Tharrington Smith attorney Kris Gardner offers an update on recent legislation in the North Carolina General Assembly which impacts the Beer Franchise Law. Gardner’s practice at Tharrington Smith focuses primarily in local government law, litigation and alcoholic beverage control law. He also serves as general counsel to the North Carolina Beer & Wine Wholesalers Association.

North Carolina General Assembly Modifies Beer Franchise Law

By Kristopher B. Gardner, Tharrington Smith, LLP

June 8, 2012

The North Carolina General Assembly adopted legislation to modify the Beer Franchise Law, which governs the relationship between beer distributors and their brewer suppliers.  The legislation, S.L. 2012-4, was ultimately agreed to by all industry members.  The new law takes effect immediately, with the exception of the nondiscriminatory pricing provision, which takes effect October 1, 2012.  An overview of the legislation is presented below.

Brand Extension Rule Codified (18B-1303)

About 20 years ago the N.C. ABC Commission adopted a rule that provided a brand extension fell within the wholesaler’s franchise agreement for that particular brand.  These rights cannot be assigned to a different wholesaler within the same territory.  This rule is now codified into the Beer Franchise Law.

Additional Prohibitions Added to Protect

Integrity of Independent Distribution Tier

Unauthorized access of wholesalers bank accounts [18B-1304(3)]:  A brewery is now prohibited from withdrawing money or otherwise accessing a wholesaler’s bank account without the wholesaler’s consent.  Before enactment of the law, some brewers withdrew money from wholesalers’ bank accounts even when there was a disagreement about how much was owed to the brewery.  This practice is now prohibited.

Franchise agreements that conflict with State law [18B-1304(4), (5)]:  For many years, breweries (mostly from other states) have presented North Carolina wholesalers with franchise agreements that clearly conflicted with our state’s laws.  In some ways this is understandable – national breweries prefer a uniform agreement and may not revise it to comply with each states’ laws.  Most breweries were unable or unwilling to discuss modifying their franchise agreements.  This left considerable doubt about what provisions of the agreement were enforceable.  The law now provides that a brewery may not present or pressure a wholesaler to sign a franchise agreement that attempts to waive compliance with the franchise law.  It also provides that a wholesaler that enters into such an agreement does not waive rights protected under the law.

Execution of new franchise agreement not required as part of a sale, transfer of merger [18B-1304(6)]:  One of the most commons ways breweries forced wholesalers to sign franchise agreements that contracted away the protections of the franchise law was to require them to sign such an agreement as part of a wholesaler merger, or a wholesaler’s acquisition or transfer of a brand.  The breweries would refuse to approve the deal unless the wholesaler signed a new franchise agreement that purported to undermine the protections of the law.  This practice is now prohibited.

No forced amendments to franchise agreements [18B-1304(7)]:  Several franchise agreements purported to give the brewery the right to terminate the franchise, without penalty, if the wholesaler refused to agree to a contract amendment presented by the brewery.  This would enable the brewery to force unfavorable – and in some cases, unobtainable – standards of performance upon a wholesaler.  The new law prohibits this practice.  All contract amendments must be agreed to by the brewery and the wholesaler.  The failure to come to an agreement on the terms of an amendment cannot be used as a pretext for terminating the franchise.

Wholesalers free to distribute other brands [18B-1304(8)]:  Many franchise agreements tried to prevent wholesalers from distributing competing brands.  This practice would substantially limit the ability of craft brewers to find a way to market.  The new law allows a brewery to implement such limitations only if the acquisition of the new brand would result in the wholesaler acquiring 80% or more by volume of all beer sold in the territory at the time of the acquisition.

Wholesalers’ ability to manage its own brand manager [18B-1304(9)]:  The new law provides that a brewery may refuse to approve, or terminate, a wholesaler’s brand manager only if the person fails to meet reasonable standards and qualifications.  What is reasonable depends on the facts and circumstances of each particular case.  However, breweries can no longer unilaterally control the personnel matters that are traditionally the responsibility of an independent wholesaler in dealing with its brand manager.

Nondiscriminatory pricing to wholesalers [18B-1304(10)]:  One of the easiest ways to force a wholesaler out of business or pressure it to merge with another wholesaler is to raise the wholesaler’s purchase price of product from the brewery.  But this lever isn’t just used to force wholesaler consolidation – it can be used indiscriminately for just about any reason.  Discriminatory pricing also enables “reachback pricing”, which allows a brewery to reach back and unfairly take a wholesaler’s earnings (e.g. A wholesaler raises its price-to-retail $0.10/case.  The next day the brewery raises its price to that wholesaler on the same package by $0.07/case, thus enabling the brewery to capture 70% of the wholesaler’s revenue).  All of these practices threatened the independence of state-based wholesalers.

The new law, effective October 1, 2012, requires a brewery to offer uniform prices, rebates and other terms to all North Carolina wholesalers.  Of course, the brewery can select whatever price it chooses, and can raise or lower that price as it deems appropriate at any time.  But it must sell the same product to all N.C. wholesalers at the same price.

Of course, there are exceptions:

• Freight and transportation costs – Obviously, freight and transportation costs may differ from one part of the state to the other.
• Special events in a particular market not to exceed 14 consecutive days – There may be special events in a particular market that necessitate promotional pricing.  The example discussed among industry members and legislators during the passage of S745 was the NASCAR race in and around the Charlotte market.  Remember that the promotional pricing must be related to the special event.  This helps define what a special event is in a particular market – the promotional pricing must be tied to that special event.  That is, after all, the very purpose of the promotional pricing.  A brewery cannot, for example, cite a small arts festival as a special event for promotional pricing if the promotion (lower price) is not tied to the special event (the festival).  But if the brewery is marketing promotional pricing to a particular event (e.g. NASCAR race, U.S. Open), it can offer promotional pricing to a wholesaler(s) that distributes product within that market for a period not to exceed 14 consecutive days.  Keep in mind this does not limit the promotion at the retail level to 14 days.  This provision only deals with sales between the brewery and the wholesaler.  So the promotional pricing to the wholesaler cannot exceed 14 days.  The promotion can occur at the retail level for as long as the retailer desires.
• Point-of-sale advertising materials, sponsorships, consumer specialty items, consumer sweepstakes, and novelties:  These items are obviously market-sensitive, and a brewery need not provide the same point-of-sale advertising materials, etc. to all wholesalers throughout the state.  A point-of-sale beach theme display at a grocery store may not fit well in the mountains, and vice-versa.  The brewery has discretion to offer these items to wholesalers as it deems appropriate.
• Lowering price to match competition:  To the extent it wasn’t obvious, a brewery can always lower its price to match competition.  This can be done statewide or in a particular market (e.g. in response to a competitor’s promotional pricing for a special event).

Franchise Relief for Small Breweries

No-cause termination by small brewery [18B-1305(a1)]:  Some small breweries expressed a desire to have the ability to terminate their franchise agreement with their wholesalers without good cause.  In these circumstances, small brewers had little bargaining power compared to their wholesale distributors.  The new law allows a brewery’s self-distribution rights to revert back to the brewery without good cause.  This provision applies to those breweries that hold a N.C. brewery permit, and which sell less than 25,000 barrels per year.  The self-distribution rights revert back to the brewery following the fifth business day after written notice is provided to the wholesaler.  In exchange for the ability to terminate without good cause, the brewery must pay the wholesaler for the distribution rights.

Clarification of What Good Cause Means

Good cause for termination does not include a brewery transfer or sale [18B-1305(d)(4)]  The new law confirms that a wholesaler’s franchise rights remain even if the brewery is sold or transferred to another entity.  This is most relevant for imports.

Good cause for termination does not include a wholesaler’s failure to meet unfair standards of performance [18B-1305(d)(5)]  Breweries frequently provide franchise agreements that provide them with the unilateral ability to set standards of performance.  This could give them the ability to set standards that no wholesaler could achieve, and then use this “failure” as a pretext to terminate the franchise agreement.  The new law provides that good cause for termination does not include a wholesaler’s failure to meet standards of operation or performance which have been imposed unilaterally by the brewery without a fair opportunity for the wholesaler to bargain as to the terms, unless the terms are implemented on a national basis and are consistently applied to all North Carolina wholesalers in a nondiscriminatory manner.

Good cause for termination does not include a wholesaler’s acquisition of competing brands [18B-1305(d)(6)]  The new law prevents a brewery from defining good cause for termination to include a wholesaler’s acquisition of competing brands.

Good cause for termination does not include the desire of the brewery to consolidate wholesalers. The new law prevents a brewery’s desire for wholesaler consolidation to serve as a basis for good cause termination.

Wholesaler Mergers and Acquisitions

Wholesaler mergers clarified; factors that can be considered in transfer or merger (18B-1307(b)]  The new law confirms the approval process for mergers.  The law allows a wholesaler to sell to, or merge with, any qualified wholesaler.  (Transfers to designated family members do not require prior approval.)  The new law designates important but non-exclusive factors that the brewery may consider for approval, such as whether the resulting entity:

• has the financial capacity to successfully operate the new business;
• has proven business experience to hire and maintain a successful management team;
• has other experience to enable it to operate successfully if the resulting entity does not have experience in the beer business; and
• is already a wholesaler for the brewery in a different territory.

The new law also provides that a brewery must consider the entity resulting from a sale or merger on its own merits and may not pre-determine a wholesaler as the only one it will approve.  However, for a proposed purchase of a wholesaler’s business, a brewery may redirect the distribution rights to a different wholesaler if the brewery’s preferred wholesaler agrees to match the purchase price for the distribution rights.  (Match-and-redirect does not apply to wholesaler mergers.)  The effect of these new provisions is to prohibit a brewery from announcing in advance that it will only approve a sale or merger to a particular wholesaler.

Beer Franchise Law Supersedes Conflicting Contract Provisions

The beer franchise law is part of all franchise agreements and trumps any conflicting provision in a franchise agreement  (18B-1308)  The new law confirms that a wholesaler’s rights under the franchise law may not be waived or superseded by a franchise agreement that conflicts with state law.  The franchise law also trumps a provision in a franchise agreement that purports to require arbitration or to require remedies to be sought in a different jurisdiction.

Mediation

Mediation of disputes (18B-1309)  The new law requires a wholesaler and brewery to mediate disputes arising under the franchise law unless a party seeks injunctive relief or commences legal action in order to avoid expiration of a statute of limitations.  It authorizes the N.C. ABC Commission to designate a mediator, or it may direct the parties to choose one at their expense.

Conclusion

The revised Beer Franchise Law further protects the independence of North Carolina beer distributors and promotes the integrity of the three-tier regulatory system for the distribution of malt beverages.  This legislation was primarily in response to a sense among wholesalers that their ability to operate as independent businesses was quickly eroding.  The new law confirms North Carolina’s affirmation of a strong, state-based three-tier system for the distribution of malt beverages based upon an independent distribution tier.