When a Family-Owned Elevator Goes Belly Up: The Risk in Deferred Payments
In the last of this four-part series, industry experts talk about why delaying grain payments is not a sound marketing strategy and how farmers can protect their paycheck.
The majority of farmers do it. They delay getting paid for their grain to avoid paying taxes. But this marketing strategy backfired on Minnesota farmers when a privately owned elevator filed for Chapter 7. It left nearly 90 farmers who had delayed grain payments wondering how – or if – they’d get paid.
“The farmers who did business with the Porter Elevator found out they had little or no recourse and were last on the list as far as creditors to get paid,” says Al Kluis, a grain commodity trader and market analyst.
The bankruptcy petition estimated that when all assets were liquidated and administrative expenses paid, there would be no funds left to pay the more than $500,000 believed to have been deferred.
While the affected farmers could make a claim against a $125,000 state bond, it wouldn’t even come close to covering what had been deferred. These individuals weren’t the only ones who could make a claim against that money. The farmers who’d received a bad check for grain sold to the elevator in the days leading up to its closure could also apply for those funds. Those totals, too, were well beyond what the bond could cover.
When all was said and done, farmers who made a claim against the bond received about 10% of what they were owed.
“I’ve always told farmers you defer grain at your own risk,” says Kevin Stroup, an attorney with Stoneberg, Giles and Stroup. “They do it to avoid paying taxes, but they’re taking the risk of nonpayment. Farmers are an unsecured creditor and are counting on an elevator having the money in six months when they try to collect that deferred payment. How do you know the money is going to be there? In the case of the Porter Elevator, farmers didn’t know the true financial condition of that privately owned elevator.”
A delayed price contract, also known as a deferred price contract, allows you to move grain without establishing any price. With this type of contract, the title to the grain passes to the buyer once it is delivered.
“If a farmer sold his grain and deferred the payment, that grain now belongs to the elevator. In this instance, the farmer is seen as an unsecured creditor,” Stroup says.
Normally, when you sell cash grain, you are establishing a futures price and a basis price. “Let’s take corn as an example,” says Kluis. “May corn is trading at $3.60. The basis into southern Minnesota and northern Iowa is about 40¢ under that. Cash price is $3.20.”
Each of those transactions, he says, can be done separately. “You can say you want to hedge the May futures at $3.60 and hope that the basis improves,” he explains. “If you hedge at $3.60 and the basis improves to 25¢ under, then all of a sudden you have the higher price.”
You can also lock in the basis first and say you want to go 40¢ under what May corn is trading at. “If the price rallies up to $3.90, you have $3.50 corn,” Kluis says. “When you put it under a delayed pricing agreement, you have not locked in either side.”
Typically, he adds, a farmer has to have the deferred grain priced by August 31 or September 30, or the elevator prices it out for you. “Unfortunately, a lot of farmers put grain under a DP contract and don’t do anything until the last possible day,” says Kluis. “Then they end up selling quite often right at the low.”
He adds that when it comes to marketing grain, to not make a decision is a bad decision. “You’re not managing your risk,” he says. “You’re just sticking your head in the sand.”
If there wasn’t delayed pricing and an elevator really needed to buy a farmer’s grain, it would have to improve the basis or do something to entice you to sell. “But once the farmer, in essence, gives his grain to the elevator, it can fill the train or keep the feed mill going,” he says. “It has no incentive or reason to bid up anything.”
Kluis offers these tips when marketing your grain.
- Take advantage of a futures contract or call option. “If you don’t like the market price, sell it and buy back with a futures contract or a call out,” he says.
- Spread your assets. “Make sure that when you deal with an elevator, you deal with two or three rather than just one,” says Kluis. “What was devastating about the Porter Elevator bankruptcy was that some farmers had 100% of their grain there.”
- Watch your position. “Try not to get into a position where your grain is not hedged or sold and then you put it under a DP contract hoping that things will improve. Hope is not a marketing plan,” he says.
Bad for the Farmer, Bad for the Industry
Not only does Kluis believe DP contracts are bad for farmers because they’re not making a good risk management decision, it’s also bad for the industry. “If enough farmers put enough grain on DP, it really trashes the basis,” he says. “And then if you are dealing with an elevator that turns out to go under, you’re screwed.”
“In this day and age, where there is so much capital involved in farming, a farmer can’t suffer a catastrophe like the one we saw at the Porter Elevator very easily,” says Stroup. “If you’re going to take a big financial risk with someone, you’d better know they can cover their position.”
Protecting Your Paycheck
To reduce a farmer’s risk, companies like CHS Insurance offer deferred grain payment bond programs. Scott Chapman, the director of surety at CHS Surety, offers insight into their programs designed specifically for farmers who contract with an elevator or cooperative.
SF: How long has CHS been offering this type of program?
SC: CHS has had a surety program in place for more than 30 years. We began offering bonds during the mid-1980s farm crisis, when growers needed additional financial protection. Originally, the bond program provided blanket coverage – securing every deferred contract regardless of size. Today, the bond program is much more flexible, giving growers the ability to choose which contracts to secure and which ones they are willing to risk. Growers also now have the ability to combine contracts so that several, smaller contracts can be secured by a single bond.
SF: Why offer this type of program?
SC: A surety bond guarantees the grower payment if a cooperative or elevator becomes financially insolvent. In today’s economic environment of shrinking margins and compressed cash flows, surety bonds also provide farmers additional borrowing leverage. Lenders not only consider the grower’s assets, but include those of the cooperative or elevator in their financial assessment as well when deferred payments are guaranteed with a bond.
SF: Can you explain how the program works?
SC: CHS works with cooperatives and elevators to ensure they are financially stable before authorizing them to offer surety bonds. An authorized co-op can typically bond a deferred payment contract the same day. If a grower does business with a cooperative that isn’t already bond approved, they can contact CHS directly to get the process started. Typical turnaround time in that case is two to three days.
There is also an advanced payment bond program that allows growers to prepay for inputs, which protects growers who pay in advance for inputs prior to delivery.
SF: How many farmers have taken advantage of the bond program you offer?
SC: The surety bond business has been steady since the program’s inception, and we expect to see growth as the ag economy continues to constrict.
SF: Why should a farmer consider a bond program?
SC: There are several reasons farmers opt for bond coverage. First, when deferring a large portion of their grain, farmers can take advantage of surety bonds to protect their assets. Second, when cash flows are tight and producers are looking to borrow against the value of the deferred grain, lenders look more favorably at their balance sheet because that payout is guaranteed. Finally, surety bonds provide peace of mind through added protection against unforeseen events, such as bankruptcy.
SF: What is the cost to the farmer for this program?
SC: A 12-month premium for a deferred payment contract averages around 1% of the market value of the grains at point-of-sale, due when the contract is written. To bond a $100,000 deferred payment contract for one year, a grower would pay a $1,000 premium. Bonds secured longer than 12 months typically incur an additional premium and are valued at the guarantor’s discretion.
HOW WE REPORTED THE STORY
Laurie Bedord, Advanced Technology Editor, first learned about the Porter Elevator bankruptcy in February 2016. At the time, farmers were hesitant to talk because the investigation was ongoing and it was still a very sensitive subject in the community. Nine months later, she began contacting farmers who did business with the elevator, a vendor hired by the elevator, two attorneys who offered legal advice to some of the parties affected, as well as a representative from the Minnesota Department of Agriculture and USDA officials involved in the case.
Bedord also interviewed a Minnesota state representative working to change the legislation affecting elevator insolvencies. In addition, she spoke with the North Dakota Public Service Commission to compare the legislation it has in place with Minnesota to protect farmers in an elevator bankruptcy situation.
Hundreds of pages of court documents provided detailed information on the financial situation of the family-owned elevator as well as the names of the numerous farmers, suppliers, and vendors affected by the bankruptcy.
Attempts to reach the president of the Porter Elevator for comment were unsuccessful.