Legal Perspective

Feedstock: Procurement contracts must help manage risk
By Mark Hanson and Todd Guerrero | July 01, 2006
One of us recently had lunch with a longtime colleague, Don Hofstrand, from Iowa State University and discussed the changing landscape of grain supply and demand, particularly as it relates to renewable energy consumption. It made us reflect on the maxim, "good facts obscure the law," and the corollary "the law is defined in times of changing facts." The surge in renewable fuels is premised on the abundant, renewable supply of grain feedstocks at commercially stable prices. The dramatic changes in supply and demand, occurring within 50 miles of biofuel facilities throughout the Midwest grain-producing states, are also having local and regional effects on grain feedstock. Because of these changes, more facilities are revising their practices, procedures and risk assessment when assessing start-up potential, expansion and ongoing operations.

Many consultants and databases are available to conduct grain availability studies within a given area. Some studies even assess the changes of corn and soybean plantings and availability. In areas with new consumption sources, it may take a year or two before area supply and demand adjust.

While many developers and facilities assume grain availability, lenders and financing sources are requiring contracted grain procurement. The Uniform Commercial Code (UCC) generally covers grain procurement contracts where grain is defined as "goods," similar to commercial transactions. Federal and state clear title laws, however, have a separate procedure for obtaining and clearing a security interest in grain sourced from producers, which generally will not be identified as part of a UCC search. Grain procurement agreements should have provisions about purchasing grain free and clear of liens, with a recognition that undisclosed liens may subject the buyer to "double payment" if the federal clear title provisions are not complied with. The grain clear title laws do not cover products manufactured from grain, such as oil, but in times of short grain supplies, oil suppliers who contract grain purchases may nonetheless be at risk.

To be enforceable, the language of feedstock procurement contracts generally needs to describe the purchase/sale transaction, price, quantity and delivery requirements. Developers sometimes propose to "lock up" their supplies with "requirements contracts" or contracts that generally provide that the supplier will meet all of the feedstock requirements of the facility at market price. Vague language will make the contract more difficult to enforce. We generally recommend using ranges of volume and pricing to reflect the parties' intention. If it is the intent to purchase feedstocks at any price, that intent should be clearly stated.

For many contracts, failure to deliver feedstocks will result in direct (the difference between the contract and the market price) and consequential damages (loss resulting from not having the feedstock, particularly if substitute feedstock cannot be acquired). Some contracts waive these provisions or specify liquidated (specified and limited) damages, which need to be carefully considered.

Feedstock procurement and pricing presents a substantial risk profile in all biofuels facilities, particularly for biodiesel. A timely review of these risks is necessary, and the risks must be addressed in feedstock procurement agreements.

Mark Hanson and Todd Guerrero are members of the Agribusiness & Energy Practice Group of Lindquist & Vennum PLLP, a leading provider of legal assistance on renewable energy projects throughout the country. They can be reached at (612) 371-3211.
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