Few farmers want to relinquish any control over their business, but more may find their bankers claiming some authority in their hedge account in the future.
"I see the handwriting on the wall,” says Jim Bower, a commodity broker and marketing adviser in Lafayette, Ind. "In the aftermath of the financial crisis, banks are going to require full transparency from their clients. Given the importance of good marketing and the extreme market volatility, more will require third-party agreements.”
In a nutshell, these agreements mean that the bank has a security interest in the account and receives notice of all trade orders and copies of brokerage statements. It also may have the power to stop the farmer from making trades, be able to withdraw money from the account, or even close the account.
"By bringing the bank into the agreement, it makes the relationship more cooperative and more professional,” Bower says. "There has to be more accountability and transparency.”
As a broker, Bower believes such agreements will be beneficial to all parties, and he is in the process of finalizing the legal wording for such a contract for his clients. —Linda H. Smith
Hedge Account Control Agreements
Given the opportunity, bankers will always ask for more collateral from farm borrowers, not less. In addition to crops, land, equipment, farm program payments and crop insurance proceeds, bankers may also seek a security interest in a producer's hedging account.
Article 9 of the Uniform Commercial Code (UCC) permits a lender to perfect a security interest in "investment property” by use of a "control agreement.” The UCC definition of investment property includes commodity contracts.
The control agreement is in addition to the bank's normal security agreement and must be signed by the producer, the bank and the producer's commodity broker. A control agreement typically includes the following provisions:
• a security interest in all funds that may accumulate in or that can be withdrawn from the hedging account;
• a security interest in all commodities futures contracts the broker transacts for the producer and the proceeds thereof;
• the security interest is subject to the prior payment to the broker of all costs incurred by the producer as the result of the commodity contract transactions, including the broker's fees and commissions;
• the bank is permitted to withdraw funds from the account on demand and the producer cannot withdraw funds without the bank's permission;
• the bank, without the producer's consent, can direct the broker to liquidate open positions in the account;
• the bank can advance margin calls to the broker on behalf of the producer;
• the producer is permitted to continue to make hedging transactions unless the bank notifies him to stop doing so.
The control agreement perfects the bank's security interest in the account without the necessity of filing a financing statement. Once so perfected, the security interest has priority over other secured creditors who do not have "control” of the account.
Obviously, a bank that exercises its rights under a control agreement must do so with care. Prematurely liquidating contracts and applying hedging account funds to a producer's loans may undermine risk-management strategies that were designed and implemented to help the producer maximize his returns in the face of market volatility. This may hurt the bank as well as the producer.
If you are asked to sign a control agreement, it's a good idea to request the bank set up a separate line of credit for the money necessary to fund the hedging account. This will let you delineate the loan funds targeted for growing crops from those deployed for marketing, while impressing upon the bank the risk-management objectives to be served by the hedging account. —Allen H. Olson, agricultural lawyer with Moore, Clarke, DuVall & Rodgers, P.C., in Albany, Ga.
To contact Linda Smith, e-mail LSmith@farmjournal.com.
Top Producer, October 2008