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“Distributors: Know Your Rights in Brewery Consolidations”

by Gary Ettelman, Esq. and Keith Hochheiser, Esq.

Ettelman & Hochheiser, P.C.
100 Quentin Roosevelt Boulevard, Suite 401
Garden City, NY 11530
(516) 227-6300 • www.e-hlaw.com

Distributor consolidation is a fact of life in today’s beer industry. However, the termination notice of a distributor’s contract is not necessarily the final word on the issue. In fact, there are many protections available to distributors, both through a well-negotiated contract, as well as existing statutes and common law. Understanding these “bundle of rights” and how to leverage them is in the best interest of every distributor.

“State Franchise Laws – Only A Starting Point”

The vast majority of states have implemented specialized franchise laws which provide protection to beer wholesalers. Most of these statutes primarily focus on protecting against termination without cause. Accordingly, when faced with a potential termination, one of the first things that counsel will do is determine if there is beer wholesaler legislation concerning the relationship. Many lawyers will undertake only a two step analysis – 1. What does the contract say about termination?; and 2. Is there a beer statute that governs? However, even in states which have not enacted specific beer wholesaler legislation, protection against termination without cause may sometimes be found in more general franchise statutes. Typically, qualifying as a “franchise” under general franchise statutes is not difficult. Accordingly, these statutes must be analyzed as well.

Most distributors and, worse, many lawyers believe that the inquiry ends after reviewing the distribution agreement and state franchise laws; the truth is, it is only the beginning of the inquiry as to what constitutes the distributor’s bundle of rights. These bundle of rights are critical to distributors whether or not there is a beer franchise statute on point. It is these bundle of rights that increase the value of the distributor’s business interests and provide significant protections against terminations.

“Distribution Rights as Intellectual Property”

Perhaps the most important right a distributor may have is the classification of its distribution rights as Intellectual Property (IP) as opposed to a mere contractual right. The distinction is profound. As a contract right a distributor only has the limited rights stated in the contract and these rights only last while the contract is in force. On the other hand, IP is an asset, which may not be taken or diluted without appropriate compensation.

Courts have recognized that distribution rights may, under certain circumstances, be properly characterized as IP. This is due to the fact that the distributor typically has a history of building a brand within a given territory. It is the distributor (i.e., company executives and employees), after all, who creates the goodwill with the customer, which, in turn, can be credited with building incremental sales and consumer loyalty for a particular brand. Furthermore, in marketing a brand, the distributor typically makes substantial investments to advance product sales. These investments may include building temperature-controlled warehousing, purchasing trucks and painting brand logos and participating in various advertising and marketing promotions. These investments are generally made at the request of the brewery or in fulfillment of requirements under the distribution agreement.

Since the rationale for enacting franchise laws to protect distribution rights often involves a recognition of the “equity” that distributors develop in their brands, these laws substantiate the case for distribution rights being viewed as the distributor’s IP, even in states that don’t have franchise laws. Various other state and federal laws also bolster this position.

Further proof of distribution rights as an IP asset may be found in the various documentation involved in the brewery/distributor relationship. This documentation may include assignment documentation between distributors and brewers, financial reporting documents and statements, and tax allocations and methodologies.

Additional support may be found in various sections of the Internal Revenue Code which deal with the treatment of certain intangible assets. Combining all of the above, distributors may have strong arguments that their distribution rights should be treated as an asset, and not a contract right.

Significantly, the IP value of distribution rights are typically considerably higher than the termination value assigned in the distribution agreement (i.e. the contract rights). Support for this conclusion is found in various federal legislation and common law as well as in widely accepted economic theories. Perhaps the most important aspect of distribution rights rising to the level of IP is that a distributor has the right to protect its IP and can preclude others from infringing upon those rights. This is because of various rights and protections afforded under federal legislation concerning IP rights. This means, for example, that even in the absence of an exclusive distribution agreement, a distributor may be able to prevent a brewery from appointing other distributors to compete in the distributor’s territory, and from terminating the distributor’s IP rights without payment for the termination of those rights.

“Benefits Afforded Under the UCC and Common Law”

Another significant part of the distributor’s bundle of rights is found in various sections of the Uniform Commercial Code (UCC). It is imperative that distributors know that the UCC applies to every beer distribution agreement and is supplementary to the actual contract between brewery and distributor. The UCC often provides the distributor with substantial rights – even when the distribution agreement provides otherwise. While distributors can gain the optimum protections by tying into certain sections of the UCC during the initial contract negotiations, this body of law nevertheless affords rights to distributors with existing contracts. For example, contractual termination rights that are very favorable to the brewery may not be enforceable under the Uniform Commercial Code. The Uniform Commercial Code also offers substantial protection and assistance to a distributor that wants to sell or assign its rights to third parties. It provides protection from a brewer’s failure to consent to the assignment, irrespective of the existence of a franchise statute.

Often times a brewery will unknowingly trigger a particular provision of the UCC which creates a heightened duty for the brewer to supply product to the distributor as well as a substantial obstacle for terminating the distribution agreement. For these reasons, it is essential that distributors utilize a law firm experienced in the UCC and its broad application to assist distributors in asserting these rights, whether negotiating a distribution agreement or analyzing a distributors rights with respect to a threatened termination.
In addition to the UCC, various state statutes and common law protect distributors against unfair business practices. One practice, which may qualify as “unfair” is the unauthorized utilization of a distributor’s confidential sales information. It is common practice for breweries to mandate certain reporting requirements of their distributors. Distributors are often required to routinely report such information as their customer lists, quantity of sales, pricing and products sold to specific accounts. Legally, this is the confidential information of the distributor and can not be utilized by any party other than the distributor. If, after terminating a distributor, the brewery discloses this confidential information to the terminated distributor’s successor the terminated distributor will have a claim based on unfair competition. There are numerous other practices which constitute unfair competition and which are prohibited by various statutes and common law. Sophisticated counsel will be aware of this element of the distributors bundle of rights and analyze a potential termination in light of these various unfair competition laws.

Another right that we have utilized successfully is enjoining distributor terminations is the “recoupment theory”. This is a theory which relates both to the principle of fair business practices as well as recognizing the distribution right as IP. The recoupment theory simply provides that where a distributor is required to make certain investments in order to carry the brewery’s brand, the term of the distribution agreement may not be shorter than necessary for the distributor to recoup its investment together with a reasonable profit; notwithstanding a provision in the agreement that permits the brewer to terminate before that time. Accordingly, in those cases where the distributor has made substantial investments and has not had a sufficient period of time to earn a reasonable rate of return on that investment many courts will enjoin a termination. In addition to the foregoing statutes and laws a distributor’s course of performance with a brewer, i.e. the actual manner in which the parties have conducted business, may create additional rights or even contradict written terms of an agreement. An experienced attorney will first look at the contract and then compare its terms to how business has actually been conducted.

“Two Basic Principles”

Distributors should recognize two basic principles in their relationships with breweries. First, it is important to understand that a properly negotiated contract at the outset gives the distributor the greatest opportunity to maximize its bundle of rights. Second, distributors should not make the common mistake of believing that their contract is the final word or that it is enforceable as written. Instead, distributors should realize that a distributor’s bundle of rights always supplements the written contract. This is true regardless of any clause in their agreement which provides that the written agreement is the entire agreement between the parties (i.e. what is commonly called a “merger clause”).

“Be Proactive”

The protections we have discussed in this article are by no means exhaustive of all the remedies and protections afforded distributors but are merely demonstrative of the many rights that distributors enjoy. The key is to know what your rights are. Although a well negotiated contract will give a distributor greater protections, distributors with existing agreements should not despair in believing they have only minimal protection. As discussed, the contract is just the starting point. Moreover, modifications may be requested from time to time by a brewery which will give the distributor the opportunity to revisit some issues. In any event, to obtain the maximum protection, distributors must be proactive not reactive. Distributors should not wait until they are being terminated to seek legal advice. At the first sign of problems with a brewery and suspicion of a possible termination, distributors should contact qualified counsel. Our experience has been that there are always measures that can be taken, not only to thwart a termination, but equally important, to help create a better working relationship with the brewery. As a result of strategies outlined by experienced counsel, you too may be able to prevent being consolidated and at the end of the day, establish a stronger relationship with the brewery. The key is to know your particular bundle of rights.

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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