Ettelman & Hochheiser, P.C.

100 Quentin Roosevelt Blvd • Garden City, NY 11530 • Tel (516) 227-6300 • Fax (516) 227-6307,,,

ARTICLES AND NEWSLETTERS

“THE LEGAL BUZZ”

SUB-DISTRIBUTION RIGHTS REVISITED

If you have been following our Legal Buzz articles over the years you will no doubt have noted a common theme: vigilance. We are always striving to make wholesalers proactive when it comes to legal or potential legal issues. For example, roughly two years ago in this column we wrote an article on the rights of sub-distributors (See, Sub-Distributors Beware: You May Not Have the Statutory Protection You Think You Have, “Modern Brewery Age”, Summer 2005). In that article we raised a certain hypothetical regarding potential issues that could arise under a sub-distribution relationship where, for example, the rights to import a significant brand is transferred from a major importer to a “Mega-Domestic Brewer”. Our not so subtle reference was to a potential transfer of the Corona/Modelo rights from Gambrinus to Anheuser-Busch. While we may have missed that prediction, it was not by much; the movement of the import rights from Gambrinus did obviously occur, however Barton Beers (Crown Imports) became the successor to Gambrinus as opposed to Anheuser-Busch. In any event, we strongly suggested in that article that any wholesaler engaged in what might even arguably be considered a sub-distribution relationship with another wholesaler review their situation to determine what rights, if any, they would possess if and when such a transfer occurred. Now, that the Modelo transfer has come to fruition, and based upon recent events, many wholesalers have lamented they wished they had heeded our advice. Now, because they were not proactive, many distributors have been placed in a defensive position and are madly scrambling to preserve what they believe are their distribution rights.

THE DISTRIBUTION OF MODELO BRANDS IN NEW YORK STATE

Perhaps this “mad scramble” is best exemplified by what is taking place in New York State. A short peek at relatively recent history is illuminating. Some time prior to the passage of New York’s Alcoholic Beverage Control Law §55-c in 1996, a single distributor claimed to have obtained from Gambrinus the exclusive rights to distribute the Modelo brands in all of New York State. That distributor entered into sub-distribution agreements with a number of wholesalers throughout the state for the sub-distribution of the Modelo brands. Those agreements apparently were all for a one year term and stated expressly that they were entered into on a trial basis. These “sub-distribution” agreements all apparently expired by the express terms of the agreements at least ten years before Barton took over the rights from Gambrinus.

Despite the fact that these initial agreements expired, the wholesalers that initially signed those sub-distribution agreements continued to distribute the Modelo brands in their respective territories right up until the day that Barton took over the reins from Gambrinus. We understand that during the entire time that those wholesalers were distributing Modelo products just about all of their dealings were directly with Gambrinus, not with the “master wholesaler”. Those wholesalers all submitted their purchase orders directly to Gambrinus, Gambrinus accepted their purchase orders and shipped product directly to the wholesalers. Gambrinus prepared annual business plans directly with the wholesalers, listed these wholesalers not as sub-distributors, but as wholesalers on all their various reports and generally dealt directly with all of those wholesalers just as Gambrinus dealt directly with the rest of its network of wholesalers.

On the other hand, the “master wholesaler” apparently has historically done only two things with respect to those “sub-distributors”. First, the “master wholesaler” delivered invoices to the wholesalers for all product purchases (and received payment from the wholesalers which it then transmitted to Gambrinus). Second, the “master wholesaler” initiated the deposits for all containers under New York’s “Bottle Bill”.

That was the course of performance which existed in the New York market between the Modelo wholesalers and Gambrinus for over a decade. One would have thought that, when Barton took over, in order to assure a smooth transition in the market, Barton would have continued the same course of performance in the market. One would have been wrong.

BARTON IGNORES HISTORY

In fact, the very first thing that Barton/Crown did when they took over the import rights from Gambrinus is change the way that business had been conducted in New York for the last ten years or so by (i) requiring all other New York wholesalers to place their orders for products through the “master wholesaler”; and (ii) declaring that the “master wholesaler” had the distribution rights to the Modelo brands for all of New York State and that all other wholesalers were merely sub-distributors of the “master wholesaler.” Obviously, many wholesalers were upset by this turn of events.

Is this really a bad thing for the distributors that are now being treated as sub-distributors? One could certainly argue that nothing really has changed since all the wholesalers are still buying and selling Corona and the rest of the Modelo brands and are still making their profits just as they had before. Who cares if you have to place your orders with a “master wholesaler” or directly with the brewer, as long as you get the beer? The reason that they should care is simple, but profound. In fact, it can be reduced to a single word - EQUITY. More specifically, the burning question that must be answered is: Who owns the equity in the distribution rights in the “sub-distributors” territories? Do the wholesalers that have invested in and built up the brand over the last ten years or so own the equity in their territories, or does the “master wholesaler” own the equity in the other wholesaler’s territory simply because Barton/Crown has now anointed them “Master Wholesaler”? To answer the question, you have to look at the statutory framework and the transactions which resulted in Barton/Crown obtaining the import rights.

As you all know, Barton’s affiliate Crown Imports obtained the import rights to the Modelo brands for the eastern portion of the United States effective January 1, 2007. Under New York’s ABC Law §55-c a “successor to a brewer” is defined essentially as an entity which acquires the beer brands of a brewer. As such, Barton/Crown is a successor to a brewer under 55-c. The importance of this is that successor brewers are obligated under 55-c to honor the terms of wholesaler agreements in existence when they take over the brands. As we have already discussed, Gambrinus did enter into “55-c agreements” with all the so called “sub-distributors,” which agreements were defined by the course of performance between those distributors and Gambrinus over the years. Significantly, under 55-c, a brewer (or a successor to a brewer) may not terminate, amend, or modify a 55-c agreement without good cause. Good cause is narrowly defined to include only an uncured breach of an agreement, certain “bad boy” conduct, and the implementation of a statutory regional or national policy of consolidation. So, when Barton/Crown took over, they were obligated to honor Gambrinus’ agreements with its wholesalers and they could not terminate, modify or amend those agreements without good cause. In other words, under 55-c wholesalers own the equity in the distribution rights in their territories.

Indeed, equity is the key to all beer or franchise statutes. Equity, or the ownership of distribution rights, is what prevents a brewer, successor brewer or master wholesaler from terminating an agreement without cause and/or without compensation. In the absence of wholesaler equity, a supplier is bound only by the terms of existing agreements. Moreover, in the absence of a written agreement a supplier can terminate a non-equity owning wholesaler without cause, on reasonable notice, and without compensation. Turning back to our example, if the “master wholesaler” owns the equity to the distribution rights - and according to Barton they do - the “master wholesaler” can terminate any so-called sub-distributor that does not have a written agreement which prohibits termination simply by giving reasonable notice, and without payment of any compensation of any kind or nature. On the other hand, if Barton recognized and honored the distributions agreements that those wholesalers created and developed with Gambrinus, i.e. if the “sub-distributor” wholesalers own the equity to the distribution rights in their territories then neither the “master wholesaler” nor Barton could terminate those rights other than by complying with NY ABC Law §55-c.

Some wholesalers have asked whether they can just wait and see what happens. After all, they are still getting beer - even though they have to buy from the “master wholesaler”. Further, they argue, it’s not likely that the “master wholesaler” would want to terminate them since they aren’t in the master wholesaler’s footprint. Although the argument is attractive in its simplicity, here is the problem with the logic. First, remember what we said about how business was conducted with Gambrinus for over a decade. It is precisely because of that course of performance that all of the “sub-distributor” wholesalers may claim statutory “agreements” with Gambrinus that are binding on Barton as a successor. Remember also, that the very first thing that Barton did was change the way that business has been done under Gambrinus. By changing the course of performance and, particularly, by actually purchasing beer from another wholesaler instead of directly from the supplier these wholesalers are creating a new course of performance; one which arguably may support the claim that they are, in fact, sub-distributors and not direct distributors. The key to all of this, of course, is the fact that the various protection of 55-c do not apply to sub-distributors, hence sub-distributors have no equity under ABC Law §55-c. Second, while there may be no immediate risk that the “master wholesaler” may want to pull the brand from one of its “subs” since they do not deliver in the sub’s footprint who is to say whether they may expand into the territory in the future. Or, what if one of the sub’s competitors offers the master wholesaler big chunk of money to purchase the distribution rights in a sub’s territory. Either way, what may have seemed like an unlikely event can become a likely event overnight.

ONCE AGAIN, WITH FEELING: BE PROACTIVE

The point of all of this is straight-forward. If you are in a sub-distribution relationship or believe that a supplier may claim a sub-distribution relationship, you must take action to protect your equity. There are a number of things that can be done, the most obvious of which is negotiating an agreement with your wholesaler supplier. In fairness, this is precisely what the so-called “master wholesaler” of the Modelo products has promised its erstwhile “sub-distributors” in New York. The key is making sure that your agreement recognizes that you and not the master wholesaler owns the equity in the distribution rights in your territory. Do not be fooled by an agreement that purports to give you equity but does so in a way that you are not getting what you have bargained for. For example, if the proposed agreement grants you equity in or recognizes that you own the sub-distribution rights as opposed to the distribution rights you may not be getting what you think you are. That is because you may be subject to a state statute, such as New York’s ABC Law §55-c that does not recognize sub-distribution rights. Accordingly, the fact that you own sub-distribution rights may effectively mean nothing. Bottom line: make sure that the agreement gives you the equity that you would otherwise enjoy as a wholesaler under the circumstances. To paraphrase a famous actress, without equity, you are simply relying upon the kindness of strangers.

Be vigilant!!