27 March 1998

Fast growth means whole-farm agreements need updating

NOBODY, it seems, knows how many whole farm contract agreements have been set up, but the number is growing and some existing agreements should be updated.

The main reason why the terms of some agreements may need to be renegotiated is the recent downturn in farm incomes, says Gary Markham, head of agriculture for accountants, Grant Thornton.

Many existing agreements were negotiated several years ago when profits were much higher, and in some cases the terms agreed at that time are no longer appropriate, he says.

"The reduced levels of management profit being earned in both arable and livestock farming can mean there is a deficit after the first charges have been taken. Any losses are normally carried forward to be carried by the contractor in the following year, and in these cases the structure of the original agreement is no longer sustainable.

"I have renegotiated many contracts since the results of the 1997 harvest were known. If the first charges are too high for current profit levels, the landowner must reduce them."

Another reason why some whole farm contract agreements should be renegotiated is because the existing terms may not meet the governments policies. The landowning partner in the agreement should be seen to be bearing an appropriate share of the risks and rewards of the farming business, and this should be made clear in the terms of the agreement, and it should also be carried out in practice. Failure to meet this requirement could adversely affect the tax position of the landowning partner.

"The Labour government has implied that it will be taking a stricter line on this in future, and it is possible there may be plans to go further than the current Inland Revenue approach," Mr Markham explains. "Some of the agreements make the landowners position appear to be more like an absentee landlord, with the contracting partner making all the management decisions and doing the buying and selling as well as providing machinery and labour.

"It is difficult to know where the line should be drawn, as the government has not stated its policy yet, but the critical factor is being able to show that the landowning partner is carrying a share of the normal risks and rewards."

Mr Markham says some of the agreements he sees appear to leave the farmer exposed to a harsher interpretation by the Inland Revenue, which could decide to say no to retirement relief and rollover.

Agreements may also need adjustment to sort out problems which were not adequately covered in the original terms. Working out the detail of how a new agreement will work can be extremely complicated for somebody who does not have the relevant experience, and it is not unusual to find points which were left out or need to be amended. Examples could include agronomists fees or the cost of swathing the oilseed rape.

"I know of some deals which were worked out by the two partners with no outside help, and these can work well, but it is much more usual to take professional advice. The professionals need to have commercial and taxation knowledge, and both could be covered by the same person, but the agreement should also be run past a solicitor to make sure the legal aspects are right."

"But despite the problems, most agreements appear to work well, and current financial pressures are forcing many more farmers to consider changing the basis on which they farm," says Mr Markham. Although whole-farm contracting is attracting a great deal of interest, it is not always the best answer, he warns.

"Whole-farm contracting is one of a number of options available at present. The others include machinery syndicates, sharing machinery, joining a machinery ring or contracting out some of the work, and it is important for anybody considering restructuring their farm business to look at all the options before deciding." &#42

Whole-farm contracting is on the rise, but some existing agreements should be updated. Inset: Gary Markham:"If charges are too high for current profit levels, the landowner must reduce them."

Draft with care to avoid pitfalls

Falling incomes, the prospect of some kind of modulation, and the increasing average age of farmers continues to encourage many landowners to look at different ways of managing their businesses.

Few would deny that contracting arrangements can provide a solution – but they need to be drafted carefully if potential pitfalls are to be avoided. So what are the options?

&#8226 Informal agreement – These verbal arrangements operate successfully up and down the country. But they should only be used in cases where the landowner requires the contractor to undertake specific tasks, ie the ploughing or harvesting. Generally they are agreed in advance on an amount/acre/activity basis.

&#8226 Formal agreement – Where a wider role is required from the contractor, agreements must be formalised in writing. This will prevent disputes, together with any potential tenancy or partnership claim. While DIY standard agreements are available, circumstances vary and it is important to go through any agreement and make appropriate changes. As with the informal arrangement, contracting fees may be based on a fixed amount an acre, but could be an overall amount rather than one for each separate activity.

&#8226 Profit share – Introducing such an element can undoubtedly improve performance of a contractor, but care needs to be taken to ensure no unintentional partnership exists (as in the case above). It is recommended that division of profits always be in the landowners favour, and that the contractor and landowner operate their businesses independently, with separate farm accounts and bank accounts.

&#8226 Management agreement – The introduction of a manager adds another potential costs layer into the agreement. This again needs to be carefully drafted.

Once the Agenda 2000 detail emerges, the most appropriate option for farmers looking to contract-out will become clearer. Meantime, the likelihood is that there will be an increasing trend towards smaller areas coming under contract and, as a result, management agreements and their associated costs will cease to be a viable option in most cases. Instead, more informal but written contracting agreements are anticipated.

Draft with care to avoid pitfalls

Falling incomes, the prospect of some kind of modulation, and the increasing average age of farmers continues to encourage many landowners to look at different ways of managing their businesses.

Few would deny that contracting arrangements can provide a solution – but they need to be drafted carefully if potential pitfalls are to be avoided. So what are the options?

&#8226 Informal agreement – These verbal arrangements operate successfully up and down the country. But they should only be used in cases where the landowner requires the contractor to undertake specific tasks, ie the ploughing or harvesting. Generally they are agreed in advance on an amount/acre/activity basis.

&#8226 Formal agreement – Where a wider role is required from the contractor, agreements must be formalised in writing. This will prevent disputes, together with any potential tenancy or partnership claim. While DIY standard agreements are available, circumstances vary and it is important to go through any agreement and make appropriate changes. As with the informal arrangement, contracting fees may be based on a fixed amount an acre, but could be an overall amount rather than one for each separate activity.

&#8226 Profit share – Introducing such an element can undoubtedly improve performance of a contractor, but care needs to be taken to ensure no unintentional partnership exists (as in the case above). It is recommended that division of profits always be in the landowners favour, and that the contractor and landowner operate their businesses independently, with separate farm accounts and bank accounts.

&#8226 Management agreement – The introduction of a manager adds another potential costs layer into the agreement. This again needs to be carefully drafted.

Once the Agenda 2000 detail emerges, the most appropriate option for farmers looking to contract-out will become clearer. Meantime, the likelihood is that there will be an increasing trend towards smaller areas coming under contract and, as a result, management agreements and their associated costs will cease to be a viable option in most cases. Instead, more informal but written contracting agreements are anticipated.