28 April 2001

Is it your contract farming agreement that has a stranglehold on your business? Then its time to renegotiate, says

Tom Allen-Stevens

Contract killing

AFTER a contract farming agreement is signed, as long as it works well, its put in a drawer and never again needs to see the light of day. At least that is what usually happens. Now an increasing number of agreements – even the best ones – are resurfacing. The dust is blown off, terms are reconsidered and the parties concerned are renegotiating.

The reason is that very few agreements were ever drawn up with the foresight that profitability would plummet to todays levels. The contractors profits have taken the squeeze for too long, and now it is the turn of the formerly sacrosanct owners prior charge.

"Overall the profitability of farming is really quite dire," says Simon Ward. As a farm consultant with Bidwells he helped set up a fair number of agreements in East Anglia. Now he has set up his own consultancy, Increment, and is helping other clients renegotiate.

"It isnt that long ago that some contractors were offering a £140/acre prior charge for some agreements in my area. Now that figure has come down to between £65 and £100."

And the wet conditions have stretched agreements to their limit: where a lower payment is made to the contractor for set-aside than for cropped areas, many contractors have had to rethink their priorities. "Crops drilled late are likely to produce a lower margin than set-aside. So the owner would rather the land went into set-aside, while the contractor needs the contracting payment for growing a crop. I know of one instance where the contractor preferred to drill other peoples land rather than his own."

So there is a real potential for conflict, but a contract farming agreement still represents one of the best farming arrangements available for both parties, says Mr Ward: "The beauty of this type of agreement is that the contractor receives a guaranteed payment and there are clear tax advantages for the owner. Whats more, unlike a farm business tenancy (FBT), the risk of low profitability is shared across two businesses."

But what really drives the market for these agreements is the need for people to work through the current depression. "Many businesses may be losing money by keeping their contracts, but at least they can maintain their cashflow. Guaranteed income for work is better than speculative income for crops."

Mr Ward advises that both owner and contractor should size up their agreement and work out first how well it is working. "First and foremost, there needs to be a good rapport. You need to be in touch with the person making decisions. These agreements work best when both parties get on well and trust each other."

Client care

Secondly, both parties should ensure they have chalked up a good track record. Contractors should be able to demonstrate they have farmed well. Good client care is important – it puts you in a stronger position if you carry out hedge and ditch maintenance or carry out work under a Countryside Stewardship agreement. The financial return is often only part of the service supplied by the contractor or required by the land owner.

"Owners often do not appreciate the extras, especially in older agreements. Establishing game cover is a classic example – it can be a serious inconvenience for a contractor. Meanwhile owners should ensure they have maintained a good working agricultural knowledge. With no idea of the price of wheat, or the cost of fuel and labour, you cannot hope to understand the argument from the contractors perspective."

Just holding regular meetings can ensure the owner stays in touch and has a grasp on the issues affecting the contractor. Mr Ward also advises that owners themselves prepare quarterly or monthly accounts for the agreement.

One important issue to bear in mind is how robust the other partys business is, although this is usually more important for new contracts. Mr Ward warns owners that the rosiest tenders for a contract may come from the least sustainable businesses. It may be equally as important for the contractor to check that the land provider (owner or tenant) is financially secure. Safeguards can be built into an agreement in case the land is suddenly given up to ensure that there is a reasonable period to write off any additional capital investment.

The renegotiation itself should be done face to face, says Mr Ward. You should ensure you state your case clearly before getting into the nitty-gritty of deciding terms.

This is where an agent can help: "They can be very handy as honest brokers. They are generally seen as giving good, unbiased views, based on experience from a number of agreements they may have been involved with." But it is important to be clear whether the agent is acting for both parties or just one, adds Mr Ward.

When it comes to deciding amounts, both parties should be realistic. Traditionally it is set-aside that has underpinned the prior charge for the owner, so there is little point in a contractor suggesting too low a figure. "You could tender below the set-aside rate, but you would have to justify it," says Mr Ward.

Owners should take a long-term view, and also look at the assets theyre offering. Mr Ward points out that while the prior charges for best quality land may still be too low, there are many agreements on poorer quality land paying way over the odds. Very often the contractor will also store the grain, and this is often undervalued.

A renegotiation can also be a chance to review agreements where there is a differential contractor payment for set-aside. "You could build into the agreement how much land is to go into set-aside. It should be flexible enough to cope with difficult years like this one, but fair to both sides."

Fighting over detail can be pointless however – it is more important to retain the trust. "If the trust in the relationship is good, are you really going to let it all fall apart for £5 an acre? For owners it can cost more than that to set up a new agreement. And if youre happy with the job being done, why rock the boat? For the contractor, if the actual costs of farming the land are marginal – fuel, wearing parts, sundry items – even a low fixed contracting payment should more than cover these."

Radical cost cutting measures are always an option for contractors, however. Joint farming ventures with nearby like-minded businesses can boost the overall margin for the business. Or whole aspects of the operation, like harvesting, could be contracted out to a third party.

"In some cases it could be worth the contractor looking through the other end of the telescope. If you have the opportunity to shed your labour and sell your machinery you should not discount the possibility that it could be worth putting your own business up for tender."

There could be an argument for the owner to take a more radical look at the agreement, too. Oliver Harwood, CLAs national rural surveyor, points out that an FBT could be more appropriate: "You have to watch its treatment for income tax purposes, but an FBT will still entitle you to full inheritance tax relief. If your primary aim is not tax status, then an FBT at least puts a bottom in the market for the kind of terms you might agree with the contractor."

Bigger slice

Alternatively a share farming agreement allows owners a bigger slice of the action. But if an owner is just looking to make his side of the deal look more attractive without lowering the prior charge, he could offer the agreement more assets: "You could buy shares in the local grain co-op if theres no storage on farm. Other sweeteners include fertiliser or chemical storage or a cottage."

James Townshend of Velcourt, the UKs largest contract farmers, feels that paying the most competitive prior charge should not be the highest priority. "The vast majority of owners in our agreements are looking for more than outright rent. They want to be sure their land is farmed properly with good husbandry, and they recognise there must be enough provision for the contractor or the relationship will be short term."

And he feels many of the prior charges quoted could be a myth: "In reality these high prior charges simply dont exist these days – theres not a sufficient profit element in the agreement to cover them."