Commercial Transactions – An Overview

Background

Commercial transactions are an integral component of the agricultural production system.  Producers’ purchase of inputs, sale of cattle at auction, leasing of land, custom harvesting arrangements, sale of farm equipment, and contract for aerial application of pesticides are a few examples.  These transactions are primarily governed by state law, though federal law may apply in some situations as well, often having unique provisions applicable to agriculture. Agricultural transactions cover many areas of commercial law including the sale of goods, leasing, contract law, secured transactions, and commodity futures trading.

The primary law governing commercial transactions, including those that occur in an agricultural context, is the Uniform Commercial Code (UCC).  The UCC is a model law that has been adopted in varying forms by most states.  UCC provisions tend to be uniform among the states, though different provisions and interpretations exist among the various jurisdictions. The UCC governs the majority of commercial transactions.

This overview focuses primarily on agricultural commercial transactions relating to the sale and leasing of goods associated with agriculture.  For a discussion of the related area of production contracts, please visit the Production Contracts Reading Room.


Uniform Commercial Code – Article 2

The UCC is comprised of eleven Articles.  Article 2 is the most applicable to commercial transactions in the agriculture context.  Article 2 of the UCC governs the sale of “goods,” which is defined as all things that are movable at the time of identification to a contract for sale.  “Goods” includes specially manufactured goods, the unborn young of animals, and growing crops.

The sale of goods is often carried out through contracts, either written or oral. Contracts are agreements between parties that define the duties and obligations of each party regarding a particular transaction. Contract law is individual to each state and can vary across jurisdictions. However, for states that have adopted the UCC essentially unchanged, laws regarding the sale of goods are very similar. Typically, a contract requires that the parties must intend to create a legally enforceable agreement, the parties must be legally able to enter into a contract, the subject of the contract must be permissible, consideration for the obligations must exist, and there must be mutuality of agreement and obligation. The UCC provides some explicit rules regarding contracts.

Article 2 applies only to the sale of goods, and any contract for an amount greater than $500.00 must be written, but many terms, with the exception of quantity, are not required to be included if they are implied. In order to be enforced against a party, that party must have signed the contract. An exception exists for parties that are merchants, in which case a memorandum confirming the oral contract may be sent and, if no objections are raised, a valid contract is formed.

The merchant status of farmers is important in an agricultural context because merchant status removes some statutory protections. Merchants are defined as people that deal in goods of the kind being sold or people that express knowledge or skill in the buying or selling of such goods. Jurisdictions vary widely on whether farmers are merchants, and the decision is often based on factors such as the length of time a farmer has marketed products, the business skill of the farmer, the farmer’s awareness of marketing opportunities and the farm operation, and past experience in marketing products.

The UCC can act as a gap filler for contracts. If terms are missing, it provides defaults. If the price is missing from a contract, the buyer may be required to pay a reasonable price under the circumstances. If a delivery time is omitted, a reasonable one is assumed. However, if a contract with vague delivery terms concerns agricultural commodities, care must be taken to comply with Commodity Futures Trading Commission (CFTC) regulations.

The UCC also creates implied warranties as to the sale of goods. Merchants are deemed to sell goods that are merchantable. Merchantable goods must fit the ordinary purpose for their use, and they must be of reasonable average quality. If a seller knows of a buyer’s purpose for the goods and the buyer relies on the seller’s expertise, then the implied warranty of fitness for a particular purpose may arise. If a contract is breached, the UCC provides remedies.


Uniform Commercial Code – Article 2A

Leases of goods are governed by Article 2A of the UCC.  Article 2A operates in a similar fashion to Article 2 and involves many of the same issues. It provides the general rules for the creation of lease agreements and provides remedies for breach of leases, with special rules applicable to parties that are merchants. Article 2A is important in agriculture because many items necessary for agricultural production are leased.


Uniform Commercial Code – Article 9

Article 9 of the UCC governs secured transactions. Secured transactions are an integral part of production agriculture because large amounts of credit are often needed, and lenders often provide agricultural producers credit that is secured by collateral such as crops or livestock. For a complete discussion of Article 9, please visit the Secured Transactions Reading Room. Additional information pertaining to other credit issues regarding real property and operating loans is provided in the Finance and Credit Reading Room.


Commodity Futures

Many commercial agricultural transactions take place in the “cash market,” where commodities are exchanged for cash with delivery scheduled for the near future. For example, a farmer that delivers a load of grain to an elevator and is paid at the time of delivery based on the amount delivered and the price the elevator is willing to pay is participating in a cash market transaction. One variation of the cash market involves cash forward contracts.

Under cash forward contracts, producers agree to deliver a specified amount of a commodity in the future at a price determined at the time the contract is executed. These contracts allow farmers to take advantage of cyclical commodity prices that typically fall during harvest when crops are marketed and rise throughout the rest of the year. Farmers bear the risk that prices will climb during harvest or that they will be unable to deliver the required amount of the commodity. These contracts require actual delivery of the commodity, though some contracts called, hedge-to-arrive contracts, may permit the roll-over of the delivery date.

Other agricultural commercial transactions involve the commodity futures market, which is a marketing tool that operates similarly to cash forward contracts, but where delivery of the commodity is not usually expected. Commodity futures contracts are contracts for the sale of a commodity at a specified price and delivery at a future date, but delivery is typically not made because the contracts are liquidated before maturity. The futures are bought and sold by traders only on exchanges carefully regulated by the CFTC, as authorized by the Commodity Exchange Act, 7 U.S.C. §§ 1-27f.

Futures are used by agricultural firms that deal in commodities to hedge against price fluctuations. The cash market and the futures market tend to move parallel to each other because they respond to the same information about the supply and demand of the commodities. This parallel movement of the two markets allows hedging to take place. For example, a cotton farmer that takes his crop to market in the fall when prices are low might enter into a short position, the seller of a commodity futures contract, in the futures market for cotton. As harvest approaches commodity prices normally fall and any loss on the actual sale of the cotton is offset by gains made from the liquidation – closing out of a short or long position in the futures market – of the farmer’s short position by purchasing futures contracts. The same hedging technique can be used by processors, handlers, producers, or any other party that handles the actual commodity to offset the risk of price fluctuations.

This hedging technique does not allow the party to capture favorable price gains; it only allows the reduction of risk associated with unfavorable price movements. In order to capture favorable gains, the futures markets have option contracts that give parties the right but not the obligation to enter into futures contracts for a specified price during a particular period of time. These options are purchased with a price that reflects the cost of protecting against price fluctuation risks, which allows price risk protection and the ability to capture favorable price moves.


Farmer Cooperatives

Many agricultural commercial transactions are conducted by farmer cooperatives. Transactions involving cooperatives can be affected by unique rules that must be considered.  For information pertaining to cooperatives, please visit the Cooperatives Reading Room.


Direct Marketing

In an effort to increase their profitability, some farmers pursue direct marketing as a means to distribute their product. Methods of direct marketing vary widely and may be as simple as roadside stands and local farmer’s markets or as complex as branded and packaged commodities sold through the mail or to specific customers. These types of commercial transactions are regulated primarily by state and local laws, though federal laws may apply in some situations.


Additional Considerations

The Packers and Stockyards Act and the Perishable Agricultural Commodities Act are relevant to certain commercial transactions arising in the agricultural context.  These statutes offer protection, subject to certain conditions, to agricultural sellers of livestock or perishable agricultural commodities, fresh fruits or vegetables. These laws protect sellers of covered commodities with statutory trusts that allow the recovery of their proceeds from the nonpaying buyer’s assets. Sellers of covered commodities are also protected from processors’ potential unfair business practices. For a complete discussion of these laws, please visit the Packers and Stockyards Reading Room and the Perishable Agricultural Commodities Act Reading Room.