Contract Considerations For The Craft Beer Distribution Relationship
By Mulcahy LLP on May 19, 2016
The explosion of craft breweries in the U.S. has injected countless brewers and labels into this burgeoning market. Competition for shelf space and distributor attention often forces anxious and inexperienced brewers into unfavorable distribution relationships that can be detrimental to the development or existence of their brands.
Regardless of the size and sophistication of the brewer, there are certain activities that a prudent brewer must undertake before entering into a distribution relationship. For instance, the brewer should set realistic goals and develop a distribution strategy that maximizes the local market(s) and the name recognition for the brand. Likewise, the brewer should fully vet multiple distribution candidates to locate the distributor with the capacity, resources, and market penetration necessary to achieve the brewer’s goals. A sound distribution strategy and the right partner are keys to the success of any brand.
Of similar importance is the parties’ use of a well-crafted contract to govern the rights, duties, and expectations of the distribution relationship. Amazingly, however, many distribution relationships are guided by no more than a “handshake deal.” This is a recipe for disaster.
In today’s internet era – with seemingly unlimited form contracts a mouse click away – there is no good reason to enter into a distribution relationship without a binding, written agreement. Representations that the distributor is going to invest time, money and other resources developing a market for a brand should be reduced to writing. A distribution agreement provides the parties with a roadmap for their relationship and helps to avoid future misunderstandings that can lead to costly litigation.
In the absence of a written agreement – or in certain circumstances, irrespective of the written agreement – many states have beer franchise laws that supply the key terms governing the beer distribution relationship. However, these laws are limited and should not be used as a substitute for written distribution agreement. Important issues such as payment terms, stock rotation, competing labels and other items critical to the relationship are not covered by the franchise laws. Moreover, state franchise laws historically favor the distributor and a properly crafted distribution agreement can be used to help blunt some of the one-sided aspects of these laws.
Having underscored the significance of a written distribution agreement, the purpose of this article is to identify and address several of the contract terms that the brewer should strongly consider before signing on the dotted line. While the enforceability of many of these terms may vary from state to state depending upon the applicable beer franchise laws, each of these terms may prove critical in the future growth and development of a brand and are at least worth discussion irrespective of the laws of the state.
1. Territory Limitations
Territorial limits pertain to the geographical areas or locations outside of which a distributor is not permitted to distribute the brewer’s labels or other products. For instance, a distribution agreement that limits the distributor to a specified county or series of zip codes within a region precludes the distributor from offering the brewer’s products outside of the identified county or zip codes.
Territory limitations can be necessary for a variety of reasons. For instance, it may be wise for young and unproven brands to only offer product to a smaller geographic territory closer in proximity to their place of business and those retailers and consumers that may be more familiar with the products. Alternatively, the brewer may desire to limit the territory to the distributor’s proven geographic territory irrespective of the brewer’s location. Under either scenario, expansion may be warranted after the brand gains recognition and the distributor achieves success in the smaller territory.
A territorial limitation provision should be crafted to maximize the distribution resources and coverage for a particular region. The granting of excessive distribution territories to unfit distributors could be devastating to the growth of a brand and cut out access to valuable retailers and consumers in the excess territory.
2. Distributor Exclusivity
In addition to territorial limitations, a brewer may also grant brand or label exclusivity to a distributor in a particular region – free from competition with other distributors offering the same products. This arrangement essentially provides the distributor with a monopoly over the product for the specified territory. Distributors strongly favor distributor exclusivity and often argue that this type of arrangement is good for the brewer as it will prevent potentially harmful intra-brand competition. In truth, however, distributor exclusivity is rarely beneficial to a brand.
These types of agreements preclude brewers from franchising additional distributors to carry the brand in the event the distributor’s sales start to lag or its sales or marketing teams are otherwise underperforming. Instead, the alternative distribution model – i.e., the granting of non-exclusive territories – allows multiple distributors to offer the brewer’s products in the same geographic territory.
Nonetheless, distributors commonly insist on an exclusive distribution arrangement in exchange for their investment of time, money and effort building a market for the brewer’s product. The exclusivity provides the distributor security in knowing that their investment into the product for the designated territory will not be defeated by other usurping distributors offering the same products. Without exclusivity, distributors may have no incentive to allocate their resources to properly develop the brand within a given territory.
Because of these conflicting positions, a middle ground may be necessary. For instance, it may be necessary to draft the distribution agreement as a non-exclusive relationship, but then only to grant one franchise at a time. So long as certain benchmark criteria are achieved, a second franchise will not be granted for the same territory. This would prevent intra-brand competition and incentivize the distributor to fully develop the brand without restricting the brewer’s options going forward.
Of course, small and start-up craft brewers have little leverage to convince a capable distributor to forego brand or territory exclusivity. In this scenario, it is of critical importance that the distribution agreement contains a termination for cause provision – allowing the brewer to replace the distributor in the event certain sales and other criteria are not satisfied.
3. Pricing Flexibility
Distributors understandably seek to limit price fluctuation on a product. After all, they have customers (i.e., retailers) that depend upon certain prices when placing and maintaining orders. While this may ultimately benefit all parties, the brewer is now precluded from adjusting prices to account for periods of inflation, increased demand, unforeseen rise in costs, or other unanticipated expenses.
To mollify the concerns of both parties, the brewer should insist upon contract language that allows for price increases (or decreases, if applicable) following written notice and a specified waiting period. For distributor agreements that are renewed annually, 30-day notice provisions are generally implemented.
Absent pricing flexibility built into the distribution agreement, a brewer may be forced to continue doing business, if possible, at the deflated prices until the agreement is renewed.
4. Annual Renewal
Distribution agreements that include an annual termination and renewal provision provide the parties with an opportunity to evaluate their business relationship on a yearly basis. This contractual term allows the distribution agreement to automatically renew for another full year absent prior notice of termination by one of the parties.
An annual termination provision provides both parties with an opportunity to review the terms of the agreement once each year and, if necessary, renegotiate unfavorable terms. More importantly, it provides the brewer an opportunity to escape the contract on an annual basis in the event the distributor is not performing as anticipated.
Because of the clear benefit an annual renewal provision grants the brewer, this is an area of law that is heavily regulated by state beer franchise laws. Many states limit a brewers’ ability to terminate a distribution arrangement absent a showing of “good cause.” This statutory termination limitation may trump an annual renewal provision in the distribution agreement, thereby precluding the brewer from ending the relationship upon the expiration of the one-year term. Legal counsel knowledgeable in the relevant market’s beer franchise laws should be consulted before any distributor relationship is terminated, irrespective of the length of the contract.
5. Post-Termination Obligations
Not unlike any other relationship, there may come a time when the brewer and distributor decide to part ways and terminate their agreement. Absent a clear roadmap directing the parties’ post-termination activities, this already tense situation can quickly escalate to litigation.
Upon termination, the distributor should be obligated to pay, within a specified period of time, all amounts owed to the brewer for past sales. The agreement also should require the distributor to identify the status of any outstanding orders. Further, the distributor should be obligated to return all samples, displays, promotional materials, or other items in the possession of the distributor but belonging to the brewer.
The agreement should also grant the brewer the right, but not the obligation, to repurchase any inventory held by the distributor at the price at which the products were purchased. The principal benefit of such a provision would allow the brewer to avoid the distributor’s selling of the remaining inventory at highly reduced prices.
Arbitration is a legal proceeding outside of the courthouse in which a neutral third-party (arbitrator) acts as both the judge and jury in ruling on the dispute. Arbitration provisions are commonplace in commercial contracts and provide both advantages and disadvantages over a traditional court action.
Historically, arbitration has been advertised as the quicker, less expensive alternative to court to resolve a dispute. In truth, however, this is not always the case. Complex commercial arbitrations have been known to drag on for years, and, when factoring in the hourly rate of the arbitrator(s) and the administrative fees of the arbitration service provider, the costs associated with arbitration can even exceed those of litigation.
Nonetheless, arbitration is still a preferred method for many companies to resolve their disputes because of the private nature of the proceedings, the predictability of an arbitrator over a jury, and the contractual limitations governing the arbitration proceeding (i.e., punitive damage waiver, choice of law, choice of venue, etc.) that may not be enforceable in a court action. Because of these benefits, most distribution agreements today continue to include mandatory arbitration provisions that govern “any and all disputes” between the parties.
Also, in the event specialized areas of law are at issue in the dispute – e.g., alleged violation of beer franchise laws, unfair business practices, or other state-specific statutes – it is preferred to have access to an arbitrator with technical knowledge and experience in the beverage and/or distribution industries, rather than a judge (and jury) who may not be familiar with the issues.
As the craft brewing segment has matured, so too has the legal savvy of its entrepreneurs. Distribution agreements are an important tool in the construction of the distribution relationship. The craft brewer is well-advised to invest the time and resources necessary to negotiate and draft a strategically sound distribution agreement. The advice and assistance of experienced legal counsel in this process cannot be understated. A well drafted distribution agreement will help eliminate the unnecessary expenditure of resources on unproductive and often harmful activities and should discourage future litigation.
This article was prepared by Kevin A. Adams (firstname.lastname@example.org), of the Irvine law firm of Mulcahy LLP. Mulcahy LLP is a boutique litigation firm that provides legal services to franchisors, manufacturers and other companies in the areas of antitrust, trademark, copyright, trade secret, unfair competition, franchise, and distribution laws.
Disclaimer: While every effort has been made to ensure the accuracy of this article, it is not intended to provide legal advice as individual situations will differ and should be discussed with an experienced franchise lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.
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