Legal

How to Do Business in a Franchise State

A drinks lawyer explains how franchise law works and how suppliers can protect their businesses

Franchise States
Illustration by Jeff Quinn.

Over the last decade, disagreements between suppliers and distributors regarding the freedom to terminate relationships in what are known as franchise states have been at the forefront of beverage alcohol litigation. A recent one that gained attention was the Wisconsin Federal Court case in which Pernod Ricard alleged that the Wisconsin Fair Dealership Law—a franchise law—did not apply to the relationship between Pernod and its distributor. A few years back, in another case that was dubbed the “liquor wars,” Bacardi and Diageo were each in litigation with Major Brands over applicability of the Missouri franchise law.

Understanding How Franchise Laws Work

State franchise laws, where they exist, give in-state distributors assurance that they will not be abruptly terminated by their suppliers for no reason. Proponents say these laws allow the distributor to invest in a brand without the fear of spending significant resources and committing to a brand just to have it taken away. Critics of state franchise laws argue that the state legislature should not be so heavily involved in private business dealings between suppliers and distributors. After all, in “open” states, the supplier and distributor have the freedom to contractually determine how the business relationship may be terminated if, say, the distributor is not meeting goals or performing up to the supplier’s standards. The question suppliers generally ask when entering a franchise state is: Can they do anything to protect themselves if they want to later terminate the relationship with the distributor?

Historically, big beer manufacturers, like Anheuser-Busch and MillerCoors, had their own dedicated wholesalers. This was lucrative for those wholesalers, but also put them in the position of being entirely dependent on the whims of big beer. Think of it like McDonald’s: That franchise is not also selling Burger King and Wendy’s burgers. A wholesaler could go out of business if it was terminated by a big beer brand. Beginning largely in the 1970s, franchise laws were established in various states to protect local businesses. The intent was to combat unequal bargaining power of the big brands—which was then more prevalent—and to prevent large producers from dominating small distributors by abruptly taking their business elsewhere, which would likely result in a complete shutdown of the distributor. Although most common for beer, which has a franchise law in almost every state, franchise laws also exist in many states—just under half—for wine and spirits.

As a result of wholesaler consolidation, distributors are not at the mercy of big brands anymore. It is uncommon for a wholesaler to solely distribute one brand. As a result, “there is no brand that if pulled from a distributor would put that distributor out of business,” says Steve Gross, the vice president of state relations at the Wine Institute, based in San Francisco. If you consider a traditional distribution agreement as like a prenup, “franchise states are like a marriage you can never get out of,” says Chris Sywassink, the general manager of Ghost Coast Distillery in Savannah, Georgia. In some franchise states, like Georgia, it is nearly impossible for a supplier to switch distributors unless approval is granted by the state revenue commissioner (or the commissioner’s designated agent) after a showing of cause at an administrative hearing.

Managing the Distribution Relationship

So what can a supplier in a franchise state do if it wants to terminate a distribution agreement? The first line of defense is to only enter a distributor relationship you won’t want to terminate, says Antonia Fattizzi, founder of Cork and Tin, a consultancy that assists small and emerging boutique wine and craft spirits brands. Whether it is an open state or a franchise state, “go into the relationship with the idea of a long-term partnership where you don’t plan to walk away in a couple of years.” She suggests reviewing a proposed distributor’s long-term goals and objectives, as well as speaking with retailers about their experiences with the distributor and other suppliers of similar size in the market.

Despite such precautions, though, termination is sometimes the best option. With no federal franchise law, termination of distribution relationships in franchise states is a state-by-state question. The first question is whether a franchise relationship has been established. For instance, some state franchise laws don’t apply until the distributor’s revenue from sales of the supplier’s brands exceeds, say, five percent. Assuming the franchise law does apply, the next step is to consider whether there are any straightforward reasons for terminating that are allowed, such as if the distributor has gone bankrupt or lost its license.

However, the majority of legal arguments available to a supplier for getting out of a distribution relationship revolve around whether the supplier has what the states call  “good cause” or “just cause.” Some states are very specific in their definitions of “good cause” and even provide examples. Other states provide no guidance as to what is considered good cause. In Nevada, which has a franchise law applicable to beer, wine, and spirits, a supplier cannot terminate a distribution agreement unless the supplier has first established that good cause exists. The law in that state defines good cause as either a distributor’s failure to substantially comply with a supplier’s “essential and reasonable requirements” if the requirements are not discriminatory, or as “bad faith by the wholesaler in carrying out the terms of the franchise agreement.” In the state of Vermont, beer and wine suppliers may not terminate a franchise unless good cause is shown, but good cause is not specifically defined by statute.

When advising Wine Institute members on going into a franchise market, Gross tells them to hire a good lawyer and make sure they understand what will be required for them—as the supplier—to terminate the distribution agreement. Although a distributor may not require a distribution agreement in a franchise state, it is often in the interest of the supplier to have one, so that the supplier can, Gross notes, tailor the contract to the specific laws of the state. Without an agreement in place—and many distributors in franchise states don’t require one—the supplier is at the mercy of whatever the state franchise law outlines. For instance, failure to achieve mutually agreed-upon goals may not be a reason to terminate based on a plain reading of the franchise law. However, the franchise law may very well say a supplier can terminate for good cause due to a material breach by the distributor. If you have an agreement, the parties can agree that failure to hit those goals is a material breach and, therefore, a reason for the supplier to terminate for good cause.

In addition, many franchise laws require the supplier to provide written notice in the event that the distributor does fail to achieve mutually agreed goals, or otherwise breaches an agreement, and the supplier wants to terminate. In Colorado, a distributor has sixty days to try to fix the breach. In Louisiana, a distributor has ninety days to cure the breach before the supplier can terminate. So if a supplier wants to terminate, it should document those failures and send official notice as outlined in the agreement. That may mean sending a written letter via certified mail, not just making a formal complaint over the phone.

Because of the complexity of navigating state franchise laws, the first step for a supplier is to understand whether it is entering into a relationship that creates franchise protection for the distributor. Where franchise protection exists, the supplier should only get into the relationship after understanding how it can get out.

Ryan Malkin is principal attorney at Malkin Law, P.A., a law firm serving the alcohol beverage industry. Nothing in this article is intended to be and should not be construed as specific legal advice.

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