“Children of a Greater God?”

In a landmark judgement issued last month, the Supreme Court has ruled that under the Sugar Factories Control Act, 1950, “sugarcane growers have a preferential right to recover the purchase price of unpaid goods over the rights of secured creditors (banks) of a mill”. BR Research does not find itself competent to comment on legal jurisprudence relied upon in the judgement; however, the order has laid bare the structural fault lines in the regulatory framework that governs the industry, and demand immediate attention of the legislature.

The Court notes that sugarcane growers have a statutory right to the title of white sugar [produced by a sugar mill] to the extent of their unpaid dues, a right guaranteed under the Act. Furthermore, the Act “arms Cane Commissioner with the coercive tool to recover the price from factory owners as arrears of land revenue”. Thus, the Commissioner has lawful authority to seize any sugar bags under pledge with the bank[s] and force-sell the same to settle the liability owed to growers.

The judgement lays emphasis that “the Sugar Factories Control Act 1950 is a special and beneficial legislation, promulgated to protect the weaker segment of the sugarcane growers”, and thus confers upon them a “statutory first charge”.

Under the law, sugar mills are required to make payments to cane growers within the mandatory 15-day period since date of purchase. Since all of the sugar produced from cane purchased cannot be sold within 15 days, sugar mills obtain bank financing to make payment for the residual amount against pledge of sugar bags.

It is worth emphasizing here that bank financing against pledge of sugar is sanctioned for the explicit purpose of payment to growers. Thus, under normal course of business, the implementation of the Act – that is settlement of grower dues within fortnight - does not warrant any intervention by administration or courts. However, exceptions may arise due to peculiar market conditions that could make the enforcement of the law problematic.

Consider a hypothetical scenario where a sugar mill purchases cane worth Rs 250 million from growers during a given crushing season. Upon processing, the net realizable value of the sugar produced may be Rs 300 million (a realistic assumption based on long-term conversion values). The sugar producer may pledge up to two-thirds of his output with commercial banks i.e. Rs 200 million, against which bank may sanction finance of Rs 150 million after deduction of margin requirement, in line with industry standards.

Thus, out of the Rs 250 million dues owed to cane growers, mill would be able to settle Rs 150 million from bank loans, while it must settle the remainder through own sources, or distressed sale of sugar that is unpledged. In case the market price of sugar falls, the mill would either be required by the banks to post additional margin or arrange liquidity to repay the difference.

This is exactly the peculiar situation that developed between 2016 and 2018 for two consecutive crushing seasons, that sowed the seeds of the crisis of trust that we witness today. Between Nov-2016 and Mar-2018, the retail price of sugar fell by one-third due to two consecutive bumper crops. By 2018, annual carryover stock rose from average of 12 percent in preceding years, to a whopping 42 percent of national demand.

When mills have unsold carryover stock from previous years under bank pledge or own inventory, banks are reluctant to renew financing lines in subsequent seasons causing a liquidity crunch. Under these circumstances, factory owners can either seek permission from the Cane Commissioner to not operate for the entirety of the crushing season, or ensure that they have deep enough pockets to self-finance cane procurement during adverse market conditions.

Remember, under the Sugar Factories Control Act, a functional unit must procure all cane in the reserved area, and duly make payment for the same irrespective of market prices or level of unsold inventory. In case of failure to make payment within 15-day period, the factory owner is liable to pay interest at 11 percent per annum.

The Order notes that the protections extended to sugarcane growers are unique due to their unequal negotiating capacity, one that it compares to “David and Goliath”. In any other case, if a “buyer, when transferred title and possession, may pledge the goods, the unpaid seller would be left without recourse of law but a suit for damages. In cases where the company goes into liquidation and the unpaid seller’s goods are pledged, the right of the unpaid seller, being that of an unsecured creditor when they do not hold a SFC, would give way to the secured creditor.”

Naturally, this assessment raises certain questions. The Sugar Factories Control Act was promulgated at a time when white sugar was a regulated commodity, and mills’ output was purchased by the State, which supplied the same to consumers under ration card system. Because the State guaranteed procurement of all sugar produced, the sugar mills could in turn ensure timely payment to growers. This is clearly no longer the case. While mills have raked in windfall profits in some seasons, their profitability or cashflow is no longer guaranteed as it was in the past.

It is also debatable whether sugarcane farmers – as a cohort – face exploitation. As per last Agricultural Census, cane growers have the highest share in large-sized farms (25 acre+). Based on SBP credit data, cane farmers have the second-highest share (26 percent) in farm credit, second only to wheat. Consider also that area under cane is only one-third of area under rice, yet avails double the amount of bank credit than rice growers!

The law also fails to explain why the statutory protection is not extended to growers of other crops such as cotton, considering that over half of all farms in the country are classified as small-landholdings – five acres or less. If the uneven bargaining position is the only metric, thousands of other Davids must also look towards legislature for preferential treatment through statutory first charge. Countless small-scale vendors routinely face aging receivables from large scale manufacturers – with no “Cane Commissioner” acting as their guardian angel. Are sugarcane growers “children of a greater god?”