DRAFT

 

THE MIZORAM STATE AGRICULTURAL

PRODUCE MARKETING

(DEVELOPMENT AND REGULATION)

 

BILL, 2006

 

Addendum on Contract Farming

 

Contract Farming Agreement and Its Specifications

 

1.         Introduction : Contract farming is an agreement between processing and/ or marketing firms, market intermediaries and the farmers for the production and support of agricultural products under forward agreement, frequently at predetermined prices. The arrangement invariably involves the purchaser in providing a degree of production support to farmers through, for example, the supply of inputs and the provision of technical advise. The basis of such arrangements is a commitment on the part of farmer to provide a specific commodity in quantities and quality standards determined by the purchaser and commitment on the part of the registered market intermediaries to support the farmer’s production and to purchase the commodity. Contract farming is thus a means of allocating the distribution risk between processor and grower. The latter assumes risk associated with production while the former assumes the risks of marketing  the final produce. For some critics. “contract farming” is just another of the ills Associated with economic globalization. On one side, there are a mass of unorganised small-scale farmers, with little bargaining power and few of the resources needed to raise productivity and compete commercially. On the other side are powerful agribusiness entrepreneurs, offering production and supply contracts, which – in exchange for inputs and technical advice – enable it to exploit cheap labour and transfer most risks to the primary producers. Contract farming, the critics say, is essentially an agreement between unequal parties, and more likely to generate debt than development for the small farmer. But this is rarely the case. An FAO guide “Contract farming : Partnerships for growth” argues that well managed contract farming has proven effective in linking small farm sector to sources of extension advice, mechanization, seeds fertilizer and credit, and to guaranteed and profitable markets for produce. “It is an approach that can contribute to both increased income for farmers and higher profitability for sponsors. “When efficiently organized and managed, contract farming reduces risk and uncertainty for both parties and provides the producer the opportunity to add value to his production.

 

2.         Merits of contract farming : The prime advantage for farmers is that the sponsor will normally undertake to purchase all produce grown, within specified quality and quantity parameters, often at pre-determined prices. Contracts can provide farmers with access to a wide range of managerial, technical and extension services that otherwise may be unobtainable. Small-scale farmers are frequently reluctant to adopt new technologies because of the possible risks and costs involved. In contract farming, private agribusiness will usually offer improved methods and technologies because it has a direct economic interest in improving farmers’ production to meet its needs. In many instances, the larger companies provide their own extension support to contracting farmers to ensure production is according to specification. Skills the farmer learns through contract farming may include record keeping, improved methods of applying chemicals and fertilizers and knowledge of the importance of quality and of the demands of export markets. The returns that farmers receive for their crops on the open market depend on prevailing prices and their ability to negotiate with buyers but contract farming can, to a certain extent, overcome this price uncertainty. Frequently, sponsors indicate in advance the prices to be paid and these are specified in the agreement.

 

 

            Contract farming arrangements can contribute to adding value by (a) facilitating the emergence of agro – processing plants which would otherwise not exist if supplies were not forthcoming in an organized manner (b) enabling the export of produce from small farmers which otherwise would not be able to access these demanding markets (c) encouraging higher quality production and Better handling & sorting thus increasing the value of small holder production and  (d) by enabling producers and processors to achieve economies of scale, thereby lower costs and making them more competitive.

 

3.         Risk Factors in Contract Farming : For farmers, there is the uncertainty involved in growing new, unfamiliar crops and producing for markets that might not always live up to their expectations – or their sponsors” forecasts. Inefficient management can lead to overproduction, and in some cases sponsors “may be tempted to manipulate quality standards in order to reduce purchases”. One of the biggest risks for farmers is debt which can be caused by production problems, poor technical advice, significant changes in market conditions, or a company’s failure to honour contracts. On the sponsor’s side, risks can arise when dealing with farmers who, in turn, may have negotiated use of the land with traditional owners. Before entering into contracts, the sponsor needs to ensure that access to land is secured, at least for the term of the agreement. But a more serious problem  is when farmers break the contract and sell their produce in alternative markets, sometimes encouraged by rival sponsors or ruling higher prices in open market.

 

4.          Managing Arrangements: The contract farming system has to be seen as a partnership between agribusiness and farmers. Good service delivery by the sponsor is a precondition for successful contract farming. Sponsors must therefore take responsibility for coordinating production and marketing activities well. Managers must ensure the transparency of all  interactions with the farmers and they must ensure that farmers understand both their own obligations and those of the sponsor. Farmers default in contract farming arrangements can be reduced by following interventions :

 

  1. Organizing Farmers’ Associations : Peer pressure within the group screens out potential defaulters and can reduce the risk of default. In addition, economies of scale  can be realized in the delivery of services, thereby reducing costs. Farmers will also benefit by having a stronger hand in negotiations with companies.
  2. Good communication and close monitoring of farmers : Good communications help to foster good company-farmer relations and a sense of trust, which has a positive effect by reducing strategic default. Group members can monitor each other where there is a need to ensure quality and traceability of produce, and to prove due diligence throughout the chain.
  3. Range and quality of services offered : The better and broader the range of services offered, the closer the relationship between farmer and the business, and more the farmer stands to lose by breaking the relationship.

 

5.         Types of Contract farming :  Contract farming agreements can be classified into three, not mutually exclusive categories :  (i) market-specification, (ii) resource providing, and  (iii) production management. Market specifications contracts are pre-harvest agreements that bind the firm and grower to a particular set of conditions governing the sale of the crop. These conditions often specify price, quality and timing. Resource providing contracts oblige the processor to supply crop inputs, extension, or credit, in exchange for a marketing agreement. Production management contracts bind the farmer to follow a particular production method or input regime, usually in exchange for a marketing agreement or resource provision. In various combinations, these contract forms permit firms to influence the production technology and  respond to missing markets without having to operate their own plantations. Eaton and Shepherd in their book titled ‘Contract Farming – Partnership for Growth’ (FAO – 2001) have presented five organizational models for contract farming.

 

  1. Centralised Model: The sponsor purchases crops from farmers for processing, and markets the product. Quotas are distributed at the beginning of each growing season and quality is tightly controlled. This model is generally associated with tobacco, cotton, sugar cane, bananas, coffee, tea, cocoa and rubber crops.
  2. Nucleus estate Model :  The sponsor owns and manages a plantation, usually close to a processing plant, and introduces technology and management techniques to farmers (sometimes called “satellite” growers). Mainly used for tree crops, but has also been applied to dairy production.
  3. Multipartite Model : Usually involves statutory bodies and private companies jointly participating with farmers. Common in China, where government departments, township committees and foreign companies have entered into contracts with villages and individual farmers.
  4. Informal, or individual developed Model : Individual entrepreneurs or small companies make simple, informal production contracts with farmers on a seasonal basis, particularly for fresh vegetables and tropical fruits. Supermarkets frequently purchase fresh produce through individual developers.
  5. Intermediary Model :  Formal subcontracting of crop production to intermediaries is common in Southeast Asia. In Thailand, large food processing companies purchase crops from individual “collectors” or farmer committees, who make their own informal arrangements with farmers.

 

6.         Specifications of Contract Farming agreements : Contents of a contract farming agreement depends on a number of factors such as the nature of the product, the primary processing required, if any, and the demands of the market in terms of supply reliability. Quality incentives, payment arrangements, the level of control the sponsor wants to have over the production process also influence the nature of the agreement, and the extent to which the parties have capital tied up in the contract. A contract covering, for example, oil palm, tea or sugar, where significant long-term investment is required from all parties, will be different from a contract covering annual crops such as fruits and vegetables for local supermarkets may not be the same as one covering such produce destined for overseas, markets, which may have more rigid controls on pesticide use and product quality as well as higher presentation and packaging standards. Although corporate bodies, government agencies and individual developers are of necessity the catalysts of the contract, farmers and their representatives must be given the opportunity to contribute to the drafting of the agreement and assist in the wording of specification in terms farmers can understand. Management must ensure that agreements are fully understood by all farmers. The terms and conditions entered into must be written down for independent examination and copies given to the farmers’ representatives. Copies should also be available to relevant government agencies.

 

            The legal framework of the Agreement should comply with the minimum legal requirement of the Indian Contract Act. local practice must be taken into account and arrangements for arbitration must be addressed. Agreements, in the form of a written contract, usually cover the responsibilities and obligations of each party, the manner in which the agreement can be enforced and the remedies to be taken if the contract breaks down. In most cases, agreements are made between the sponsor and the farmer, although in the case of multipartite arrangements, the contracts can be between the sponsor and farmer associations or cooperatives.

 

The Specifications : Within the broad categories of market-specification, resource-providing, and produce-management contracts, firms must specify terms that include :

 

  1. Marketing : How much of the product will be purchased. When, and at what price for what quality? Must the grower deliver all of his product, a share or set amount.

 

  1. Inputs and technical assistance  : How will inputs and technical assistance be delivered. How much, and at what price and quantity ?

 

  1. Credit : Will the grower receive credit in cash or kind? How much will he receive, at what interest rate? What will be the collateral?
  2. Production Management : What technological procedures must the grower follow. How will the grower be monitored?
  3. Delivery and grading : Who will transport the harvest to the processor and how will quality be graded ?
  4. The duration of the contract :
  5. The way in which the price is to be calculated using :
    1. Prices fixed at the beginning of each season.
    2. Flexible prices based on world or local market prices
    3. Spot-market prices
    4. Consignment prices, when payment to the farmer is not known until the raw or processed product has been sold, or
    5. Split pricing, when the farmer receives an agreed base price together with a final price when the sponsor has sold the product
  6. Procedures for paying farmers and reclaiming credit advances;

    i)          Arrangements covering insurance

    j)          Registration of Contract Farming Agreement with the notified Govt. Agency and Dispute resolution mechanism.

 

 

CONTENTS OF A CONTRACT FARMING AGREEMENT

 

MANDATORY PROVISIONS –

 

I.  Parties To The Agreement

 

  1. Contract Farming Sponsor – It may be a sole proprietor, a company registered under the Companies Act. 1956, a partnership firm registered under the Partnership firm 1932. a Government Agency. A Cooperative Societies registered under the State Cooperative Societies Act and shall include its administrators, successors, representative and assignee.
  2. Contract Farming Producer’s includes and agriculturist, farmers associations, self-help groups, authorized tenants and farmers cooperatives societies registered under the State Cooperative Act. The expression shall include the successor, heirs, executors and representatives of the party contracting the agreement.

 

II.  Description of Farm Land Covered by Contract Farming Agreement.

 

  1. Acreage, Location – This would provide land particulars as recorded with the revenue authority of the concerned area.
  2. Facilities available – This would stipulate availability of irrigation, its kind and other specific features reflecting on production.
  3. Nature, tenure, rights etc. of the Contract Farming Producer’s on the land.

 

III.  Duration of Agreement.

 

  1. Seasonal
  2. Annual
  3. Long Term (3-5 years)

 

Explanatory note : The duration of agreements depends on the nature of the crop. Contracts for short-term crops such as table vegetables are normally issued and renegotiated on a seasonal basis, whereas crops such as tea, coffee, sugar cane, and cocoa require long-term contracts that can be amended periodically.

 

IV.  Description of Farm produce

 

            This would clearly indicate name of the agricultural produce with specific variety or any other characteristic, which the buyer wants the producer to grow on the contracted land identified under clause 2.

 

V.  Quantity Specification of the Farm Produce

 

            This would indicate the quantity of produce in respect of which the agreement is entered into. This could be determined on the following basis :

 

  1. On volume basis
  2. On Area Basis
  3. Entire Crop
  4. Fixed Quantity

 Explanatory note      : Quotas are employed in the majority of contracts in order to utilize processing, storage and marketing capacities efficiently: guarantee markets for all farmers: ensure quality control: and monitor farmer’s performance. The allocation and distribution of production quotas will vary according to crop and circumstances. Where there is no alternative market for the crop and farmers have made significant long-term investments in production (tree crops)or processing facilities (e.g. tobacco curing barns), the sponsor must be committed to purchase the entire crop covered by the quota. This obligations, of course is subjected to the crop meeting the agreed quality specification. The most common and practical method is to allocate quotas on an area basis, with sponsor calculating the total area to be calculated in relation to the project’s processing capacity and their knowledge of each farmer’s expected yield. Where there are alternative markets for crops under contract, quite often farmers are tempted to sell outside the contract. Quotas deliberately set at levels lower than the farmer’s actual production capacity may enable them to take advantage of high open market prices when they occur. Such an arrangement is likely to apply particularly when the pricing arrangement is for a fixed price rather than a market-based price.

 

VI.  Quality Specifications of Commodity Contracted

 

  1. Quality specifications in terms of size, weight, degree of maturity, packaging, intrinsic quality like juice content, safety requirements, if any
  2. Agency to decide quality in case of dispute
  3. Consequences of non conformity with quality specifications

 

  1. Rejection
  2. Reduction in price
  3. Any other

 

Explanatory note:  Contracts should contain quality specifications of produce covered by the agreement and indicate as to whether the produce that does not conform to the agreed criteria can be rejected. It is important that farmers fully understand the reasons for standards. Contract sponsor should demonstrate the grades to farmers at the beginning of each season and explain the rationate for the specifications. Wherever possible, the number of grades should be kept to a minimum and each grade’s specifications should be presented in clear terms. Often, however, there may be a need for only one standard, with all produce delivered being required to fall within a particular specification range.

 

VII.   Crop delivery arrangements .

 

  1. At Farm gate
  2. At Processing Unit
  3. At specified collection centers
  4. Transportation arrangements

 

Explanatory note       :   Arrangements for collection of products or delivery by the farmers vary widely. Some ventures stipulate that farmers should deliver their harvest to processing plants at given dates: others may include the use of the sponsor’s transport to collect harvested crops at centrally located buying points. For contracted fresh vegetables a normal practice is farm gate collection. When the sponsor’s transport is used there is normally no cost to the farmer. In the sugar industry, farmers deliver their harvested cane to central loading point from which it is then transported to the crushing mill, weighed and purchased. Many formal contracts have claused that outline the obligations of both the farmer and the sponsor regarding delivery and collection respectively. As a routine practise sponsors and their extension staff should confirm delivery or collection arrangements at the beginning of each season and reconfirm these prior to harvest.

 

VIII. Pricing arrangements

 

  1. Fixation of Price
  2. Payment and Loan/Credit  Recovery procedure
  3. Advance Payment
  4. Credit in cash/Kind(input)
  5. Recovery of Bank Loan
  6. Payment on Delivery
  7. Final Payment
  8. Arrangement with Banks

 

Explanatory note       :   Pricing and payment arrangements are the most discussed and challenging components of all farming contracts. The choice of which crop pricing structure to use is influenced by whether the crop is for the local or export market, the seasonal nature of production and the degree of competition in the marketing system. The application of transparent pricing formulas is crucial and the drafting of a clear pricing structure and the organization of a practical method of payment encourage confidence and goodwill. There are several ways prices offered to farmers can be calculated. Fixed prices are the most common method. The practice is usually to offer farmers set prices at the beginning of each season. In almost all cases, fixed prices are related to grade specifications. Flexible prices structure applies to prices calculated on a formula related to changing global and local markets. This form of pricing is common in, for example, the sugar industry where the final price to the farmer is known only after the processed sugar has been sold. Under Split pricing system an agreed base price is paid out at the time of purchase or at the end of the harvesting season. The final price is calculated once the sponsor has on-sold the commodity, and depends on the prevailing market price. If the crop is sold in the fresh form the second price can usually be calculated within a month. When the product is processed it may take much longer.

 

IX. Registration and dispute Resolution Mechanism

 

            In the majority of cases, it is highly unlikely that a sponsor will take legal action against a small holder for a breach of contract. The costs involved are inclined to be far in excess of the amount claimed, and legal action threatens the relationship between the sponsor and all farmers, not just those against whom action is being taken. Action by a farmer against a sponsor is similarly improbable. As neither side is likely to seek a legal remedy through the courts, it is important that quick and easy ways of resolving disputes are identified in the agreement. A body representing the sponsor, farmers and other interested like Market Committtee might be the most appropriate forum, which can act as an arbitrator. For the purpose, appropriate legal provision will have to be made in the law governing the marketing of agricultural produce (APMC Act) to inter-alia provide for compulsory registration of all contract farming agreements and the procedure for settlement of disputes arising there from.

 

X.  Indemnity in favour of producer

 

            In order to protect producers land and properties it is essential that an indemnity is  provided to him. The sponsor in any case shall not have any right whatsoever over the title or possession of the producers land.

 

OPTIONAL PROVISIONS:

 

XI. Cultivation/Input Specifications to be followed by the Producer

 

  1. Land preparation
  2. Nursery
  3. Fertilization
  4. Pest management
  5. Irrigation
  6. Harvesting

 

Explanatory note       :  When sponsor provide seeds, fertilizers and agrochemicals, they have the right to expect that those inputs will be used in the correct quantities. They also have the right to expect that farmers follow the recommended cultivation practices. Of  particular concern is the possibility that farmers may apply unauthorized or illegal agrochemicals, which can result in toxic residues, with dramatic repercussions for market sales. It is therefore essential to spell out these clearly so that all contracted farmers adhere strictly to the project’s input policies. Sponsors and their extension staff must make every effort to explain to farmers why the specifications and input recommendations must be followed.

 

XII. Insurance arrangements

 

  1. Price Fluctuations
  2. Pest Epidemic
  3. Natural calamities
  4. Acts of God
  5. Destruction of Assets
  6. Loan Default
  7. Production Loss
  8. Buyer’s Insolvency

 

Explanatory note       :   Agricultural  investments always involve risk. The five most likely reasons for investment failure are poor crop management, climatic calamities, pest epidemics, market collapse and price fluctuations. The standard agribusiness approach to indemnify against quantity shortfalls is crop insurance. As the farming involved in a contract arrangement becomes technologically more advanced, the range of risks to which it is subject generally becomes more limited. In many cases some of the remaining risks can be managed with the assistance of insurance. Where there are fixed price contracts there is no apparent risk to farmers with regard to payment for their crops. If a market collapses, the sponsor should automatically shoulder the loss. However, if the sponsor becomes bankrupt, farmers could be permanently affected. Where contracts are on a flexible on spot-price basis the stability of farmers’ incomes is always at risk. In theory, the proposal of crop and property  insurance for farmers in contract farming ventures is appealing. However, a qualified  risk analysis has to be made to determinate the economic advantages of insurance against the specific risks applicable to the particular crop. Some authorities classify the four main categories of crop insurance in order of “their comprehensiveness in terms of coverage of risks” as follows:

 

(i)  Acts of Gods         :           This category encompasses natural disasters such as drought, floods, hail, storms, cyclones, lightning, insect plagues and disease epidemics that are beyond management control.

 

(ii)  Destruction of specified assets   :           Tractors and farm implements can be insured against damage and theft. Insuring of curing kilns by farmers when growing tobacco under contract is essential. If a contract-farming venture is well established, management can sometimes organize the insurance of non-contractual farm buildings and housing as part of the sponsor’s total indemnity policies, reducing the cost of premiums to the grower.

 

(iii)  Loan default       :           In almost all ventures, sponsors assume the liability of credits advanced by management to the farmer for the contracted crop. It  is therefore important that advanced do not accumulate into debts that the farmer cannot. repay. Sponsors  normally allow farmers who cannot repay advances because of climatic or other mitigating factors to extend their loans to the following seasons. Sponsors. Of course, do have the option to indemnify their farmer loans against default  through their own insurance brokers.     

 

(iv)  Production and income loss      :           Insurance against both production and income loss is expensive and complex. Production loss may be caused by a combination of factors that are difficult to insure against. To determine who is culpable when a crop is destroyed by  insects is one example. Was it an “Act of God” or the failure of the farmer to take measures for pest control at the appropriate time, or was it the fault of  management for not training and instructing the farmers in pesticide techniques? there are also social risks that could cause crop loss such as theft and animal damage.

 

XIII.   Support Services To Be Provided By  Sponsor :

 

The sponsor of large volume of produce may as part of the agreement provide one or more of the following services:

  1. Coordination of production which includes identifying suitable production areas and forming farmers’ groups:
  2. Provision of extension advice on new cultivation/harvesting practices, appropriate use of chemicals, and efficient farm management :
  3. Transfer of Technology leading to higher yield and/or improved quality:
  4. Cropping schedules ; and
  5. Training and awareness programmes.

XIV.    Farmer-Management Forum:

 

  1. Organisation of Farmers’ Association
  2. Interaction with Associations

 

Explanatory note:     Intermediary bodies that link management/sponsor and farmers for purposes of negotiation and interaction are necessary for all contracts. By creating farmer-management forums, sponsors can negotiate contracts with farmers either directly or through their  representatives. The representatives should meet with management/sponsor periodically, but atleast three times in a season. The first meeting should be at the beginning of season in order to ratify  the pricing structure and the season’s crop schedules. A second meeting is advisable immediately before harvesting to discuss the crop progress and to confirm buying procedures. A final meeting to review performance at the end of harvest, which may coincide with the final payment to farmers. The farmers management forums include Farmers Associations, Farmers Co-operatives. Farmers Groups or any other organisation of the farmer by whatever name called (to be named in the agreement).

 

XV.   Monitoring Quality and Yields:

 

Each contract farming agreement must incorporate quality control and monitoring system suitable for its particular operation. Sponsor must prioritize monitoring procedures and decide how often they should be carried out, in what locations and who should be inspected and at what locations. Checking product quality can take place before, during and immediately after harvesting as well as at the time farmers grade their own production and when the produce reaches the company’s processing or packaging facility.

 

 

 

 

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