Avoid Hemp Litigation with a Real Agricultural Production Contract

07 May Avoid Hemp Litigation with a Real Agricultural Production Contract

As everyone knows by now the 2018 Farm Bill legalized hemp production by de-scheduling the crop under the Controlled Substance Act.  We’ve written extensively about federal hemp rules and regulations as well as those in California, Oregon and Washington. We’ve also addressed hemp in terms of  USDA Organic Certification, international trade issues, and the FDA stance on hemp derived CBD in cosmetics. We’ve also offered a free webinar on West Coast Hemp CBD. We’re on it.

In light of the breaking news that California has opened up for commercial hemp cultivation and that the Oregon growing season had just begun, this post concerns the more granular topic of agricultural production contracts – i.e. the contracts at the start of the supply chain between farmers and consumers.

What is an Agricultural Production Contract (“APC”)?

Broadly speaking an APC is an agreement between producers and contractors for a specific agricultural commodity. These contracts typically specify the production practices to be used, identify the party responsible for supplying the required resources for production, and specify the quantity, quality, and method of payment for the commodity. APCs are used by farmers, ranchers, and agribusinesses to manage risk and control expenditures. Payment is typically predetermined and outlined in the contract.

An APC is one of several ways in which the marketplace handles the purchase and sale of agricultural commodities. Others include cash forward contracts, which concern the sale of a fixed amount of the commodity at a set price for future delivery; marketing agreements, in which a member of a cooperative agrees to sell some or all of a commodity produced through the organization, and futures contracts, in which the sale and purchase of a standardized quantify of a commodity is negotiated for future delivery on a regulated commodity exchange. An APC by contrast means the sale or production of a specified commodity or commodities by the grower to an identified party under an agreement signed in advance.

The APC contract model has associated benefits and risks. An APC may help agricultural companies (i) control quality by providing for control over the production methods, (ii) manage supply, and (iii) protect a company’s intellectual property and control the unauthorized reproduction or sale of a crop. An APC may benefit the grower by (i) reducing financial risk by making the contractor responsible for the costs of production, (ii) providing access to capital financing, and (iii) permitting access to new technology or markets.

An agricultural production contract is a complex creature typically governed by state law including the Uniform Commercial Code. Legislators in several states have proposed, and in some cases enacted, laws concerning the terms of agricultural production contracts. In 1990, Minnesota became the first state to enact such laws. Other states, including California, Oregon, Washington, have enacted various statutes that relate to payments, liens, bailments, and duration of the contract.

Why Should I Care?

Because money. (As people say nowadays). The scope and scale of commercial hemp production is likely to dwarf the sort of farming operations that one sees in the recreational cannabis industry. So the dollar values and the corresponding risks are much higher for everyone involved.

Take, for example, a lawsuit filed not long ago in Oregon in which the plaintiff seeks to recover some $57 million from the defendants over an alleged breach of an agricultural production contract (a “Sharecrop Agreement” as defined the complaint). Under the agreement, the defendant agreed to plant, grow, dry, and harvest 13 acres of hemp at 1,450 plans for acre, for a total of 19,000 plants. The plaintiff agreed to pay all actual costs associated with the crop, which plaintiff would then sell, be reimbursed for expenses, with the remaining balance sold a particular price per pound divvied up between the plaintiff and the defendant. At the outset of the deal this may have looked good from the defendant’s perspective – since plaintiff was covering production costs and responsible for marketing and selling the crop. The defendant, however, promised that it would use “best farm practices” and promised to deliver a “top quality product with a minimum of 10% on average CBD oil content as determined by a random test collected by Farmer and Buyer.”  But then things went south, according to the plaintiff, when the defendant refused to hand pick the crop (is this what “best farm practices” means?) and failed to meet the 10% on average CBD oil content, and only allowed the plaintiff to pick up half of the 217,227 lbs of crop. The plaintiff claims that the first two allegations reduced the value of the crop and the last amounted to theft that altogether caused tens of millions in damages.

What Should I Do?

Hemp farmers and purchaser of industrial hemp should carefully consider the special issues that industrial hemp presents before entering into contract for hemp production. Here are some of the factors parties to an industrial hemp production contract should consider before signing on the dotted line:

• Do state laws restrict or regulate the terms of agricultural production contracts?
• What are the contractual and regulatory consequences for the farmer and buyer who do not quite follow the letter of the law governing agricultural production contracts?
• What happens if the state licensing authority revokes the growers ability to sell, store, or transfer hemp?
• What happens if the hemp does not satisfy pre-harvest THC testing?
• What happens if the hemp does not satisfy post-harvest THC testing?
• When will the testing for CBD or other components of hemp occur?
• How is the hemp chain-of-custody maintained and documented, who is responsible for this, what are the repercussions if something goes awry?
• What happens if the hemp is seized during transport?
• Who bears the risk of the USDA deciding not to approve the state’s hemp production plan?
• Are there / should there be limitations on change of ownership during the duration of the contract?
• Who bears the risk of complying with state record keeping requirements?
• Who is responsible for testing of hemp for human consumption or hemp items for other industries and to what standards?
• What happens if the state allows commercial cultivation before or without submitting a plan to the USDA?

As with anything cannabis related (hemp or marijuana), your generic form agreements are not going to fit the bill here. In fact, such agreements often do more harm than good. This means that the next step is integrating the above considerations into your APC along with other particulars using language the courts will enforce – should that be necessary.