplied, primarily energy. Normally the price of the building and interest is fixed for the length of the note. If a building loan carries a variable rate, the grower has this additional risk.

 

Although risks are shared, the contractor carries the bulk of it. If the contract calls for a payment per animal transferred, the grower will lose typically $10 to $12 if an animal dies. If the payment is made by pig space, the grower may face no production risk within the allowable limits of mortality.

 

The grower shoulders all risk related to manure handling and disposal, as well as dead animal disposal. In addition, the grower bears any financial setbacks from an unfulfilled or unrenewed contract. The contractor faces similar risks in that the grower may not fulfill the terms of the contract or renew the contract at expiration.

 

Determining a “Fair” Return
When evaluating a contract, the grower needs to estimate the payment to be received and make sure it can cover a fair return for the resources contributed. A fair return to labor is the prevailing wage rate for similar farm work, multiplied by the estimated labor hours required to fulfill the contract.

 

A fair return to capital items means enough income to pay for capital items at cost. The payment proposed in the contract must cover all utilities, fuel, insurance, property taxes, supplies, phone, manure handling, repairs/maintenance and interest on borrowed money. In addition, there must be enough cash inflow to replace the facility in the long term.

 

A fair return to land used can be calculated by estimating the prevailing rental value of the land on which the buildings and lagoon are located (immediate site only).

 

Some production risks involved are inescapable for the grower but can be minimized. Given the necessary risk, the contractor’s payment must also include a share in the profits and losses of the hogs produced in proportion to the total risk born.

 

Evaluating Cash Flow
All parties are faced with a critical question: Will the contract pay? Investment decisions must be judged for feasibility as well as profitability. Most people tend to focus on profitability and ignore economic feasibility, or cash flow concerns.

 

Assume the project is technically feasible (a suitable site has been located satisfying all legal and environmental criteria). The tool that assesses economic feasibility is the cash flow budget. For most contracts, 12 to 18 months of monthly cash flow budgeting is sufficient, with an annual estimate for the next five years. The annual estimate needs to include an inflation factor (standard is 5 percent) for costs. It is important that parties prepare their own cash flow budgets and not rely solely on cash flow budgets constructed by others.

 

Monthly cash flow analysis is important because most projects that require buildings have an extended period of cash outflow before any inflow. In addition, most capital suppliers require that the parties keep current on interest even before income develops. An understanding must be reached about the source of the operating dollars prior to the sale of the first hogs. The success of the project often hinges on a start-up that comes in at or under budget and proceeds at or ahead of schedule.

 

Most lenders are familiar with monthly or quarterly payments, but the flow of hogs through a building does not always occur on a monthly or quarterly basis. As a result, the lender needs to understand the flow of hogs through the building and when cash will be available to service debt. The borrowers should work with lenders to develop a payment schedule that matches the flow of hogs.

 

A project is infeasible if it can’t produce enough cash inflow to service debt and pay all other costs — including a fair return to labor and a safety margin of extra cash. The amount of extra cash needed is decided by the borrower, but a minimum of 10 percent inflow over all outflow is normally a banker’s baseline requirement.

 

Cash flow budgeting is the only way to see how sensitive a contract’s outcome is to a variety of factors, including:

• changes in start-up costs
• changes in interest rates for variablerate borrowers
• operating cost overruns
• different levels of payment for performance

 

Not all feasible opportunities are profitable. Some infeasible projects, however, can appear very profitable when the outcome over the entire life of an investment is averaged. Averages, however, can be misleading.

 

An example is a contract that works well once the building is paid off. But due to low equity, the contract does not generate enough repayment capacity to satisfy debt servicing in the early years of the investment. Averaged over a 20-year period, the project’s profitability looks good. A close inspection, however, may reveal that financial collapse would occur prior to reaching the 20th year.

 

If a contract is feasible, the next step is to evaluate its profitability for comparison with other potential farm investments. For a typical contract building, should any capital be left once the building, associated land, labor and all other input costs are paid?

 

The answer is yes, if the contract grower is contributing management expertise or assuming any risk in the venture. Management and risk are paid a return called profit. If the grower does not contribute to these inputs, no profits are warranted. Most contracts share a small amount of the total profits with the grower because the integrator supplies the management and assumes the price risk for the hogs.

 

The only way to know if the split is fair is for the contract grower to calculate the profit expected. It is important for the contract grower to evaluate whether that amount fairly compensates any management or risk taken.

 

CONTRACT EVALUATION

 

When evaluating a contract, it is important to realize that there is no one contract that is best for everyone. Contracts are flexible and it is possible to tailor them to given situations. As a result, a contract that is good for one person may not be good for his/her neighbor. Contracts can and should be developed so that they are favorable to all parties involved.

 

Motivations of Contract Production: The Contractor

 

Expanded Operation
For pig owners, the motivation of contract production is usually related to expansion. The owner wants to expand production but cannot find sufficient capital or is unwilling to risk additional capital in fixed assets (buildings, land, etc.). If available capital is used only for pigs and the acquisition of short-term assets (such as feed and transportation services), the contractor can own and control a larger number of animals by working interdependently with the contract grower.

 

Improved Health
Sometimes the contractor’s motivation is to obtain a better-quality growing environment than what he/she can provide or can buy with limited capital. In the case of limited capital, the owner may choose to invest limited resources in genetic repopulation of the herd while entering into a contract for high-quality finishing space that will exploit more fully the lean growth potential of the new genetics.

 

Decreased Production Risk
Large-scale feeder pig finishers traditionally purchase their pigs from auction markets or from brokers who assemble the pigs from a large number of sources. This acquisition method increases the likelihood of health problems during the finishing phase. Health problems reduce growth rates and increase feed/gain and, thereby, reduce profitability.

 

One way to solve this problem is for the finisher to expand into the farrowing and nursery functions to control the quality and health status of the pigs. This usually requires a financial investment that is beyond the ability of most finishers. Some large-scale finishers and custom finishing lots have overcome this problem by contracting with parties willing to perform the farrowing and nursery functions. Often, this reduces the number of farms supplying pigs. In addition, it increases the lot size to facilitate all-in all-out (AIAO) pig flow and saves the finisher the cost of investing in the complete set of farrow-to-finish production buildings.

 

Increased Profits
Contract relationships are increasingly common among producers who multiply genetics for a seedstock producer. Most multipliers focus a great deal of attention on the gilts and have little use for the barrows. Rather than sell the barrows as feeder pigs, many choose to have the pigs finished offsite through a contract grower. In this way, the multiplier conserves resources for gilt production facilities and captures the finishing income lost through the sale of the feeder pigs. The multiplier can build a larger sow production base, if both barrows and gilts are finished under contract production, and a larger one still, if all functions — farrow through finish — are completed under contract.

 

Meeting Multiple Objectives
Commercial producers and family farms are also using these same methods. Many producers are expanding production and improving health status by converting a single-site farrow-to-finish farm to a two-or three-site production system using contract growers. Typically, producers convert the home site to breeding/gestation and farrowing while contracting for off-site nursery and finishing. Often, the producer has a single-site farrow-to-finish operation that cannot be expanded because adjacent land is unavailable or too expensive. In addition, manure management may have reached its capacity on the existing site. By converting the farm to breeding stock only (and perhaps a nursery) while adding finishing through off-site contract growers, the producer achieves multiple benefits. These include expansion of production over the entire system (increasing the sow base), improvement in health status through two-or three-site production protocols and reduced environmental-and odor-related risks.

 

Optimal Utilization of Related Assets
Lastly, some input suppliers, such as feed mills, have entered into contract hog production. Usually their motivation is to guarantee a full feed mill when overall sales are trending downward due to demographic changes in production. In some areas, packing plants are implementing contract production to ensure a supply of high-quality animals. Developing contract production as a means to sell other inputs has not generally been successful because of internal conflicts of purpose and a lack of focus. All of the variants and motivations listed above, however, are increasingly common throughout the industry.

 

Corporate Farming Laws
Corporate ownership of farm land and livestock is restricted in many Midwestern states (Minnesota, Iowa, Nebraska, South Dakota, Kansas, Missouri, Illinois). As evidenced by growth of contract production, this generally does not affect the ability to contract in these states. However, typically definitions of “family farm” or “family farm corporation” will determine who can actively engage in contracting. Nearly always excluded are firms which are organized as Chapter C Corporations. However, variations on exclusion exist for Sub-Chapter S corporations and Limited Liability Corporations. For example, there are proportion rules which require that a predetermined proportion of the shareholders of a sub-chapter S corporation or other form of Limited Liability Corporations be actively engaged in farming which is again subject to definition. Hence, any new contractors entering a region should inform themselves of applicable corporate farm restrictions and the eligibility and hence enforceability of contract production.

 

A recent change to the status of contract production relates to the change in ownership of firms and in particular their acquisition by packers. Several states have restrictions on packer ownership of livestock. Hence, a packer owning livestock, but contracting for building space could be construed as violating these restrictions on ownership. Similarly, they would also likely violate corporate farm laws themselves.

 

Motivations of Contract Production: The Contract Grower

 

Reduced Price Risk
Price risk reduction, and therefore a more stable income, is usually the grower’s motivation for contract production. Since returns are not tied to the market price for pigs, the risk of large fluctuations in income is reduced.

 

Specialization
The grower may also be attracted to specializing in a fixed set of activities (such as finishing operations). Specialization often leads to simplification of the production and decision-making functions. Simplification of tasks, combined with training and regular field service, allows the novice pig producer or someone without previous livestock experience to be successful almost immediately.

 

Investment Alternative
Some contract growers have decided to enter production contracts purely as an investment alternative. In the Southeast, as capital began to exit tobacco production, producers investigated alternative crop and livestock possibilities. Swine production drew tremendous interest and investment from tobacco farmers because it has offered consistently profitable returns for low-cost producers. For this group, a key attraction to contract growing is that no previous experience with pigs is required.

 

The ability of novices to enter and succeed in the market has been instrumental to the rapid growth of contracts. Although no studies have yet pinpointed the exact proportion, it is likely that a large number of the current contract swine producers have limited previous experience in swine production. One of the typical contract grower profiles is a husband-and-wife team who leave jobs in town to work together in a contract farrowing unit. Typically, both are from rural backgrounds and own 50 to 100 acres of land that may not be suitable for intensive crop production. By investing in a contract farrowing unit, they can return to agricultural vocations and work together to support their farm and lifestyle.

 

A Means of Entry
Some producers enter contract relationships hoping to eventually emerge as an independent producer. Investment in a 500 to 600 sow farrow-to-finish operation requires several million dollars — an amount that typically precludes an entry-level producer. With a more modest investment, however, the producer can build a 500- to 600-head contract farrowing unit. When the debt is retired in seven to 10 years, the producer can end the contract arrangement and use the equity of the farrowing unit to build a nursery and finishers sized to the sow herd. Other alternatives include ending the contract relationship and working with contract nursery and finishers or selling weaned pigs on a contractual basis to nursery/finishers.

 

Income Diversification and Reduced Cropping Costs
In the Corn Belt, where land is intensively cultivated, some producers are choosing contract finishing to diversify and stabilize income as well as to utilize manure nutrients. Farmers who are exclusively crop producers can diversify their income stream and mitigate the effects of seasonal and random crop price and income shocks. Finishing buildings are the least labor-intensive and require the fewest overall husbandry skills. Finishing units also produce the greatest volume of manure nutrients per dollar of capital invested. This yields the added benefit of decreased fertilizer costs for crops. In some areas of the country, the value of manure nutrients does not offset the cost of capturing, containing and disposal — making manure management a true cost of production. In areas of intensive crop production, benefits from utilizing the effluent often exceed total costs associated with capture, containment and application.

 

Different Contracts/Different Motives

 

Just as people choose to become contract growers for a variety of reasons, there are also different motives for the particular type of contract they choose. There are three major types of contracts:

• farrowing
• nursery
• finishing

 

Each contract type produces very different returns and cash flows for the same dollar of capital investment.

 

Farrowing contracts produce the greatest cash inflow per dollar of capital invested because they have the highest labor component of any contract type. In addition, farrowing contracts usually enjoy the most generous bonus structure for top performance. The base return to labor across contract types is roughly equal on an hourly basis. The breeding/farrowing function, however, offers the grower the greatest possible chance to influence production outcome and thereby qualify for bonuses. Rewards tend to be generous for achieving higher-than-average pig production.

 

Nursery and finishing contracts are less labor-intensive and therefore normally generate less total income per dollar of capital investment. Nursery buildings turn over more rapidly (six or seven times per year) than finishing buildings (2.5 to three times per year), so cash inflows are more frequent. Some finishing contracts compensate growers with an inpayment (at the time of pig placement) and an outpayment (when pigs are removed) to increase the frequency of inflows and reduce interest costs.

 

Lease Contracts
This is a specific form of contracting wherein the farmer owns the production facilities and then leases their use to a second party. In contrast to other production contracts (pig space or fee per animal finished), the farmer may not be required to perform any other production activities than the use of the facility. As with other contracts it is important to determine the payment terms of the contract. If only facility resources are contributed, the payment will typically be lower and a value yielding a reasonable return to economic costs of ownership is sufficient. This can be determined by evaluating the value of the facility less any depreciation and amortized over the life of the building. Any additional payments for labor, management or feed may not be necessary.

 

Another feature is that lease contracts typically preclude issues of competitiveness associated with tournament type contracts. In tournament contracts, growers who contribute management and labor which can affect pig growth and performance are often ranked with their peers and paid according to their ranking. The lease case associates management and production risks with the lessor so that this performance risk is not associated with the facilities. Lease contracts, however, should be thought of as other rental property agreements and include provisions regarding what constitutes normal wear and tear on facilities and what constitutes excessive damage which should be compensated and what is required to keep the condition of the buildings suitable for their intended use on the part of the owner.

 

Another aspect of leasing relates to its effect on legal liabilities stemming from environmental issues. In this case, the owner is likely clearly liable for any facility issues. This also raises issues of who is responsible for manure disposal and maintaining odor abatement systems. For example, is odor abatement part of the physical facility or is it a result of the hogs raised by the lessor? These issues should be clearly stated in any lease agreements.

 

Another liability issue is in regard to worker welfare. If the lessor provides the labor and management in the facility, who is liable for any injuries or health issues which may arise? For example, were breathing conditions created by poor ventilation which is more of a function of facility design? Or if a worker sustains a knee injury while vaccinating pigs (clearly not facility related) is the owner of the facility still liable because the injury occurred on the premises? These issues are important to consider in any lease arrangement and as with all cases, legal consultation is encouraged.

 

Evaluating a Contract
A standard swine production contract does not exist. Each pork production contract needs to be evaluated on its own merits. Maturities as well as compensation and incentive schemes vary within regions and across the country. Each contract offers the contractor and grower different advantages. They vary in how risk — for production, income and market — is shared between the participants. Each party must carefully assess the relationship to ensure that his/her goals are likely to be met. Contract production offers contractors a means to grow more rapidly than their own individual resources would allow. By aligning with growers, contractors can often improve their animals’ health status while reducing the risks of environmental harm by spreading production over a larger geographical area.

 

Contract production offers growers a reduced-risk means of entry into swine production. By joining forces with an established and successful contractor, the grower has the training, service, and support necessary to be successful. The grower needs to choose a contractor with a long history of financial stability and fairness to business associates. The grower should be comfortable with the management practices of the contracting company. The grower also should assess the contractor’s long-term commitment to the swine business and to the region.

 

In addition, it is important to consider the use of standardized buildings. By working with a contractor who requests standardized buildings, the grower has the flexibility to choose another contractor, if competitive forces dictate. In addition, if the grower exits the business, he/she is assured of a higher initial appraised valuation and a higher resale value for the building.

 

It seems likely that a substantial portion, but certainly not all, of future swine production in the United States will be carried out through contractual relationships. For the industry to progress, these must be win-win relationships for growers and contractors. Each party to a contract should obtain legal and financial assistance prior to writing or agreeing to a contract. Each party’s full understanding in advance of the commitments and duties stipulated by the contract will minimize surprise and disappointments should misunderstandings arise.

 

Both parties need to understand that the relationship in a contract arrangement is a business relationship that must be developed wisely and carefully. Both parties must document the promises made by each other in the contract, so that either party can resort to the contract if it is necessary to challenge the actions or positions of the other party.

 

BENEFITS AND RISKS OF CONTRACT PRODUCTION

 

Benefits of Contract Production to the Contractor

 

Quality Control
Because contracts provide control over the production methods and inputs used, they help ensure commodity uniformity and quality. In turn, quality controls make the commodity more suitable for standardized consumer products. Under a contract system, adjustments to match consumer desires with production can be done easily from the top down, simply by changing the contract specifications.

 

Supply Management
Through contracts, swine owners have greater production flexibility to meet input supply, as well as marketing and processing needs.

 

Use of New Technologies
Contracts often promote, or even require, the adoption or application of related technologies or production methods, some of which may also be marketed.

 

Intellectual Property Protection
Contracts give the contractors control over the release of specialized genetics that may create value-added traits. In such cases, the contract serves as a form of intellectual property protection to control the unauthorized reproduction of these specialized genetics.

 

Market Protection
Contracts preserve the confidentiality of the commodity’s pricing and marketing arrangements as well as the identity of the end-user or purchaser.

 

Reduced Financial Risks
Contracts provide the contractor with a mechanism to project the financial interests, and thus potential returns, farther down the production process, without having to own the land or production facilities for these processes.

 

Benefits of Contract Production to the Grower

 

Reducing Financial Risk
Contracts can stabilize income variations with a set cash flow and also reduce the need to borrow capital.

 

Access to Capital
Contracts may provide access to capital, by making the grower a more attractive borrower. With the contractor providing some of the inputs (feed and animals), the financial burden on the grower decreases and his/her ability to finance the operation increases. Where capital is limited, this type of agreement may be the sole means of entering the business of pork production.

 

Access to New Technologies
Contracts can provide access to new technologies or improved genetics.

 

Access to New Markets
Contracts can offer access to new commodity markets that may offer new sources of demand or higher prices.

 

Higher Prices
Contracts can provide higher prices or price premiums for raising a specialized product or for using certain production methods.

 

Other Benefits
Contracts can remove marketing decision risks, unleash capital, provide the opportunity to use excess labor and facilities and provide year-round cash flow.

 

Risks of Contract Production to the Contractor

 

Additional Risks for Contractor
Under a contract relationship, the contractor generally assumes more risk than the grower. The contract transfers the risks in feed costs, feeder pig prices and market prices to the contractor.

 

No Ameniable Parties
In developing a contract, the contractor risks that no grower will accept the terms presented and sign the contract.

 

Litigation Possibilities
A contract, as a legally binding document, could lead to litigation that might result in a costly loss for the contractor.

 

Losses Due to Improper Husbandry
The contractor risks that the grower may fail to properly care for the animals, resulting in animal losses.

 

Loss of Control Over Technology
By working in close cooperation with a grower, the contractor risks losing control of proprietary technology.

 

Counting on Grower’s Dependability
Although a contract is in place, the grower could simply decide to walk away from it, causing a disruption in the contractor’s business.

 

Grower Inefficiencies
Inefficient growers may lose a substantial number of hogs and invested dollars before the problem is corrected.

 

Risks of Contract Production to the Grower

 

Long-Term Investments/Short-Term Contracts
Under swine production contracts, it is common for the grower to build a new facility to contractor specifications. This usually requires borrowing significant amounts of money. Many contracts, however, are for a much shorter contract period than the loan’s financing period. As a result, a short-term contract can create serious risks if it is terminated before the building is paid for. This risk is especially prevalent in areas where the contractor may be the only party marketing livestock and, therefore, the only contracting party available. In this case, the grower may want to link the length of the contract to the financing life of the facility.

 

Risk of Not Being Paid
Production contracts are in many ways a new form of marketing, in which the producer depends on the swine owner to pay for the services rendered under the terms of the agreement. Until the producer is paid, he/she is an unsecured creditor. As a result, the issue of how to protect the producer’s right to be paid is an important one and the history and financial stability of the contractor is a very important factor in establishing a contract.

 

Reduced Producer Control
Without exception, a contractual agreement reduces the producer’s control over management decisions. This is a difficult cost to quantify, since it affects each producer differently.

 

Limitation on Producer Returns
The risk reduction that results from many coordination agreements is a trade-off between income variability and expected level of income. That is, contract payments will be less on average over time than the returns from independent production at the same level of volume and efficiency. The difference may be considered a risk premium that accrues for the entity willing to take the risks.

 

Bankruptcy

 

Grower Bankruptcy Considerations

1. Status of Livestock – A threshold issue, in the event the grower files bankruptcy, will be the ownership of the livestock. The contractor in such a case will need to establish very quickly that he/she is the owner of the livestock in order to avoid subjecting the farm products to the claims of the grower’s creditors and, perhaps, the grower’s bankruptcy trustee.
2. Competing security interests – A secondary consideration will be the resolution of various and potentially diverse claims to the livestock or other products. Potential claimants include the contractor’s lender, the grower’s lender, other growers (e.g., feedlot operators), and suppliers. Some states have contracting specific lien regulations, which apply. Both parties should consult legal counsel as to the existence of such laws and their impact on the contractual arrangement. The contractor will want to take all steps necessary to ensure that he/she is able to obtain the benefit of its bargain with its grower.
3. Termination of Production Contracts – While the terms of a production contract often times provide that the contractor may terminate the contract should the grower file for bankruptcy protection, such a provision may not be enforceable by the contractor under the Bankruptcy Code. As a result, a contractor maybe obligated to continue to do business with a grower notwithstanding the bankruptcy case.
4. Chapter 12 Eligibility – In evaluating a potential bankruptcy for a grower, the characterization of income derived from a production contract must be considered. In order to qualify for Chapter 12, a debtor must have derived more than 50% of his income in the previous tax year from a “farming operation.” Thus an issue may arise as to whether income generated by a production contract will qualify as farming income for purposes of Chapter 12. The resolution of that issue will generally turn on whether the grower is “at risk” for market losses. If the grower is compensated on a fixed schedule and does not own the commodities produced, it is less likely that his grower contract income will be considered farm income for Chapter 12 eligibility purposes. In general, most farm debtors will find Chapter 12 more advantageous than the alternative, Chapter 11. As a result, whether a grower is eligible for Chapter 12 may be significant.

 

Contractor Bankruptcy Considerations

1. Executory Contracts in Bankruptcy – A production contract will likely be deemed to be an executory contract which is subject to rejection by the contractor in a bankruptcy case. In other words, should the contractor file a bankruptcy petition, he/she may be able to “walk away” from a production contract. Following rejection, the grower will be entitled to an unsecured claim in the contractor’s bankruptcy case. If the production contract is considered to be a lease, the amount of the claim of the grower will generally be limited by the provisions of the Bankruptcy Code to the rents owed under the lease for a period of one year.
2. Secured Claim of Grower – The grower may be entitled to assert a secured claim against livestock in his possession when the contractor files bankruptcy based on some state laws. Under these laws, a grower who feeds, pastures or otherwise cares for livestock is entitled to a lien against the livestock so long as they remain in the grower’s possession. However, production contracts often contain provisions by which this lien is waived by the grower.

 

Liability or Accountability Issues
Liability for environmental violations and nuisances and food safety issues will be an increasingly important issue. There are two basic liability issues with environment. One is the disposal and spill of manure and the other is nuisance that is generally an odor issue. Another related issue may be such things as road usage and improvement where frequent and large trucks damage public roadways. Without provisions in the contract, it is currently not clear with whom the liability resides. In one recent case in Missouri, it was ruled in a nuisance suit that the contractor was liable for the nuisance created by a poorly situated hog facility, even though the grower had determined the site for the facility. As in most cases, one should not assume that the liability resides with one party or the other. A well-designed contract can define specifics of where the liability will reside in these reasonably foreseen circumstances.

 

Insurance coverage is one way to also protect against liability in cases of physical loss of facilities or livestock. The contract should clearly state who is responsible for insurance coverage of which aspects of production. It is often difficult for the contractor to obtain insurance for livestock held in a grower’s facility. Therefore, it is likely that insurance will be held by the owner of the physical facility. Provisions can be made for compensation for a portion of the premium of the insurance.

 

PERFORMANCE ASSURANCE

 

Strategic Assessment of the Contractor

 

Before entering a long-term contract agreement, the grower is wise to make a careful assessment of the contractor. The following is adapted from a list used by a major agricultural lender to assess the risk involved in lending to contractors and their contract growers.

 

Financial Position
Fulfilling long-term commitments requires a sound financial position. The contractor’s balance sheet is the key factor in determining his/her financial condition. Unless the company is publicly traded, however, this information may be difficult to access. Growers can inquire about the contractor’s financial strength from related parties, public records, and input suppliers without compromising confidentiality. Growers can even ask the farm or company directly about its financial health and work with the contractor to find a way of sharing this pertinent information without comprising the contractor’s right to privacy and competitive protection.

 

Strategic and Historical Commitments to Contracting and to the Region
It is important to assess the contractor’s long-term commitment to the use of contract growers and to the region where the prospective grower lives. The contractor’s fixed asset investments within the region often indicate long-term commitments. The contractor will often first invest in contract breeding/gestation and farrowing units and then try to secure nurseries and finishers through local contract growers. The investment in production facilities as well as offices, training programs and management relocation to the region are all indicators of a strategic presence.

 

If the company owns feed mills or packing plants in the area, these may also indicate a long-term, strategic commitment. None of these factors ensure a fool-proof agreement, but the absence of investment in the local area can be a red flag. How the company has treated contract growers in other areas is also a strong indicator of the relationships that is likely to emerge in a newly developing area.

 

For an independent producer seeking to acquire contract growers, reputation in the community and historical commitment to pig production and to excellence are good signs.

 

Business Focus and Goals
Does the contractor have a clear focus within the swine production business and a clear plan for development in the region? Is pig production the only business of the contractor or is it one of many? Core competency and strategic focusing are necessary for success in an industry that is undergoing rapid change.

 

Does the contractor have clear goals? Are the goals of the contractor realistic for the region? If the contractor is a family farm, is continuity likely in the business goals of the current contractors and the potential heirs? Are the contract buildings proposed a positive response to the changing economic structure of the industry or are they a reaction to disease problems and overcrowding due to a lack of planning?

 

Services and Support
The grower should carefully assess the services, training and support offered by the contractor — especially if the grower has little or no experience in swine production. Breeding and farrowing functions are labor-intensive and require a high degree of skill. Nursery and finishing operations require less skill, but regular and timely contractor service and support will create the best outcome.

 

Grower’s Assurance of Contractor Performance
The contractor should provide the grower with proper financial information and with a list of the other growers that the contractor has recently worked with. The grower can use these growers as references regarding how the contractor has performed in the past.

 

Without proper assessment of the contractor, the grower, by default, accepts the risk of the contractor not being able to perform the contract under consideration.

 

Strategic Assessment of the Grower

 

Before entrusting their pigs to the care of contract growers, contractors should be sure that the grower is capable of managing the proposed project’s debt load. In addition, the contractor should assess the grower’s motivation for entering the relationship and his/her long-term interest in producing pigs on contract. Many contractors allow the bank to evaluate the grower’s finances for constructing the required buildings. If a loan is required and approved, the contractor often assumes that the grower has passed the financial test. In fact, contractors need to do their own assessment of a grower’s financial situation.

 

If continuously renewed, the typical swine production contract loan is self-liquidating. This means that the normal contract payments will cover the loan payments (even if it is 100 percent financed). Since the payments are not subject to market price risk, the contract is relatively safe. Some factors that lenders consider when determining the grower’s ability to finance new buildings are listed below. Contractors are wise to use this information to help screen candidates prior to a grower’s request for a bank loan.

 

Financial Position
The grower’s financial position is determined by several factors, including:

• the level of debt
• how the debt has been structured
• cash flow position
• other farm income and expenses
• off-farm income

 

In general, the contractor wants to find a grower who is choosing contract production in a proactive manner, as an investment or source of income for the farm or family. Contractors should carefully screen prospective growers who are choosing contracting for reactive reasons. These reasons include financial failure of other farming or business enterprises, the feeling of being “forced” into contracting because of changes in the industry or as a last-ditch effort to remain in agriculture. These motives are not necessarily disqualifiers, but an individual assessment should be undertaken to make sure the prospective grower is a long-term player and capable of managing the investment.

 

Production Management Ability
Although contract production is often systematized, the grower must demonstrate varying degrees of production management ability depending on the type of contract. Contract breeding/gestation and farrowing functions are the most complex, requiring heat detection and breeding skills (including artificial insemination in some systems), as well as careful and timely determination of pregnancy maintenance or loss. Farrowing skills and minimizing preweaning mortality are critical to the success of both parties. Growers should receive adequate training, but need to be assessed for their willingness, interest and ability to master these skills. If the unit is large enough, the grower may need to hire labor to accomplish all of the tasks in a timely manner. The contractor should assess the ability of the grower to hire, train, motivate and retain high-quality labor. The contractor should supervise the training provided by the grower to be confident of its effectiveness.

 

Contractor’s Assurance of Performance by Grower
The grower needs to supply proper financial information and a list of recent business contacts as references. The grower should authorize its bank and other parties it has done business with to release pertinent information upon the contractor’s request. The contractor has an interest in determining the grower’s financial ability to perform under contract by learning how the grower has performed in other business relationships.

 

Without proper assessment of the grower, the contractor, by default, accepts the risk of the grower not being able to perform the contract under consideration.

 

DUTIES AND RESPONSIBILITIES OF THE CONTRACTOR AND GROWER

 

Editor’s note: As this text is designed as a ready reference for parties interested in contracting, it has been written to maximize access to information. Please note that this chapter details the basic aspects that need to be covered in any pork production contract. Chapters 6, 7 and 8 cover the same ground, but add specific information about farrowing, nursery and finishing contracts respectively.

 

The Contract

 

Whether a production contract is a useful tool or a risky proposition depends on the relationship between the parties, the language of the contract and the performance under the agreement. The grower can assume the party offering the contract has every intention of fulfilling the agreement and has no interest in a legal dispute. The grower must also assume that the contractor received legal advice in drafting the contract and has protected his/her business from risks. Assuming, however, is a risky way to do business. When in doubt, it is important to ask questions. Both parties need to be aware of their rights and obligations in advance, instead of being unpleasantly surprised later. It is important for both parties to consult an attorney before signing a contract.

 

It is best to have a written agreement that spells out the many contingencies that could arise during the contracting period. With a written document, it will be much easier to settle disputes if they arise. Here’s a checklist for contractors and growers in preparing a contract:

• Clearly understand the written contract.
• Make sure that issues that are important to either party are confirmed in writing.
• Rely on what’s written, not verbal explanations or interpretations.
• If there are changes to be made in the contract, make sure both parties sign it.

 

Contract Terms

 

The complete terms of the contract should be reviewed by both parties with the help of both financial and legal experts, so that all terms and financial obligations are understood. Since there is no such thing as a standard contract for swine production, growers need to evaluate all contracts before deciding which one is most satisfactory.

 

In brief, contract terms need to spell out all the responsibilities of each party. In addition, the grower should be satisfied with specific terms related to:

• contract length
• conditions of contract renewal
• base compensation
• bonus compensation
• default provisions
• conflict resolution
• guarantees made by either party

 

It is important to rely on what is written, not verbal explanations or interpretations. Any changes that are made in the contract should be confirmed in writing. If the contractor and grower have signed both a farrowing and finishing contract, it must be determined when the animals pass from the farrowing contract to the finishing contract.

 

The success or failure of any contract will depend on the people involved. All participants in a contract must be able to work together, to communicate and to learn from each other. Successful agreements are the result of cooperative, not adversarial, relationships.

 

Compensation

 

Contract Payments
The cash payments to the grower are the easiest and most flexible variable in offsetting other contract terms. To a large degree, swine contracts deal with allocating the economic risks between the parties. Shifting additional risk to the grower should result in additional compensation and vice versa. It is important to keep this in mind when drafting, reading or negotiating a swine contract.

 

Many contracts allow for multiple payments during the period that a group of pigs is on the farm. That is, the contractor may pay every three weeks, every month or once, at marketing. Others pay part at placement and the remainder at marketing. Spreading out payments is preferred by many contract producers because it eases cash flow burdens. These provisions should be clearly spelled out in the contract and understood by all parties. The grower should realize at the outset that he/she is not compensated for hogs that die.

 

Methods
Most contracts have one of three compensation methods for growers. The first is a base payment per live animal transferred, plus a bonus based on some productive or efficiency measure. Bonuses for reduced death loss and uniformity (sort) are also common. These methods of compensation can cause income fluctuations for the grower outside of his/her control. For instance, if the contractor elects to feed the finishing animals for an additional two weeks, the grower receives no additional compensation. Annual income will be reduced, as the number of animals transferred out of each finishing building will be reduced by the longer feeding period.

 

This problem has led to a second compensation method based on a per-pound-of-gain payment, with bonuses for efficiency. By compensating the grower for weight gain, the contractor maintains the flexibility to feed the animals to optimal weights without penalizing the grower or reducing his/her income.

 

A third compensation method, popular in the upper Midwest, originally evolved for finishing contract, but is also now a popular wean to finish compensation method. This involves paying the grower on a per pig space, per year basis. A fixed payment of $32 per pig space, per year is common. The contractor then assumes the burden for the wise and economical use of the building. Growers complain that this method locks them into a fixed labor income. Since the payment includes a return to labor, the grower experiences a real decline in labor income over the life of the contract, assuming inflation. Some systems are considering indexing payments to the Consumer Price Index or some standard measure of inflation to overcome this problem. Contractors have been concerned that this method removes the grower’s incentive for excellence and vigilance, since it is a fixed payment that is not tied to performance or death loss.

 

Bonuses
It is important that bonuses be fair and be based on things within the control and influence of the grower. Pitting growers against each other to determine bonus levels has been successful in some areas and has caused friction in others.

 

Minimum Payment
The contractor should pay the grower a minimum amount for each market hog. The minimum payment provision should override any inconsistent provisions in the contract and can be used to avoid a situation where the grower has to return some of the advanced payments because of deductions under other contract terms.

 

Maximum Payment
Some contracts contain a maximum payment stating that the payments to the grower will not exceed a specified amount for each market hog. This maximum payment overrides any inconsistent provisions of the contract.

 

Progress Payments
With progress payments, the contractor will pay the grower a specified amount per pig within a given number of days after the pigs are delivered to the grower. These payments are an advance against the total payments made under the contract. In some contracts, the grower may be required to refund some of the advance payment.

 

Final Settlement
Under most contract arrangements, the contractor computes the payments to the grower. The contractor should provide the grower with a copy of the computation and the information used to make the computations. The grower should verify that the contractor has used accurate information. These records should include only those items relevant to the computation of the grower’s payments under this contract, such as packer returns, feed company invoices and copies of scale tickets for pigs and market hogs.

 

Death Loss

 

The term “death loss” refers to all reductions in the number of live animals. The following are usually not considered death losses:

• death of pigs reimbursed by the broker or seller of the pigs
• losses covered by casualty insurance
• culls

 

Death losses include all deaths and mysterious disappearances, except culls and losses that are reimbursed by insurance or by the seller of the pigs. At this point, this definition appears to be the industry norm, although many contracts are not specific on this issue.

 

Losses Due to Improper Animal Husbandry
Most contracts adjust the payments to the grower based on the death losses that occur. The underlying idea is that the grower’s husbandry practices affect death losses, and the grower should be motivated to keep death losses to a minimum. The grower should be responsible for death losses caused by the failure to follow proper animal husbandry practices. Ideally, the parties would agree on which death losses are attributable to husbandry practices and, therefore, the responsibility of the grower, but this is not always practical.

 

It can be argued that most of the death losses that occur in the first few days after the pigs are delivered are primarily the result of the incoming condition of the pigs, not the grower’s animal husbandry practices.

 

To be fair to both parties, the contract can stipulate a time frame for death loss culpability. The grower is presumed not to be responsible for early losses, i.e., losses during the first (specified) days after contractor’s animals are delivered to the grower’s facilities. Death losses after the specified number of days will be presumed to be due to substandard animal husbandry practices and will be the grower’s responsibility. Either party can rebut this presumption with convincing evidence of the death loss cause.

 

Death Loss Verification
It is common in contracts for the contractor to have the right to physically verify any or all death losses that occur. This is normally done by requiring the grower to save and preserve either ears, snouts or other body parts until a representative of the contractor can verify the mortality.

 

Death Loss Deduction
In some contracts, the payments to the grower are reduced by the cost of death losses in excess of a stated allowed percentage. Option A uses just the purchase price of the pig, and option B uses the entire investment in the animal. Since the investment in the animal can only be estimated, option B is more likely to cause disagreement between the parties.

 

Figuring death loss:

 

• Option A: Loss equals the price of the pig. The financial cost of each death loss is the average initial purchase price of a pig.
• Option B: Loss equals the total investment in the animal. The financial cost of each death loss is the estimated inventory cost of the animal at the time of death. This is the average initial purchase price of a pig, plus the estimated cost of feed and medicine for the dead animal. A set dollar value can be established in the contract (i.e., $100 per mortality).

 

In some contracts, if an unverified disappearance (number of hogs sold minus the number of pigs placed) in excess of a given percentage occurs, the grower may be required to pay the difference.

 

Death Loss Bonus
Some contracts contain a death loss bonus stipulating that the contractor will pay the grower a bonus for each market hog. This is normally based on a death loss that falls under a given percentage. An example of a death loss bonus is:

 

Transit Losses
Contracts can address transit losses in two ways:

• Option A: Transit losses are included in the contract payment. Hogs that die in transit to the packing plant as “market hogs” will be treated as market hogs. The parties will assume that the hogs that die in transit have the same average weight as the hogs that are actually marketed.
• Option B: Transit losses are excluded in the contract payment. Hogs that die on the way to market will not be treated as market hogs. This results in the grower absorbing some of the risk for transit losses through reduced payments under the contract.

 

Division of Expenses

 

An area that often confuses growers is the division of expenses, or “who pays for what.” The division of expenses may vary from contract to contract, even within the same contracting firm. As always, it is important not to assume that just because a practice seems standard that it will be covered that way in the contract. Which party supplies and pays for supplies and tools needs to be stipulated in the contract. Examples include bedding, disinfectants, ear tags, taggers, syringes and needle teeth clippers.

 

Length of Contract

 

Before entering long-term contractual arrangements, growers need to be satisfied that the investment is sound. Several factors determine this. Most contracts within the first 10 years of continuous use:

• pay for the complete cost of the capital investment (buildings and equipment, but not land)
• return about 9 percent to average capital invested
• compensate the grower for labor contributed at farm level wages
• produce about a 1 percent to 3 percent return on risk

 

Contract maturity is a double-edged sword. Lenders usually like to see the length of the contract equal the length of the financing. This may be the safest approach for the bank, but it is not always best for the grower. By locking down the terms of the contract for seven years, for instance, the grower loses the flexibility to act on a more generous offer from competing contractors. In addition, the grower may be locked into less favorable terms if competitive pressures produce new contracts with better compensation schedules or terms. A short-term contract, however, can create serious risks if it is terminated before the building financing is repaid. The risk is greatest in areas where the contractor is the only party contracting hogs, leaving the grower with no other marketing channel.

 

Insurance

 

The following commercial insurance should be maintained and provided for by the contractor and/or the grower:

• liability
• animal casualty
• building casualty

 

The contract should specify which party is responsible for carrying each kind of insurance, and, in some contracts, minimum limits are set. The party maintaining the insurance should provide the other party with a certificate of insurance upon request.

 

It is the responsibility of the grower to maintain workmen’s compensation insurance, unemployment compensation insurance, disability and health insurance benefits and all similar insurance for his/her employees.

 

Termination of Contract

 

How and by whom can the contract be terminated? This is an important question, because market conditions may fluctuate, causing either the contractor or grower to rethink the agreement. Most contracts provide an avenue for either party to terminate the agreement. Usually this requires notice be given to all other parties involved a set number of days prior to termination.

 

The contract should outline the steps for termination and explain the valid reasons for termination. In some contracts, the contractor reserves the right to take over the management of the unit. Other contractors provide a manager for a fee. The grower may want to be assured of compensation should the contract be ended by removal of the hogs.

 

Early Termination of Contract
The most difficult early termination issue is proper animal husbandry. The contractor needs to maintain the right to terminate if growers are not able to correct in short order any husbandry practices that threaten the lives or economic value of the swine.

 

The grower is entitled to compensation for services rendered before the termination, and both parties are entitled to damages resulting from the other party’s breach of contract.

 

Early Termination by the Grower
The following contract terms are considered necessary preconditions for the continued performance of the grower. Any early termination becomes effective when the grower gives the contractor a notice of termination that specifies one of the following reasons for the termination:

• Failure of delivery. The grower may end the contract if the contractor fails to deliver contract swine in substantial compliance with the contract. The grower may not end the contract for this reason after accepting delivery of the contract swine.
• No feed source. The grower may end the contract if the contractor fails to provide a source of feed or feed ingredients in substantial compliance with this contract.
• Delinquent payment. The grower may end the contract if the contractor fails to make the payments to the grower in substantial compliance with this contract.

 

The grower may be liable to the contractor for damages if arbitrators or a court determine that the early termination was not justified.

 

Early Termination by Contractor
The following contract terms are considered necessary preconditions for the continued performance of the contractor. Early termination goes into effect when the contractor gives the grower a notice of termination that specifies one of the following reasons for the termination:

• Improper animal husbandry. The contractor may end the contract if the contractor, in his/her sole judgment, determines that the grower is not using animal husbandry practices in substantial compliance with the contract.
• Failure to report death or disease outbreak. The contractor may end the contract if the grower fails to comply with the death notification requirements of the contract.
• Grower’s removal of contract swine. The contractor may end the contract if the grower removes any of the contract swine from the contract facilities without the contractor’s written permission (except for removal of dead animals and isolation of animals as permitted in the contract).
• Commingling. The contractor may end the contract if the grower brings any swine other than the contract swine onto the contract facilities without the contractor’s written permission.
• Diversion of feed. The contractor may end the contract if the grower feeds any of the feed or feed ingredients purchased by the contractor to any animals other than to the contract swine.
• Failure to forward records. The contractor may end the contract if the grower fails to forward production records in substantial compliance with the contractor’s instructions. Before ending the contract for this reason, the contractor must give the grower a written notice stating that the contractor will end the contract if the grower does not provide the production records in a timely manner.
• Failure to follow instructions. The contractor may end the contract if the grower fails to follow the contractor’s instructions as required in this contract. Before ending the contract for this reason, the contractor will give the grower a written notice stating that the contract will end if the grower does not follow the contractor’s instructions specified in the notice.
• Continued poor performance. The contractor may end the contract if the grower continually fails to perform as specified by the terms of the contract. The contractor may be liable to the grower for damages if arbitrators or a court determine that the early termination was not justified.

 

Rights Following Termination
The termination of the contract, either at its scheduled end or earlier, does not terminate the rights and liabilities of the parties. At the end of the contract, the contractor may enter the contract premises for the purpose of removing any remaining feed and the contract swine (unless the grower has exercised an option to buy the swine as provided in the contract).

 

Delivery and Marketing

 

Capacity or Occupancy
The contract should spell out not only the capacity of the building, but also its minimum occupancy rate.

 

Timing of Delivery
The contract should address the timing of delivery. The contractor needs to start delivering animals to the grower within a specified number of days after signing the contract. The contractor then needs to bring the herd up to full size within a specified time after starting deliveries.

 

The delivery timing of the pigs is especially important. As there are many deliveries over time, the delay between the truck picking up the hogs and the truck delivering the pigs is crucial to the grower’s earnings for the year. A contractor has a legitimate economic reason for wanting to control when to deliver the animals to the grower, and there is nothing inherently wrong with this practice. A grower that is assuming the risk of having empty or under-utilized facilities, however, should understand this risk, and be compensated for it.

 

One alternative would be for the contractor to pay the grower a specified amount per day that the grower’s facilities sit empty between the signing of the contract and the delivery of the next contract herd. The grower must realize that there will be a certain amount of downtime needed to allow for the cleaning of the facilities and repairs and that the contract should address this period.

 

The contract should stipulate how many days the contractor has to bring the contract herd up to full size after starting deliveries. Without this stipulation, the grower risks delays and the financial risk that his/her facilities will sit empty.

 

Selection of Pigs
It is industry norm for the contractor to select the pigs for contracting. If the contractor supplies the animals, then the agreement should state the necessary precautions that the contractor must take to ensure that disease is not introduced on the farm. Precautions may include testing, prior record of vaccinations or a guarantee that all animals come from a single source. Also, it should be spelled out clearly in the contract if particular genetics are to be used. The contractor is responsible for complying with applicable laws regarding the movement of swine. All necessary inspection certificates or health certificates are to be obtained by the contractor.

 

The grower and the contractor have a financial interest in the grower receiving high-quality pigs. There are more grower complaints about the incoming condition of the pigs, however, than any other aspect of swine contracts.

 

The grower responsible for feed efficiency and death loss is at a disadvantage if the contractor delivers low-quality pigs. The contract should also contain provisions for the producer to renegotiate compensation if low-quality or sick animals are delivered.

 

If animals cross state lines, they are health-papered to a location and must remain there in quarantine for a specified period. Growers intuitively want the right to decline pigs at time of delivery, despite the fact that many problems cannot be spotted by a physical inspection. Contractors are reluctant to give the growers a unilateral right of rejection, largely because this rejection leaves a contractor with a truckload of pigs that don’t have a home.

 

Marketing of Hogs
It is also the industry norm for the contractor to control the time for marketing the hogs. Under certain market conditions, the contractor has a financial incentive to delay marketing in the hopes that prices will rise. Although this is a legitimate economic reason, the delay can cause the grower to care for animals after they have reached what the grower assumed to be market weight. Delays can affect feed efficiency bonuses.

 

In the case of marketing delays, there are two options:

• Option A. The grower is compensated for marketing delays that reduce fair returns. The contractor controls when the hogs will be marketed and pays the grower an agreed amount per pound for each market hog, assuming that the average weight for the herd at marketing exceeds a specified poundage. This is only an issue when the contractor is paying the grower on a per-head basis.
• Option B. The grower bears the risk of marketing delays.

 

Facilities

 

Type
Growers should build facilities that will be accepted by other contractors or that can be sold to another producer if necessary. A good rule of thumb is for the grower to build a foundation and shell that has a 25-year life expectancy. It is important to budget to replace the interior equipment every five to seven years. The grower needs to consult an engineer and negotiate changes if the contractor’s quality specifications are not met or exceeded. It is important not to settle for the argument that quality changes cannot be made since the material specifications are part of a proven system.

 

Cost
The cost of the facilities should be commensurate with the quality of the building proposed and be the norm for the region where it is to be constructed. Large-scale contractors can often save growers a significant amount on building costs by using their volume purchasing power and assistance in subcontracting and building the facilities.

 

The grower should develop a detailed cash flow budget to determine the timing of cash inflows and outflows and to test for financial feasibility. Do not rely on cash flows prepared exclusively by the contractor. The budget should cover monthly cash flow for the first 24 months, then five years of annual cash flow estimates. The budget is key not only for obtaining a loan, but also for maintaining financial control. Careful budgeting assures that the start-up phase is planned. The cost of facilities must be in line with the proposed payment level and frequency of payment. The lender and extension personnel can assist in the budgeting process.

 

Standardization
For the contract grower, the greatest protection for ensuring constant use of the buildings over the financed period is to build standardized buildings. Contracts can be broken by either party or jointly dissolved. A building of standard size, design and quality is more likely to be in demand by other swine producers in the future. In addition, standardized facilities tend to hold their value much longer, assuming appropriate maintenance. With standardized buildings, the grower has the flexibility to choose another contractor or sell the buildings to other producers if they decide to leave the business.

 

Standardized buildings also indicate that the contractor is producing pigs using a system, and systematic production is needed to produce high-quality, uniform animals and to remain competitive in the industry long term.

 

Nutrient Management
The grower typically has full responsibility for compliance with federal, state and local environmental laws. Careful site selection is the key to avoiding environmental problems. The site should be professionally evaluated to ensure it is a feasible location for swine production. In general the following should be considered:

• the quality and quantity of available water
• the containment of manure and other effluent
• the environmentally suitable disposal method of these production byproducts
• the disposal of dead animals consistent with legal guidelines

 

Neighbors in the immediate area should be informed of the proposed production prior to any dirt work or construction. Discovering strong objections early will help the grower assess the long-term feasibility of the project and whether a different site should be developed.

 

Specific points to consider are:

1. The facility must have an adequate land base to support the buildings and an adequate-size earthen or concrete manure storage basin. Concrete pits under slats are also acceptable.
2. State regulations should be reviewed for any current regulations pertaining to the facility and storage basin. State regulations and permits, as well as county zoning requirements, must be met or obtained.
3. Construction of the building and storage basin should be under the supervision of an approved engineer.
4. Manure storage with disposal easements must meet state requirements.
5. The property must have an adequate water supply that meets the minimum water quality standards.
6. The site must be approved by the lender and a written commitment should be obtained prior to construction.

 

Site
Many contractors require growers to limit the use of the farm complex to just the contractor’s swine. Contractors believe that this reduces disease risks and the possibility that some of the contractor’s feed will be fed to other animals. With the contractor’s prior permission, the grower may isolate in a separate facility animals showing signs of illness or new breeding stock.

 

The contract facilities are normally used exclusively for the contract swine. The contract should stipulate how close any other swine can be to the contract facilities. This is critically important where “contract facilities” are defined as part of a farm complex.

 

It is important to pick a site that can be carved out of existing property or that stands alone on a clearly accessible and identifiable site.

 

Condition
The grower is usually responsible for maintaining the contract facilities and keeping the equipment in good operating condition at all times. The grower is responsible for making a good faith effort to keep wild animals out of the contract facilities. The contractor is not liable for physical damage to the contract facilities caused by the contract swine.

 

The contractor may void the contract if the grower does not maintain the facilities. The only exception is if such failure is due to conditions beyond the grower’s control, such as weather or the unavailability of supplies.

 

Normally it is the grower’s responsibility to have the facility cleaned, disinfected and ready for receipt of additional hogs from the contractor within a given number of days (typically seven) after the last hog is removed from the facility. It is also the grower’s responsibility to notify the contractor that he/she is ready to accept additional hogs.

 

Facility Security
The grower usually provides adequate security for the contract facilities, including yard lights and either a locked gate or a blocked drive to restrict vehicle access.

 

Facility Overhead
The grower usually pays for the maintenance of the contract facilities, and all water, electricity and fuel for these facilities. It is the grower’s obligation to maintain the roads to the facilities.

 

Capacity
It is important that the contract stipulate a minimum capacity or number of animals to pass through the facilities. Without such a guarantee the grower risks having made investments and incurred costs that are not recoverable. A general rule of thumb is that the facility will be filled to at least 90 percent capacity at all times. Alternatively, the contractor may opt to guarantee a certain number of animals or groups of animals per year. Farrowing operations will often determine the production guarantee through a minimum number of working sows maintained on the farm.

 

Owner’s Access
Under the contract, the contractor should be able to enter the premises to inspect the swine, determine that they are being properly cared for, provide medication and for other reasons related to the contract. The contractor will comply with the grower’s sanitation instructions (cleaning boots, wearing coveralls and showering, for example) before entering the contract facilities. Some growers want to limit this access, either for disease control or to avoid disruption in the operations.

 

The contract needs to clarify if contractors have access at any time to the facilities or if there is a specified time and protocol for the contractor to enter the premises. The contract should also stipulate the number of people that may enter the premises at one time.

 

Health Care

 

The contract needs to spell out health care practices allowed or required and/or procedures to follow should health problems arise. The means of reporting and accounting for death loss should also be covered.

 

Scheduled Health Care
The contractor usually details the animal care products that the grower is expected to use. The grower is expected to follow the directions on the product or the directions of a specified or selected veterinarian. The grower is not to use animal care products other than those specified by the contractor or by a veterinarian. The contractor usually pays for the scheduled health care costs.

 

The contractor is usually responsible for ensuring that the instructions regarding animal care products comply with existing laws. The grower is also responsible for meeting withdrawal schedules, presuming that the contractor has notified the grower of the expected time for marketing the animals.

 

Unscheduled Health Care
The contractors commonly pay for all health care and have complete control over the health care. The grower reports all significant disease symptoms to the contractor. All cases of death or disappearance must be reported within a specified time period to the contractor. The contractor usually pays for unscheduled health care costs.

 

In the case of health problems, the grower is normally told to call the contractor’s service representative. The service representative then inspects the animals and determines the proper course of action. The grower is usually not allowed to call a veterinarian. As contractors typically pay the veterinary bills, they are often concerned that the grower will call the veterinarian too frequently. It is in the best interest of both parties, however, to keep the animals as healthy as possible.

 

For health care, other possible arrangements include:

• Option A. Shared-cost approach to balance the interests of the two parties. Under a shared-cost scenario, the grower is allowed to call a veterinarian whenever he/she thinks it is prudent. By sharing the cost, however, the grower has an incentive not to call the veterinarian unnecessarily. In this case, the grower’s compensation schedule needs to be increased to offset this added expenditure.
• Option B. Parties share control. The contractor selects the veterinarian for the contract swine. Either party may call the veterinarian selected by the contractor to discuss the contract swine or to ask the veterinarian to inspect the contract swine. The grower may call a different veterinarian if the veterinarian chosen by the contractor is not available and the grower believes it is an emergency.

 

Husbandry Practices

 

Standard of Husbandry Practices
The grower is expected to care for the contract swine using generally accepted animal husbandry practices. The contractor should provide the grower with the expected husbandry practice instructions and the grower needs to agree to follow these directions. It is very important that the grower understands and follows the husbandry practices stipulated in the contract.

 

If the grower fails to carry out these instructions, the contractor has the right to enter the grower’s premises to perform the grower’s duties. Any expense incurred by the contractor in this situation is charged to the grower and deducted from the payments owed.

 

It is a good idea for both the contractor and the grower to keep a written record of all important conversations with the field serviceman who will be monitoring proper husbandry practices. The written record should include the date, time, place, names of those present and a summary of what was said.

 

Management Control
Most of the disputes that arise between grower and contractor concern the grower’s management autonomy. Growers are often under the impression that they can continue to raise and market hogs the way they always have and receive the risk alleviation in the contract. Generally, this is not the case. Contractors often have very strong opinions about what should be done and will often dictate their management control in the written agreement. It is important that growers understand the limits being placed on them before they enter into the agreement. This may entail outlining farrowing schedules, feed schedules, hygiene and a host of other management practices to be followed.

 

Labor
The grower usually provides all of the labor involved in caring for the contract swine, including assisting in the loading and unloading of swine entering or leaving the contract facilities. The grower may use employees or independent contractors to care for the contract swine and the grower will pay for such labor.

 

Production Records
The grower is usually required to prepare periodic production records as instructed by the contractor within a given number of days after the end of a specific production period. These records include all information reasonably necessary for the proper and efficient management of the pigs, including death loss.

 

Feed Quality
If the contractor supplies the feed, then the contract may specify the ration quality and the ingredients. For example, the contract may specify a minimum lysine level and a minimum metabolizable energy level. This is especially important if the contract pays a bonus for feed efficiency, because subpar feed quality can greatly reduce feed intake, rate of gain and feed conversions. Feed consistency and density in feeders is important. Parties should consider requiring a labeled feed analysis or provision for providing for feed testing upon either party’s request.

 

Culling Practices
There are several common ways to approach culling:

• Option A. Grower’s discretion. The grower determines when an animal should be culled from the herd and notifies the contractor of all culls.
• Option B. Contractor’s discretion. The grower monitors the contract swine and make recommendations to the contractor regarding animals that should be culled. The contractor determines when an animal should be culled from the herd.
• Option C. Mutual agreement. The contractor and the grower reach a mutual agreement to determine when an animal should be culled from the herd.

 

Manure Management and Disposal of Dead Animals

 

The grower is expected to remove and dispose of dead animals, manure, used bedding and other waste products in a timely manner. The grower is responsible for complying with applicable laws regarding disposal of dead animals and manure. The grower usually pays any charges imposed by a rendering plant or other dead animal disposal method. In some contracts, the contractor reimburses the grower for a percentage of the rendering plant costs.

 

SPECIFICATIONS OF A FARROWING CONTRACT

 

Duties and Responsibilities

 

The Contract
Whether a farrowing contract is a useful tool or a risky proposition depends on the relationship between the parties, the language of the contract and the performance under the agreement. The grower can assume the party offering the contract has every intention of fulfilling the agreement and has no interest in a legal dispute. The grower must also assume that the contractor received legal advice in drafting the contract and has protected his/her business from risks. Assuming, however, is a risky way to do business. When in doubt, it is important to ask questions. Both parties need to be aware of their rights and obligations in advance, instead of being unpleasantly surprised later.

 

Contract Terms
The complete terms of the contract should be reviewed by both parties with the help of both financial and legal experts, so that all terms and financial obligations are understood. Since there is no such thing as a standard farrowing contract, growers should evaluate all contracts before deciding which one is most satisfactory.

 

In brief, contract terms need to spell out all the responsibilities of each party. In addition, the grower should be satisfied with specific terms related to:

• contract length
• conditions of contract renewal
• base compensation
• bonus compensation
• timing and figuring of payment
• default provisions
• conflict resolution
• guarantees made by either party

 

In the farrowing contract, items that should be specifically noted include:

• performance standards for sow productivity
• sow death loss
• sow culling
• pig survivability
• sow and pig feed usage
• medication usage as determined by the contract

 

Compensation
Farrowing contracts are usually paid on the basis of a per weaned animal transferred, as the contractor has little or no flexibility in delaying removal of the animals (as in finishing buildings). Bonuses for achieving excellent production and low death losses are typically generous. The bonuses are a key reason why a disproportionate number of growers choose farrowing and/or nursery contracts. The fact that less manure is produced in these operations also contributes to their appeal.

 

Fixed Payments vs. Incentives
The method of payment can have important implications on incentives to perform under contracts. This is the issue of moral hazard which is nearly always present in contracting arrangements. With fixed payment contract in which the grower receives a fixed payment per pig or pig space, the moral hazard resides mostly with the grower. In this case the incentive to put in extra effort to improve performance is not rewarded under the contract and there is an incentive to incur the least possible cost both in terms of effort and other inputs.

 

With an incentive based contract, the grower often receives premiums in addition to a fixed payment for superior performance of the livestock. Under this arrangement, the moral hazard resides with the contractor. The definitions for superior performance in this case should be set so they are attainable with reasonable effort. However, this is often subjective assessment and the contractor may have an incentive (pay lower premiums) to set the standard relatively high. In an effort to remove some of the subjectivity, tournament contracts have arisen which rank growers against each other. In this way, superior performance is benchmarked against other similar situations and provides a ranking without actually having to set a predefined level. One of the common issues with tournament contracts is that some growers feel as though they are placed in unfair circumstances. For example, the pigs delivered by the contractor are not as high quality or uniform as those delivered to others under the tournament. This has been a common point of contention in broiler and turkey grower contracts. It is important to understand all payout provisions and to also understand how this affects incentives for all participants in the contract.

 

Contract Payments
The cash payments to the grower are the easiest and most flexible variable in offsetting other contract terms. To a large degree, swine contracts deal with allocating the economic risks between the parties. Shifting additional risk to the grower should result in additional compensation and vice versa. It is important to keep this in mind when drafting, reading or negotiating a farrowing contract.

 

Many contracts allow for multiple payments. That is, the contractor may pay every three weeks, every month or once, at marketing. Sometimes contractors pay part at placement and the remainder at marketing. Spreading out payments is preferred by many contract producers because it eases cash flow burdens. These provisions should be clearly spelled out in the contract and understood by all parties. The grower should realize at the outset that he/she is not compensated for hogs that die.

 

Payment Structures
There are various ways that contracts cover payments for yardage fees. Some of the options are addressed below. The contractor may use any one or a combination of the following:

• Option A. Sow fee. The contractor pays the grower a specified amount, multiplied by the average number of sows and mated gilts in the breeding herd. This is usually done on a monthly basis, based on the preceding month’s inventory.
• Option B. Pig fee. The contractor pays the grower a specified amount equal to the number of marketable pigs sold. This is usually done each month based on the marketable pigs sold the previous month. The definition of a “marketable pig” is any pig that meets standards developed by the contractor.
• Option C. Crate or pen space. The contractor pays the grower a specified amount for each crate and/or square foot of pen space in the nursery building.
• Option D. Fixed fee. The contractor pays the grower a specified amount for each pig within a given number of days after the pigs are marketed.
• Option E. Pig per sow fee. The contractor pays the grower a specified amount per marketable pig produced per sow. A formula is usually used to determine this.
• Option F. Portion of gross proceeds. The contractor pays the grower a specified percent of the proceeds from the sale of market pigs. The gross proceeds are determined by subtracting the following expenses from the sale proceeds: cost of transportation, transportation insurance, checkoff payments, commissions and yardage.
• Option G. Efficiency bonus. Some farrowing contracts provide an efficiency bonus, in addition to the base payment for each pig produced, based on the number of pigs produced per sow per year. Here’s an example of such a bonus:

 

Compensation Settlement
Under most contract arrangements, the contractor computes the payments to the grower. The contractor should provide the grower with a copy of the computation and the information used to make the computations. The grower should verify that the contractor has used accurate information. These records should include only those items relevant to the computation of the grower’s payments under this contract, such as feed company invoices and copies of scale tickets for pigs and sow inventory.

 

Division of Expense
An area that often confuses growers is the division of expenses, or “who pays for what.” The division of expenses may vary from farrowing contract to farrowing contract, even within the same contracting firm. As always, it is important not to assume that just because a practice seems standard that it will be covered that way in the contract. Which party supplies and pays for supplies and tools needs to be stipulated in the contract.

 

Expenses that need to be accounted for include:

• veterinary care
• animal care products such as feed additives or injections
• dewormers
• insecticides or pesticides
• utilities
• supplies
• tools
• uniforms
• disinfectants
• syringes
• taggers
• tooth clippers
• ear tags

 

Which party supplies and pays for supplies and tools varies and needs to be stipulated in the contract.

 

Length of Contract
Before entering long-term farrowing contractual arrangements, growers need to be satisfied that the investment is sound. Several factors determine this. Most contracts within the first 10 years of continuous use:

• pay for the complete cost of the capital investment (buildings and equipment, but not land)
• return about 9 percent to average capital invested
• compensate the grower for labor contributed at farm level wages
• produce about a 1 percent to 3 percent return on risk

 

Contract maturity is a double-edged sword. Lenders usually like to see the length of the contract equal the length of the financing. This may be the safest approach for the bank, but it is not always best for the grower. By locking down the terms of the contract for seven years, for instance, the grower loses the flexibility to act on a more generous offer from competing contractors.

 

In addition, the grower may find themselves locked into less favorable terms if competitive pressures produce new contracts with better compensation schedules or terms. A short-term contract, however, can create serious risks if it is terminated before the building financing is repaid. The risk is greatest in areas where the contractor is the only party contracting hogs, leaving the grower with no other marketing channel.

 

Farrowing contracts normally extend over a longer period than finishing contracts, due to the longer natural cycles and the increased costs likely at the beginning and end of the contract.

 

Insurance
The following commercial insurance should be maintained and provided for by the contractor and/or the grower:

• liability
• animal casualty
• building casualty

 

The contract should specify which party is responsible for carrying each kind of insurance, and, in some contracts, minimum limits are set. The party maintaining the insurance should provide the other party with a certificate of insurance upon request.

 

If required by law, it is the responsibility of the grower to maintain workmen’s compensation insurance, unemployment compensation insurance, disability and health insurance benefits and all similar insurance for himself and his employees.

 

Termination
How and by whom can the contract be terminated? This is an important question, because market conditions may fluctuate, causing either the contractor or grower to rethink the agreement. Most contracts provide an avenue for either party to terminate the agreement. Usually this requires notice be given to all other parties involved a set number of days prior to termination.

 

In the event of an early termination, most farrowing contracts allow the contractor to take exclusive possession and control of the contract facilities for a short time period to make other arrangements for the contract swine. Some farrowing contracts provide the grower with a purchase option. The formula for determining the purchase option should approximate the expected market value of the animals at the time.

 

The contract should outline the steps for termination and explain the valid reasons for termination. The termination of the contract, either at its scheduled end or earlier, does not terminate the rights and liabilities of either the grower or the contractor.

 

Delivery and Marketing

 

Capacity
The contract should specify the minimum number of breeding animals the contractor is to maintain at the contract facilities.

 

Timing of Delivery
The contract should also address the timing of delivery. The contractor needs to start delivering animals to the grower within a specified number of days after signing the contract. The contract should stipulate how many days the contractor has to bring the contract herd up to full size after starting deliveries. Without this stipulation, the grower risks delays and the financial risk that his/her facilities will sit empty.

 

Selection of Breeding Stock
It is industry norm for the contractor to select the breeding stock. The grower, however, has a financial interest in receiving high-quality animals, and this issue merits attention in the contract. If the contractor supplies the animals, then the agreement should state the necessary precautions that the contractor must take to ensure that disease is not introduced on the farm. Precautions may include testing, prior record of vaccinations or a guarantee that all animals come from a single source. Also, the contract should clearly state if a particular genetics is to be used. The contractor is responsible for complying with applicable laws regarding the movement of swine. All necessary inspection certificates or health certificates are to be obtained by the contractor.

 

Growers intuitively want the right to decline pigs at time of delivery, despite the fact that many problems cannot be spotted by a physical inspection. Contractors are reluctant to give the growers a unilateral right of rejection due to various state health regulations pertaining to the movement of swine. To address this problem one of the following options can be used:

• Option A. Grower may decline. The grower may decline all or part of the breeding stock at the time of delivery. Normally the problem, such as underlines or soundness, must be identified at the time of delivery. Usually the grower must keep the animal until cull shipping is available.
• Option B. Grower approval of source. The contractor tells the grower the proposed source or sources for the breeding stock and the grower has the right to reject any proposed source. The contractor only delivers breeding stock from a source that the grower has approved.
• Option C. From contractor’s own herd. The breeding stock will come from the contractor’s own herd.
• Option D. Contractor selects. The contractor selects breeding stock without any contract standards.

 

Marketing
It is the industry norm for the contractor to control the time for marketing the hogs. The primary goal of a farrowing contract is for the grower to market the maximum number of pigs at the weight designated by the contractor. Normally the grower monitors the weight of the pigs and notifies the contractor each week regarding the number of pigs that are at or near the desired weight. The contractor should take delivery of the pigs within a reasonable time after the pigs reach a predetermined age or weight.

 

Facilities

 

Nutrient Management
The grower typically has full responsibility for compliance with federal, state and local environmental laws. Careful site selection is the key to avoiding environmental problems. The site should be professionally evaluated to ensure it is a feasible location for swine production. In general the following should be considered:

• the quality and quantity of available water
• the containment of manure and other effluent
• the environmentally suitable disposal method of these production byproducts
• the disposal of dead animals consistent with legal guidelines

 

Neighbors in the immediate area should be informed of the proposed production prior to any dirt work or construction. Discovering strong objections early will help the grower assess the long-term feasibility of the project and whether a different site should be developed.

 

Specific points to consider are:

1. The facility must have an adequate land base to support the buildings and an adequate-size earthen or concrete manure storage basin. Concrete pits under slats are also acceptable.
2. State regulations should be reviewed for any current regulations pertaining to the facility and storage basin. State regulations and permits, as well as county zoning requirements must be met or obtained.
3. Construction of the building and storage basin should be under the supervision of an approved engineer.
4. Manure storage with disposal easements must meet state requirements.
5. The property must have an adequate water supply that meets the minimum water quality standards.
6. The site must be approved by the lender and a written commitment should be obtained prior to construction.

 

Site
Many contractors require growers to limit the use of the farm complex to just the contractor’s swine. Contractors believe that this reduces disease risks and the possibility that some of the contractor’s feed will be fed to other animals.

 

The contract should stipulate how close any other swine can be to the contract facilities. This is critically important where “contract facilities” are defined as part of a farm complex. Some contractors require fencing for biosecurity reasons. Growers are often required to take care of the land within a given distance from the buildings. Some contractors require signs on the premises giving notice of ownership of all swine.

 

It is important to pick a site that can be carved out of existing property or that stands alone on a clearly accessible and identifiable site.

 

Contractors require a suitable and accessible road for feed trucks, delivery trucks, hog trucks and field service personnel. Any wrecker charges incurred during the feed delivery or swine hauling because of improperly kept roads or driveways are usually charged to the grower.

 

Condition
The grower is usually responsible for maintaining the contract facilities to a set standard and keeping the equipment in good operating condition at all times. The contractor is not liable for physical damage to the contract facilities caused by the contract swine.

 

The contractor may void the contract if the grower does not maintain the facilities. The only exception is if failure to do so is due to conditions beyond the grower’s control, such as weather or the unavailability of supplies or the contractor’s failure to perform.

 

Facility Security
The grower usually provides adequate security for the contract facilities, including yard lights and either a locked gate or a blocked drive to restrict vehicle access. In some contracts, the grower agrees that the personnel caring for the swine will not work at any other swine farms or visit the swine confinement areas of other swine. This is designed to minimize the chance of exposing swine to harmful disease.

 

Facility Overhead
The grower usually pays for the maintenance of the contract facilities. The grower provides all utilities including, but not limited to, water and electricity, to operate all facilities required to grow the swine for a farrowing contract.

 

Owner’s Access
Under the contract, the contractor should be able to enter the premises to inspect the swine, determine that they are being properly cared for, provide medication and for other reasons related to the contract. The contractor is to comply with the grower’s sanitation instructions (cleaning boots, wearing coveralls and showering, for example) before entering the contract facilities. Some growers want to limit this access, either for disease control or to avoid disruption in the operations.

 

The contract needs to clarify if the contractor can have access to the facilities at any time or if there is a specified time and protocol for the contractor to enter the premises. The contract should also stipulate the number of people that may enter the premises at one time and the conditions for entering the premises.

 

Health Care

 

The contract needs to spell out health care practices allowed and procedures to follow should health problems arise. The means of reporting and accounting for death loss should also be covered. In addition, some contracts require proof of death loss.

 

Scheduled Health Care
The contractor usually details the animal care products that the grower is expected to use. The grower is expected to follow the directions on the product or the directions of a specified or selected veterinarian. The grower is not to use animal care products other than those specified by the contractor or by a veterinarian. There are different arrangements regarding who pays for scheduled health care costs.

 

The contractor is usually responsible for ensuring that the instructions regarding animal care products comply with existing laws. The grower is responsible for making sure that any animal care products not given pursuant to the instructions of the contractor or a veterinarian comply with the law. The grower is also responsible for meeting withdrawal schedules, presuming that the contractor has notified the grower of the expected time for marketing the animals.

 

Unscheduled Health Care
The grower reports all significant disease symptoms to the contractor. All cases of death or disappearance must be reported within hours after discovery by the grower. The contract usually specifies who will bear the costs of unscheduled health care.

 

In the case of health problems, the grower is normally told to call the contractor’s service representative. The service representative then inspects the animals and determines the proper course of action. The grower is usually not allowed to call a veterinarian. As contractors typically pay the veterinary bills, they are often concerned that the grower will call the veterinarian too frequently. It is in the best interest of both parties, however, to keep the animals as healthy as possible.

 

One possible alternative to the standard arrangement is sharing control between the parties. In this way, the contractor selects the veterinarian for the contract swine. Either party may call the veterinarian selected by the contractor to discuss the contract swine or to ask the veterinarian to inspect the contract swine. The grower may call a different veterinarian if the veterinarian chosen by the contractor is not available and the grower believes it is an emergency.

 

Husbandry Practices

 

Standard of Husbandry Practices
The grower is expected to care for the contract swine using generally accepted animal husbandry practices. The contractor should provide the grower with the expected husbandry practice instructions and the grower needs to agree to follow these directions. It is very important that the grower understands and follows the husbandry practices stipulated in the contract.

 

If the grower fails to carry out these instructions, the contractor has the right to enter the grower’s premises to perform the grower’s duties. Any expense incurred by the contractor in this situation is charged to the grower and deducted from the payments owed.

 

It is a good idea for both the contractor and the grower to keep a written record of all important conversations with the field serviceman who will be monitoring proper husbandry practices. The written record should include the date, time, place, names of those present and a summary of what was said.

 

Management Control
Most of the disputes that arise between grower and contractor concern the grower’s management autonomy. Growers are often under the impression that they can continue to raise and market hogs the way they always have and receive the risk alleviation in the contract. Generally, this is not the case. Contractors often have very strong opinions about what should be done and will often dictate their management control in the written agreement. It is important that growers understand the limits being placed on them before they enter into the agreement. This may include detailing farrowing schedules, feed schedules, hygiene and a host of other management practices to be followed.

 

Labor
The grower usually provides all of the labor involved in caring for the contract swine, including assisting in the loading and unloading of swine entering or leaving the contract facilities. The grower may use employees or independent contractors to care for the contract swine and the grower will pay for such labor.

 

Production Records
The grower is usually required to prepare periodic production records as instructed by the contractor within a given number of days after the end of a specific production period. These records include all information reasonably necessary for the proper and efficient management of the pigs, including death loss. The contractor usually provides the feeder with all necessary forms and documents for maintaining the required swine production records.

 

Culling Practices
The contractor culls the breeding stock periodically and replaces culled animals with new breeding stock. The grower signs a receipt for each delivered animal.

 

SPECIFICATIONS OF A NURSERY CONTRACT

 

Duties and Responsibilities

 

The Contract
Whether a nursery contract is a useful tool or a risky proposition depends on the relationship between the parties, the language of the contract and the performance under the agreement. The grower can assume the party offering the contract has every intention of fulfilling the agreement and has no interest in a legal dispute. The grower must also assume that the contractor received legal advice in drafting the contract and has protected his/her business from risks. Assuming, however, is a risky way to do business. When in doubt, it is important to ask questions. Both parties need to be aware of their rights and obligations in advance, instead of being unpleasantly surprised later.

 

Contract Terms
The complete terms of the contract should be reviewed by both parties with the help of both financial and legal assistance, so that all terms and financial obligations are understood. There is no such thing as a standard nursery contract. As a result, growers should evaluate all contracts before deciding which one is most satisfactory.

 

In brief, contract terms need to spell out all the responsibilities of each party. In addition, the grower should be satisfied with specific terms related to:

• contract length
• conditions of contract renewal
• base compensation
• bonus compensation
• default provisions
• conflict resolution
• guarantees made by either party

 

Compensation
Nursery contracts are usually paid on per-animal-transferred basis, as the contractor has little or no flexibility in delaying removal of the animals (as in finishing buildings). Bonuses for achieving excellent production and low death losses are typically generous. The bonuses are a key reason why a disproportionate number of growers choose farrowing and/or nursery contracts. The fact that less manure is produced in these operations also contributes to their appeal.

 

Fixed Payments vs. Incentives
The method of payment can have important implications on incentives to perform under contracts. This is the issue of moral hazard which is nearly always present in contracting arrangements. With fixed payment contract in which the grower receives a fixed payment per pig or pig space, the moral hazard resides mostly with the grower. In this case the incentive to put in extra effort to improve performance is not rewarded under the contract and there is an incentive to incur the least possible cost both in terms of effort and other inputs.

 

With an incentive based contract, the grower often receives premiums in addition to a fixed payment for superior performance of the livestock. Under this arrangement, the moral hazard resides with the contractor. The definitions for superior performance in this case should be set so they are attainable with reasonable effort. However, this is often subjective assessment and the contractor may have an incentive (pay lower premiums) to set the standard relatively high. In an effort to remove some of the subjectivity, tournament contracts have arisen which rank growers against each other. In this way, superior performance is benchmarked against other similar situations and provides a ranking without actually having to set a predefined level. One of the common issues with tournament contracts is that some growers feel as though they are placed in unfair circumstances. For example, the pigs delivered by the contractor are not as high quality or uniform as those delivered to others under the tournament. This has been a common point of contention in broiler and turkey grower contracts. It is important to understand all payout provisions and to also understand how this affects incentives for all participants in the contract.

 

Contract Payments
The cash payments to the grower are the easiest and most flexible variable in offsetting other contract terms. To a large degree, swine contracts deal with allocating the economic risks between the parties. Shifting additional risk to the grower should result in additional compensation and vice versa. It is important to keep this in mind when drafting, reading or negotiating a nursery contract.

 

Many contracts allow for multiple payments during the time that a group of pigs is on the farm. That is, the contractor may pay every three weeks, every month or once, at marketing. Sometimes contractors pay part at placement and the remainder at marketing. Spreading out payments is preferred by many contract producers because it eases cash flow burdens. These provisions should be clearly spelled out in the contract and understood by all parties. The grower should realize at the outset that he/she is not compensated for hogs that die.

 

Payment Structures
There are various ways that contracts cover payments for yardage fees. Some of the options are addressed below. The contractor may use any one or a combination of the following:

• Option A. Pig fee. The contractor pays the grower a specified amount equal to the number of marketable pigs sold. This is usually done each month based on the marketable pigs sold the previous month. The definition of a “marketable pig” is any pig that meets standards developed by the contractor.
• Option B. Pen space. The contractor pays the grower a specified amount for each crate and/or square foot of pen space in the nursery building.
• Option C. Portion of gross proceeds. The contractor pays the grower a specified percent of the proceeds from the sale of market pigs. The gross proceeds are determined by subtracting the following expenses from the sale proceeds: cost of transportation, transportation insurance, checkoff payments, commissions and yardage.

 

Bonus Structures
Some contractors build bonus agreements into nursery contracts. The contractor may use one or a combination of the following or other methods.

• Option A. Mortality Payment. A mortality payment is designed to provide bonuses to growers who maintain a low mortality rate. Normally the bonuses are established on a scale of 1 percent mortality to 2.5 percent mortality. A per-head bonus is paid ranging from $0.25 to $0.30 for a 1 percent mortality rate down to no bonus for a 2.5 percent or above mortality rate.
• Option B. Feed Efficiency Payment. A feed efficiency payment is paid for pigs emerging from the contract nursery. An example is shown below:

Final Settlement
Under most contract arrangements, the contractor computes the payments to the grower. The contractor should provide the grower with a copy of the computation and the information used to make the computations. The grower should verify that the contractor has used accurate information. These records should include only those items relevant to the computation of the grower’s payments under this contract, such as feed company invoices and copies of scale tickets for pigs and sow inventory data.

 

Division of Expense
An area that often confuses growers is the division of expenses, or “who pays for what.” The division of expenses may vary from nursery contract to nursery contract, even within the same contracting firm. As always, it is important not to assume that just because a practice seems standard that it will be covered that way in the contract.

 

Expenses that need to be accounted for include:

• veterinary care
• animal care products such as feed additives or injections
• dewormers
• insecticides or pesticides
• utilities
• supplies
• tools
• uniforms
• disinfectants
• syringes
• taggers
• tooth clippers
• ear tags

 

Which party supplies and pays for supplies and tools varies and needs to be stipulated in the contract.

 

Length of Contract
Before entering long-term nursery contractual arrangements, growers need to be satisfied that the investment is sound. Several factors determine this. Most contracts within the first 10 years of continuous use:

• pay for the complete cost of the capital investment (buildings and equipment, but not land)
• return about 9 percent to average capital invested
• compensate the grower for labor contributed at farm level wages
• produce about a 1 percent to 3 percent return on risk

 

Contract maturity is a double-edged sword. Lenders usually like to see the length of the contract equal the length of the financing. This may be the safest approach for the bank, but it is not always best for the grower. By locking down the terms of the contract for seven years, for instance, the grower loses the flexibility to act on a more generous offer from competing contractors. In addition, the grower may find themselves locked into less favorable terms if competitive pressures produce new contracts with better compensation schedules or terms. A short-term contract, however, can create serious risks if it is terminated before the building financing is repaid. The risk is greatest in areas where the contractor is the only party contracting hogs, leaving the grower with no other marketing channel.

 

Farrowing/nursery contracts normally extend over a longer period than finishing contracts, due to the longer natural cycles and the increased costs likely at the beginning and end of the contract.

 

Insurance
The following commercial insurance should be maintained and provided for by the contractor and/or the grower:

• liability
• animal casualty
• building casualty

 

The contract should specify which party is responsible for carrying each kind of insurance, and, in some contracts, minimum limits are set. The party maintaining the insurance should provide the other party with a certificate of insurance upon request.

 

It is the responsibility of the grower to maintain workmen’s compensation insurance, unemployment compensation insurance, disability and health insurance benefits and all similar insurance for himself and his employees.

 

Termination
How and by whom can the contract be terminated? This is an important question, because market conditions may fluctuate, causing either the contractor or grower to rethink the agreement. Most contracts provide an avenue for either party to terminate the agreement. Usually this requires notice be given to all other parties involved a set number of days prior to termination.

 

In the event of an early termination, most nursery contracts allow the contractor to take exclusive possession and control of the contract facilities for a short time period to make other arrangements for the contract swine.

 

The contract should outline the steps for termination and explain the valid reasons for termination. The termination of the contract, either at its scheduled end or earlier, does not terminate the rights and liabilities of either the grower or the contractor.

 

Delivery and Marketing

 

Capacity
The contract should spell out not only the capacity of the building, but also its minimum occupancy rate.

 

Timing of Delivery
The contract should also address the timing of delivery. The contractor needs to start delivering animals to the grower within a specified number of days after signing the contract. The contract should stipulate how many days the contractor has to bring the contract herd up to full size after starting deliveries. Without this stipulation, the grower risks delays and the financial risk that his/her facilities will sit empty.

 

Selection of Pigs
It is industry norm for the contractor to select the breeding stock. The grower, however, has a financial interest in receiving high-quality animals, and this issue merits attention in the contract. If the contractor supplies the hogs, then the agreement should state the necessary precautions that the contractor must take to ensure that disease is not introduced on the farm. Precautions may include testing, prior record of vaccinations or a guarantee that all animals come from a single source. Also, the contract should clearly state if a particular genetics is to be used. The contractor is responsible for complying with applicable laws regarding the movement of swine. All necessary inspection certificates or health certificates are to be obtained by the contractor.

 

The grower and the contractor have a financial interest in the grower receiving high-quality pigs. There are more grower complaints about the incoming condition of the pigs, however, than any other aspect of swine contracts.

 

The grower responsible for feed efficiency and death loss is at a disadvantage if the contractor delivers low-quality pigs. The contract should also contain provisions for the producer to renegotiate compensation if low-quality or sick animals are delivered.

 

Growers intuitively want the right to decline pigs at time of delivery, despite the fact that many problems cannot be spotted by a physical inspection. Contractors are reluctant to give the growers a unilateral right of rejection due to various state health regulations pertaining to the movement of swine. To address this problem, the grower can opt to decline all or part of the pigs at the time of delivery. Normally the problem must be identified at the time of delivery or shortly thereafter. Usually the grower must keep the animal until cull shipping is available. Examples of specifications would include:

• All males must be castrated
• Must weigh at least “X” pounds at receiving point
• Must have no visible ruptures
• Must show no signs of:
  • Observable rhinitis — deformed nose or bleeding
  • Coughing or thumping
  • Scouring
  • Malformed joints
  • Observable abscesses
  • Prolapse
  • Observable lice or mange
• Must have tail docked

 

Marketing
It is the industry norm for the contractor to control the time for marketing the hogs. The primary goal of a nursery contract is for the grower to market the maximum number of pigs at the weight designated by the contractor. Normally the grower monitors the weight of the pigs and notifies the contractor when the pigs are at or near market weight.

 

Facilities

 

Nutrient Management
The grower typically has full responsibility for compliance with federal, state and local environmental laws. Careful site selection is the key to avoiding environmental problems. The site should be professionally evaluated to ensure it is a feasible location for swine production. In general the following should be considered:

• the quality and quantity of available water
• the containment of manure and other effluent
• the environmentally suitable disposal method of these production byproducts
• the disposal of dead animals consistent with legal guidelines

 

Neighbors in the immediate area should be informed of the proposed production prior to any dirt work or construction. Discovering strong objections early will help the grower assess the long-term feasibility of the project and whether a different site should be developed.

 

Specific points to consider are:

1. The facility must have an adequate land base to support the buildings and an adequate-size earthen or concrete manure storage basin. Concrete pits under slats are also acceptable.
2. State regulations should be reviewed for any current regulations pertaining to the facility and storage basin. State regulations and permits, as well as county zoning requirements must be met or obtained.
3. Construction of the building and storage basin should be under the supervision of an approved engineer.
4. Manure storage with disposal easements must meet state requirements.
5. The property must have an adequate water supply that meets the minimum water quality standards.
6. The site must be approved by the lender and a written commitment should be obtained prior to construction.

 

Site
Many contractors require growers to limit the use of the farm complex to just the contractor’s swine. Contractors believe that this reduces disease risks and the possibility that some of the contractor’s feed will be fed to other animals.

 

The contract facilities are normally used exclusively for the contract swine. The contract should stipulate how close any other swine can be to the contract facilities. This is critically important where “contract facilities” are defined as part of a farm complex. Some contractors require fencing for biosecurity reasons. Growers are often required to take care of the land within a given distance from the buildings. Some contractors require signs on the premises giving notice of ownership of all swine.

 

Most contractors require a suitable and accessible road for feed trucks, delivery trucks, hog trucks and field service personnel. Any wrecker charges incurred during the feed delivery or swine hauling because of improperly kept roads or driveways are usually charged to the contract producer.

 

It is important to pick a site that can be carved out of existing property or that stands alone on a clearly accessible and identifiable site.

 

Condition
The grower is usually responsible for maintaining the contract facilities to a set standard and keeping the equipment in good operating condition at all times. The contractor is not liable for physical damage to the contract facilities caused by the contract swine.

 

The contractor may void the contract if the grower does not maintain the facilities. The only exception is if failure to do so is due to conditions beyond the grower’s control, such as weather or the unavailability of supplies or the contractor’s failure to perform.

 

Facility Security
The grower usually provides adequate security for the contract facilities, including yard lights and either a locked gate or a blocked drive to restrict vehicle access. In some contracts, the grower agrees that the personnel caring for the swine will not work at any other swine farms or visit the swine confinement areas of other swine. This is designed to minimize the chance of exposing swine to harmful disease.

 

Facility Overhead
The grower usually pays for the maintenance of the contract facilities. The grower provides all utilities including, but not limited to, water and electricity, to operate all facilities required to fulfill a nursery contract.

 

Owner’s Access
Under the contract, the contractor should be able to enter the premises to inspect the swine, determine that they are being properly cared for, provide medication and for other reasons related to the contract. The contractor is to comply with the grower’s sanitation instructions (cleaning boots, wearing coveralls and showering, for example) before entering the contract facilities. Some growers want to limit this access, either for disease control or to avoid disruption in the operations.

 

The contract needs to clarify if the contractor can have access to the facilities at any time or if there is a specified time for the contractor to enter the premises. The contract should also stipulate the number of people that may enter the premises at one time.

 

Health Care

 

The contract needs to spell out health care practices allowed and procedures to follow should health problems arise. The means of reporting and accounting for death loss should also be covered. In addition, some contracts require proof of death loss.

 

Scheduled Health Care
The contractor usually details the animal care products that the grower is expected to use. The grower is expected to follow the directions on the product or the directions of a specified or selected veterinarian. The grower is not to use animal care products other than those specified by the contractor or by a veterinarian. There are different arrangements regarding who pays for scheduled health care costs.

 

The contractor is usually responsible for ensuring that the instructions regarding animal care products comply with existing laws. The grower is responsible for making sure that any animal care products not given pursuant to the instructions of the contractor or a veterinarian comply with the law. The grower is also responsible for meeting withdrawal schedules, presuming that the contractor has notified the grower of the expected time for marketing the animals.

 

Unscheduled Health Care
Contractors commonly pay for all health care to have complete control over the process. The grower reports all significant disease symptoms to the contractor. All cases of death or disappearance must be reported within hours after discovery by the grower.

 

In the case of health problems, the grower is normally told to call the contractor’s service representative. The service representative then inspects the animals and determines the proper course of action. The grower is usually not allowed to call a veterinarian. As contractors typically pay the veterinary bills, they are often concerned that the grower will call the veterinarian too frequently. It is in the best interest of both parties, however, to keep the animals as healthy as possible.

 

One possible alternative to the standard arrangement is sharing control between the parties. In this way, the contractor selects the veterinarian for the contract swine. Either party may call the veterinarian selected by the contractor to discuss the contract swine or to ask the veterinarian to inspect the contract swine. The grower may call a different veterinarian if the veterinarian chosen by the contractor is not available and the grower believes it is an emergency.

 

Husbandry Practices

 

Standard of Husbandry Practices
The grower is expected to care for the contract swine using generally accepted animal husbandry practices. The contractor should provide the grower with the expected husbandry practice instructions and the grower needs to agree to follow these directions. It is very important that the grower understands and follows the husbandry practices stipulated in the contract.

 

If the grower fails to carry out these instructions, the contractor has the right to enter the grower’s premises to perform the grower’s duties. Any expense incurred by the contractor in this situation is charged to the grower and deducted from the payments owed.

 

It is a good idea for both the contractor and the grower to keep a written record of all important conversations with the field serviceman who will be monitoring proper husbandry practices. The written record should include the date, time, place, names of those present and a summary of what was said.

 

Management Control
Most of the disputes that arise between grower and contractor concern the grower’s management autonomy. Growers are often under the impression that they can continue to raise and market hogs the way they always have and receive the risk alleviation in the contract. Generally, this is not the case. Contractors often have very strong opinions about what should be done and will often dictate their management control in the written agreement. It is important that growers understand the limits being placed on them before they enter into the agreement. This may include detailing farrowing schedules, feed schedules, hygiene and a host of other management practices to be followed.

 

Labor
The grower usually provides all of the labor involved in caring for the contract swine, including assisting in the loading and unloading of swine entering or leaving the contract facilities. The grower may use employees or independent contractors to care for the contract swine and the grower will pay for such labor.

 

Production Records
The grower is usually required to prepare periodic production records as instructed by the contractor within a given number of days after the end of a specific production period. These records include all information reasonably necessary for the proper and efficient management of the pigs, including death loss.

 

SPECIFICATIONS OF A FINISHING CONTRACT

 

Duties and Responsibilities

 

The Contract
Whether a finishing contract is a useful tool or a risky proposition depends on the relationship between the parties, the language of the contract and the performance under the agreement. The grower can assume the party offering the contract has every intention of fulfilling the agreement and has no interest in a legal dispute. The grower must also assume that the contractor received legal advice in drafting the contract and has protected his/her business from risks. Assuming, however, is a risky way to do business. When in doubt, it is important to ask questions. Both parties need to be aware of their rights and obligations in advance, instead of unpleasantly surprised later.

 

It is best to have a written agreement that spells out the many contingencies that could arise during the contracting period. With a written document, it will be much easier to settle disputes if they arise. Here’s a checklist for contractors and growers in preparing a contract:

• Clearly understand the written contract.
• Make sure that issues that are important to either party are confirmed in writing.
• Rely on what’s written, not verbal explanations or interpretations.
• If there are changes to be made in the contract, make sure both parties sign it.

 

Contract Terms
The complete terms of the contract should be reviewed by both parties with the help of both financial and legal experts, so that all terms and financial obligations are understood. Since there is no such thing as a standard finishing contract, growers should evaluate all contracts before deciding which one is most satisfactory.

 

In brief, contract terms need to spell out all the responsibilities of each party. In addition, the grower should be satisfied with specific terms related to:

• contract length
• conditions of contract renewal
• base compensation
• bonus compensation
• default provisions
• conflict resolution
• guarantees made by either party

 

The success or failure of any contract will depend on the people involved. All participants in a contract must be able to work together, to communicate and to learn from each other. Successful agreements are the result of cooperative, not adversarial, relationships.

 

Compensation

 

Contract Payments
The cash payments to the grower are the easiest and most flexible variable in offsetting other contract terms. To a large degree, swine contracts deal with allocating the economic risks between the parties. Shifting additional risk to the grower should result in additional compensation and vice versa. It is important to keep this in mind when drafting, reading or negotiating a swine contract.

 

Many finishing contracts allow for multiple payments during the period that a group of pigs is on the farm. That is, the contractor may pay every three weeks, every month or once, at marketing. Spreading out payments is preferred by many contract producers because it eases cash flow burdens. These provisions should be clearly spelled out in the contract and understood by all parties. The grower should realize at the outset that he/she is not compensated for hogs that die.

 

Fixed Payments vs. Incentives
The method of payment can have important implications on incentives to perform under contracts. This is the issue of moral hazard which is nearly always present in contracting arrangements. With fixed payment contract in which the grower receives a fixed payment per pig or pig space, the moral hazard resides mostly with the grower. In this case the incentive to put in extra effort to improve performance is not rewarded under the contract and there is an incentive to incur the least possible cost both in terms of effort and other inputs.

 

With an incentive based contract, the grower often receives premiums in addition to a fixed payment for superior performance of the livestock. Under this arrangement, the moral hazard resides with the contractor. The definitions for superior performance in this case should be set so they are attainable with reasonable effort. However, this is often subjective assessment and the contractor may have an incentive (pay lower premiums) to set the standard relatively high. In an effort to remove some of the subjectivity, tournament contracts have arisen which rank growers against each other. In this way, superior performance is benchmarked against other similar situations and provides a ranking without actually having to set a predefined level. One of the common issues with tournament contracts is that some growers feel as though they are placed in unfair circumstances. For example, the pigs delivered by the contractor are not as high quality or uniform as those delivered to others under the tournament. This has been a common point of contention in broiler and turkey grower contracts. It is important to understand all payout provisions and to also understand how this affects incentives for all participants in the contract.

 

Methods
Most contracts have one of three compensation methods for growers. The first is a base payment per-live-animal transferred, plus a bonus based on some productive or efficiency measure. Bonuses for reduced death loss and uniformity (sort) are also common. These methods of compensation can cause income fluctuations for the grower outside of his/her control. For instance, if the contractor elects to feed the finishing animals for an additional two weeks, the grower receives no additional compensation. Annual income will be reduced, as the number of animals transferred out of each finishing building will be reduced by the longer feeding period.

 

This problem has led to a second compensation method based on a payment per pound of gain, with bonuses for efficiency. By compensating the grower for weight gain, the contractor maintains the flexibility to feed the animals to optimal weights without penalizing the grower or reducing his/her income.

 

A third compensation method, popular in the upper Midwest, has evolved for finishing contracts. This involves paying the grower on a per pig space, per year basis. A fixed payment of $32 per pig space, per year is common. The contractor then assumes the burden for the wise and economical use of the building. Growers complain that this method locks them into a fixed labor income. Since the payment includes a return to labor, the grower experiences a real decline in labor income over the life of the contract, assuming inflation. Some systems are considering indexing payments to the Consumer Price Index or some standard measure of inflation to overcome this problem. Contractors have been concerned that this method removes the grower’s incentive for excellence and vigilance, since it is a fixed payment that is not tied to performance or death loss.

 

It is important that bonuses be fair and be based on things within the control and influence of the grower. Pitting growers against each other to determine bonus levels has been successful in some areas and has caused friction in others.

 

Market Hog Defined
A “market hog” is any hog for which the contractor receives at least 1 percent of the top market value for hogs.

 

This definition is important for calculating payments to the grower because it specifies a percentage of top market value. The top market value specification determines whether a hog with a price discount is considered a market hog or not.

 

Payment Structures
There are various ways that contracts cover payments for yardage fees.

• Option A. Daily fee. The contractor pays the grower a specified amount per day for each hog in the herd. This payment is usually computed monthly and is due on a given day of the next month.
• Option B. Fixed fee per pig. The contractor pays the grower a specified amount for each pig within a given number of days after the herd is delivered to the grower.
• Option C. Variable fee. The contractor pays the grower the amount specified for the average weight of the pigs that are delivered. This payment is made within a given number of days after the herd is delivered to the grower.
• Option D. Fixed fee per hog. The contractor pays the grower a specified amount for each hog within a given number of days after the herd is marketed.
• Option E. Pen space. The contractor pays the grower a specified amount for each square foot of pen space in the building.
• Option F. Pounds gained fee. The contractor pays the grower a specified amount per pound of weight gain. “Weight gain” is the average weight of the market hogs less the average weight of the pigs, times the number of market hogs. The grower may or may not receive weight gain payments for culls or casualty losses.

 

Bonuses

 

Feed Efficiency Bonus
The contractor may pay the grower a specified bonus, on a per-hog basis, for each one-hundredth of a point that feed efficiency is less than the target efficiency. Feed efficiency is the weight of the feed fed to the herd, divided by the weight gain. Weight gain is the average weight of the market hogs less the average weight of the pigs, times the number of market hogs.

 

One of the factors that effects feed efficiency is the hog’s weight at market. Since the contractor usually controls the timing of marketing, the feed efficiency bonus may need to be adjusted by different production parameters. It is important to note that the feed fed to culls and casualty losses is included in determining the feed efficiency, although these animals may not produce weight gained in the formula.

 

Here is an example of a feed efficiency bonus:

 

Rate of Gain Bonus
In addition to a per-head or per-pen-space payment, the grower may receive a rate of gain bonus. Here is an example:

 

Final Settlement
Under most contract arrangements, the contractor computes the payments to the grower. The contractor should provide the grower with a copy of the computation and the information used to make the computations. The grower should verify that the contractor has used accurate information. These records should include only those items relevant to the computation of the grower’s payments under this contract, such as packer returns, feed company invoices and copies of scale tickets for pigs and market hogs.

 

Death Loss
The term “death loss” refers to all reductions in the number of live animals. The following are usually not considered death losses:

• death of pigs reimbursed by the broker or seller of the pigs
• losses covered by casualty insurance
• culls

 

Death losses also include all deaths and mysterious disappearances, except culls and losses that are reimbursed by insurance or by the seller of the pigs. At this point, this definition appears to be the industry norm, although many contracts are not specific on this issue.

 

Losses Due to Improper Animal Husbandry
Most contracts adjust the payments to the grower based on the death losses that occur. The underlying idea is that the grower’s husbandry practices affect death losses, and the grower should be motivated to keep death losses to a minimum. The grower should be responsible for death losses caused by the failure to follow proper animal husbandry practices. Ideally, the parties would agree on which death losses are attributable to husbandry practices and, therefore, the responsibility of the grower, but this is not always practical.

 

It can be argued that most of the death losses that occur in the first few days after the pigs are delivered are primarily the result of the incoming condition of the pigs, not the grower’s animal husbandry practices.

 

To be fair to both parties, the contract can stipulate a time frame for death loss culpability. The grower is presumed not to be responsible for early losses, i.e., losses during the first (specified) days after contractor’s animals are delivered to the grower’s facilities. Death losses after the specified number of days will be presumed to be due to substandard animal husbandry practices and will be the grower’s responsibility. Either party can rebut this presumption with convincing evidence of the death loss cause.

 

Death Loss Verification
In some contracts it is a common practice for the contractor to have the right to physically verify any or all death losses that occur. This is normally done by requiring the grower to save and preserve either ears, snouts or other body parts until a representative of the contractor can verify the mortality.

 

Death Loss Deduction
In some contracts, the payments to the grower are reduced by the cost of death losses in excess of a stated allowed percentage. Option A uses just the purchase price of the pig, and option B uses the entire investment in the animal. Since the investment in the animal can only be estimated, option B is more likely to cause disagreement between the parties.

 

Figuring death loss:

• Option A. Loss equals the price of the pig. The financial cost of each death loss is the average initial purchase price of a pig.
• Option B. Loss equals the total investment in the animal. The financial cost of each death loss is the estimated inventory cost of the animal at the time of death. This is the average initial purchase price of a pig, plus the estimated cost of feed and medicine for the dead animal.

 

In some contracts, if an unverified disappearance (number of hogs sold minus the number of pigs placed) in excess of a given percentage occurs, the grower may be required to pay the difference.

 

Death Loss Bonus
Some contracts contain a death loss bonus stipulating that the contractor will pay the grower a bonus for each market hog. This is normally based on a death loss that falls under a given percentage. An example of a death loss bonus is:

 

Transit Losses
Contracts can address transit losses in two ways:

• Option A: Transit losses are included in the contract payment. Hogs that die in transit to the packing plant as “market hogs” will be treated as market hogs. The parties will assume that the hogs that die in transit have the same average weight as the hogs that are actually marketed.
• Option B: Transit losses are excluded in the contract payment. Hogs that die on the way to market will not be treated as market hogs. This results in the grower absorbing some of the risk for transit losses through reduced payments under the contract.

 

Division of Expenses
An area that often confuses growers is the division of expenses, or “who pays for what.” The division of expenses may vary from contract to contract, even within the same contracting firm. As always, it is important not to assume that just because a practice seems standard that it will be covered that way in the contract. Which party supplies and pays for supplies and tools needs to be stipulated in the contract. Examples include bedding, disinfectants, ear tags, taggers, syringes and needle teeth clippers.

 

Other Bonus Payments

• Feed conversion bonus: A bonus is paid for meeting a specified feed conversion for a group of hogs.
• Sort bonus: A bonus is paid for sorting the hogs to weight prior to shipping.
• Record keeping bonus: A bonus is paid for following company requirements and recommendations pertaining to record keeping. Records may include: mortality, animal removal and production.

 

Minimum Payment
The contractor should pay the grower a minimum amount for each market hog. The minimum payment provision should override any inconsistent provisions in the contract and can be used to avoid a situation where the grower has to return some of the advanced payments because of deductions under other contract terms.

 

Maximum Payment
Some contracts contain a maximum payment stating that the payments to the grower will not exceed a specified amount for each market hog. This maximum payment overrides any inconsistent provisions of the contract.

 

Progress Payments
With progress payments, the contractor will pay the grower a specified amount per pig within a given number of days after the pigs are delivered to the grower. These payments are an advance against the total payments made under the contract. In some contracts, the grower may be required to refund some of the advance payment.

 

Length of Contract

 

Before entering long-term contractual arrangements, growers need to be satisfied that the investment is sound. Several factors determine this. Most contracts within the first 10 years of continuous use:

• pay for the complete cost of the capital investment (buildings and equipment, but not land)
• return about 9 percent to average capital invested
• compensate the grower for labor contributed at farm level wages
• produce about a 1 percent to 3 percent return on risk

 

Contract maturity is a double-edged sword. Lenders usually like to see the length of the contract equal the length of the financing. This may be the safest approach for the bank, but it is not always best for the grower. By locking down the terms of the contract for seven years, for instance, the grower loses the flexibility to act on a more generous offer from competing contractors. In addition, the grower may find themselves locked into less favorable terms if competitive pressures produce new contracts with better compensation schedules or terms. A short-term contract, however, can create serious risks if it is terminated before the building financing is repaid. The risk is greatest in areas where the contractor is the only party contracting hogs, leaving the grower with no other marketing channel.

 

Insurance

 

The following commercial insurance should be maintained and provided for by the contractor and/or the grower:
• liability
• animal casualty
• building casualty

 

The contract should specify which party is responsible for carrying each kind of insurance, and, in some contracts, minimum limits are set. The party maintaining the insurance should provide the other party with a certificate of insurance upon request. It is the responsibility of the grower to maintain workmen’s compensation insurance, unemployment compensation insurance, disability and health insurance benefits and all similar insurance for himself and his employees.

 

Termination of Contract

 

How and by whom can the contract be terminated? This is an important question, because market conditions may fluctuate, causing either the contractor or grower to rethink the agreement. Most contracts provide an avenue for either party to terminate the agreement. Usually this requires notice be given to all other parties involved a set number of days prior to termination.

 

The contract should outline the steps for termination and explain the valid reasons for termination. The grower may want to be assured of compensation should the contract be ended by removal of the hogs.

 

Early Termination of Contract
The most difficult early termination issue is proper animal husbandry. The contractor needs to maintain the right to terminate if growers are not able to correct in short order any husbandry practices that threaten the lives or economic value of the swine.

 

The grower is entitled to compensation for services rendered before the termination, and both parties are entitled to damages resulting from the other party’s breach of contract.

 

Early Termination by the Grower
The following contract terms are considered necessary preconditions for the continued performance of the grower. Any early termination becomes effective when the grower gives the contractor a notice of termination that specifies one of the following reasons for the termination:

• Failure of delivery. The grower may end the contract if the contractor fails to deliver contract swine in substantial compliance with the contract. The grower may not end the contract for this reason after accepting delivery of the contract swine.
• No feed source. The grower may end the contract if the contractor fails to provide a source of feed or feed ingredients in substantial compliance with this contract.
• Delinquent payment. The grower may end the contract if the contractor fails to make the payments to the grower in substantial compliance with this contract.

 

The grower may be liable to the contractor for damages if arbitrators or a court determine that the early termination was not justified.

 

Early Termination by Contractor
The following contract terms are considered necessary preconditions for the continued performance of the contractor. Early termination goes into effect when the contractor gives the grower a notice of termination that specifies one of the following reasons for the termination:

• Improper animal husbandry. The contractor may end the contract if the contractor, in his/her sole judgment, determines that the grower is not using animal husbandry practices in substantial compliance with the contract.
• Failure to report death or disease outbreak. The contractor may end the contract if the grower fails to comply with the death notification requirements of this contract.
• Grower’s removal of contract swine. The contractor may end the contract if the grower removes any of the contract swine from the contract facilities without the contractor’s written permission (except for removal of dead animals and isolation of animals as permitted in the contract).
• Commingling. The contractor may end the contract if the grower brings any swine other than the contract swine onto the contract facilities without the contractor’s written permission.
• Diversion of feed. The contractor may end the contract if the grower feeds any of the feed or feed ingredients purchased by the contractor to any animals other than to the contract swine.
• Failure to forward records. The contractor may end the contract if the grower fails to forward production records in substantial compliance with the contractor’s instructions. Before ending the contract for this reason, the contractor must give the grower a written notice stating that the contractor will end the contract if the grower does not provide the production records in a timely manner.
• Failure to follow instructions. The contractor may end the contract if the grower fails to follow the contractor’s instructions as required in this contract. Before ending the contract for this reason, the contractor will give the grower a written notice stating that the contract will end if the grower does not follow the contractor’s instructions specified in the notice.
• Continued poor performance. The contractor may end the contract if the grower continually fails to perform as
  specified by the terms of the contract.

 

The contractor may be liable to the grower for damages if arbitrators or a court determine that the early termination was not justified.

 

Rights Following Termination
The termination of the contract, either at its scheduled end or earlier, does not terminate the rights and liabilities of the parties. At the end of the contract, the contractor may enter the contract premises for the purpose of removing any remaining feed and the contract swine (unless the grower has exercised an option to buy the swine as provided in the contract).

 

Delivery and Marketing

 

Capacity or Occupancy
The contract should spell out not only the capacity of the building, but also its minimum occupancy rate.

 

Timing of Delivery
The contract should also address the timing of delivery. The contractor needs to start delivering animals to the grower within a specified number of days after signing the contract. The contractor then needs to bring the herd up to full size within a specified time after starting deliveries.

 

The delivery timing of the pigs is especially important. As there are many deliveries over time, the delay between the truck picking up the hogs and the truck delivering the pigs is crucial to the grower’s earnings for the year. A contractor has a legitimate economic reason for wanting to control when to deliver the animals to the grower, and there is nothing inherently wrong with this practice. A grower that is assuming the risk of having empty or under-utilized facilities, however, should understand this risk, and be compensated for it.

 

One alternative would be for the contractor to pay the grower a specified amount per day that the grower’s facilities sit empty between the signing of the contract and the delivery of the next contract herd. The grower must realize that there will be a certain amount of downtime needed to allow for the cleaning of the facilities and repairs and that the contract should address this period.

 

The contract should stipulate how many days the contractor has to bring the contract herd up to full size after starting deliveries. Without this stipulation, the grower risks delays and the financial risk that his/her facilities will sit empty.

 

Selection of Pigs
It is industry norm for the contractor to select the pigs. If the contractor supplies the hogs, then the agreement should state the necessary precautions that the contractor must take to ensure that disease is not introduced on the farm. Precautions may include testing, prior record of vaccinations or a guarantee that all animals come from a single source. Also, the contract should clearly state if a particular genetics is to be used. The contractor is responsible for complying with applicable laws regarding the movement of swine. All necessary inspection certificates or health certificates are to be obtained by the contractor.

 

The grower and the contractor have a financial interest in the grower receiving high-quality pigs. There are more grower complaints about the incoming condition of the pigs, however, than any other aspect of swine contracts.

 

The grower responsible for feed efficiency and death loss is at a disadvantage if the contractor delivers low-quality pigs. The contract should also contain provisions for the producer to renegotiate compensation if low-quality or sick animals are delivered.

 

Growers intuitively want the right to decline pigs at time of delivery, despite the fact that many problems cannot be spotted by a physical inspection. Contractors are reluctant to give the growers a unilateral right of rejection due to various state health regulations pertaining to the movement of swine. To address this problem, the grower can opt to decline all or part of the pigs at the time of delivery. Normally the problem must be identified at the time of delivery or shortly thereafter. Usually the grower must keep the animal until cull shipping is available.

 

Examples of specifications would include:

• All males must be castrated
• Must weigh at least “X” pounds at receiving point
• Must have no visible ruptures
• Must show no signs of:
  • Observable rhinitis — deformed nose or bleeding
  • Coughing or thumping
  • Scouring
  • Malformed joints
  • Observable abscesses
  • Prolapse
  • Observable lice or mange
• Must have tail docked

 

Marketing of Hogs
It is also the industry norm for the contractor to control the time for marketing the hogs. Under certain market conditions, the contractor has a financial incentive to delay marketing in the hopes that prices will rise. Although this is a legitimate economic reason, the delay can cause the grower to care for animals after they have reached what the grower assumed to be market weight. Delays can affect feed efficiency bonuses.

 

In the case of marketing delays, there are two options:

• Option A. The grower is compensated for marketing delays that reduce fair returns. The contractor controls when the hogs will be marketed and pays the grower an agreed amount per pound for each market hog, assuming that the average weight for the herd at marketing exceeds a specified poundage. This is only an issue when the contractor is paying the grower on a per-head basis.
• Option B. The grower bears the risk of marketing delays.

 

Facilities

 

Type
Growers should build facilities that will be accepted by other contractors or that can be sold to another producer if necessary. A good rule of thumb is for the grower to build a foundation and shell that has a 25-year life expectancy. It is important to budget to replace the interior equipment every five to seven years. The grower needs to consult an engineer and negotiate changes if the contractor’s quality specifications are not met or exceeded. It is important not to settle for the argument that quality changes cannot be made since the material specifications are part of a proven system.

 

Cost
The cost of the facilities should be commensurate with the quality of the building proposed and be the norm for the region where it is constructed. Large-scale contractors can often save growers a significant amount on building costs with their volume purchasing power and assistance in subcontracting and building the facilities.

 

The grower should develop a detailed cash flow budget to determine the timing of cash inflows and outflows and to test for financial feasibility. Do not rely on cash flows prepared exclusively by the contractor. The budget should cover monthly cash flow for the first 24 months, then five years of annual cash flow estimates. The budget is key not only for obtaining a loan, but also for maintaining financial control. Careful budgeting assures that the start-up phase is planned. The cost of facilities must be in line with the proposed payment level and frequency of payment. The lender and extension personnel can assist in the budgeting process.

 

Standardization
For the contract grower, the greatest protection for ensuring constant use of the buildings over the financed period is to build standardized buildings. Contracts can be broken by either party or jointly dissolved. A building of standard size, design and quality is most likely to be in demand by other swine producers in the future. In addition, standardized facilities tend to hold their value much longer, assuming appropriate maintenance. With standardized buildings, the grower has the flexibility to choose another contractor or sell the buildings to other producers if they decide to leave the business.

 

Standardized buildings also indicate that the contractor is producing pigs using a system, and systematic production is needed to produce high-quality, uniform animals and to remain competitive in the industry long term.

 

Nutrient Management
The grower typically has full responsibility for compliance with federal, state and local environmental laws. Careful site selection is the key to avoiding environmental problems. The site should be professionally evaluated to ensure it is a feasible location for swine production. In general the following should be considered:

• the quality and quantity of available water
• the containment of manure and other effluent
• the environmentally suitable disposal method of these production byproducts
• the disposal of dead animals consistent with legal guidelines

 

Neighbors in the immediate area should be informed of the proposed production prior to any dirt work or construction. Discovering strong objections early will help the grower assess the long-term feasibility of the project and whether a different site should be developed.

 

Specific points to consider are:

1. The facility must have an adequate land base to support the buildings and an adequate-size earthen or concrete manure storage basin. Concrete pits under slats are also acceptable.
2. State regulations should be reviewed for any current regulations pertaining to the facility and storage basin. State regulations and permits, as well as county zoning requirements must be met or obtained.
3. Construction of the building and storage basin should be under the supervision of an approved engineer.
4. Manure storage with disposal easements must meet state requirements.
5. The property must have an adequate water supply that meets the minimum water quality standards.
6. The site must be approved by the lender and a written commitment should be obtained prior to construction.

 

Site
Many contractors require growers to limit the use of the farm complex to just the contractor’s swine. Contractors believe that this reduces disease risks and the possibility that some of the contractor’s feed will be fed to other animals. With the contractor’s prior permission, the grower may isolate in a separate facility animals showing signs of illness or new breeding stock.

 

The contract facilities are normally used exclusively for the contract swine. The contract should stipulate how close any other swine can be to the contract facilities. This is critically important where “contract facilities” are defined as part of a farm complex. Some contractors require fencing for biosecurity reasons. Growers are often required to take care of the land within a given distance from the buildings. Some contractors require signs on the premises giving notice of ownership of all swine.

 

Most contractors require a suitable and accessible road for feed trucks, delivery trucks, hog trucks and field service personnel. Any wrecker charges incurred during the feed delivery or swine hauling because of improperly kept roads or driveways are usually charged to the contract producer.

 

It is important to pick a site that can be carved out of existing property or that stands alone on a clearly accessible and identifiable site.

 

Condition
The grower is usually responsible for maintaining the contract facilities and keeping the equipment in good operating condition at all times. The grower is responsible for making a good faith effort to keep wild animals out of the contract facilities. The contractor is not liable for physical damage to the contract facilities caused by the contract swine.

 

The contractor may void the contract if the grower does not maintain the facilities. The only exception is if such failure is due to conditions beyond the grower’s control, such as weather or the unavailability of supplies.

 

Normally it is the grower’s responsibility to have the facility cleaned, disinfected and ready for receipt of additional hogs from the contractor within a given number of days (typically seven) after the last hog is removed from the facility. It is also the grower’s responsibility to notify the contractor that he/she is ready to accept additional hogs.

 

Facility Security
The grower usually provides adequate security for the contract facilities, including yard lights and either a locked gate or a blocked drive to restrict vehicle access. In some contracts, the grower agrees that the personnel caring for the swine will not work at any other swine farms or visit the swine confinement areas of other swine. This is designed to minimize the chance of exposing swine to harmful disease.

 

Facility Overhead
The grower usually pays for the maintenance of the contract facilities. The grower provides all utilities including, but not limited to, water and electricity, to operate all facilities required to grow the swine for a finishing contract.

 

Capacity
It is important that the contract stipulate a minimum capacity or number of animals to pass through the facilities. Without such a guarantee, the producer risks having made investments and incurred costs that are not recoverable. A general rule of thumb is that the facility will be filled to at least 90 percent capacity at all times. Alternatively, the contractor may opt to guarantee a certain number of animals or groups of animals per year.

 

Owner’s Access
Under the contract, the contractor should be able to enter the premises to inspect the swine, determine that they are being properly cared for, provide medication and for other reasons related to the contract. The contractor is to comply with the grower’s sanitation instructions (cleaning boots, wearing coveralls and showering, for example) before entering the contract facilities. Some growers want to limit this access, either for disease control or to avoid disruption in the operations.

 

The contract needs to clarify if the contractor can have access to the facilities at any time or if there is a specified time for the contractor to enter the premises. The contract should also stipulate the number of people that may enter the premises at one time.

 

Health Care

 

The contract needs to spell out health care practices allowed or required and/or procedures to follow should health problems arise. The means of reporting and accounting for death loss should also be covered.

 

Scheduled Health Care
The contractor usually details the animal care products that the grower is expected to use. The grower is expected to follow the directions on the product or the directions of a specified or selected veterinarian. The grower is not to use animal care products other than those specified by the contractor or by a veterinarian. The contractor usually pays for the scheduled health care costs.

 

The contractor is usually responsible for ensuring that the instructions regarding animal care products comply with existing laws. The grower is responsible for making sure that any animal care products not given pursuant to the instructions of the contractor or a veterinarian comply with the law. The grower is also responsible for meeting withdrawal schedules, presuming that the contractor has notified the grower of the expected time for marketing the animals.

 

Unscheduled Health Care
The contractors commonly pay for all health care and have complete control over the health care. The grower reports all significant disease symptoms to the contractor. All cases of death or disappearance must be reported within a specified time period to the contractor. The contractor usually pays for unscheduled health care costs.

 

In the case of health problems, the grower is normally told to call the contractor’s service representative. The service representative then inspects the animals and determines the proper course of action. The grower is usually not allowed to call a veterinarian. As contractors typically pay the veterinary bills, they are often concerned that the grower will call the veterinarian too frequently. It is in the best interest of both parties, however, to keep the animals as healthy as possible.

 

For health care, other possible arrangements include:

• Option A. Shared-cost approach to balance the interests of the two parties. Under a shared-cost scenario, the grower is allowed to call a veterinarian whenever he/she thinks it is prudent. By sharing the cost, however, the grower has an incentive not to call the veterinarian unnecessarily. In this case, the grower’s compensation schedule needs to be increased to offset this added expenditure.
• Option B. Parties share control. The contractor selects the veterinarian for the contract swine. Either party may call the veterinarian selected by the contractor to discuss the contract swine or to ask the veterinarian to inspect the contract swine. The grower may call a different veterinarian if the veterinarian chosen by the contractor is not available and the grower believes it is an emergency.

 

Husbandry Practices

 

Standard of Husbandry Practices
The grower is expected to care for the contract swine using generally accepted animal husbandry practices. The contractor should provide the grower with the expected husbandry practice instructions and the grower needs to agree to follow these directions. It is very important that the grower understands and follows the husbandry practices stipulated in the contract.

 

If the grower fails to carry out these instructions, the contractor has the right to enter the grower’s premises to perform the grower’s duties. Any expense incurred by the contractor in this situation is charged to the grower and deducted from the payments owed.

 

It is a good idea for both the contractor and the grower to keep a written record of all important conversations with the field serviceman who will be monitoring proper husbandry practices. The written record should include the date, time, place, names of those present and a summary of what was said.

 

Management Control
Most of the disputes that arise between grower and contractor concern the grower’s management autonomy. Growers are often under the impression that they can continue to raise and market hogs the way they always have and receive the risk alleviation in the contract. Generally, this is not the case. Contractors often have very strong opinions about what should be done and will often dictate their management control in the written agreement. It is important that growers understand the limits being placed on them before they enter into the agreement. This may entail outlining farrowing schedules, feed schedules, hygiene and a host of other management practices to be followed.

 

Labor
The grower usually provides all of the labor involved in caring for the contract swine, including assisting in the loading and unloading of swine entering or leaving the contract facilities. The grower may use employees or independent contractors to care for the contract swine and the grower will pay for such labor.

 

Production Records
The grower is usually required to prepare periodic production records as instructed by the contractor within a given number of days after the end of a specific production period. These records include all information reasonably necessary for the proper and efficient management of the pigs, including death loss.

 

Feed Quality
If the contractor supplies the feed, then the contract may specify the ration quality and the ingredients. For example, the contract may specify a minimum lysine level and a minimum metabolizable energy level. This is especially important if the contract pays a bonus for feed efficiency, because subpar feed quality can greatly reduce feed intake, rate of gain and feed conversions. Feed consistency and density in feeders is important. Parties should consider requiring a labeled feed analysis or provision for providing for feed testing upon either party’s request.

 

Culling Practices
There are two common culling methods:

• Option A. Grower’s discretion. The grower determines when an animal should be culled from the herd and notifies the contractor of all culls.
• Option B. Contractor’s discretion. The grower monitors the contract swine and make recommendations to the contractor regarding animals that should be culled. The contractor determines when an animal should be culled from the herd.

 

Manure Management and Disposal of Dead Animals

 

The grower is expected to remove and dispose of dead animals, manure, used bedding and other waste products in a timely manner. The grower is responsible for complying with applicable laws regarding disposal of dead animals and manure. The grower usually pays any charges imposed by a rendering plant or other dead animal disposal method. In some contracts, the contractor reimburses the grower for a percentage of the rendering plant costs.

 

Wean-to Finish Contracts

 

With the advent of wean-to-finish production, there has also been growing interest in wean-to-finish production contracts. Contracts for wean-to-finish (WTF) production are still relatively new and are less prevalent than either nursery or finishing contacts and are emerging as a hybrid of the two.

 

Because of the similarities with finishing contracts, only those unique features to wean-to-finish contracts are discussed. For issues not found below, please refer to the appropriate title under finishing contracts

 

Wean-to finish contracts offer several advantages when compared to conventional finishing contracts. Because the unit is typically turned only twice per year, there is less loading, unloading, and power-washing required. Also in some instances, the buildings are double filled for the first 4-6 weeks thereby providing extra income to the grower for a period of time. The primary disadvantage to the grower when compared to finishing contracts, is the extra labor required the first four weeks to care for the newly weaned pigs.

 

Compensation
Wean-to-finish contract compensation is generally based on pig space, however some contracts do base compensation on the number of animals transferred or on the pounds of gain. Payment per pig space (based on 7.2-7.5 square feet per pig) ranges from $34-36 per pig space, oftentimes with the potential for bonus payments which may raise the total payment to $38 per pig space.

 

Contract Payments
It is becoming increasingly common for contract grower to receive monthly payments rather than a single payment at marketing. Because payment is commonly based on physical structure and not animal numbers or performance, growers receive a relatively stable income and contractors are afforded the flexibility to adjust animal number, marketings and production.

 

Bonuses
Bonus structures are less common with wean-to-finish contracts than other types of production contracts. If bonuses are offered, they are typically based on mortality, feed conversion or sort/cull percentages. Bonuses are typically on a per head basis as previously discussed with finishing contracts.

 

Specific to wean-to-finish contracts is the practice of double-filling the barn when weaned pigs are first moved into the building. After eight weeks, half the pigs are moved to a finish building, usually offsite. Because of the increased micro-management involved during the first four weeks, an additional payment may be made to the grower.

 

If bonuses or deductions are part of the contract, then a final settlement is made upon sale of the market hogs. The contractor computes the final settlement amount. The contractor should provide the grower with a copy of the computation and the information used to make the computations. The grower should verify that the contractor has used accurate information.

 

DISPUTE RESOLUTION

 

If a dispute arises under a production contract, the parties have a choice to make about the type of dispute resolution procedure to follow. The most common options are litigation, mediation and arbitration.

 

The choice of procedure is influenced by several factors. The party bringing legal action may have control over which procedure to use, but is limited by stipulations in the contract or state law about the procedure for resolving disputes. The other party may not have a choice except to defend or respond in the forum chosen by party bringing legal action.

 

Litigation

 

The most common method for resolving legal disputes is filing a lawsuit in a local state court declaring an alleged breach of the contract. The success of any case depends on the agreement involved, the conduct in question, the quality of the evidence presented, the state law on contractual issues and the damages that can be proven to have occurred.

 

When considering suing over an alleged breach of contract, it is important to decide how to place a fair and reasonable value on the damages sustained. Although a party may have an arguably valid claim, the dollar amount involved may not justify a lawsuit. But litigation is only one option for resolving legal disputes. In recent years there has been increasing interest in the United States in using methods of alternative dispute resolution (ADR). ADR methods are becoming more important in production contract relations because many contracts include ADR provisions and some state laws encourage their use. The two main forms of ADR for producers to understand are mediation and arbitration.

 

Mediation

 

Mediation is a system of dispute resolution that requires the parties to meet and discuss their differences with a trained mediator. The mediator is a neutral party who works with the parties to reach a solution to their problem. The mediator does not act like a judge in resolving the matter or imposing a legal decision. Instead the mediator’s role is to help facilitate communication between the parties and to help them try to identify options, other than going to court, for resolving their differences. The idea is that mediation may be more effective in helping parties resolve matters in the long term because it helps restore communication between the parties. Mediation is often a quicker and less costly alternative to litigation. Under most state laws, the parties divide the cost of the mediation.

 

It is important to recognize, however, that mediation will not necessarily result in dispute resolution. The mediator does not have the authority to order the parties to take certain actions or to force them to agree. If mediation does not result in an agreement, the parties may still file a lawsuit to obtain a decision.

 

Mediation received considerable attention and use in farm states as a way to resolve agricultural credit conflicts in the 1980s. Several states have adopted mandatory mediation for different types of agricultural disputes. In 1990, Iowa became the first state to require the use of mediation to resolve disputes involving livestock production contracts. Under the Iowa law, a farm resident or other party may request mediation of a dispute involving “the performance of either person under a care and feeding contract, if both persons are parties to the contract.” [Iowa Code ß654B.1(2)(a)] The term “care and feeding contract” is defined as “an agreement, either oral or written, between a farm resident and the contractor of livestock, under which the farm resident agrees to act as a grower by promising to care for and feed the livestock on the farm resident’s premises.” Under the Iowa law, courts cannot hear such cases until the parties present a release obtained from the mediation service.

 

Several state laws regulating contracting call for disputes to be handled by ADR first. For example, Minnesota Code sections 17.90 – .98, enacted in 1991, establish a number of requirements for agricultural contracts and include the stipulation that a “contract for an agricultural commodity between a contractor and a producer must contain language providing for resolution of contract disputes by either mediation or arbitration.” Similarly, the law enacted in Kansas in 1994 to authorize use of swine production contracts by corporations and packers requires that swine production contracts “contain language providing for resolution of contract disputes by either mediation or arbitration.”

 

Arbitration

 

The second major form of ADR important in production contracting is arbitration. As a dispute resolution procedure, arbitration is closer to litigation because it involves a process that results in a legal decision determining the rights and obligations of the parties. Instead of taking the matter to court before a judge and jury, in arbitration the parties take the dispute before an arbitrator or panel of arbitrators with expertise in resolving a specific type of commercial dispute. There can be one arbitrator or, more commonly, a panel of three arbitrators. Each party appoints an arbitrator and the two arbitrators appoint a third individual. Each party pays for its own arbitrator and half the costs of the third arbitrator. The decision of any two of the arbitrators is final and is enforced by law.

 

The parties to the dispute present the facts to the arbitrators and make their legal arguments based on the contract and the law governing their relationship. The arbitrators then issue a ruling. Arbitration is considered less costly than litigation because the procedure is usually shorter. Parties participating in arbitration are generally responsible for paying their share of the costs.

 

There are different types of arbitration depending on the nature of the decision rendered. Some forms of arbitration allow the parties to appeal the decision to the courts. In such cases, arbitration is just a step in trying to resolve the matter. In other cases, however, the ruling may serve as the final decision, in which case it is called “final binding arbitration.” With binding arbitration, the parties may not appeal the dispute and are bound by the decision of the arbitrator.

 

Whether a matter must be submitted to arbitration and, if so, whether the arbitration decision is final depends on several factors. First and most important is whether the contract obligated the parties to use arbitration. Arbitration clauses are becoming increasingly common in agricultural contracts. The second factor is state law. Each state has a law concerning the procedures for using arbitration and for determining how arbitration agreements are to be enforced. Most laws recognize that written agreements requiring parties to arbitrate disputes are valid and enforceable, unless contradictory grounds exist under that state’s law. For example, such grounds may be that the requirement for binding arbitration is unfair.

 

APPENDIX 1

 

Glossary of Contracting Terms
Although consistent terminology for swine contracts has not yet evolved, listed below are definitions for terms commonly used in contracts.

• Arbitration: An alternative method of resolving legal disputes (other than going through the traditional court system) that is intended to decrease the time and expense involved in legal disputes. In arbitration, a neutral third party hears both sides and renders a decision.
• Breach: When one or both parties break contractual obligations by failing to perform one or more of the conditions of the contract.
• Contract swine: The animals being managed under the contract, including offspring of these animals.
• Contract facilities: A farm or portion of a farm described in the contract where the contract swine are to be kept.
• Contractor: The person or company that owns the animals. May also be referred to as the “owner.”
• Default: Failure to perform a contractual or legal duty.
• Grower: The pork producer who cares for the animals. May also be referred to as the “feeder” or “producer.”
• Litigation: The traditional method of resolving a dispute by using the judicial process to file and settle a lawsuit.
• Market hog: Any hog for which the contractor receives at least 1 percent of the hog’s top market value from the packer.
• Mediation: An alternative method of resolving disputes (other than going through the traditional court system) in which a neutral third party helps the disputing parties reach an agreement but has no power to render a decision in the matter.
• Oral modifications: Verbal changes made to a written agreement that may not be binding because they are not in writing.
• Termination: Ending a contract prior to the agreed date, either by mutual agreement or by one party exercising the right to end the contract because of the other party’s failure to meet the terms of the agreement.

 

APPENDIX 2

 

Contracting Checklist:
Points to Consider and Questions to Ask

• What is the reputation of the contractor? What is the contractor’s credit rating?
• Consult with a building engineer, veterinarian, nutritionist, financial advisor, attorney and other specialists as needed.
• Have a written legal contract that specifies all details of the arrangement.
• Know who provides or pays for each input and expense.
• Does the contract specify how and when the grower is paid?
• Do not rely on protection supplied by the contractor.
• What is the length of the contract?
• When is the contract officially fulfilled? When animals are loaded on the truck, when they are delivered to the plant, or at some other specified point?
• Can the contractor terminate the contract during a production cycle? If they do remove their animals, how will the grower be paid?
• Will the grower be treated as unsecured creditor if the contractor’s business fails?
• Does the contract specify the date of animal delivery and pickup?
• What is the quality of the animals? Can the grower renegotiate compensation if some of the animals are of low quality or if they appear to be sick?
• What is the feed and ration specifications?
• Will the contractor verify weights and prices?
• Does each party have control of the areas where they are responsible?
• Who controls health care? Who will provide it? Who will pay for it?
• How are death losses handled? Is there an animal death clause? Are both parties adequately protected by it?
• If new facilities are to be constructed, are terms explicitly stated regarding volume of livestock, length of time the contract is enforceable and liabilities of each party?
• Who carries insurance on the animals? Who carries insurance on any buildings?
• Is there a provision for arbitration or mediation?
• If there is arbitration, litigation, or mediation who pays the cost?
• Are there lien considerations?
• If the grower is required to provide records for inspection, the contractor should be required to do so as well. If the contract is set at a fixed rate per head, plus a percentage of profit, the grower needs to have a right to inspect the contractor’s records in order to protect his/her own interests.

 

APPENDIX 3

 

Contract Production Work Sheets
Both the contractor and producer need good production records and information to evaluate the contract effectively. With this information, the two parties can project results and determine the implications of the proposed contract specifications.

 

Two general work sheets are provided to help in this analysis. The work sheet for contract feeder pig production provides growers with a form for calculating expected costs and returns, given the contract arrangements. It is organized into variable costs (1) and fixed costs (2), or those costs covered by the producer. Break-even compensation (5 and 6) and returns (7, 8, and 9) are projected. This form may need to be modified to fit particular situations.

 

Production cost information should come from the grower’s records. If it is not available, however, information from sources such as Livestock Enterprise Budgets for Iowa or the Iowa Swine Enterprise Record Summary provide a base for initial contract analysis. Similar pork production information is available in many states. Return information will relate to the contract’s specifications. Information on production efficiency, such as feed efficiency or death loss, is needed to evaluate bonus payments or discounts.

 

Contractors can also use the form by filling in their costs. Revenues reflect expected market value and the share received. Variable and fixed costs reflect the costs of items provided by the contractor.

 

The contract feed pig finishing work sheet provides a form for budgeting expected costs and returns for finishing operations. It is also organized around variable costs (1); fixed costs (2); necessary compensation to breakeven (4 and 5); compensation level (6); and management returns (7). From this it is clear that production information is a key component in effective contract evaluation. The best information source would be the respective farm production records. If these are not available, however, information can be gleaned from the ongoing record services mentioned above.

 

CONTRACT FEEDER PIG FINISHING (PER LITTER)

 

Production Costs

• Variable Costs Per Litter
  • Veterinary Costs $________
  • Utility Costs $________
  • Labor Cost (8-13 hours) hr @ $ $________
  • Misc. (bedding, manure handling, etc.) $________
  • Total Variable Costs (add above 4 entries) $________ (1)
• Fused Costs Per Litter – Depreciation, interest, taxes, and insurance on buildings and equipment (15-20 percent of investment per-sow capacity, litters produced per year, per sow unit capacity) $________ (2)
• Total Cost Per Litter (1 + 2) $________ (3)
• Number of Feeder Pigs Produced Per Litter _________head (4)

 

Returns

• Necessary Compensation for Weaner Pigs Per Head to Cover Total Variable Costs (1 ÷ 4) $________ (5)
• Necessary Compensation for Weaner Pigs Per Head to Cover Total Production Costs (break-even) (3 ÷ 4) $________ (6)
• Compensation
  • Base Payment/head $________
  • Bonus/head $________
  • Penalty/ head $________
  • Total Compensation/Head (add above 3 entries) $________ (7)
• Estimated Return to Management Per Head (7 – 6) $ ________ (8)
• Estimated Return to Management Per Litter (8 x 4) $________ (9)

 

Prepared by James Kliebenstein and Chris Hillburn of the Iowa State University Economics Department

 

CONTRACT FEEDER PIG FINISHING (PER HEAD)

 

Production Costs

• Variable Costs Per Pig
  • Veterinary Costs $ _______
  • Utility Costs $ _______
  • Labor Cost – Hours (.6 to 1) @ $__________ per hour $ _______
  • Misc. Costs (interest, etc.) $ _______
  • Total Variable Costs (add above 4 entries) $________ (1)
• Total Fixed Costs Per Pig – Depreciation, insurance, taxes, and interest on buildings and equipment (12-18 percent of investment per head turnaround rate)a $________ (2)
• Total Finishing Costs Per Pig Produced (1 + 2) $________ (3)

 

Returns

• Necessary Compensation Per CWT to Cover Variable Costs (1) [Finish Weight (CWT) – Placement Weight (CWT)] $________ (4)
• Necessary Compensation Per CWT Produced to Cover Total Finishing Cost (breakeven) (3) [Finish Weight (CWT) – Placement Weight (CWT)] $________ (5)
• Compensation
  • Base Payment/Head $ _______
  • Feed Efficient Bonus/Head $ _______
  • Death Loss Bonus or Penalty/Headb $ _______
  • Total Compensation (add above 3 entries) $________ (6)
• Estimated Return to Management Per Hog (6 – 3) $________ (7)

^aInvestment per head is related to the finishing system. It could range from $70 to $180 per head.
^bIf there is a penalty, spread the death loss penalty over the number of hogs marketed.
Prepared by James Kliebenstein and Chris Hillburn of the Iowa State University Economics Department

 

REFERENCES

DiPietre, Dennis. “Contracts: Shared Risks and Returns,” Hogs Today, November 1993.
 
DiPietre, Dennis. “Can It Work? Will It Pay?,” Hogs Today, December 1993.
 
DiPietre, Dennis. “A Financial Analysis of a 1000 Head Contract Hog Finishing Floor,” 1994.
 
“Investment Opportunities in Livestock Production Contract Hog Finishing,” Farm Credit Services of the Midlands.
 
“Contracting Can Be Great . . . Or Awful,” Farmland News, September 1994.
 
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