Co-authored by Dean Zimmerli
Benjamin Franklin once stated that “if you fail to plan, you are planning to fail.” Planning is an integral part of every farming operation. Farmers must regularly engage in advance planning to determine the crops they will plant or livestock they will raise, ensure access to the necessary inputs, and determine the timing and manner in which they will market their harvested crop or finished livestock. But while most farmers are experienced at planning for their operational needs during good times, fewer farmers invest the time to prepare in advance to respond to challenges that may arise.
Unfortunately, farming operations are exposed to a wide variety of potential disasters. Natural disasters such as floods, drought, frost, extreme temperatures, hail, and wind can damage crops, injure livestock, or destroy farm buildings or equipment. Insect infestations, disease outbreaks, and quarantines also pose significant threats to farming operations. And fires, explosions, ventilation system failure, chemical releases, and other mechanical failures can occur at any time and imperil both the safety of farmers and economic health of the business. While these dangers can never be completely eliminated, planning in advance to respond to foreseeable threats to your farm operation may limit the long-term harm that these disasters pose to your business and reduce (at least a little) the stress that these disasters can cause. This article will provide a checklist of steps that you can take to prepare yourself and your farm to respond to these challenges.
Identify Potential Risks
The first step in preparing a comprehensive disaster response plan is to evaluate your operation to determine the specific types of disasters that may arise and the impact that each type of disaster may have on your operation. In order to accomplish this task, you will need to identify specific facilities or equipment that may pose a risk of catastrophic failure that could cause significant damage to people, property, or the environment (such as the failure of a manure storage facility or the explosion of a grain bin). You should also identify external events that would cause a significant disruption to your farming operation (such as extreme adverse weather or disease outbreaks) and the portions of your operation that may be susceptible to these threats.
The number, type, and scope of potential risks that are identified will vary significantly among operations. For example, a business consisting of one hog finishing barn that is operating under an independent contractor agreement, will generally have significantly fewer and less varied risks than a larger, integrated operation that combines a livestock operation with multiple barns on multiple sites and a crop operation with significant equipment and grain storage facilities.
After identifying potential risks that may impact your farming operation, the second step in preparing a comprehensive disaster response plan is to review on-going contractual obligations to assess the impact that each of the potential disasters may have on your operation. Specifically, many farming operations may routinely have contracts to either purchase supplies or services used in the farming operation or to market and sell crops, livestock, or other products that are produced in the farming operation. In reviewing each of these types of contracts, you should consider the following questions:
- Does this contract require you to purchase specific quantities of supplies or sell specific quantities of farm products on an on-going basis or at some future date, or does the contract merely provide general terms for future purchases or sales that will be determined based on actual needs in the future? For example, a marketing contract may require a farmer to deliver a specific quantity of grain or livestock each month the contract is in force. Alternatively, the contract may establish price and other general terms for the amount of grain or livestock that is actually produced by the farm during the specified period.
- What are the circumstances under which the contract may be terminated? For example, a contract may allow either party to terminate the contract at any time after giving a specified period of notice (e.g., contracts that may be terminated on 30 days or 1 year written notice to the other party). Other contracts may specify certain conditions that would allow either or both parties to terminate the contract (either immediately or after some notice period). And yet other contracts may only allow early termination in the event of a default of the contractual obligations (and then only by the party who is not in default).
- Does the contract allocate the risk of loss associated with future events that may occur? For example, some contracts include “force majeure” clauses that excuse one (or both) parties from continued performance under the contract or allows termination of the contract without penalty if certain “acts of God” (e.g., fires, natural disasters, disease outbreaks, war, labor strikes, etc.) interfere or make the on-going performance of the contract impracticable.
The answers to these questions will determine the amount of future financial or legal exposure to which your farming operation may be exposed if a disaster substantially impacts your operation and reduces the amount of services or supplies that you need or the amount of farm products that you will have available to market.
In addition to these production contracts, farmers should also carefully review the terms of any promissory notes, loan agreements, security agreements, or other loan documents to assess the impact that disasters may have on the operation. For example, many loan documents include provisions that require farm business to maintain minimum financial ratios (e.g., debt-to-equity or debt-to-income ratios) or a borrowing base. Most loan documents also require the borrower to protect collateral and notify the lender of any material adverse events that may impact the operation. A farmer should be aware of any applicable requirements imposed by such loan documents and consider whether each particular potential disaster may implicate such requirements.
Review Insurance Coverage
In addition to reviewing potential liabilities that may arise from a disaster, farmers should also review their insurance policies to confirm that their property is adequately protected and they have sufficient liability protection for risks that may arise from foreseeable disasters. Common insurance questions that should be considered as part of disaster planning include the following items:
- Do any crop or livestock insurance policies provide adequate coverage to meeting ongoing financial obligations of the farming operation in the event of losses to growing crops or livestock from a disaster?
- Do property insurance policies provide coverage for damage to or losses of property used in the farming operation resulting from foreseeable disasters? In addressing this issue, it is important to review any policy conditions, exceptions, and exclusions that may limit insurance coverage for certain events.
- Do property insurance policies provide an adequate amount of coverage for damage to or losses of property used in the farming operation? In particular, it is important to consider whether the policy merely covers the value of the property or whether the policy instead covers the cost to replace the property.
- Do property insurance policies provide coverage for lost revenue or profits that are suffered as a result of an insured lost?
- Do liability insurance policies provide coverage for damages that may be incurred by third parties as a result of foreseeable disasters? For example, an explosion at a farm facility may cause harm to employees or other persons or harm to other nearby property. Again, in addressing this issue, it is important to review any policy conditions, exceptions, and exclusions that may limit insurance coverage for certain events. In particular, farmers should be aware of issues related to any pollution exclusions to determine the impact that such provisions may have on coverage from the routine application or use of manure, fertilizer, pesticides, herbicides, or other common farm chemicals.
- Who is covered by liability insurance policies? This includes both the scope of persons use actions will be covered if they cause liability and the universe of persons who may submit claims if they are damaged under the policy. It is important to review policy coverages to make sure that all necessary owners, officers, and employees are covered.
In addition to reviewing coverage issues, farmers should review insurance policies to determine any applicable reporting and claim submission requirements in the event of a disaster or other insured loss. Most insurance policies include strict timing requirements within which reports or claims must be submitted following events that may cause an insured loss.
Regulatory Reporting Requirements
Farming operations are increasingly subject to permitting and regulatory requirements imposed by federal, state, and local governmental agencies. And these regulatory requirements may include reporting obligations that can be triggered by certain disasters (or if certain events occur as part of certain disasters). For example:
- Releases of Hazardous Substances – Two separate federal laws—the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) and the Emergency Planning and Community Right-to-Know Act (EPCRA)—require persons in charge of facilities to report any releases of hazardous substances in excess of specified thresholds to the National Response Center (operated by the United States Coast Guard), the Minnesota Duty Officer, and applicable local emergency response officials. These requirements apply to all such releases of hazardous substances, including releases that occur as the result of natural disasters or actions by a third party. For example, if a release of anhydrous ammonia (which has a reportable quantity of 100 pounds (or approximately 18 gallons) occurs at a farm—whether because of a leak or other equipment failure, natural disaster, or even an intentional act of a third party (such as attempted theft of the anhydrous ammonia)—the farmer is required to report the release to the applicable emergency response agencies.
- Animal Disease Outbreak – Farmers are required a suspected or clinically-diagnosed case or positive test result for certain animal diseases to the Minnesota Board of Animal Health, Minnesota Poultry Testing Laboratory, and/or the Minnesota Duty Officer.
Farmers should review all applicable permit conditions and regulatory reporting obligations in advance of a disaster and prepare a list of those requirements (and the necessary contact information) to ensure that these obligations are satisfied.
Prepare a Written Disaster Plan
After identifying potential risks that may impact your farming operation and reviewing the potential harms and reporting obligations associated with each such risk, you should prepare a written disaster plan that provides a step-by-step response plan for each potential disaster or emergency that might arise in your operation. The plan should include all legal, regulatory, or contractual reporting obligations and provide the specific contact information to be used in making the reports. The plan should also identify potential outside vendors or service providers who may be necessary to implement the plan. The plan should also identify particular persons who will be responsible for implementing each step of the plan and the timing in which the step should be completed. Trade or commodity groups, industry experts, and governmental agencies may have useful guidance regarding requirements and best practices that can be considered in preparing your disaster plan to respond to specific disasters.
Copies of the disaster plan should be kept at all facilities so that the plan is readily available in the event of an emergency. The plan should also be clearly communicated to employees who will be responsible for implementing the plan.
Prepare a the Financial Impact of a Disaster
Even after the immediate emergency conditions of a disaster have been addressed, farmers must also be prepared to address the long-term operational impacts of the disaster. For example, once the smoke clears or the debris is cleaned up, debt payments will still need to be made, employees will still have to be paid, and other expenses will continue to be incurred.
In order to prepare for the financial impact of a disaster, you should evaluate your liquidity or working capital position. Cash is king when dealing with a negative cash flow situation resulting from a disaster. So you should know how much available working capital you have, and what sources you have to obtain cash, including deposit accounts, lines of credit, receivables, and other sources. If you have excess inventory on hand, you may need to liquidate some to provide cash in the short term.
Next you must calculate your working capital “burn rate.” Total all of your unavoidable expenses and debt payment requirements, along with any additional expenses related to responding to the disaster, to determine how much cash will be going out each month. Compare this to any remaining income you have and your available working capital, and this will determine how long you can continue to operate. For example, if your monthly cash flow is negative ($20,000), you will deplete $200,000 of working capital reserves in just ten months. If you expect your operations to continue to be impacted beyond ten months, then you must consider other options such as additional loans to be able to continue operations.
Through all of this you should also carefully review your loan agreements or other contracts. Many loan agreements have terms and conditions that may cause an event of default in the case of a disaster. You should not ignore these terms; instead, it is best to be proactive and sit down with your lender to negotiate a modification that might delay payments or modify the loan while your work through recovery from the disaster. Particularly when lenders are comfortable that insurance may eventually compensate for damage or losses, they will often be willing to work out extensions to allow time for claims to be processed through insurance.
Many disasters that may impact a farming operation are simply unavoidable. And some level of stress and difficulty is unavoidable when disasters strike. But with advanced preparation, the immediate stress of many disasters can be reduced and will allow a farmer to respond in a deliberate manner that will mitigate some of the potential harms that could arise.
This information is general in nature and should not be construed for tax or legal advice.