Ettelman & Hochheiser, P.C.

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ARTICLES AND NEWSLETTERS

“THE LEGAL BUZZ”
MODELO V. GAMBRINUS: PERFORMANCE DOES NOT COUNT”

Easily, the most noteworthy legal news in the beer industry of recent vintage is the announcement of the arbitrator’s decision permitting Modelo to terminate Gambrinus as of the end of 2006. While the decision may have taken longer than anticipated, no one seemed shocked by the outcome; including us. While contemplating the result of the arbitration, and the widespread effects and potential effects the decision will necessarily have on the industry we were reminded of one of the first “conversations” we had with a brewery executive. We were representing a significant wholesaler in a termination case against a major supplier and we had the opportunity to take the deposition of one of the higher ranking executives of the brewer. Under examination the executive begrudgingly admitted that the wholesaler they wanted to terminate (our client) was actually a better performer than the wholesaler they wanted to use. During one of the breaks in the deposition we were sitting around making small talk when we wondered aloud why they would want to terminate our client in favor of another distributor when our client had been doing a better job. The executive’s response was as shocking as it was eye opening. What he said – in complete sincerity-was “Performance Doesn’t Matter.” When we replied that in our experience performance always mattered, he explained matter-of-factly that if a wholesaler did not fit within their business model, then the wholesaler’s performance simply did not matter.

We think it is fair to say that Gambrinus is living proof that the same applies at the import level as well the wholesale level in this industry. After all, it certainly did not appear that Gambrinus was doing anything but a stellar job, yet Modelo chose to terminate them. Why? Many theories have been discussed, but we think the answer is apparent: Gambrinus simply did not fit within Modelo’s business model; hence, their performance did not count. The interesting part is going to be finding out exactly what Modelo’s business model is. In this article we will discuss a few potential alternatives. Regardless of Modelo’s next move, one thing is certain: a whole lot of folks out there will be impacted. Equally true is if you are one of the potentially effected businesses, you need to prepare your game plan now.

Who Is On Deck?

The big question, of course, is who will Modelo appoint to replace Gambrinus? Industry pundits seem to place the early odds in favor of Barton Beers. By all indications Barton is doing a fine job for Modelo in the West. Further, there have been no major problems between Modelo and Barton that have been publicized. If Modelo’s model is simply to have one importer for the country, consolidating into the Barton house would make practical sense. There is familiarity, there is history, and there would be some economies of scale realized from having only one importer for the entire country. Barton has been a good performer, but does Barton fit into the Modelo business model? Stated otherwise, is the desire to have one importer for the country sufficient to have motivated Modelo to terminate Gambrinus and incur the significant costs associated with that termination? It is possible, but one would think there would have to be more. Then again, one would think that performance always counts, and one would be wrong.

So, if not Barton, then who? The prognosticators tell us that next in line is A-B. Budweiser already owns a large equity position in Modelo; albeit supposedly a non-voting interest. However, we have all read the many accounts of the purported friction between Modelo and Budweiser. Under the circumstances is Modelo willing to place its continued success in the hands of A-B? The allure of a Budweiser/Corona distribution network is, no doubt, strong, but Modelo may believe that the price of admission is too high; particularly in light of the fact that the brands are presently trending in opposite directions.

Still, it is hard to argue with the fact that Barton’s east coast distribution network is not comparable to A-B’s. Barton could elect to continue the presently existing Gambrinus appointed wholesalers rather than attempt to give the Modelo brands to existing Barton wholesalers, but this could create difficulties for Barton, on both legal and practical levels. From a legal standpoint, assuming the existing agreements between Gambrinus and its wholesalers could expose Barton to significant liability. From a practical standpoint, Barton would no doubt prefer to deal with its existing wholesalers, particularly in territories where Barton brands have a strong presence. Accordingly, even if the existing Gambrinus wholesaler for a particular territory was a good performer there are many reasons why Barton’s business model would require it to offer the brand to their existing wholesalers. After all, if performance doesn’t count at the brewery level, it doesn’t count at the import level either.

A third possible alternative for Modelo is simply for Modelo to take over the Gambrinus territory and import the product themselves. No doubt, this is a major undertaking by a brewer that has not had experience importing in the States; particularly given the volume of product involved. However, Modelo certainly has had plenty of time to develop its current model, whatever it is. Moreover, there is an awful lot of money to be made by the brewery if they could pull this off; money that may very well be the subject of Modelo’s business model. Needless to say this would be a bold move on Modelo’s part; one that has the greatest risk as well as the potentially greatest reward. Complicating matters for Modelo would be the fact that they would have to create their own distribution network. One option would be to assume the agreements of the existing Gambrinus distributors, however this would raise significant legal issues for Modelo which could discourage them from doing so.

Which leads us to a final alternative; a joint venture between Modelo and either A-B or Barton. By forming a joint venture Modelo could get a piece of the importing pie and hedge much of the risk that would be associated with importation of the Modelo brand by itself. If Modelo’s business plan includes generating revenues from the importation of its brands into the US, this would be the safest mechanism for them to do so.

The Beer World Waits.

Whatever Modelo decides to do there is sure to be significant repercussions throughout the industry. If Barton does not get the East Coast, either directly or as a joint venture partner with Modelo, it doesn’t take a rocket scientist (or even a mere distribution lawyer) to appreciate that they will have significant concerns about being terminated on the West Coast at some point in the future. From there, everything basically runs down-hill. Existing Gambrinus distributors are necessarily feeling significant angst over the decision and likely are taking little comfort form the oft repeated (but seldom complied with) brewer mantra that Modelo supports their distribution network. Remember folks, performance doesn’t matter!

While many existing Gambrinus distributors may be relying on local beer statutes for protection, there is no guaranty that they will be able to avail themselves of statutory protection if the new importer refuses to recognize their agreements and attempts to appoint another wholesaler. There are many issues that will have to be examined to determine if an existing Gambrinus wholesaler can maintain its distribution rights or be compensated for losing them. Suffice it to say that there are significant arguments that can be raised on both sides of the fence – and no doubt will be.

Then there are the Barton wholesalers. The East Coast Barton distributors are hoping that Barton gets the brand so that they can get a crack at Corona, but there are significant legal hurdles which have to be overcome in order to do so. There will also likely be significant costs to acquire the brand; costs which will have to be analyzed in terms of overall profitability.

Finally, we have approached by some wholesalers that have a somewhat unique problem – they do not have agreements directly with Gambrinus but rather have sub-distribution agreement with another wholesaler. Depending, of course, on the ultimate identity of the new importer, those folks may have significant problems for many reasons, not the least of which is that under many state statutes, they are not considered wholesalers for the Corona product and thus do not have the protection against termination or guarantees of payment that wholesalers enjoy.

Be Vigilant!

If you have followed our articles, by now you should notice one recurring theme – vigilance. Business people hire professionals for two principal functions. First, to clean up the mess after it has hit the fan. Second, to keep the crap from hitting the fan in the first place! We believe very strongly that the folks that prepare for the future through diligent planning and counseling are the most successful and best able to handle the uncertainties which face every business. The unsettled nature of Modelo sales in the East (and West) is a prime example. You can sit on your hands and wait for the proverbial phone to ring or you can act. While there are certain things that distributors can do to protect themselves against the loss of the brand, or to maximize the ability to be offered the brand should the new importer have the right to change distributors, it is essential to develop game plans with your business counselors now. Look at it this way: how long do you think it took Modelo to develop its plans for importation and distribution in the United States? How long do you think Gambrinus spent developing its defense and alternative strategies? Now ask yourself if losing or gaining the Modelo brands would impact your business in a significant fashion. If the answer is yes and you haven’t started to plan your strategies you’d better start today!