Top of Iowa Co-op. v. Sime Farms, Inc.

• Decision Date: 22 March 2000
• Docket Number: No. 98-1166.,98-1166.
• Citation: 608 N.W.2d 454
• Parties: TOP OF IOWA COOPERATIVE, an Iowa Corporation, Appellee, v. SIME FARMS, INC., Appellant.
• Court: Iowa Supreme Court

608 N.W.2d 454

TOP OF IOWA COOPERATIVE, an Iowa Corporation, Appellee, v. SIME FARMS, INC., Appellant.

No. 98-1166.

Supreme Court of Iowa.

March 22, 2000.

Glenn L. Norris, George F. Davison, and David N. May of Hawkins & Norris, Des Moines, for appellant.

Richard K. Updegraff, Sean P. Moore, and Miranda L. Hughes of Brown, Winick, Graves, Gross, Baskerville, and Schoenebaum, P.L.C., Des Moines, for appellee.

Considered en banc.

TERNUS, Justice.

The appellee, Top of Iowa Cooperative, sued the appellant, Sime Farms, Inc., for damages arising out of Sime Farms' failure to deliver corn under four hedge-to-arrive (HTA) contracts. Sime Farms claimed that the contracts were illegal and that, in any event, the Coop had repudiated the contract by making an unreasonable demand for assurances. A jury found in favor of the Coop and awarded damages against Sime Farms. We affirm.

I. Background Facts and Proceedings.

A. Hedge-to-arrive contracts. Before we discuss the particular facts of this case, it is helpful to briefly review the nature of HTA contracts. "[I]n a basic HTA contract, a farmer and grain elevator enter into a contract that contemplates delivery of a specified quantity of grain at a fixed point in time in the future." Andersons, Inc. v. Horton Farms, Inc., 166 F.3d 308, 319 (6th Cir.1998). In a typical HTA contract, the elevator sets the price it is willing to pay based on the open market price on the Chicago Board of Trade (CBOT) for the delivery period, minus what is known as the basis.¹ (The basis is simply the elevator's cost of doing business, such as transportation costs, storage, labor, and utilities, plus a profit.) Upon entering into an HTA contract, the elevator hedges its purchase by simultaneously selling a futures contract on the CBOT, thereby protecting itself from any change in the cash price of corn at the date of delivery.

Although the transaction up to this point is relatively straightforward, there are several complicating factors. First, grain elevators must conduct their trading on the CBOT through licensed brokers. When the price of corn on the futures market rises, the contract with the broker typically requires the elevator to pay what is known as "margin money"—the difference between the original futures contract price and the current futures price—in order to maintain its futures position.² The elevator recovers the margin money when it sells the corn delivered by the farmer at a higher cash price.³ Of course, if the farmer does not deliver, the elevator has no grain to sell, and it cannot recover its margin. Thus, the elevator's hedged position remains risk-free only so long as the farmer can be counted upon to deliver the grain specified under the contract.

In addition, HTA contracts prevalent in the 1990's had two features that distinguished them from traditional grain contracts where the parties agreed on a fixed price for a specified future delivery date. In HTA contracts, the basis was not set at the time of contracting. Rather, the farmer was allowed to choose when to set the basis, provided it was done within the time period specified in the contract. This contract term introduced an element of speculation into the contract, because an elevator's basis generally fluctuated. Consequently, a farmer who delayed setting the basis was open to the risk that the elevator's basis would increase, thereby lowering the price the farmer would receive for his grain.

The second element of risk in HTA contracts is introduced when the farmer is allowed to postpone delivery to a later date. This practice is known as rolling. When the price of grain rises by or near the time set for delivery, the farmer may prefer to sell his grain on the current cash market for a higher price rather than deliver the grain to the elevator for the contract price. Under these circumstances, the parties may agree to modify the contract by delaying, or rolling, the delivery date to a date in the future. To preserve its hedged position, the elevator buys back, at the current price, the futures contract it had previously sold on the CBOT and enters into another futures contract to sell grain on the new delivery date.

The complicating factor in rolling is that the price of corn for the new date of delivery generally is not the same as the current price for the old delivery date. This difference is called the spread. If the new price is higher, the spread is positive and will result in a gain or carry. If the new price is lower, however, it will result in a loss or inverse. This gain or loss is fixed at the time of the roll and is added to or deducted from the new contract price under the rolled HTA contract. Thus, when the farmer decides to roll, he can determine at that time whether he will incur a gain or loss. The problematic risk arises when the farmer rolls to a month when he will not have grain on hand to deliver. He has then exposed himself to an additional, unknown risk because he will have to roll again before he will be able to make the agreed-upon delivery. If the market deteriorates and the price of corn falls, the farmer may ultimately be required to deliver grain at a significant loss.

Unfortunately, this predicament is precisely the situation that faced Sime Farms in the summer of 1996, which brings us to the facts of this case. In recounting the facts, we view them in a light most favorable to upholding the jury's verdict. See Lawrence v. Grinde, 534 N.W.2d 414, 418 (Iowa 1995)

.

B. Factual background. Top of Iowa Cooperative is a farmer-owned cooperative that operates in several locations, including Lake Mills, Iowa. Prior to January 1995, the Lake Mills location was owned and operated as the Farmers Coop Elevator Company of Lake Mills. Sime Farms, Inc. is an Iowa corporation wholly owned by Mark Sime. As its name suggests, its business is farming. Sime Farms is a member of the Coop, and for many years prior to the time in question, did nearly all of its grain and agronomy business with the Coop's predecessor, Farmers Coop Elevator Company. (In the remainder of this opinion, we refer to both entities as the Coop.)

In the fall of 1994 and the spring of 1995, Sime Farms entered into three HTA contracts with the Coop. These contracts called for the delivery of a total of 40,000 bushels of corn in December 1995. This grain represented Sime Farms' entire annual corn production. One month before delivery was due under these contracts, Sime Farms contracted to sell an additional 20,000 bushels of corn for delivery in May 1996. The Coop hedged each contract by selling futures contracts on the CBOT for corresponding delivery dates.

In November 1995, Sime Farms rolled its December 1995 delivery dates to March 1996. Although the HTA contracts did not specifically address the ability of Sime Farms to roll, the contracts contemplated this possibility by providing for a fee of one cent per bushel for each roll. Handwritten modifications were made on the contracts indicating the new delivery dates. The contract price was also adjusted to reflect the spread between the current December 1995 futures price and the March 1996 futures price. This adjustment was a positive six cents, a seven-cent carry minus the one-cent roll fee. Sime Farms then sold its 1995 crop on the cash market at a price significantly higher than the December 1995 futures price it had contracted to receive under the original HTA contracts.

Although the roll to March 1996 resulted in a gain or carry, the parties were aware at the time of this roll that a roll to July 1996 or December 1996 would result in a significant inverse, or loss. The parties also knew that Sime Farms would have to roll again into at least December 1996 because it had no grain to deliver until it harvested its 1996 crop.

In February 1996, the contracts were rolled to May 1996. This roll resulted in a gain of slightly less than three cents per bushel, which was added to the contract price. In April 1996, all four contracts were rolled to July 1996. This roll resulted in a thirteen-cent-per-bushel loss or inverse, and so this amount was deducted from the price the Coop agreed to pay Sime Farms for July delivery. By late April 1996, the inverse between July 1996 and December 1996 was around $1.30 per bushel. Because Sime Farms had no corn to deliver in July 1996, it was faced with the prospect of rolling into December 1996 at a significant loss, or breaching its contracts with the Coop. If Sime Farms breached the contracts, the Coop would have to repurchase the offsetting futures it held on the CBOT, resulting in a loss of the margin money it had paid.

By May 1996, the Coop was becoming increasingly concerned about farmers' abilities and willingness to perform on the outstanding HTA contracts. The Coop's manager, Paul Nesler, spoke with Mark Sime at least once in May regarding the inverse situation and the effect of rolling into December. Sime told Nesler that he would get back to the Coop about what he planned to do, but he never did. The Coop's concerns were heightened even further when, that same month, the Iowa Attorney General's office announced that some of the HTA contracts might be "illegal."

On June 6, 1996, the Coop sent a letter to Sime Farms and similarly-situated producers in which the Coop stated that "[i]n response to recent market and non-market developments," the Coop wanted to confirm that its customers holding HTA contracts were capable of and intended to perform. The Coop stated it would consider compliance with the following two conditions as adequate assurance of Sime Farms' ability and willingness to perform: (1) payment in full of all commissions and margins previously paid by the Coop, or a binding letter of credit obligating an institutional lender to pay such commissions and margins; and (2) the return of a signed copy of the Coop's letter agreeing to delivery of the agreed-upon quantity of grain on or before the delivery...