Be realistic with contract deals
By Edward Long
LANDLORDS and contractors must be more realistic when negotiating contract farming deals, a leading adviser has warned.
Richard Levin, of Brown & Cos Bury St Edmunds office, says some agreements are being struck at levels that are unsustainable at current cereal prices.
"Over the past five years, contract farming has become more popular than farm business tenancies," he says. "They work very well if set up properly, but some recent deals have been over-cooked and may end in early termination.
"Often insufficient account is taken by either party of the cereal price slump. The result could be a divisible deficit, which can lead to unnecessary recrimination. It would be far better for both sides to have a lower initial expectation and have something to carve up between them at the end of the year."
A 250ha (500-acre) wheat and oilseeds-based business typically generates an average gross margin of £225/acre, says Mr Levin. Deducting £30/acre for fixed costs such as fuel, insurances, drainage, finance charges, pest control and administration leaves £195 in the pot.
If the owner retains £80/acre, and the contractor a similar amount, that leaves £35/acre to divide between the two parties. The contractor usually takes 80% and the owner 20%. Overall, the owner ends up with £87/acre and the contractor with £108/acre.
"In the past the retention figure was between £90/acre and £110/acre. Today, this would be too high. It could be argued that it would be better to start with both the owners and contractors initial charges at £60/acre, and split the excess 50:50.
"This would give slightly less return to the contractor, but for a reduced risk, as the landlords return is more affected by the final result than previously."
Contractors must remain competitive, he adds. While they may have invested in larger equipment to cope with a greater workload, this does not mean they can automatically pass on the extra depreciation and finance costs to the landlord. When tendering for business, they should also consider the downtime involved in travelling to the other farm. It is not unheard of to move kit 30 miles, twice as far as 10 years ago, and this costs money.
Landlords have seen the retention figure rise when cereal prices were reasonable. Now, with cereal prices on the floor, they must accept that a more realistic attitude is vital for the success of any contract farming deal.
Over the past few years there have been cases where both parties have had to face divisible losses. Some agreements state that any deficit should be carried forward for the life of the agreement, whereas others do not. Brown & Co advises both parties at the outset to read the small print.
Mr Levin would like to see agreements reviewed annually to allow for the uncertainties in arable farming, rather than after three years. This would give an opportunity to fine-tune the reward split to reflect market prices. *