2017-06-14 

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Balance of Risk Shifts in Contract Farming Agreements

Farm businesses tendering to become a contractor under a Contract Farming Agreement (CFA) are seeking greater certainty about the income they will receive from the venture and are striking deals which shift the balance of risk back towards the farmer.

Richard Means, partner in the farming department of Strutt & Parker, said as CFAs are renewed or renegotiated the trend is for a higher contractor’s charge than has been seen in the past.

wheat bales

“Contractors are looking at ways to improve and protect their position. Five years ago the average contractor’s charge was around £230- £240/ha, but now we are seeing contractors bidding at levels around £275-£300ha for typical contractor services on combinable crop farms in the East of England and the Midlands.

“We’re also seeing a shift in the first tier of divisible surplus to be more in the contractor’s favour. In 2016, the average first split to the contractor was 59%, but the trend on review is for that percentage to move upwards. At low levels of profitability that protects the contractor, but at good levels of profitability for the farm the returns for both parties are not dissimilar.”

The contractor’s charge is the payment per hectare that a contractor receives for providing labour and machinery and the day-to-day management to farm the land under a CFA.

The divisible surplus is the revenue that is divided between the farmer and contractor after variable costs, the contractor’s charge, fixed costs and the farmer’s retention or first charge have been deducted from receipts.

Mr Means said that there is still strong interest in CFAs from contractors, especially for land and farms which are well-provided for in terms of storage, drainage and other facilities and where the farmer is willing to maintain infrastructure.

Entering into a CFA remains a good opportunity for people who want to expand their business without having to buy extra land or enter into a tenancy agreement, which require higher levels of working and long-term capital, he said.

“However, the number of interested contractors is certainly nowhere near what it was when the wheat price was £160/t and contractors were really falling over themselves to take on extra land,” he said.

“People are taking a more rational decision about how they are able to integrate the land within their own business. They are also likely to ask more questions about issues such as the level of blackgrass and what that will cost them to farm the land.”

Mr Means said while farmers were assuming more of the risk, the average return was in many cases significantly better and more stable than the income from farming in-hand, as the farmer benefited from the contractor’s lower labour and machinery costs. The farmer also kept the tax benefits of being a working farmer and had more control over farming practices, compared to a tenancy.

‘It is still a very good model for both the farmer and contactor. In well-structured agreements, both sides should be incentivised by the same outcomes – producing high yields, controlling costs and meeting the farmer’s objectives for sustainable land management.”

Mr Means said uncertainty about the impact of Brexit meant clauses were being inserted into agreements to protect against future changes in level of support.

“In all our agreements there is also a clause stating that you are allowed to review the agreement, even if it is not a review year, so long as both parties agree. I think most people accept that the smart thing is to be flexible and sit down to work out how to get the most from the agreement once there is clarity on the situation.”

Mr Means advises contractors tendering for a new CFA to make sure they are fully costing for the level of service they will be providing and show keen attention to detail.

“Are they taking crops back to their own farm and storing them on behalf of the farmer? Are they doing all the hedge cutting? Is the contractor doing all the field work and agronomy? You have to be very clear and careful about what is provided because the contractor’s charge can vary massively from the average levels depending on the agreed level of service provided.”

His advice for farmers is to be fair and honest about the true performance of the farm and be willing to keep reinvesting if they want to attract the best offers.

“Some farmers are very good at looking at reinvestment back into the farm, for example into drainage and storage, but others aren’t prepared to spend much money. However, if you have poor storage you are either reliant on a contractor with their own or co-operative storage, so you are going to limit your options.”

Strutt & Parker CFA 2016 results

Strutt & Parker’s contract farming results for harvest 2016, based on 51 agreements covering 13,300ha of combinable crops and roots in England, showed that total receipts were £1,157/ha which is a similar level to 2015. While variable costs fell by over £30/ha, mainly due to lower spending on fertiliser, income remained under pressure because of weaker commodity markets and lower yields.

Fixed costs were stable at at £114/ha, resulting in an average net margin, after a contractor’s charge of £270/ha, of £359/ha.

Total returns to the farmer averaged £311/ha, which was £11/ha higher than in 2015, but below the five-year average of £383/ha.

The contractor’s total income averaged £319/ha, which was £4/ha higher than in 2015, but again below the five-year average.

Notes:

A Contract Farming Agreement is a joint venture, between a landowner or tenant (referred to as the farmer) and another farm business (known as the contractor), where the farmer provides the land and buildings and engages the contractor to provide the services to grow the crop.

The contractor provides labour, machinery, management expertise and can provide additional buildings if needed. Any crops grown are the property of the farmer.

Strutt & Parker

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