Brazil's Best Counsel 2023: Chapter Opening: Agribusiness

Fernando Bilotti Ferreira and Vivian Castellan Bernardino, partners at Santos Neto Advogados, analyses the Future Contracts in the Brazilian agribusiness sector.

Posted mardi, mai 9 2023
Brazil's Best Counsel 2023: Chapter Opening: Agribusiness

The importance of future purchase contracts of commodities for the agribusiness production chain

In the agribusiness sector, buying and selling agricultural products is marked by strong risks. The sources of such risk are multiple: natural causes (climate, pests, natural disasters); price fluctuations in the international market (demand and supply shocks by producers and/or buyers); the terrible Brazilian infrastructure (highways, strikes by truck drivers, logistical problems in the ports); etc. In order for this economic activity – which for some years has been the great engine of the Brazilian economy, and also the great driver of national productivity – to become possible, it was essential to develop mechanisms to share the risks among the various agents of this system.

Price variation is inherent to agribusiness. For this very reason, the market has self-regulated to create future purchase contracts of commodities (“Future Contracts”) with fixed price as a hedge mechanism that ensures the margins of both sides, sellers and buyers. Predetermined price grants predictability to producers and trading companies and ensures their respective margins regardless of a possible fluctuation of the commodity price, upwards or downwards, at the time of delivery. The Future Contracts also allows trading companies to organize, in advance, the logistics to transport and export the production. 

Considering how the market is currently structured, with the regular use of Future Contracts, both rural producers and trading companies are protected from the price variations verified in the agribusiness sector. By fixing the price of the product, both the seller (rural producer) and the buyer (trading) know exactly how much they will receive or pay for the product and can plan their entire cash flow based on these obligations, without having to worry about the fluctuation of the product in the market.

The performance of Future Contracts was one of the main subjects of agribusiness discussed by Brazilian courts in 2021 and 2022

The performance of Future Contracts was one of the main subjects of agribusiness discussed by Brazilian courts in 2021 and 2022. The surge of the dollar and the increased demand made the spot market more attractive to producers when compared to the contracts that had already been settled with tradings and cooperatives for a fixed price.

As occurred around 20 years ago, the courts have been confirming that these factors – surge of dollar, rise in prices and margin reduction – do not justify the revision or breach of Future Contracts by producers.

In future contracts with fixed price, there is no loss to any of the parties, since the fixed price ensures the margins from side to side. What may occur depending on the variation of the product price is something like the loss of an opportunity to have a higher profit, in case the transaction was made at the time of delivery (spot market) . 

For both sides, there is the alternative of operating only in the spot market and therefore taking all the risks associated with supply-demand and price variation. It may occur that the producer does not find enough demand to sell the production at the time of harvest or that the market price at that time is lower than expected. It may also occur that the trading does not find sufficient supply or that the market price at that time is higher than expected.

For the very reason of ensuring the projected margins by and for each of the parties, Future Contracts contain certain provisions addressing punitive penalties in case of breach as well as indemnification equivalent to the difference between the fixed price and the price of the market at the time of delivery. Such contractual provisions, known as washout, prevent that one party breaches the agreed terms in view of the opportunity to earn more, since such breach causes considerable losses to the counterparty and the whole chain . 

The courts have been confirming the validity and enforceability of the washout clauses and condemning the producers that are not complying with the Future Contracts to indemnify the trading companies for the difference between the fixed price of the commodity and its price on the market at the time of delivery .

This type of contract is so powerful that not even challenging weather conditions can authorize the breach. Climate changes are also inherent to the agribusiness and such changes are not considered to be unpredictable by Brazilian courts. In fact, technology provides agribusiness players with not only a certain level of predictability of weather conditions but also with preventive tools capable of avoiding or reducing production breakage.

Crop breakage is a known risk of the agricultural production. Generally, the market itself manages extreme situations and finds negotiated solutions which enable the maintenance of the commercial relationship among all participants. These solutions may include, for instance, the possibility of the producer delivering a future crop or other products.

The market players are well aware of the agribusiness characteristics, their area of practice and the products they commercialize. Institutional acts, either by governments or courts, have been directed to reinforce such self-regulation and ensure autonomy and freedom for the participants. 

Santos Neto Advogados is proud to lead important discussions about future purchase contracts of commodities with fixed price before Brazilian courts.  

Brazilian agribusiness is on the way to become more professionalized and to be even more attractive to investments. Volatilities represent risk, to which investors are averse. Mechanisms capable of bringing certainty and predictability to the market, such as future purchase contracts with fixed price, are then welcome and must be encouraged.

Santos Neto Advogados continues to boost the agribusiness and to contribute to this important sector of the Brazilian economy.