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1608 PD: Challenging USDA milk marketing orders; complexity hurts farmers

Ben Yale Published on 06 November 2008

As any experienced litigator will tell you, how a lawsuit and what it is fought over differs from why you are in court in the first place. When it comes to court challenges to administrative decisions, the difference between what happened in the rulemaking and the litigation can be even more different.

So it was in the court challenge to the recent USDA decision to shift a quarter of a billion dollars from the pockets of producers to processors. A group of seven dairy cooperatives, United Dairymen of Arizona, Select Milk Producers, Zia Milk Producers, Lone Star Milk Producers, Arkansas Dairy Cooperative Association, Maryland Virginia Milk Producers and Continental Dairy Products, along with two producers, sued USDA to stop its implementation of higher make allowances. After being first in U.S. District Court and then the Court of Appeals hours later, both courts denied the demand for an injunction.

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The rulemaking that led to this lawsuit was supposed to lead to improvements in the end product formulas. These are the formulas used to set component prices and minimum prices in the milk marketing orders. The industry made a wide range of proposals. These included changes to the products being used for pricing, product yields and make allowances. There was even a proposal to replace end-product pricing with a competitive pay-price program. In the end, except for correcting an obvious error in a yield, the USDA ignored all of those proposals and only increased make allowances.

End-product pricing is reverse-price engineering. It starts with a finished basic dairy commodity product, such as nonfat dry milk (NFDM), and works backwards in the processing chain to arrive at the value of the milk used to make that product. This is done by deducting from the price of the product the costs of manufacturing and then multiplying the result by the number of pounds of product that comes from a pound of commodity. For NFDM, that is the pounds of NFDM yielded from a pound of solids-not-fat (SNF).

The acronym, PAY, summarizes the formula: Product price less Allowance for manufacturing times Yield. Using this basic system, prices are determined for the components butterfat, protein, SNF and other solids. The protein component is more complicated due to the adjustment for the value of butterfat, but fundamentally it uses the same methodology.

In theory, it seems like a workable plan. In individual plant contracts with producers, such agreements can accurately reflect what is happening to that particular milk. But when the single formula is expected to cover every plant in the entire country, it fails. The values used in the formulas have no consistency. Prices come from one sector of the industry, make allowances come from another overlapping but distinct sector, and the yields, well, no one knows where they come from. The result is a formula designed to represent plants making the product but represent no plant.

Farmers understand how this works. County agents, salesmen and nutritionists all tout a certain feed mix, or process or procedure. They say it worked on another farm, but it does not work the same on yours. Different farms get different production from the same kind of cows and similar feed. Costs vary between farms. Size of operations can impact costs. So it is with manufacturing plants – there is a lot of diversity, too much to capture in a single formula.

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Plants make a multitude of products. The formulas only focus on a few. For example, 40-pound block and 500-pound barrel cheddar cheese represent the value of all cheese products. The fast-growing use of 640-pound blocks is ignored, as is volume of Italian style cheeses.

NFDM pricing has not been straightforward, either. Last spring, the USDA discovered that many powder plants were not accurately reporting their sales and were effectively reporting cheaper sales and not higher-value ones. The USDA investigated and estimated that producers lost $50 million dollars by this “mistake.”

The problem is bigger than that. A typical powder plant makes not only NFDM but skim milk powder (SMP). SMP is dried milk of which the protein content is standardized. NFDM is the dried milk after removal of the fat. Plants also produce condensed skim. Condensed skim milk is essentially NFDM before it is dried. All the solids are there, and in some processes this is preferable to the powder. Plants produce and price whatever is the most profitable for the plant.

Even if it were only NFDM, there are multiple ways to price the product, not all of which are captured for the formula. Do you include those that are long-term contracts, exports, inside sales, etc.? In addition, a powder plant also produces buttermilk and dried buttermilk powder. The USDA only looks at NFDM and ignores higher-valued SMP, condensed and buttermilk.

Yields are not so simply defined either. USDA, despite using this formula for almost 10 years, has refused to conduct any study on product yields. Instead, it relies on yields it made up itself. Here is the result of such logic: NFDM is SNF plus water. By weight, the moisture in NFDM is about 3 to 5 percent of the product. What that means is that SNF with 3-percent moisture can result in 1.02 to 1.03 pounds of NFDM per pound of dry SNF. But the USDA’s yield is 0.99. That’s right, the USDA says that if a plant takes 1 pound of dry SNF and adds water, it gets less than a pound of finished NFDM! It would be laughable except it costs dairymen dearly.

Here is the implication on the formula: Assume a pound of NFDM sells for $1 per pound. Assume the make allowance is 16 cents. Subtract 16 cents from the dollar for a net of 84 cents and multiply that by the yield for 83 cents. That is what plants have to pay for the SNF in raw milk. But reverse this. A plant pays 83 cents for a pound of SNF and by adding water the plant actually gets a yield of 1.03 pounds of NFDM. Instead of receiving $1 from the pound of SNF, it actually receives $1.03. That gross receipt less the 83 cents paid for the milk means that plants are really receiving a “make allowance” of 20 cents, not 16.

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Now move the price to $1.50 per pound. The net price less the make allowance is $1.34 and at 0.99 yield, the value of SNF is fixed $1.327. At the true yield, the pound of SNF will yield 1.03 pounds of NFDM worth $1.545. Subtracting the minimum component price, the difference now approaches 20.5 cents.

There is more. The bulk of the NASS price that drives these formulas comes from plants in California. Plants there produce more half of the powder in the U.S. Plants east of California generally sell powder for more than the NASS price. The NASS price is an average price between the lower West Coast and the higher central and eastern areas. This can range several cents. Add that back into the formulas and now even though the make allowance is stated at 16 cents, the real margin for plants exceeds 20 cents.

But in the Never-Never Land of rulemaking, the truth about pricing and yields is ignored, and the USDA surveys limited lower value commodities, uses a make allowance for plants not from the same plants surveyed and uses yields lower than the plants’ reporting prices truly realized.

Though this example uses powder, the same issues are present in each of the other formulas in some degree. In the case of yield in the cheese formula, it is far worse than for powder. Producers are almost consistently on the wrong side of the pricing formulas. But no one is happy with the formulas. Over the years, everyone (plants and producers) has been asking for changes. The secretary invited proposals and proposals were made.

At first, the USDA decided only to hold a hearing about make allowances and exclude the other issues. After the close of that hearing in 2006, it discovered there was no evidence as to what make allowances were and reopened the hearing to hear a witness hired for that purpose. After the hearing, the USDA raised the make allowances relying on that witnesses’ testimony. Some producers sued in U.S. District Court, but that court, among other things, held that the Agricultural Marketing Agreement Act (AMAA) requirement that the costs of feeds be considered in setting minimum prices was being done “indirectly” and that was all that was required.

While that lawsuit was pending, the USDA commenced a hearing to consider proposals addressing all of the issues of pricing, yields and make allowances. It lasted 12 days, was held in three locations, utilized lots of witnesses and generated reams of exhibits. Almost a year after the last witness testified, the USDA issued a decision raising make allowances, correcting a long-standing, obvious mathematical error in the butterfat formula and ignored the other issues.

As for the make allowances, the USDA used yet its fourth method in four hearings on how to derive make allowances. Because the witness hired by the USDA to survey make allowances admitted that the make allowances he reported for cheese in the prior hearing were too high (and no doubt also because he said most efficient cheese plants were making cheese at about a 10 cents per hundredweight), the USDA chose to ignore all of that and, in its place, adopted in total the higher make allowances for plants in California as surveyed by the California Department of Food and Agriculture.

The impact was hard on producers. The USDA said, “An increase in make allowances has the immediate effect of lowering Federal Milk Market Order (FMMO) component values which, through price formulas, translate into decreased minimum prices for milk and a reduction in producer revenue.” The USDA’s economic analysis, which was prepared to accompany the Formula Rule, estimated that the direct monetary impact on dairy farmers was a reduction in producer receipts of $156 million on average for nine years, with “the greatest producer revenue impact” of $262 million in the first year.

During the hearing, Congress noted that the USDA was ignoring producer costs in making milk and the courts were not enforcing AMAA, so it added a new section to the law governing milk orders. It required the USDA Secretary, as a part of any hearing that considered make allowances and held before September 2012, to determine the costs of feed and fuel incurred by producers for each month and for each marketing area and consider those costs when deciding whether or not to adjust make allowances.

After a letter requesting the rule be reconsidered in light of the new law, the cooperatives sought judicial review of the make allowances. Obviously, the reduced minimum prices and reductions in incomes was the real pinch. But that could not be the issue in court. This is because under the law, such decisions are generally left to the agency. As a result the cooperatives could not sue on the issue most dear to them – make allowance increases which transfers wealth from the farm to the plant. Rather, they had to show that the USDA failed to comply with law. The primary challenges were that the USDA failed to comply with the requirements in the 2008 Farm Bill and the requirement that the USDA must consider economic factors within the marketing areas.

The relief sought was an injunction pending trial on the rest of the case. To obtain an injunction, you have to prove that there will be irreparable harm, likelihood of success on the merits, that others will not suffer significant harm and protection of the public interest. This begins to move farther and farther away from mistaken make allowances.

Irreparable harm is defined as a harm for which there is no remedy. For example, if there is a 200-year-old oak tree in the town park, and the town fathers want to cut it down, the injury would be irreparable because there is no money to cover the loss of something so unique. As a result, the court will hold up the cutting down until the authority of the town to cut it down is decided. In the challenge to the make allowances, the cooperatives argued that when minimum prices are reduced, producers will never be able to get those back. After all, that is why the program is so important to producers. The USDA in its economic analysis agreed with that; in court it argued that the minimum price reduction would not reduce producer income.

To further detour the cooperatives from the relief producers sought, a much larger issue arose – the right of producers to even be in court to seek judicial review of milk marketing order regulations. There is a law called the Administrative Procedures Act, which generally allows any person adversely affected by a final agency rule to seek judicial review. There are several exceptions, and the USDA argued that the law governing marketing orders, denies producers the right to challenge the USDA Secretary’s actions in court. In short, the secretary can mess with the minimum prices all he wants and even violate the law in doing so, but producers have no legal redress. That is the position that the proprietary cheese plants offered. The secretary agreed at trial, and the court held accordingly.

Over the years, courts have wrestled with judicial review of marketing orders. There are some nuances, but generally the Supreme Court and most of the Court of Appeals have indeed allowed producers to seek judicial review. On the other hand, handlers have been required to exhaust an administrative remedy before the secretary and then appeal that to the court.

The government argued that producers have the right to ask for a rulemaking hearing, to participate in the hearing, to comment in the hearing and to vote on the order. Then they have no right to judicial review. The Ninth Circuit, which includes the West, has taken that position. All other circuits have taken a different position and allowed for producer participation. As one court in Cincinnati said, the position of the government was “radical.” Until now, the D.C. court had largely allowed for suits by producers, but not handlers.

By finding that the court did not have to hear the case, the matter effectively was dismissed. Nonetheless, the court went on to consider other issues. Determinations come when the USDA issues a decision in a hearing, not at the hearing itself. The government argued, and the court agreed, that since the hearing was already over with before the law went into effect, the new law did not apply; the second issue was whether the law applied to a hearing already closed. The issue was more complex than that because what the law required, the secretary could do without the hearing and would only have done after the law passed. Again, the USDA got a pass.

Finally, the court held that the USDA does not have to directly consider producer prices; it can do so “indirectly.” Thus, the word “determine” which is to “fix as certain” has in the world of the USDA become “in a round-about way.”

As this article shows, producers have little say in how their prices are fixed. When mistakes are made, they have no redress. That is the position of the government. Now, no decisions have been made, but I expect that the standing issue will be raised on appeal. It is too important to let stand (no pun intended.) As for the mispricing of producer milk, that needs to be corrected by producers. A change in administration might help the issue, but there is no way to know that now.

So what do producers do? Educate themselves first. It is essential that producers hold their cooperatives accountable. This enormous farm-to-plant wealth transfer was called for by some producer-owned cooperatives who were struggling in their manufacturing operations. They took their own members’ income from other sources and gave it away to cover up the relative inefficiencies in their plants, relative to other plants throughout the country. This was done by reducing the price they account for their milk. To reduce the milk prices to make the cooperative plants look profitable meant that proprietary plants, bottling plants, ice cream plants, mozzarella cheese plants and yogurt plants, get cheaper milk.

Second, producers need to join with others to pressure the USDA to follow the law and respect the investments of producers. The USDA has it upside down. It believes if plants go, producers go. That is not true. If there is no plant, producers will build one. If there are no farms, plants will disappear. More money is invested by farmers in the production of milk than in the plants that process it. They need to remain viable. But the rules are stacked against producers from the start and by the time one gets to court, the ability to stop the damage is nearly impossible.

Third, producers need to decide what if any further role the USDA will play in setting prices. It does not take the government to reduce producer prices; they can do that without any orders. If the purpose will be to fund plants, not keep producers viable, then producers may have to seriously consider saying ‘no thanks’ to the order system.

Courts are a last resort, and sometimes a futile one, to stop the excesses of government action. By stopping the insanity before it gets started is a safer bet to ensure that producers are not harmed further by government error. PD

Ben Yale
Attorney at Yale
Law Office

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