Price protection seems like a good idea. So, you forward contract your
corn to an ethanol plant. How did you get into a bankruptcy proceeding
in Delaware? What do you mean you have to deliver at the new market price,
and lose the benefit of your forward contract?
Price protection seems like a good idea. Your cattle on feed eat corn.
You hedge both. But the market goes the wrong way on the grain. Live cattle
prices fall dramatically. And the banker is uncomfortable. What do you
do about the market calls to maintain your hedge?
Change came to American politics on January 20, 2009. Several months before
then, during 2008, change was inaugurated at the marketplace in America
and across the world. Looking back, did the global economy hold its breath
to complete the Olympic games and then collapse at the finish line with
the sprinters and the marathoners? Thousands of American producers of
food and fiber face calamitous losses. Their mistakes: They hedged, forward
contracted, and locked in certainty, only to find uncertainty confronting them.
What happened is less important than what can be done. The former question
is for an economist’s historical study. The latter, looking to the
future, is a producer’s question. And a lawyer’s.
An Example – Hedge To Arrive Contracts.
“Hedge to arrive” (“HTA”) contracts provide a
superb example about risks involved in marketing agricultural products.
HTA contracts are sold because they induce the producer to believe a crop
can be placed with a buyer, at a target price, with a reserved right to
“roll” the sale price and delivery date forward into the future.
The roll places delivery beyond the original date, at a newly established
price for a nominal fee. Often, HTAs are sold without a limitation on
the number of rolls, and without conventional margin call adjustments
for market changes or risks.
HTA contracts are dangerous. So often, they induce producers to believe
there is no real risk because rolls can continue perpetually, preventing
loss, and permitting enduring, unending patience with confidence the market
eventually will change.
This approach essentially teaches the unwary producer to believe that his
contract is perpetual. If he doesn’t like the delivery price at
the scheduled time, he simply rolls it forward.
But, contracts are legal instruments, and legal instruments cannot operate
to perpetuity. As a general proposition, the law abhors perpetuities and
strikes them out of contracts. The law also zealously protects priority
lien rights, and abandons unsecured creditors to the lowest class of claimants
when financial disaster strikes.
HTA contracts are largely takeoffs on market conditions that exist, and
are available, generally. A forward contract requiring performance of
payment cannot be rolled so simply, but it can be replaced with a new
marketing instrument offsetting the old, and advancing the interests of
the investor forward. Eventually, even this strategy must end, and perpetuity
These steps do not protect the seller. The elevator, as purchaser, protects
itself with its offsetting Board of Trade position. If cattle or swine
are involved, packers do the same thing with offsetting Board positions.
But the producer misses a step. As the seller, the producer’s position
is naked; performance is dependent on the general financial ability and
goodwill of the elevator, grain company, packer, or other purchaser of products.
So, why not require that the purchaser in a forward contract, hedge to
arrive contract, or other future pricing vehicle, pledge the purchaser’s
offsetting position on the Board to the producer-vendor to assure payment?
In other words, the producer would sell, and lock in a price with collateral
in the form of the buyer’s offsetting sale contract as collateral
for the sale position and eventual payment. This would add virtually no
cost to the buyer’s circumstances, assure payment, and provide little
or no adverse impact on credit circumstances.
Using the HTA example and the three factors that contracts should contain
as specified above, simple safety would add a fourth component to the
The purchaser in the hedge setting would be required to pledge its offsetting
position to the contract seller as collateral, execute a specific collateral
agreement creating a first priority lien, and the producer would perfect
the security interest in the offsetting position. The purchaser would
be required to make margin calls, keep the producer notified that they
are met and inform, and otherwise comply, with the purchaser’s hedge
or sale transaction.
As a result, the purchaser’s circumstances would remain hedged, and
the producer’s transaction would be protected.