Prepay perils

FARGO, N.D. -- Should farmers be protected when prepaid inputs are sucked up in the turmoil of an elevator or provider's financial mess?

Tony Clark thinks so. The 11-year veteran of the North Dakota Public Service Commission is thinking about his nomination to the Federal Energy Regulatory Commission, but he's also been focused on how farmers might be better protected when they enter into prepay farm input deals.

These types of deals came to Clark's attention when the Falkirk (N.D.) Farmers Elevator closed its doors April 13, leaving farmers who prepaid for seed and chemicals with no product. Clark says this is the first case of its kind during his tenure in office.

Ironically, his agency's responsibility is to protect grain contracts, which is sometimes at cross-purposes with elevator clients who have bought seed, fertilizer or chemical in advance.

In the Falkirk elevator case, the PSC first got calls and sent inspectors to "get a better sense and handle on what the situation was," Clark says. Although the agency only has jurisdiction over grain sales in such matters, all of the client calls were about blocked prepaid seed, fertilizer and chemical deals -- "the doors being closed, producers not being able to get their material," he says.

The PSC always has authority to go into any grain licensee at any time to look at the books, and measure bins for inventory, he says, even though initially there were no complaints about the grain deals, per se. "What they found was an elevator that's in a stressed situation financially," he says. "It's not an insolvency, technically."

PSC investigators typically are concerned about whether grain assets are being cleaned out and converted to cash, Clark says. The concern is whether cash assets are staying for the benefit of the producer or whether they're going to pay someone else off. "That's always our biggest concern," Clark says

The next day, the PSC met with the elevator board and its attorney. "We received some assurances, at least, that now they understood that was our concern and that there may be ways to protect some of their grain assets," he says.

When matters aren't in order, the PSC can initiate an insolvency only on the grain side, he says. This happens when a producer makes a claim with the agency because they didn't get paid or weren't able to get "redelivery" of grain that they delivered. One of those claims against Falkirk came in on April 30 and PSC officials were studying it on May 3.

Protecting the grain

Ironically, the PSC's aggressive pursuit of assets to pay grain customers in effect pits the agency against other farmers who have prepaid claims, Clark acknowledges.

"Unfortunately, it looks like prepaids are just another unsecured creditor," and, in a sense, in line behind the grain patrons in an insolvency, Clark says. Accounts receivable, grain assets and the bond are the sources of income. Effectively, people who have entered prepay agreements have simply loaned money to the company.

Clark says he's thought a lot about how prepay input clients could be better protected under state laws, but there appears to be no "silver bullet."

"It's like lots of business transactions -- not just agriculture -- if you're in a prepaid situation, you may be unsecured," Clark says. "The problem in the ag community is it's just how everybody does business. And it's huge dollars involved. Sometimes it's just done with a handshake. For the most part it works out, but sometimes it doesn't."

On the grain side, state statutes are set up to give farmers a priority over other creditors. Grain assets are preserved in a trust that doesn't go to the bank or others who are owed money.

One possible fix is to change the state law to give lien priority to the prepay contracts, Clark says. "Of course you're probably going to get a big push-back from other creditors of elevators. I might argue that some of the others might have a little better ability to absorb some of the costs than farmers do," Clark says.

Another possibility is to initiate a new bonding requirement. "The problem with bonds -- and you run into this on the grain side -- is if you set the bond requirements to really cover all of your outstanding liabilities, either bond companies might not write bonds that large, at least at the price you can afford, or they won't write it because often times they're finding on grain that you have to have net assets equal to the face value of the bond," Clark says. "For a lot of elevators, if they've done any upgrading it can be tough to have that size of a net worth."

Still another option is starting some sort of self-insurance for prepay transactions, Clark says. This might be similar to a state fund on credit-sale contracts. "There's a small price you pay for each transaction, I suppose, but it would be a much different paradigm than in the past," Clark says. Only the agriculture community could decide whether that would work. For prepaid farm inputs, this is complicated, because of the vast array of companies involved in the business. "It's not like a physical grain elevator," he says. "It's a business some elevators happen to be in, but it's not exclusive to that world.

"It would seem to me that if we're going to have an indemnity fund that we would take a good hard look at having an indemnity fund for all grain sales -- not segregating into the separate batches. For cash sales, we've got a bond plus some assets and receivables. On the credit sales we have the indemnity fund.

"I think it would make a lot more sense, it would be lot cleaner in a sense, and offer more protection for farmers, to just have an indemnity fund, period, for all sales: credit sale, cash or warehouse receipt," Clark says, and then added, that the funds could be separate but similar.

Bonding made more sense when you could base the size of the bond on the capacity of the elevator, Clark says. "Commodity prices were a lot lower. Now, capacity of the elevator has nothing to do with outstanding liabilities. Processors go through a huge volume of grain."

Clark says due diligence is important, but doesn't guarantee success in dealing with elevators.

Step one in due diligence is for farmers to make sure they're dealing with a licensed, bonded facility, but that doesn't always offer protection. "Make sure you know who you're doing business with," he says. "If someone is offering a higher price than others in the region, make sure you check into it because there may be a reason for it."

Clark wonders whether the presence of a credit sale indemnity fund would change the way farmers do business.

"Now, people, in a lot of cases, would rather be on credit sale contracts rather than cash," Clark says. "If you can get kicked into the credit sale contract, you have at least 80 percent, or $280,000" in protection. Clark says if PSC inspectors see unconverted scale tickets on cash sales, and if they've drifted to 30 days or more, then it's a credit sale. They then tell the elevator they must pay, redeliver the grain or get it converted to a credit sale contract. Technically, it's the producer's choice, Clark says.

Besides the Falkirk elevator situation, the PSC is separately involved in a case where farmers did not receive payment for seed they delivered to Anderson Seed Co. of Mentor, Minn. The PSC was named trustee for the company's bond, effective April 16. Farmers with credit sales contracts will likely have better protection than the cash contracts in North Dakota. The company had receiving stations at Selz and Durbin in the state, and larger locations in Minnesota and South Dakota.

"That (credit sales indemnity) fund will probably pay you 80 percent, up to $280,000, where if you're just on a cash side, never did get paid, never was a credit sale contract, doesn't look as favorable right now," Clark says.

How to get protection

Clark says PSC staff has estimated that perhaps 60 percent of the grain now sold to elevators is on credit-sales contracts. He says farmers use the contracts for other reasons but it wouldn't surprise him if it were in the "back of farmers' minds" to make them price-later contracts in order to get the indemnity fund protection.

He notes that farmers also might protect themselves by delivering to "a number of elevators on deferred contracts" to stay under the 80 percent maximum, up to $280,000. "What you might want to do if you have a really big sale is to deliver to a couple of licensees, so you have better coverage," Clark says. However, the locations shouldn't be related facilities operating under a single license.

"It's like with the Federal Deposit Insurance Corp., you're only covered up to $100,000, so you put (funds) in a couple of banks."

Sue Richter, director of the PSC's licensing division, says farmers may choose to defer payment into a different license year for an elevator.

On a cash sale contract, state law requires that a sale ticket be "converted" in 45 days, Richter says. When a farmer enters into a contract that provides for payment in more than 30 days, then the contract should contain all of the elements that are required to be on a credit sale contract," she says. If an elevator hasn't paid on a cash contract within 30 days, the farmer can ask for a credit-sale contract.

If farmers want protection guaranteed under the indemnity fund, they can ask for a price-later or deferred-payment contract, or some credit sale contract, Richter says.