Distribution: the Agreement and the Evolution
THE word of the year in craft beer is “distribution.” Across the country, the supplier market has fragmented with explosive brewery growth. Effective and efficient paths to market are now a mainstay of beer business viability. North Carolina is no outlier to this trend. Indeed, distribution, specifically the limits of a brewery’s right to self-distribute, is currently the most polarizing topic in our craft community. Regardless of the extent to which distribution is statutorily imposed, putting beer in the hands of consumers beyond a brewery’s immediate reach is a vital aspect of business growth. Independent distributors have long played an invaluable role in that regard and will continue to deliver that value well into the future.
In North Carolina, contracts between breweries and distributors are quite regulated. It is thus prudent for both parties to understand the statutory framework for local distribution and what terms standard distribution agreements typically address. This post aims to (1) give an overview of the most common distribution agreement provisions, (2) explain how termination of these agreements functions in North Carolina, and (3) explore how considerations of craft beer may alter negotiations between local brewers and distributors in the near future.
Below are the most common elements of distribution agreements between brewers and wholesale distributors. This is certainly not an exhaustive list, as each agreement contemplates its own set of facts and circumstances. In addition, keep in mind that, based on the goals and resources of each party, bargaining power will vary and thus so will the respective obligations (to the extent they are not statutorily imposed).
Qualifications — usually a quick description signaling that the parties possess the necessary state and federal alcoholic beverage licenses.
Exclusivity* — this is wildly important. In North Carolina, pursuant to N.C.G.S. § 18B-1303, a brewery cannot execute a distribution agreement with more than one distributor for the same brand in the same territory. Each agreement must be filed with the ABC Commission.
Term* — this is also big. In North Carolina, once a distribution agreement has been executed, it is for perpetual duration. Of course, language can be inserted to periodically renegotiate price schedules and the like. However, subject to a very narrow carve out, a brewery must be mindful that the decision to hand over distribution of its beer in a given territory to a particular distributor is to do so permanently.
Brewery Obligations — all the specifics surrounding when, how and in what quantities a brewer will supply the distributor with its beer.
Distributor Obligations — all the specifics regarding the distributor’s efforts to move the product to various points of sale and its efforts to properly represent the brewery in the course of its business.
Transfer of Ownership — success often brings new money to the table. This provision is common because brewers and distributors alike need consistency. If the brewery is bought out, the distributor needs to know the new owner will fulfill its obligations under the existing agreement. Likewise, should a distributor change ownership, a brewery must know that its beer will be managed as the original parties agreed upon.
Termination* — this, too, is wildly important. For a brewery to validly terminate a distribution agreement in North Carolina, it must meet a standard of “good cause.” We’ll speak more to this down below.
Fair Market Value — small breweries (those producing less than 25,000 barrels of beer per year) have a limited ability to reclaim distribution rights from a distributor in exchange for the fair market value of those rights. There are a number of ways to calculate this value. Additionally, even beyond the scope of small breweries, parties should have a general idea of damages should one of them breach their obligations under the contract. A sound fair market value calculation is an important piece of a potential damages number.
Label Requirements — federal and state law impose their own overlapping labeling requirements. If beer is being shipped out of state, it is crucial that the parties to the agreement outline the responsibilities regarding proper beer labeling.
Warranty of Alcohol Content — the cap on alcohol by volume also varies from state to state. Although it is difficult to anticipate enforcement efforts, a distributor will want assurances that what is advertised on the label is accurate to the extent that any margin of error in the bottle will not violate a destination state’s laws.
Again, the above list should not be taken as a comprehensive list of distribution agreement provisions or a complete description of any one or more individual provisions. In particular, the sections devoted to brewery and distributor obligations require patient and thorough attention.
The Function of Termination in North Carolina
N.C.G.S. § 18B-1305 informs us that distribution agreements in North Carolina have a certain permanence. Once executed, it takes a brewery’s showing of “good cause” to alter or terminate a distribution agreement. The statute goes on to explain that “good cause” to terminate an agreement exists only when the distributor “fails to comply with provisions of the agreement which are reasonable, material, not unconscionable, and which are not discriminatory” as compared to other, similarly situated distributors. Moreover, the statute does not allow parties to create their own standard of “good cause.”
A reading of this provision alone sheds some helpful light on why distribution regulation is currently so hotly contested in North Carolina. Simply stated, these agreements are exclusive, continuous, and nearly impossible to break off. There is, however, some redeeming justification in the form of enforceability. Distribution, as a business, requires a great amount of overhead expense on the part of the distributor and imposes a bigger burden to ultimately close the transaction loop. At its core, distribution regulation thus aims to account for that overhead and level expectations, as breweries are often in a better position to make more nimble changes than a distributor (not the least of which being the impromptu decision to switch to another distributor before the loop is complete). This is exactly why the negotiation process is so crucial and why there is no substitute for an airtight, well-drafted agreement. As it pertains to breweries looking to distribute, beer quality is often only as good as its presentation to consumers.
At the beginning of this post, we mentioned that the brewery segment of the beer industry has fragmented. That is what we know today as craft — emergent styles appealing to new palettes. That is also to say that the distribution segment has remained largely consolidated nationwide. This presents an interesting conundrum for both parties: traditional distribution processes must accommodate an evolving portfolio of beer. More poignantly, a handful of regional distributors have the task of effectively placing literally thousands of local and hyperlocal beers into new markets, to unfamiliar consumers. Concerns about maintenance of quality and product education certainly abound.
Even with legislative change on the horizon in North Carolina, we at Carolina Craft Legal maintain that a mutually beneficial balance can be reached through contract alone. Distribution will continue to be an invaluable resource for breweries with respect to growth opportunity. But the longer traditional distribution models take to adapt to the unique demands of craft, the more the power dynamics of negotiation will shift back toward brewers. Right now there is widening opportunity in the beer industry for independent distributors willing to individualize paths to retail market. Though North Carolina prohibits us from creating a new standard of “good cause,” brewers and distributors may still agree on what conduct is “reasonable, material, not unconscionable, and which [is] not discriminatory” in an evolving industry. What’s more, the innovative distributor and the ambitious brewer will undoubtedly align on what is most important: beer quality, oversight, and education.
If you are a brewery contemplating distribution within North Carolina, an existing distributor aiming to rebrand, or a businessperson looking to contribute meaningfully to the craft segment, give us a call or shoot us an email. Carolina Craft Legal would love to assist with your agreement drafting, negotiation, and related business needs.
Until next week. Cheers!