Nagel v. Adm Investor Services, Inc., 96 C 2675 <I>et al.</I>

• Decision Date: 23 August 1999
• Docket Number: No. 96 C 2675 &lt;I&gt;et al.&lt;/I&gt;,96 C 2675 &lt;I&gt;et al.&lt;/I&gt
• Citation: 65 F.Supp.2d 740
• Parties: Dennis NAGEL, et al. v. ADM INVESTOR SERVICES, INC., et al.
• Court: U.S. District Court — Northern District of Illinois

65 F.Supp.2d 740

Dennis NAGEL, et al. v. ADM INVESTOR SERVICES, INC., et al.

No. 96 C 2675 et al.

United States District Court, N.D. Illinois, Eastern Division.

August 23, 1999.

As Amended September 3, 1999.

COPYRIGHT MATERIAL OMITTED

Adam K. Hollander, Mayer, Brown & Platt, Chicago, IL, Joel J. Bellows, Laurel G. Bellows, Nicholas P. Iavarone, Christopher L. Gallinari, Bellows & Bellows, Chicago, IL, Rebecca J. Wing, Chicago, IL, for Dennis Nagel, Darlene Nagel.

Timothy C. Klenk, Richard J. Rappaport, Alison C.B. Laing, Amy Beth Manning, Ross & Hardies, P.C., Chicago, IL, for ADM Investor Services, Inc.

Mark M. Lyman, Henery Karl Becker, Daniel G. Dolan, Jr., John D. Ruark, Henderson, Becker & Lyman, Chicago, IL, Jeffry Mark Henderson, Patrick Gerard King, Henderson and Lyman, Chicago, IL, for Brighton Commodities, Inc.

James L. Fox, Abramson & Fox, Chicago, IL, Kenneth M. Snodgrass, Jr., James Roland Grebe, Goldsworthy, Fifield & Hasselberg, Peoria, IL, for Oberbeck Feed Co.

Opinion

EASTERBROOK, Circuit Judge.^†

Plaintiffs in these five consolidated actions (Nos. 96 C 2675, 96 C 2741, 96 C 2879, 96 C 2972, and 96 C 5215) are farmers who entered into hedge-to-arrive (HTA) contracts with grain merchants (including grain elevators). Under a standard hedge-to-arrive contract the farmer promises to deliver a stated quantity of grain for a price linked to the price of a futures contract that expires in the delivery month. From the farmer's perspective, this is a normal forward contract that shifts to the buyer the risk that the market price will fall before delivery (and simultaneously prevents the farmer from taking advantage of rising prices). The merchant takes a short position in a traded grain futures contract expiring in the delivery month, and the position can be calculated so that the return from this contract offsets (that is, hedges) the market risk on the cash crop: if the price of the cash commodity falls, so that the grain merchant is obliged to pay the farmer more than the spot market price on delivery, this loss will be offset by a gain in the futures contract; similarly, if the cash market price rises (so that the merchant gets a bargain on delivery), there will be an offsetting loss on the futures contract. Both the farmer and the grain merchant thus can lock in a particular price. Contracts of this general kind have been used since the early 1980s.

The contracts at issue in these five suits are known as flexible or enhanced HTA agreements, because they permit the farmers to defer delivery to any month in which a futures contract expires. When the farmer defers delivery, the grain merchant buys in its existing short position and takes a new position in the new delivery month. (This is known as rolling the hedge.) The price payable on delivery of the grain is adjusted to reflect the difference between the cost of these positions, plus a small fee (often 2¢ a bushel). Although the farmer never transacts on a futures exchange, the right to postpone delivery and obtain a new price affords farmers the economic attributes of options to establish short positions in the futures market. See generally Glenn L. Norris, George F. Davison, Jr. & David N. May, Hedge to Arrive Contracts and the Commodity Exchange Act: A Textual Alternative, 47 Drake L.Rev. 319, 322-26 (1999); Note, Risky Business: HTAS, The Cash Forward Exclusion and Top of Iowa Cooperative v. Schewe, 44 Villanova L.Rev. 125 (1999).

When the spot price drops before the original delivery date, a farmer with a flex HTA delivers and takes his profit. When the price of the cash commodity rises, a farmer is tempted to defer delivery, sell the crop for cash (obtaining a price higher than the one the grain merchant is required to pay), and hope that the price falls again before the new delivery date, so that the farmer can cover his short position. If the price stays high, the farmer may defer delivery again, still betting on a fall. But if the price remains up, the farmer is in trouble — for selling short in a rising market can inflict heavy losses. Likewise the grain merchant, which may have to realize the loss in its short futures position and post extra margin pending delivery. (As the value of the contract rises, the required margin also rises.)

In 1995-96 the price of corn rose, farmers deferred delivery, grain merchants rolled the hedges, the price stayed high, and many deals broke down. Many farmers could not cover by delivering the cash commodity on the new date. Some farmers (though not necessarily any of the plaintiffs in these five cases) had contracted to deliver more grain than they had planted, hoping that deferrals would enable them to hide the shortfall from the grain merchants until prices dropped and the obligation could be covered. Had prices declined, these farmers would have reaped windfalls; as events transpired, however, the rising market spelled financial disaster. Some grain merchants either could not absorb losses in the interim (a counterparty credit risk that the farmers may not have anticipated) or refused to post extra margin once they suspected that the farmers lacked the cash commodity in the quantity specified by the contracts. When futures exchanges liquidated the merchants' positions, both middlemen and farmers were left with losses.

Plaintiffs in these suits contend that flex HTA contracts are "futures contracts" rather than "forward contracts" and therefore are unlawful — for futures contracts must be handled by boards of trade and registered futures commission merchants, 7 U.S.C. § 6(a), which the grain elevators are not. Congress distinguished between futures ("contracts for future delivery") and forward contracts in this way: "The term `future delivery' does not include any sale of any cash commodity for deferred shipment or delivery." 7 U.S.C. § 1a(11). Defendants say that the flex HTA contracts come within this exception; plaintiffs argue otherwise. Plaintiffs' position has the support of the CFTC, at least when the deferral extends past a crop year. In re Competitive Strategies for Agriculture, Ltd., No. 98-4 (Aug. 24, 1998). But the farmers' arguments have been uniformly unsuccessful in court. See, e.g., The Andersons, Inc. v. Horton Farms, Inc., 166 F.3d 308, 317-22 (6th Cir.1998); Abels v. Farmers Commodities Corp., No. 98-3033-MWB (N.D.Iowa Mar. 26, 1999); Lachmund v. ADM Investor Services, Inc., 26 F.Supp.2d 1107 (N.D.Ind.1998), appeal pending, 191 F.3d 777 (7th Cir.) (argued Feb. 23, 1999); Barz v. Geneva Elevator Co., 12 F.Supp.2d 943 (N.D.Iowa 1998); Top of Iowa Cooperative v. Schewe, 6 F.Supp.2d 843 (N.D.Iowa 1998); In re Grain Land Coop, 978 F.Supp. 1267 (D.Minn.1997). One district court postponed decision by denying a motion to dismiss under Rule 12(b)(6), see Eby v. Producers Co-op Inc., 959 F.Supp. 428 (W.D.Mich.1997), but The Andersons later nixed these claims for Michigan and the rest of the Sixth Circuit. No federal court has decided any of these suits in favor of any farmer.

Plaintiffs also contend that the grain merchants (and their own financial advisers) defrauded them by not supplying additional information, and in particular by not warning them of the risks of deferring delivery in a rising market and of the counterparty credit risk. These claims arise under state law — surely so if the judicial view about the identity of a futures contract is accepted here, and likely so even if plaintiffs prevail on that issue. Because complete diversity is missing, these claims come under the supplemental jurisdiction, 28 U.S.C. § 1367.

I

Plaintiffs in Wilson Farm v. ADM Investor Services, Inc., 995 F.Supp. 837 (N.D.Ill.1998), and Brown v. ADM Investor Services, Inc., 995 F.Supp. 837 (N.D.Ill. 1998), signed HTA contracts that include arbitration clauses. Disputes between the farmers and the grain merchants are to be arbitrated by the National Grain and Feed Association. District Judge Manning, who handled these five cases before their reassignment to me, stayed Wilson Farm and Brown pending arbitration. 1997 U.S. Dist. LEXIS 21366 (N.D.Ill.1998). In each case the arbitral panel now has unanimously concluded that the farmer failed to deliver as promised and owes damages. Brown was ordered to pay $100,437.50 plus interest from August 26, 1996, to The DeLong Co.; Wilson Farm and associates were directed to pay approximately $400,000 plus interest from May 21, 1996, to Staley Grain, Inc. The beneficiaries seek confirmation and enforcement; the farmers ask me to vacate the awards.

Review under the Federal Arbitration Act is exceptionally narrow. 9 U.S.C. § 10(a). Plaintiffs essentially ignore the statutory grounds for setting aside awards and argue instead that Judge Manning should not have ordered arbitration in the first place. That argument is foreclosed by the law of the case, unless intervening developments justify a fresh look. But the caselaw remains lopsidedly against plaintiffs. All but one of the courts that have examined the question have held that contracts sending HTA disputes to the National Grain & Feed Association must be enforced. Compare The Andersons, 166 F.3d at 322-30; Harter v. Iowa Grain Co., 1998 WL 440905 (N.D.Ill. Jul. 24, 1998) 1998 U.S. Dist. LEXIS 11600, appeals pending, Nos. 98-3010 & 98-3817 (7th Cir.) (to be argued Sept. 13, 1999); Heitoff v. Cargill, Inc., No. 4-CV-96-337 (D.Neb. Mar. 21, 1997); Harris Farms v. Continental Grain, No. 96 C 4269 (N.D.Ill. Mar.18, 1997); Herwig v. Hahnaman-Albrecht, Inc., 1997 WL 72079 (N.D.Ill.1997) 1997 U.S. Dist. LEXIS 1650; and Hodge Brothers, Inc. v. The DeLong Co., 942 F.Supp. 412 (W.D.Wis.1996); with Hoffman v. Cargill, Inc., 59 F.Supp.2d 861 (N.D.Iowa 1999). I find Hoffman, the only contrary decision, unpersuasive for reasons given below, and in The Andersons.

Plaintiffs ask the court to view arbitration with hostility because it does not use the same procedures as litigation. But that's the point of arbitration,...