Liquor Law Update – August 2014
August 23, 2014
Distribution Agreements in Pennsylvania: Til Death Do Us Part
One of the most exciting moments in the existence of a new brewery is the moment you ink your very first distribution agreement. Yes, you never forget your first: you’ve arrived, you’re now part of the Show, and now you’re working with a partner that is also distributing beer from breweries that have been in operation for years, even decades. But like many relationships, those initial feelings of excitement can quickly dissipate when you’re presented with a contract to cement the distribution relationship. Unless you’ve been reading Pennsylvania’s Liquor Code in your spare time, the agreement presented to you for signature will likely read like it was drafted in a foreign language. But translate it you must, because unlike marriage in Pennsylvania, distribution agreements do not come with the option of a no-fault divorce.
Distribution agreements are a necessity in Pennsylvania, a byproduct of the state’s three-tier system (producers, distributors, and retailers) of alcohol distribution. Under Section 431 of the Liquor Code, a brewery that does not wish to self-distribute may only contract for distribution of its products with a duly-authorized and licensed importing distributor. Furthermore, the brewery as “manufacturer” may only contract with one importing distributor in each geographically contiguous franchise territory – so if you sign a distribution agreement with one importing distributor, you can’t sign a second agreement with a different importing distributor to distribute that product in the same territory.
Section 431 of the Liquor Code also requires that certain terms and conditions be included in any distribution agreement. Of particular importance for breweries is a provision that all distribution rights obtained pursuant to a valid distribution agreement cannot be modified, cancelled, terminated or rescinded by the brewery without good cause. “Good cause” is defined as “the failure by any party to an agreement, without reasonable excuse or justification, to comply substantially with an essential, reasonable and commercially acceptable requirement imposed by the other party under the terms of an agreement.”
Even where “good cause” exists to terminate a distribution agreement, the brewery generally must provide the importing distributor with 90 days written notice and an opportunity to cure the alleged deficiency. In the event the importing distributor acts to correct the problem, the notice to terminate is automatically rescinded. The Liquor Code does waive the notice requirement if the reason for the termination is any of the following “events of default”: (1) insolvency; (2) assignment for the benefit of creditors; (3) bankruptcy; (4) liquidation; (5) fraudulent conduct in the importing distributor’s dealings with the brewery; or (6) revocation or suspension of the importing distributor’s license for more than a 30 day period.
It must be stressed that termination without cause is not permitted in Pennsylvania, so any attempt to terminate a distribution agreement without showing “good cause” will likely result in a lawsuit. The Liquor Code specifically vests the Court of Common Pleas located in the area where the importing distributor does business with jurisdiction to hear such suits. Also, the Liquor Code provides as a remedy to the importing distributor the ability to request an injunction to prevent the termination of the contract.
Can a brewery modify these provisions? In a recent legal advisory opinion dated May 14, 2014, the Pennsylvania Liquor Control Board (the “Board”) considered such a question: whether the notice and “good cause” requirements discussed above could be waived by the parties to the distribution agreement. The question was raised in the context of whether a distribution agreement could provide for automatic termination of distribution rights upon the occurrence of a specified period of “inactivity,” i.e., not actively selling a product. It was contended that such a contractual provision was permissible under the Liquor Code because of the following provision in Section 492:
It shall be unlawful for any manufacturer to terminate without good cause any distributing rights agreement, and in no event shall any termination of any distributing rights agreement become effective for at least 90 days after written notice of such termination has been served on the affected party by certified mail, return receipt requested, except by written consent of the parties to the agreement. The notice shall state all the reasons for the intended modification, termination, cancellation, rescission or nonrenewal. The distributor or importing distributor holding such agreement shall have 90 days in which to rectify any claimed deficiency, or challenge the alleged cause.
The question before the Board, then, was whether the highlighted waiver language should be read to modify only the 90 day notice requirement, or if it should be read to also modify the good cause requirement. In keeping with its prior advisory opinions, however, the Board elected not to answer the question:
Interestingly, Section 431 of the Liquor Code also addresses the “good cause” requirement, and does not permit the parties to waive this requirement. It would seem that the General Assembly’s decision to not include a waiver provision in Section 431 should be respected, despite the Board’s decision not to express an opinion on the matter.
In any event, the advisory opinion highlights a problem with the Liquor Code: breweries are often unable to obtain definitive guidance on a disputed provision of a distribution agreement without ponying up a small fortune to litigate the dispute. What can brewery owners do to ensure peace of mind when considering their first distribution arrangement?
At a minimum, brewery owners should carefully review the section of the proposed agreement addressing the termination of the contract. If the termination provision doesn’t include the six “events of default” noted above, it should. Consider requesting that these six “events of default” be further defined to avoid vagueness in the event you need to rely on one of them. And, if you’re worried about the distributor remaining true to you and your product, consider including a requirement that you regularly sit down and discuss the business and the distributor’s efforts. This will help encourage cooperation throughout the relationship, and, should a dispute arise, avoid a he said/she said situation.
Of course, the easiest way to ensure peace of mind is to hire competent legal counsel with experience in the liquor laws of Pennsylvania. An attorney with experience in the craft brewing industry can prepare the distribution agreement on your behalf, and negotiate with the importing distributor as to its terms. Ultimately, hiring an attorney saves you money in the long-term – something we can all raise a glass to.
Tim Horstmann is a business attorney (and craft beer drinker) with the law firm of McNees Wallace & Nurick in Harrisburg, Pennsylvania. The Firm’s dedicated Alcoholic Beverage and Liquor License Practice Group regularly advises startup and established craft breweries and distilleries. When he’s not in his cellar checking on the 120 minute IPA he laid down, you can reach him at (717) 237-5462, or by e-mail at firstname.lastname@example.org.
© 2014 McNees Wallace & Nurick LLC
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