Thursday, September 3, 2009

Don't Gulp the Force Majeure De Jure - a cautionary tale

Recently I read an article on by Stu Ellis that was sent out by a colleague regarding the effect of COOL and H1N1 on vertically integrated livestock agriculture. There has been large scale unprofitability in the pork market due to increased food inputs and a decrease in exports attached to the misperceptions of the H1N1 virus based on its more common nomenclature of "swine flu". According to the article, there has been reported losses by the

Iowa State Economists for 18 months in the pork market. Naturally, there is a push down the chain effect as these vertically integrated businesses are set up through production contracts with hog producers that are minimally negotiable. In these contracts there is a "ForceMajeure" Clause, a.k.a. "Acts of God." The secondary name is slightly misleading as a forcemajeure clause can typically cover many things that typically wouldn't be attributed to a diety, such as a changes in law, regulations, riots, and coups. The clause is anticipated to cover extraordinary situations that are beyond the control of the parties and would frustrate the purposes of the contract. These clauses are typically enforceable unless it can be shown that the the use of the clause was overreaching or unconsciousable (a legally defined term).

The panic around the H1N1 pandemic and the push of COOL are now being used as rationale to repudiate contracts through the force majeure clauses, which is a major concern in the livestock sector as there is a lack of insurance options that can be found in row cropping operations. The pork integrators have either repudiated the contracts or simply renegotiated a new contract based on there being a "frustration of purpose" (another legally defined term) in implementing the original contract based on the terms as they were drafted. Some scholars argue that the renegotiation aspects is not typical of use of the force majeure clauses. However, tobacco contracts that were considered void by one party through a force majeure clauses were renegotiated based on price terms in the past. Therefore that behavior has been accepted in general agribusiness dealings beforehand, whether a court would enforce that is still unclear as I can assume that many producers simply took the lower renegotiated price.

Now there are a few concerns I have regarding the whole situation of H1N1 and COOL being used under a Force Majeure clause triggering occurrence, even if there is language in the forcemajeure clause speaking to changes in regulations and legislation.

1.) These are market aberrations directly linked to the product, which can be broadly anticipated by the very participation in a fluid market. A Force Majeure typically covers things such as catastrophic crop damage, earthquakes, four horseman, and rain that forces you to grab two of every animal.

There is an obvious counter in that if the market shuts down where the goods were anticipated to go due to back-to-back contracting (Having a sales contract in place to hedge a production contract, where you as a merchant or integrator are the middle person) than there would be a frustration of purpose of the overall operation that the production contract is just merely one aspect. However, I would argue that unless there is explicit language created a escape hatch for the integrator based on the frustration of purpose in another contract or there is precondition that the "non-producer to integrator" back-to-back contract must be enforceable. More concisely, a force majeure clause should only pertain to events that frustrate the contract that is subject to the clause, not to the entire market unless that is explicitly stated in the contract.

2.) In line with the lack of insurance available to livestock producers, there also seems to be a lack of any traditional or spot market outside of the contracts where the pig producer could sell the pork. Therefore, the unconsciousability could be used in the new offer to renegotiate as there are no viable alternatives to the producer at the time. This argument would obviously depend on the other clauses of the contract and the state where it is brought as contract laws vary from state-to-state.

The market would only be a concern if the integrator repudiates the contract and abandons the hogs or signs over title to the hogs to the producer. However, the market is still virtually unavailable to go at it your own if you are a hog farmer which would still allow anunconsciousability argument for any renegotiation.

3.) The contractor's lien spoken of in the article should be expanded and enacted in all states that there are a multitude of vertically integrated agriculture. These producers are purely service providers, much like a mechanic, where they have a temporary possessory interest in the goods (hogs in this case) but do not have actual title to the animals. As long as the producers actually file these statutory liens it could be effective means, so long as there is some form a non-retaliation provision for enforcing statutory rights.

****I put this on the seed law blog since many seed companies are going into new areas through use of production contracts and crops that will not have subsidized crop insurance, therefore no crop insurance may be covering the product as many contractors will say "give me whatever you produce as we need to use it all so that we can ramp up production." This is where I implement this cautionary tale due to the increased used of GM seeds and the constant back-and-forth on the general acceptance of GM. So:

1.) Please read the contract and understand it. Have an attorney trained in these type of contracts to take a look to help with the understanding. I understand this can be pricey, but if you are undertaking a huge obligation in your business (you be the judge), please seek assistance in understand the legally defined terms.

2.) You may be able to negotiate the contract much more than a vertically integrated hog producer without having the other party walk away from the table.

3.) Make the expectations and clauses known in the contract to avoid future surprise - it will save money and hurt feelings, as well allow the parties to truly assess liabilities. In other words, Be a Straight Shooter.

4.) Get to know your rights if there is future communications where the other party tells you want the contract means, and you take it as a surprise.

Don't be afraid of taking advantage of opportunities for new markets or technologies, but please make informed choices or you may be eventually visiting another type of attorney - a bankruptcy one.

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