The new draft dairy regulations: What actions should producers and processors take?

Last year, DEFRA announced that new dairy regulations were to be put before parliament with the intention of regulating contracts between milk producers and dairy processors in the Dairy sector. This week, the The Fair Dealing Obligations (Milk) Regulations 2024 (“Draft Regulations”) have been laid before parliament.

But what exactly do these new regulations cover, how will they impact your business and what actions can you take to ensure you’re ahead of the curve?

Introduction

DEFRA are responsible for improving and protecting the environment, growing the green economy and supporting the UK’s food and farming industries.

As part of the government’s wider strategy to grow a thriving British food and drink sector, between June and September 2020, DEFRA conducted a public consultation to review the contractual relationship between producers and processors of dairy. The consultation considered if contractual regulations are necessary to supply fair and transparent contracts. The current regime was heavily criticised during the Covid 19 crisis, where producers were said to be disproportionately impacted, baring heavy costs in comparison to those of dairy processors. Following this, a report was produced which considered the feedback from the consultation.

DEFRA has now published the Draft Regulations, and we consider the main details of these below. Once in force, the Draft Regulations will apply to all milk purchase contracts, unless:

1. they are in place within 12 weeks of the Draft Regulations coming into force; and
2. all of the milk to be purchased under the contract is acquired within 12 months and 12 weeks of the Draft Regulations coming into force.

Milk Purchase Contracts

The Draft Regulations provide that milk contracts must be used between dairy farmers and processors, and that the contract must contain a term for the processor to act in good faith.

Further, it introduces strict requirements for the format and duration of the contract. Contracts must be in writing and must be signed. Contracts may either be for a fixed period or “evergreen,” where they continue until terminated. They must however state which of the two they are, as well as the date at which the obligation to supply commences.

The majority of dairy processors are likely to be dealing with milk purchase contracts in such a manner already, but if not, it is a prompt for those without formal contracts to get them in place.

Pricing Mechanisms

It is very well known that the dairy industry is subject to extreme fluctuations and volatility in pricing. Producers are said to be currently more exposed to the cost risks of such fluctuations than processors due to discretionary pricing clauses in contracts. These commonly used clauses allow processors to unilaterally vary the price of milk at a given time effectively pushing the risk onto the producers. It is said that these clauses can lead to poor farming practices and animal welfare concerns as producers might cut corners to keep their businesses afloat. The new regulations intend to protect the producers from these sudden price changes imposed on them by processors by sharing the price volatility risk between them both.

The Draft Regulations provide that milk purchase contracts may specify that a price is fixed, variable or a combination of the two.

Where a price is fixed:

1. the contract may specify multiple fixed prices over different periods, but if so, it must clearly state which price applies to which period, and clearly define the date upon which each period begins and ends;
2.  it must set out what may constitute exceptional market conditions (for example, standard force-majeure circumstances), together with a procedure by which the price can be reviewed due to those conditions being satisfied; and
3. any price review procedure must include an opportunity for the producer to request a discussion with the processor regarding the price to be paid during the period where exceptional market conditions apply. The processor must enter into such a discussion with the producer within 30 days of the producer making the request.

Where a price is variable:

1. the processor may only have regard to factors set out in the contract when varying the price;
2. the contract must specify the period within the contract to which each set of factors relate;
3. the price cannot be determined more often than once per  month or less often than three months;
4. following any determination of the variable price, the producer may request an explanation from the processor as to how the price was determined and what factors were had due regard to, which the processor must respond to within 7 days; and
5. the contract must contain a procedure for an independent third-party to verify the variable price where the producer requests an explanation.

Due to the ability for the producer to challenge a variable price set by the producer, the Draft Regulations will therefore make it a cumbersome task to structure a contract which locks the producer into production at any given price set by the processor and not an independent mechanism such as the RPI. Processors will need to think very carefully about the price they are setting, and must have forethought when drafting a purchase contract in order to be able to justify price changes based upon the factors within the contract.

Producers should prepare for these changes and consider how they will impact their current risk analysis and management to ensure they can maintain profit.  Processors might want to consider if alternative clauses could be included in contracts to mitigate any potential financial loss.

Contract Variations

Further to the approach taken in relation to limiting variation to prices, the Draft Regulations also provide that the terms of a purchase contract may only be varied by agreement in writing. This is intended to prevent changes to contracts being imposed without both parties’ agreement, meaning farmers must be consulted and agree changes to the contract terms or ultimately not renew or serve notice to terminate the contract. Whilst the ability for a party to unilaterally vary the contract would have likely constituted an unfair term under UCTA 1977 in many circumstances, this change reinforces the position.

Contract exclusivity

The Draft Regulations provide that exclusive contracts cannot specify a fixed volume of milk to be supplied and cannot contain any term which penalises a producer if the amount produced exceeds a certain volume. It is not clear whether a price adjustment for volumes over a fixed target would constitute penalisation under the Draft Regulations, so processors ought to exercise caution. However, it is hoped that is not the case, given it is a common way to smooth supply curves.

Currently, exclusivity is a standard expectation in the majority of dairy contracts, requiring the producer to supply all of their milk to the contracted processor. The introduction of non-exclusive contracts may substantially change business plans and models for processors.  The current contract model is not compatible with non-exclusivity and producers will need to consider how they reflect these changes in the contracts if they wish to fix volume.

Processors should further consider the practical issues of this change such as the cost implications of co-ordinating supply timings, any logistical costs and any increase in their carbon footprint from picking up produce from multiple locations if they are not willing to be bound by the more restrictive terms prescribed to an exclusive contract.

Likewise, producers may see an opportunity to enter into multiple non-exclusive contracts but must ensure that when doing so they are able to meet the supply demands of multiple fixed volume contracts, so as not to find themselves inadvertently in breach.

Dispute Resolution

The Draft Regulations introduce a requirement for a purchase contract to set out a dispute resolution process whereby a producer can make a complaint to the processor, following which the processor must take all steps to investigate and resolve.

Termination

The Draft Regulations also introduce further protection to producers in relation to the termination of purchase contracts. Currently, contracts may be terminated on as little as 6 months’ notice, which the Draft Regulations increases to 12 months, unless there has been a material breach by the producer, or a reduced notice period is agreed with the producer’s consent. Further, the contract may not operate so as to require the producer to give more than 12 months’ notice to terminate.

Producers are further protected by the introduction of a “cooling off period” which will allow the producer to terminate the contract immediately within 21 days of entering into the contract without reason.

Both processors and producers should consider the impact of the new termination protections for producers, which encourages processors to work more productively with producers, rather than taking advantage of the operation of notice periods.

Enforcement Mechanism

The Draft Regulations provide for an enforcement mechanism to be created to ensure compliance. The mechanism gives producers the ability to refer complaints to the Secretary of State, who then has the power to impose either a civil penalty or compensation to the producer upon the processor, or both.

The maximum civil penalty which can be imposed under the Draft Regulations is 1% of the processor’s turnover, and is not subject to a cap, which highlights the importance DEFRA is placing on ensuring that purchase contracts are compliant with the Draft Regulations and remain fair as between the processor and producer.

Whilst we have seen DEFRA take a firm approach to civil penalties more recently, such as removing caps for fines in relation to environmental offences, placing such a stark enforcement mechanism on previously freely negotiated contracts is rather unexpected.

In light of the potential for heavy sanctions for non-compliance, processors should therefore review their contracts to ensure they are in line with the Draft Regulations, as well as ensuring they are acting in accordance with their current contracts.