Hedge-to-Arrive Contracts Found To Be Valid “Forward Contracts”

April 29, 2010 | Erin Herbold

 

All grain contracts should contain several key elements, including specification of the quality of the grain to be delivered, the date for delivery, location for delivery, the price or formula to be used in determining the price, price adjustments if a producer is unable to meet the quality specified, the quantity of grain being contracted, and, of course, the signatures of the parties and date of signing. Farmers often utilize cash-forward grain contract – contracts for future delivery at a specified time of a crop to be grown at a contract-specified price.  A variation of a cash-forward grain contract is a hege-to-arrive (HTA) contract.  It’s basically a cash-forward contract with the delivery date left open.  The farmer has the ability to roll the delivery date into the future.  But, eventually the buyer will “call” the contract and delivery will be required. When that happens, problems arise if the farmer no longer has grain to deliver. 

HTAs were problematic in the late 1990s and early 2000s, and this case points out that the issues associated with HTAs are not completely gone.

Here, a farmer entered into four HTA’s by way of a “purchase contract” with a cooperative. The HTA’s included the types and quantities of grain that the farmer would deliver, moisture percentages, and the prices that the cooperative would pay. All four of the HTA’s stated prices using the Chicago Board of Trade crop terminology. The first HTA contract was for 6000 bushels of wheat at $3.45/bushel. The second HTA contract called for 20,000 bushels of “yellow corn” at $2.58/bushel and the third HTA contract called for 50,000 bushels of “yellow corn” at $2.93/bushel. The fourth contract was for 30,000 bushels of “yellow corn” at $3.3375/bushel.

Delivery dates were not specified and the producer had the option to roll the contract to a “forward-pricing month in the same crop year.”  The contracts further specified that the buyer would make “every effort” to accept the grain covered by the contract as it was delivered, and that the seller warranted that the grain delivered would be free of any encumbrances.  The contracts also stated that any time extension would be at the buyer’s sole option.

The farmer extended the delivery period of each contract several times and was charged a “rolling fee” of $.01 per bushel for each extension. Each time the farmer “rolled” the HTA, the roll was confirmed in memo form by the co-op. In July of 1996, the farmer cancelled all four contracts, with his total liability for cancellation under the HTA contracts pegged at $234,465. The farmer attempted to pay his debt to the co-op by signing several promissory notes and did, in fact, pay the co-op $58,750 by late 2002.

In 2004, the elevator was sold and notices and a chance to vote on the sale were sent to members, including the farmer. The sale was approved by the members and the new owners attempted to collect the remaining debt from the farmer. While the farmer did make payments totaling an additional $35,000, he sued the co-op in May of 2006, claiming that the HTA contracts and the resulting promissory notes were unenforceable.  The basis for the claim as that the HTA contracts were void as “speculative futures contracts.”   He also sought reimbursement for any money that he already had paid to the co-op based on the promissory notes and dividends from the sale of the co-op. He further alleged that the co-op’s board breached a fiduciary duty to him in selling the co-op and that the co-op’s acceptance of money paid and lack of payment of dividends constituted a criminal conversion.

At trial, the co-op argued that the farmer’s claims were invalidated because of a statute of limitations violation. But, the farmer claimed that the statute of limitations was “tolled” or stayed, because he didn’t discover the alleged criminal conversion until a later date than what the co-op claimed.  The jury, based upon instructions they received regarding grain speculation and HTA contracts, found in the farmer’s favor and awarded damages of $116,072.50 to the producer for the payments on the promissory notes.

On appeal, the appellate court determined that the statute of limitations for claims of this kind was three years and that it began to run at the time the payments were received, regardless of whether the farmer discovered the alleged injury at that time. The farmer claimed that the actions of the co-op were a “continuing wrong” against him, but the court disagreed.  Since the producer did not file his complaint until May of 2006 and began remitting payments on the promissory notes to the coop in early 2000, he violated the three- year statute of limitations for his first three payments. Thus, the jury’s award for reimbursement damages was invalidated.

The appellate court also determined that there was no evidence that information was inappropriately withheld from the farmer relevant to the sale of the co-op.  The co-op sent timely notice to all co-op members and gave members an opportunity to vote on the sale, which resulted in an approval of the sale.

The appellate court next addressed the issue of the validity of HTA contracts and whether it was appropriate for the jury to make a determination on the validity of those contracts. In Indiana, a written contract is generally a question of law to be determined by the trial court judge. However, if reasonable people would find the contract to be ambiguous because of extrinsic facts, the jury is charged with determining those facts. Despite this exception, the contract here was considered to be ambiguous only because of the language used, not the extrinsic facts. Thus, this was a question for the court to resolve.

The court briefly discussed the difference between a “futures” contract and a “forward” contract, as applied to the case. The court stated that, “[A futures contract] is an executory, mutually binding contract providing for the future delivery of a commodity on a date certain where the grade, quantity, and price at the time of delivery are fixed.”  The main goal of a futures contract is to transfer the risk away from suppliers, processors, and distributors to speculators. Cash forward contracts are “individually negotiated sales of commodities between principals in which actual delivery of the commodity is anticipated, but is deferred for reasons of commercial convenience or necessity.” Thus, a futures contract is essentially a type of security agreement, like common stock, and a forward contract is an “actual, though deferred, delivery of a commodity. 

The designation of whether these HTA contracts were futures or cash-forward contracts is critical because futures contracts are governed and regulated by the federal Commodity Exchange Act (CEA), but forward contracts are regulated at the state level. Several courts have discussed the difference between futures and forward contracts as it relates to the CEA. HTA contracts are classified as forward contracts if the contract specifies the terms regarding place, delivery and quantity, and is between “industry participants,” such as farmers and grain merchants, not speculators. Further, delivery on forward contracts cannot be delayed forever, because the HTA requires the farmer to pay an additional charge for each roll of the HTA.

According to the court, all four of the producer’s HTA contracts were separate forward contracts because of the presence of specific terms and were entered into by a producer of grain and a buyer of grain - industry participants. Further, delivery could not be delayed indefinitely under the contract. Even though there was an omission of the delivery date under the contracts, the court found that the agreements were forward contracts because the producer was charged a rolling fee each time he delayed. Thus, the producer was liable to the co-op for the promissory notes executed when he violated the HTA contracts. Farmers Elevator Co. of Oakville, Inc., v. Hamilton, 2010 Ind. App. LEXIS 701 (Ind. Ct. App., Apr. 23, 2010).