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“The Legal Buzz”
“CONSOLIDATION: AN OFFER YOU CAN REFUSE -- BUT MAY WANT TO ACCEPT”

By Gary Ettelman, Esq. and Keith B. Hochheiser, Esq.

It is certainly no secret that brewers have been aggressively seeking to consolidate their domestic distribution channels. Typically, when a brewer decides to consolidate, their first step is to encourage one or more of their distributors to sell their distribution rights to the brewers chosen survivor. Indeed, some brewers can be quite emphatic in their “encouragement”. Fortunately, wholesalers do have a choice. In most circumstances when the brewer “offers” you an opportunity to sell your distribution rights to one of your competitors you do not have to accept. Wholesalers have a “bundle of rights” which typically protect them from “without-cause” termination. These rights were the subject of a previous article that appeared in this publication. However, for various reasons, a wholesaler may be well-served by agreeing to sell or swap its distribution rights to a particular brand. In addition, there are always instances where a wholesaler simply wants to buy or sell distribution rights to a brand in the absence of any brewer influence. Either way, it is important for wholesalers to understand the legal nature of the transaction and to have appropriately drafted agreements to protect themselves from unwanted and unintended results and to make sure they get what they have bargained for.

The Right to Assign

In transactions involving the sale of the right to distribute individual brands (otherwise known as an “assignment”) a variety of legal issues arise between and among the buyer, the seller and the brewer. The first issue that must be considered, is whether the seller has the right to assign the distribution rights to the brands. The starting point for this inquiry is the distribution agreement. If the distribution agreement does not expressly prohibit assignment; i.e. if it is either silent on the topic or if there is no written distribution agreement, the general rule is that the distribution agreement will be freely assignable without the consent of the brewer. There are, however, some important exceptions to this rule. The most important of these exceptions in the context of the beer industry is that a contract may not be assigned if the brewer can establish that: (1) the brewer has a “substantial interest” in having the original party perform the contract; or (2) the assignment would “materially change” the duty of the brewer, or “increase materially the burden or risk imposed” on the brewer.

The second level of inquiry is any state franchise or “beer statute” in your jurisdiction. Often times such statutes include provisions which, in essence, prohibit a brewer from “unreasonably” withholding its consent to a request for permission to assign. Generally, the reasonableness of a brewer’s decision will depend upon two factors, the capability and the credit worthiness of the proposed assignee. Accordingly, even if your distribution agreement purports to give the brewer the absolute right to withhold its consent to a proposed assignment; there may be a controlling statute which gives you the right to assign.

It is absolutely essential, however, that you verify that you have the right to sell (either with or without brewer consent) before you pursue the transaction. A distributor that attempts to make an assignment in violation of its distribution agreement or who fails to obtain the required consent of the brewer under the distribution agreement, will be in breach of the agreement giving the brewer the right to terminate either under the distribution agreement or state law.

Drafting the Contract

After you determine that you have the right to sell, it is time to prepare the contract. There are many issues to be dealt with in an agreement relating to the sale of distribution rights which will change depending upon the particular circumstances of each deal. The following are examples of some of the more pertinent issues.

A. Assignment of Rights v. Assignment of the Distribution Agreement: A Meaningful Distinction.
If the transaction is structured as an assignment of the distribution agreement, there are significant, automatic and probably unintended liabilities for both the assignor (seller) and assignee (buyer). As an example, the seller automatically guarantees to the brewer the buyer’s future performance under the distribution agreement. Likewise, the buyer automatically assumes all outstanding obligations under the distribution agreement, including obligations relating to the seller’s past performance. It is important to note that these obligations arise by operation of law. Accordingly, these obligations apply even if the assignment documentation is silent on those issues.

In light of the foregoing, the best procedure is to assign the rights to distribute the brand (as opposed to the distribution agreement) and to obtain an acknowledgment from the brewer and the purchasing party that simultaneous with the making of the assignment, the old distribution agreement will be terminated. The buyer will then have to obtain a new distribution agreement from the brewer.

B. Purchase Price. Since the purchase price of any sale is typically tied to sales of 24/12 ounce case equivalents (“CE’s”) for a given period, it is important to define the elements that go into calculating CE’s. Again, however, the particular requirements will change according to the specific situation. For example, if transshipping is an issue, a purchaser is not going to want to pay for CE’s sold or consumed out of the territory. Similarly, determining the end of the measuring period for sales may be important if there is a concern that the seller may dump beer in the market in order to artificially inflate the CE count. Once the number of CE’s is agreed upon, the seller should represent that the volume is accurate.

C. Acquisition of Inventory. The assignment agreement should always include the acquisition of saleable inventory by the purchaser. First, the agreement should define what “saleable” inventory includes. Typically this will include all products within a certain number of days of the brewer’s freshness policy. This way the purchaser is assured that it is only obligated to buy beer from the seller’s inventory that it can resell. Second, the agreement should fix the purchase price for the inventory at seller’s “laid in cost”. “Laid in cost” should be defined to include the actual purchase price paid by the seller, plus tax, plus freight costs incurred in shipping the product from the supplier to the seller’s warehouse. Finally, the agreement should contain the party’s agreement on the timing and procedure for the pick-up and payment of the inventory purchased by the purchaser.

D. Stale Beer Pick Up. It is typical for a supplier to require its distributors to retrieve stale products in the market. Depending upon the product and the market, this may be an important issue for the seller and purchaser. A purchaser may not want to be responsible to pick up stale beer sold by its predecessor but may be compelled to by the brewer. When this is an issue, the agreement should include a provisions that fixes a specific date when the responsibility for stale beer in the market shifts from seller to buyer.

E. Bottle Bills. “Bottle Bills”, the colloquial name for the laws requiring a minimum refundable deposit on beer and other refillable and non-refillable beverage containers, have been enacted in eleven states. If your business conducts operations in one of these states, it is necessary to determine whether the buyer or the seller bears responsibility for these obligations after the assignment of brand distribution rights. This obviously requires an examination of the applicable statute and regulations. Unfortunately the answer is not always readily discernable. For example, under the regulations to New York State’s Bottle Bill, a wholesaler that discontinues selling a brand may be responsible to redeem containers of the brand for 60 days after the brand is sold. In any event, the various statutes and regulations do not preclude the parties from making their own arrangements. Accordingly, the agreement should properly allocate Bottle Bill concerns. For example, it is sometimes prudent for the purchaser and seller to contractually agree that the purchaser will assume the seller’s obligation to redeem empty beverage containers for the product acquired as of the closing date, in exchange for a credit to the purchase price based upon the seller’s redemption history for the brand. In this situation it is essential that the assumption be prospective only; if the buyer assumes all of the seller’s obligations under the applicable Bottle Bill, it may find itself responsible for the seller’s pre-assignment violations.

F. Make Sure You Get What You Pay For. As already noted, the purchase price of any acquisition is generally based on CE’s sold within the territory in a given period. In addition to making sure that you aren’t paying for CE’s that were sold outside of the acquired territory it is extremely important to obtain account level information relating to the acquired customer base in the territory. A good practice is to incorporate a Schedule in the assignment agreement which lists the names and addresses of each customer, the names of the managers, the customers’ purchase history, including timing of purchases and pricing during the period used to calculate the total number of CE’s, the last purchase and delivery dates and the customers’ empty container redemption history (if applicable). Without this information, the purchaser will not realize the full value of the good-will it has paid for.
G. Preserve the Value of the Good-Will. Once you’ve paid for the good-will, you want to make sure that you retain it. To do so, it is important from a purchaser’s perspective to preclude the seller from continuing to distribute the acquired brand in its territory after an assignment. Accordingly, the contract should include provisions that, post-closing, the seller will not distribute the acquired products anywhere in the acquired territory, or represent itself as a distributor of the products in the territory.

H. Agreements Pending Closing. We’ve all heard stories where a terminated wholesaler is able to convince his customers to replace draught lines or shelf space with other products that the wholesaler still sells, prior to the time that the new wholesaler gets the brand. While this may be an example of “all is fair in war” in an involuntary termination, as a purchaser in an arms-length transaction you don’t want this to happen to you. To make sure it doesn’t, the assignment agreement should include certain covenants by the Seller to the effect that from the date of the contract and pending the closing the Seller will (i) preserve existing shelf space and location for the products on the premises of the seller’s customers; (ii) preserve existing draught lines for the products on the premises of the seller’s customers; and (iii) continue to promote, sell and distribute the products consistent with past business practices.

In the final analysis, what may seem like a simple transaction is fraught with potential problems for the unwary seller or purchaser. This does not mean, however, that you have to draft a lengthy and complex document to cover the various issues. To the contrary, the agreement should be short and succinct; appropriately addressing the significant issues for the particular transaction to assure that you get what you have bargained for. When the transaction involves the sale of the entire business of a multi-brand wholesaler, the legal issues become increasingly numerous and complex. This will be the subject of a future column.
We hope that the information provided has been informative.

Gary Ettelman and Keith Hochheiser are co-founding partners at Ettelman & Hochheiser, P.C., a national law firm concentrating in corporate and commercial transactions, distribution and licensing agreements, mergers/acquisitions, tax-free reorganizations and related litigation. The firm can be reached at: (516) 227-6300 or www.e-hlaw.com

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