So you want to… use a contract farming agreement
Contract farming agreements can work well for both parties, but only if they are fair and have been properly set up.
WHAT IS A CFA?
A contract farming agreement is a joint venture between a landowner or occupier and a contractor. Each party provides different capital inputs, sharing the cost of variable inputs and the surplus. CFAs are mainly used on arable land, but can also work for dairy and some other livestock enterprises.
WHO DOES IT SUIT?
CFAs are more flexible than tenancies and appeal to many, including:
* Those wanting to expand without requirement for large amounts of extra capital
* Those wanting to reduce capital tied up in machinery or cut down on physical farm work
* New investors wanting some involvement and the tax advantages of land ownership, but who often do not have farming experience
* Those seeking to achieve active farmer status in the run up to CAP reform
* Specialist field scale vegetable businesses
HOW DOES IT WORK?
The landowner or occupier provides land, buildings and usually a bank account with an overdraft facility to run the contract farming account. The contractor provides labour, power and machinery and often other services including crop marketing (in discussion with the farmer) and agronomy.
Arable agreements most commonly run for three years, with each party taking a payment or first charge, although it is important to understand the only guaranteed payment is that to the contractor, says consultant Richard Means of Strutt & Parker. After these and the other costs of producing crops have been accounted for, any surplus is shared in an agreed ratio.
The charges and splits vary widely between agreements, reflecting the risk to each party. A typical combinable crop farm on Grade 3 land would see both contractor and landowner first charges in a range from £80-120/acre and two tiers of surplus share. The first of these might typically be 80:20 in favour of the contractor, up to a certain margin per acre, then a 50:50 or 60:40 share in favour of the farmer. Where the agreement develops over the long term, splits can be renegotiated to reflect capital investment by either party.
The contractor usually orders inputs and sells produce in discussion with the farmer and is generally paid twice a year in arrears. The farmer remains the owner of entitlements and single farm payment claimant, with SFP income usually paid into the contract farming account.
As claimant, the farmer is responsible for cross-compliance, but usually requires an indemnity from the contractor so that if any action of the contractor results in a loss of SFP, compensation is payable for this. Advisers stress that these agreements rely on trust and openness between the parties.
CFAs are most commonly set up through a personal approach to several likely contractors, followed by viewing, tender, then interview. As well as setting out the main terms of the agreement, the tender document will require a budget from the contractor, usually covering the first year.
“It is very important to consider how realistic these budgets are. We often standardise contractors’ gross margins for yield, output and variable costs to be able to compare like with like,” says Mr Means.
WHAT ARE THE BENEFITS FOR THE FARMER?
The immediate benefit for most is a reduction in capital employed on the farm, as most of the machinery becomes surplus and is sold, reducing cost of production significantly.
These agreements allow a farmer to reduce his physical input while still living in the farmhouse and running the business. Some may want to release capital to pursue other business or investment ideas.
“CFAs are more flexible than a tenancy, allowing an individual to continue trading as a farmer. There are both income and inheritance tax advantages to this compared with an FBT. Virtually all CFA terms can be agreed between the parties,” says Mr Means.
WHAT ARE THE BENEFITS FOR THE CONTRACTOR?
Contractors can benefit from economies of scale by taking on more acres, receiving a guaranteed payment per acre with an incentive to do a good job to maximise the surplus and his overall payment.
“It is important to get the terms right and agree a ratio that works across a range of performance results, usually two tiers for sharing the divisible surplus, sometimes three, but if the farmer ends up with 100% of the top tier and the contractor nothing, then there is no incentive.
“The challenge is in setting the tiers and the divisible splits at workable levels, especially when we have such volatility in commodity prices.”
WHAT ESSENTIALS SHOULD THE AGREEMENT COVER?
A formal written agreement is essential, and although no two are the same, Mr Means suggests the following should be included:
* Identification of parties
* Schedule of land and buildings included, with map
* Clear responsibilities for crop marketing, insurance, agronomy and setting of farm policy
* Frequency of meetings
* Whether SFP is retained in agreement
* Treatment of ELS payments and obligations
* Responsibility for irrigation
* Additional contractor duties – for example, loading produce
* Surplus calculation – what costs apart from direct inputs and those charged by contractors to come out before margin is calculated – for example, drainage rates, water rates, interest, office costs
* How surplus is to be shared
* Payment dates
* Responsibility for submitting claims and mapping changes
* Requirement for tidy work, good husbandry, maintenance of rights of way, field, seed, fertiliser and spray records
* Length of agreement, break and notice clauses
* Transfer of Undertakings (Protection of Employment) Regulations – obligations of both parties regarding farm staff
Termination – a minimum of six months notice on either side for arable arrangement
* Provision for resolution of problems
* Provision for either party being declared bankrupt or in receivership
WHAT ARE THE PITFALLS?
“Quite a lot of arrangements are too complicated,” warns Mr Means. “Ideally, CFAs should be kept simple and any changes properly documented as you go along.
“It is not necessary to have an agent permanently managing the agreement but it helps to have a good consultant look at it annually and at least every two or three years to check that it is not having a disastrous effect on capital values, tax or some other legal or financial impact.
“We have seen a few badly set-up agreements, which without proper supervision have changed into something completely different after several years. One very important aspect is Agricultural Property Relief from inheritance tax on the farmhouse. If this is relevant, the farmer must take extra care in how the contracting agreement is set up and operated and how decisions are made and recorded.”
If the farmer is not involved in decision making or not seen to be taking any risk, it may be deemed that the farmhouse is not the base of the business and not used for agricultural purposes. Ideally, the farmhouse should contain the farm office, meetings should be held there, properly recorded, and invoices and other communications for the CFA should be addressed to that office.
“Cross-compliance can become an issue where, for example, the farmer is responsible for ELS work and the contractor for the rest. It must be clear who is doing what.
“The farmer might want to keep his marketing contacts or methods, or husbandry techniques which are not appropriate for the new contractor. If the contractor is on a performance-related arrangement, he should be allowed to carry out his ideas and operations within reason and not be restricted by past custom.”
CASE STUDY
Bawdsey Estate
WOODBRIDGE, SUFFOLK
More than 10 years of using a contract farming agreement has allowed the Bawdsey Estate to first consolidate its farming and then develop more diversified and potentially more financially rewarding cropping.
“This is a diversified estate, owned by the Adeane family since the 1950s, with a lot of residential property and other interests,” says Charles Loyd, one of the estate trustees. “When I got involved in the late 1990s, we needed to stabilise the farming income so we could pick up on the other areas.
“Initially, cereals and sugar beet were grown under the agreement, which broadened to include carrots, parsnips and onions as the relationship with the contractor developed.”
The development of a good working relationship between the parties has also given the family the confidence to invest in drainage, reservoirs, new water mains and irrigation over recent years to improve output.
This investment can also be seen as a vote of confidence in contractor Westrope Farming, which has been at the estate since September 2000. The agreement, which was renewed in 2007, runs for 10 years with a review every three years, giving the contractor the incentive to invest in specialist machinery and to look after the land, says Mr Loyd. “The agreement recognises that both parties need to benefit.”
Farm manager Andy Rankin is a director of the contracting company run by husband and wife team Philip and Carolyn Westrope. The estate is roughly one-third heavy marsh clay with the rest of the land loamy sand.
“Our strength is early vegetable production and late harvesting opportunities on light land. We can get onto the light land at almost all times of year but water is crucial to us,” says Mr Rankin.
“We are a family-owned business, farming is what we do – we’re not trying to diversify into other areas and we have a dedicated and skilled workforce. All the parties are comfortable in thinking long term, but this has not been a given.”
Agreements need to be fair, and if well-constructed will benefit all parties, says Mr Rankin, with honesty and openness as important as good communication.