Offtake Agreements – Connecting Hemp Growers with Buyers

December 8, 2020 |

By Rachael Z. Ardanuy, Esq., Cannabis Business Attorney and Member of Lee Enterprises Consulting

Special to The Digest

The Agriculture Improvement Act of 2018 (2018 Farm Bill) removed hemp from the Controlled Substances Act, authorized the production of hemp pursuant to USDA and state regulation, and guarantees that hemp can be moved in interstate and international commerce.  The 2018 Farm Bill did not, however, address hemp manufacturing or processing, nor did it provide a pathway to legalizing hemp-derived CBD products as foods or dietary supplements.  This is due to the fact that the Food and Drug Administration (FDA) has already approved Epidiolex, a hemp-derived CBD pharmaceutical drug used to treat certain types of epilepsy, and foods and dietary supplements cannot include approved drugs as ingredients.  FDA has indicated that it intends to create pathways for legalizing hemp-derived CBD but has yet to release any guidance.

Despite the fact that hemp-derived CBD products are not approved as a food or dietary supplement), the world has seen an explosion in the popularity and availability of hemp and hemp-derived CBD products.  Accordingly, record acres of hemp were planted across the U.S. and the world in 2019 as interested market participants sought to cash in on this popular, newly-legal commodity. Although the 2018 Farm Bill guarantees that federal law no longer prohibits the interstate transfer of hemp – which previously hampered hemp cultivators who could only look within their state borders for processing options – it failed to address and regulate manufacturing and processing of hemp.  This led to the pace of extractors and processors of hemp entering the market failing to keep pace with the acreage of hemp planted.

Many hemp growers also relied on the popularity of hemp-derived CBD products without securing down-channel commitments for their harvests. As a result, there was a glut in the market of hemp grown for CBD production and prices of biomass and extraction services fluctuated unpredictably.  Many hemp cultivation investors lost significant investments because their financial models relied on booming market statistics, but made no commitments with processors and purchasers.  This article explores how entrepreneurs interested in entering the hemp cultivation industry, as well as current hemp cultivators, can utilize offtake agreements to make their concept reality, avoid expensive pitfalls, and commit their harvests for guaranteed returns.

What is an Offtake Agreement?

Offtake agreements are commitments of a buyer to provide resources in the future to a seller based on specified prices and/or volumes.  Offtake agreements are commonly used in trade of resources such as industrial metals, liquefied natural gas and organic chemicals.  Many producers use offtake agreements when securing financing of the initial project or other required inputs for the resource production.  Offtake agreements reduce uncertainty of future cash flow by locking in a committed purchaser at specified rates (or using a formula to get to an agreed upon price) for all or a portion of the resources produced.

What Material Terms Should be Considered in a Hemp Offtake Agreement?

Binding or non-binding.

Binding offtake agreements are inherently more attractive to producers because they secure a buyer for the harvest.  Also, a binding agreement shows potential financiers that there are committed buyers for the end product, making a project a better candidate for financing.  However, non-binding agreements can also be beneficial since the goods bargained for do not exist at the time of the contract, and a change of plans in proposed operations on the part of one party may impact the other party’s decision to move forward – a non-binding agreement would allow the parties to cancel the deal.  Whether binding or non-binding, the parties can include terms to protect against unexpected events including the ability to terminate an offtake agreement upon payment of an agreed upon termination fee to the non-terminating party.

 

Parties.

There are many factors to consider when determining how to structure a business.  Tax implications, management teams, investors, operations, and other legal factors come into play.  However an offtake agreement is drafted, including language that would allow assignment of the agreement to another entity that perhaps hasn’t been formed at the time the offtake agreement is established allows for a seamless transfer and continuity of operations in the event there is a business restructuring during the term of the offtake agreement.  Consulting tax and legal advisors regarding these matters is imperative so the parties are on proper legal footing.

Source of Production.

In the case where an offtake agreement is being sought to secure financing to establish a cultivation operation, it will be important for the proposed producer to analyze state and local regulations, growing environments, and other factors to determine the most desirable location to establish the hemp cultivation facility.  Once the location of the cultivation operation is established, or if an established hemp cultivator is seeking to enter into an offtake agreement, including provisions specific to state and local law and regulation will be imperative to enforcing the agreement.  Working with a business attorney experienced in commercial agreements such as offtake agreements can help avoid unintended consequences for the parties by spotting issues specific to the location of production or the type of commodity at issue.

Another factor to consider during negotiation, and to identify in the agreement, is the proposed yield, which is directly proportionate to the amount of landmass being utilized to cultivate the hemp.  The needs of the producer and its down-channel partners and the capacity of the cultivator need to align in concept to be able to align in reality once harvest season comes.

Product Details.

As described in Dr. Susan Rupp’s introductory articles on hemp production, various hemp cultivars have been bred specifically for their higher CBD content and lower THC content.  Offtake agreements should require representations and warranties as to the cultivars to be produced. 

Volume Offered. 

Producers and purchasers have many options regarding the volume of biomass for purchase committed. Considerations such as the producer’s anticipated needs, the producer’s anticipated capacity, and whether other purchasers will rely on the producer will inform this decision.  Other options are for the producer to commit all of its harvest or all of its harvest from specified production sites.

Exclusivity.

Depending on the purchaser’s intended plans for the biomass, a hemp cultivator may wish to lock in their offtaker to exclusively purchase from the hemp cultivator, with terms worked in to allow for flexibility in the event the purchasers needs exceed the producer’s output capability.

Price.

Whether a set fee per unit or another formula is utilized to calculate the price, describing the pricing in detail will not only benefit the parties by having a clear delineation of revenue, but will allow a new business to seek commitments from investors with committed projections in place.  When negotiating price, the producer should consider all inputs going into the harvest: rent or mortgage, property taxes, insurance, labor, nutrients, IPM expenses, registration, licensing, and the list goes on.  Purchasers should consider the costs of extraction, transportation of biomass between the farm and processing facilities, insurance, labor, registration, licensing, and more.  Without knowing what you are putting in, you cannot calculate what you need to get out to not only break even, but to profit from a transaction. 

Payment. 

Will payments for harvested hemp be paid in tranches?  On consignment? Upon delivery or pick up?  All of these options should be considered when determining pricing.

What’s the Offtake Takeaway?

Venturing into a nascent industry is inherently risky.  Utilizing offtake agreements as part of the overall business success strategy can take pressure off hemp cultivators who otherwise do not have commitments or plans for the hemp beyond harvest.

 

About the author: Rachael Ardanuy is a cannabis business attorney and member of Lee Enterprises Consulting, the world’s premier bioeconomy consulting group, with more than 150 consultants and experts worldwide. The opinions expressed herein are those of the author and do not necessarily express the views of LEC.

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