Published: October 07, 2008 01:41 pm            

Farm Programs: Important to know structure of flexible lease agreements

Originally published in the Oct. 3, 2008, print edition.

The rapid rise in corn and soybean commodity prices in the past two years, and the resulting projected increase in gross crop income per acre for the 2008 and 2009 crop years, have caused many landlords to consider sharp increases in cash rental rates on rented farmland for 2009.

In most areas of southern and western Minnesota, 60 percent or more of the crop land is in some type of land rental agreement. Many producers are concerned that the favorable crop prices may not last long term, and that the gross income per acre in future years may not be high enough to justify the higher cash rental rates being implemented for the 2009 crop year and beyond.

In addition, crop input costs for seed, fertilizer, chemicals and fuel will also be considerably higher for 2009. As an alternative to the higher cash rental rates for 2009, some producers and landlords are considering a “flexible-cash rental lease” rental agreement, which allows the final cash rental rate to vary as crop yields and market prices vary.

For decades, many farm management advisers, university experts and ag lenders have been advising farmers to look at negotiating flexible-cash rental leases with their landlords as an alternative to paying high straight-out cash rental rates on rented land. This strategy has been successful for some producers and landlords in the past, and seems to make a lot of sense, given the high volatility in the current grain markets, and the high degree of uncertainty relative to future crop revenues.

However, government farm program payment considerations may cause some farmers and landlords to reconsider how a flexible-cash lease agreement is structured.

In 2007, the U.S. Department of Agriculture and the Farm Service Agency issued a rules interpretation that will likely cause many flexible-cash lease agreements to be regarded the same as a share-rental agreement, rather than be considered a cash-rental agreement.

The USDA has actually had these clarifications for Cash Leases and Share Leases in place since 1999; however, more stringent review of land rental leases by county FSA offices in the past few years has brought the issue of flexible-cash leases into greater focus and concern. If the FSA views a flexible-cash lease agreement as a Share Lease, the landlord would be entitled to a portion of direct and counter-cyclical payments, which is similar to a share-rental agreement. The landlord will have to meet all FSA requirements to qualify for receiving DCP payments. In a typical cash-rental lease, all DCP payments and CCPs go directly to the producer, and not to the landlord.

There have been some indications that the USDA and the FSA may modify the flexible-cash lease considerations for determination of whether a rental agreement is considered a cash-rental agreement or a share-rental agreement. However, as of this writing, the USDA and the FSA have not made any modifications in the current definitions or rules related to flexible-cash leases.

This modification could become more important to producers in future years, especially if producers opt for the Average Crop Revenue farm program option for 2009-12. According to current FSA rules, if a flexible-cash lease is considered a Share Lease by the FSA, the landlord will receive a determined percentage of all direct and counter-cyclical farm program payments, including any payments under the ACRE farm program option.

This could be a factor in some flexible-cash lease rental agreements for 2009 and beyond, if there are no adjustments made by the USDA and the FSA.

Following is the current USDA definition that county FSA offices are using to clarify the difference between a Cash Lease rental agreement, and a Share Lease rental agreement between a landlord and producer, from an FSA perspective regarding DCP and CCP eligibility.

Basically, the difference from an FSA perspective is as follows.

Cash Lease

Provides a land rental payment for a guaranteed sum, certain cash payment or a fixed quantity (bushels or pounds) of a crop. There is no production or price risk to the landlord.

Example: $180 per acre cash rent, or 20 bushels of soybeans per acre land rent.

Share Lease

This type of lease consists of one or the combination of the following.

• Rent payment based on the percentage quantity produced (yield).
• Rent payment based on crop proceeds (producer price or gross revenue).
• Guaranteed cash rent rate plus a bonus, based on actual yield and/or price

Flexible-cash rental leases actually originated during the farm crisis days of the 1980s, and then became quite popular again during the period of high grain prices in the mid-1990s.

Typically, a flexible lease, sets a base cash rental rate, which is established using a base yield and base price that are mutually agreed upon by the producer and the landlord. The final cash rental rate for the year is then adjusted upward or downward based on the actual crop yield and commodity price received by the producer.

More recently, landlords and producers have dropped the potential for cash rental rates lower than the base rent, and have just included upward flexibility in final cash rental payments depending on the final crop yields and commodity prices.

Typically, the base yield for a flexible-lease agreement is the crop insurance Actual Production History yield, or a five-year average of actual yield on a farm. The base price is the local market price prior to planting, usually around April 1, and the final price is typically the market price available to the producer a set date, usually around Oct. 1-30.

Flexible-cash rental lease example

Base rent: $180 per acre

Base corn yield: 175 bushels/acre

Base crop price: $5/bu. (Local cash corn price on April 1.)

Base revenue: $875/acre

Actual corn yield: 180 bu./acre

Final crop price: $6/bu. (Local cash price on Oct. 15.)

Final crop revenue: $1,080/acre (1.23 times higher than base revenue of $875.)

Final cash rental rent: $180/acre x 1.23 = $221.40/acre

The example flexible-cash lease agreement shown above would likely be considered a Share Lease, according to the FSA guidelines, and the landlord would likely qualify for a portion of the direct payments and counter-cyclical payments, including the ACRE program payments in 2009-12.

Other example flexible-lease agreements and the likely type of rental consideration by the FSA

Example 1

Cash Rental contract states that “base cash rent is $180/acre, and producer will pay landlord an additional $30/acre, if actual corn yield exceeds 175 bu./acre, or soybean yield exceeds 50 bu./acre.”

° Likely FSA determination: Share Lease (Based on producer’s yield.)

Example 2

Cash Rental contract states that “base cash rent is $180/acre, and producer will pay landlord an additional $30/acre, if producer’s actual price exceeds $5.50/bu. for corn, or $10/bu. for soybeans.”

° Likely FSA determination: “Share Lease” (Based on producer’s price.)

Example 3

Cash Rental contract states that “base cash rent is $180/acre, and producer will pay landlord an additional $30/acre, if the county average corn yield exceeds 175 bu./acre, or the county average soybean yield exceeds 50 bu./acre.”

° Likely FSA determination: Cash Lease (Based on external yield.)

Example 4

Cash Rental contract states that “base cash rent is $180/acre, and producer will pay landlord an additional $30/acre, if Chicago Board of Trade corn harvest price exceeds $6/bu., or the CBOT soybean harvest price exceeds $11/bu.”

° Likely FSA determination: Cash Lease (Based on external price.)

Example 5

Cash Rental contract states that “base cash rent is $180/acre, and producer will pay landlord an additional $30/acre if the monthly average corn price (April-October) at the local grain elevator exceeds $5.50/bu., or the monthly average soybean price exceeds $10/bu.”

° Likely FSA determination: Cash Lease (Based on external price.)

Example 6

Cash Rental contract states that “final cash rent is equal to 35 percent of the producer’s final gross value of the crop (yield x price).”

Corn example: 180 bu./acre x $5/bu. x 0.35 = $315/acre final rent.

° Likely FSA determination: Share Lease (Based on producer’s data.)

Example 7

Cash Rental contract states that “base cash rent is $180/acre, and the producer will pay the landlord an additional 40 percent of the gross crop revenue beyond the base revenue.”

Soybean example: Base revenue = $495/acre (45 bu./acre x $11/bu.)

Final revenue = $600/acre (50 bu./acre x $12/bu.)

Final cash rent = $222/acre

($600/acre - $495/acre = $105/acre x 0.40 = $42/acre + $180/acre = $222/acre)

° Likely FSA determination: Share Lease (Based on producer’s data.)

Example 8

Cash rental contract states a “cash rental rate of $180/acre,” which no additional provisions; however, the producer decides to give the landlord an additional $30/acre land rent because of his excellent crop yields and/or good commodity prices.

° Likely FSA determination: Cash Lease (No pre-set provisions.)

Bottom line

It should be noted that the “likely FSA determination” in the examples above were based on USDA rules and regulations as of Sept. 30 for DCP payment eligibility with flexible-cash lease agreements. The USDA is still reviewing the current flexible-cash lease interpretations and rules, and there could be some changes or clarifications coming for the 2009 crop year related to flexible-cash leases and DCP payments. Watch for notices from county FSA offices for more details.

Before a producer enters into a flexible-cash lease agreement with a landlord, it is probably a good idea to have the local county FSA director review the proposed rental agreement, regarding whether or not the lease would be considered a cash-rent lease or a share-rent lease.

A producer should also find out what effects a flexible-cash lease agreement would have on potential DCP payments, and if necessary, what the requirements would be for the landlord to qualify for a portion of the DCP payments. It is better to check these things out in advance, rather than have them show up later in an FSA payment audit. The penalties for “knowingly and willfully” violating FSA rules, is ineligibility for FSA programs, plus repayment of all past DCP payments plus penalties. This would be a difficult penalty for many farmers to deal with.

Utilizing flexible-cash leases agreements with landlords may still be a good management strategy for farmers to consider as an alternative to extremely high straight cash rental rates. However, both the farmer and the landlord must be aware that the FSA will likely view some types of flexible-cash leases as a share-rental agreement.

This means that the landlord will be eligible for a portion of all potential DCP payments on a given farm unit, including the ACRE farm program payments in 2009-12, provided that the landlord meets all FSA DCP payment eligibility requirements. Landlords who are eligible for Social Security also need to pay attention as to what effect the reception of farm program payments may have on the status of their future Social Security benefits.

Successful flexible-cash lease agreements have always involved good cooperation and communication between the farmer and the landlord, and this will be extremely important when dealing with the FSA requirements for flexible-cash leases.

        

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