Get up to speed on commodity contracts

Volatile commodity markets are fertile ground for contract disputes. Chartered arbitrator and contracts consultant Peter Brown answers some common contract questions.



What is a contract and how is it established?



A contract is an agreement between two parties to sell and buy a stated quantity of goods, eg grains or oilseeds, at a given price, for stated quality and for a specific delivery period. There are three elements to a contract – offer, acceptance and performance.


The agreement, however and wherever it is reached, does not have to be in writing, although the buyer will generally issue a written confirmation. The seller should always check that every detail is correct. If this is not the case, tell the buyer immediately so the matter can be clarified and a corrected confirmation issued if necessary. Silence will be taken as agreement.


It is a myth that the confirmation has to be signed to make it binding. There is not a period of reflection – a contract is a contract and it has to be performed.


It is good practice to keep a day book or diary and make notes of conversations and what was agreed. I have seen arbitrations won and lost on both sides on the strength of such notes.


Many grain merchants issue a monthly reminder of open contracts still to be performed. Growers should not ignore these reminders because by doing so they could be held to have accepted a liability to them by not querying or denying them when the original confirmation and/or the monthly reminders are received.



Can the terms of a contract be changed?



Yes, but only by agreement. Most UK grain traders issue their company terms and conditions annually and base these on the AIC No 1 Grain & Pulses contract.


Every grain seller should have a copy of the latest version (2011) and should understand the main clauses and how to interpret and apply them. That contract sets out the rights and obligations of both parties if things go wrong.


The AIC No 1 Grain & Pulses contract is not a buyer’s tool. A seller may impose his own provisions provided the buyer accepts them – the ideal time to do this when the original agreement is made.


Buyers sometimes vary the terms of the AIC No 1 contract, typically concerning quality tolerances and quality claims, so it is important to check traders’ standard terms issued every year and the written confirmation of contracts for any changes.



What causes the most common problems in ex farm contracts?



The most common disputes arise from just a few areas: force majeure, quantity, quality and delivery of grain and other commodities.



Force majeure













Top tips



• Agreements do not have to be in writing
• Keep notes of conversations and what is agreed
• Buyers and sellers can vary standard terms – but only by agreement
• Check all paperwork carefully – if anything is not as agreed, query it without delay
• Merchants’ own terms can override some of AIC No 1 contract terms
• Use HGCA seller’s checklist as a guide
• Try to establish scale-backs, discounts or allowances for lower-than-contract quality before delivery 

 


This is probably the most commonly misunderstood contract term. Sellers sometimes try to claim force majeure (AIC contract cl.19) as their defence for not delivering goods which they had sold. Force majeure does not cover the failure of a crop to yield either the contract tonnage or quality.


It is designed to provide cover when an unexpected event such as a breakdown of plant or machinery, power failure, fire or flood prevents either party from performing the contract as or when anticipated.


Force majeure provides a breathing space of 30 days for the problem to be remedied so the contract may be performed on the original terms. It is important to understand that no matter which party claims force majeure, it is the responsibility of the seller during this 30-day period (as with any extension to the contract period) to keep the goods in a deliverable condition, sweet, dry and free of infestation, taint or smell.



Quantity



Under the AIC No 1 contract, sellers are selling goods “not necessarily being the seller’s own produce”. This means that if grain of sufficient quantity and/or quality is not produced when the goods are called for, the buyer may buy-in grain of that quality to make up the shortfall.


The cost of the difference between the contract price and the market price can be charged to the seller as damages. However it also allows the seller to buy-in grain in order to meet his contract obligations and avoid the damages claim.


The AIC No.1 contract clause 5 deals with tolerances and allows delivery of plus or minus five tonnes or 15%, whichever is the lesser, of the contractual quantity. It gives the seller discretion whether an over- or under-delivery may be made.


Provided the seller is in agreement, changes made by the buyer to their own standard terms may put this at the buyer’s discretion and will override the standard AIC terms. Check paperwork carefully – standard terms of business issued yearly may take precedence over contacts issued through the year as deals are done. A seller can object to such changes, and depending on his stance and value as a supplier, may be able to reverse them.


Any damages for over- or under-delivery are calculated on the original contract tonnage, not after deduction of any tolerance.


However, if the sale tonnage is in a range, eg180t to 220t, no tolerance will be applied, because the seller’s obligation is to deliver a quantity between those two figures.


If a seller knows he is short of tonnage he should tell the buyer before the time of delivery to allow the buyer, with the seller’s agreement, to replace the likely shortfall. Where this happens, the buyer must minimise the seller’s losses.


Alternatively, the seller may himself buy-in grain to make up for the shortfall, but if the point of collection of for these buy-in goods is not close to the original farm or point of collection, then any extra haulage or administration costs this genuinely incurs may need to be discussed.


If none of the above applies and the seller simply fails to supply the full contract tonnage, then the seller is likely to be in default, allowing damages to be claimed by the buyer. The default date is the first business day after the contract period. Any damages claimed must be established according to the market price on that date or very shortly afterwards.


Damages arising from a shortfall may be deducted from the value of grain already delivered on the same contract. Where no deliveries have been made, the usual practice is that the buyer will invoice the damages (the cost of buying in against the seller) and require payment to be made within seven days.


If payment is not made within that time, the buyer is likely to apply for the damages to be determined by arbitration. However, considering the huge number of ex farm grain transactions, the number of arbitrations each year is proportionately very low and is usually fewer than 20.



Quality



A seller should try to establish any allowance or deduction for failure to meet contract quality before a load is tipped. Ideally, buyers should set out discounts or scales of allowances in contracts as they are issued.


If quality is at question at delivery, the seller or his representative may attend a second sampling and analysis. That second test result, or an average of the two tests, could make the load suitable for acceptance at the contract price.



Delivery



From time to time, for practical reasons either side may request an extension to or a pull forward of delivery dates. If this takes deliveries outside the contract period, then the party being asked to change is entitled to refuse, although where it is practical to do so, would probably wish to accommodate the request to maintain goodwill.


Depending on the relationship between the parties and the nature of the change to the contract, payment may be negotiated to recognise the cost or risk of extra storage.


Where there is a quality or quantity problem, such as in the malting barley crop of 2011, merchants may agree to roll contracts forward a year rather than default a seller with whom they wish to maintain a good relationship.


Peter Brown Associates is based at Aldeburgh, Suffolk and specialises in the resolution of contractual disputes. www.disputeresolve.co.uk





Do you have a commodity contracts question for Peter Brown? Post it on our forums at https://www.fwi.co.uk/community/forums/p/68057/198830.aspx#198830. Peter will be checking the forums and responding next week.