Crafting a Distribution Agreement for Growth
By: Brian W. Mahoney, Nixon Peabody LLP
For the craft beer industry, 2014 was another banner year. In the years ahead, America’s renewed interest in craft beer will mean a startup venture for some. For others, continued growth will bring new business challenges. At some point in a brewery’s growth, many craft brewers will look to established beer distributors to expand their customer base.
A well-thought-out distribution agreement can be a crucial element of a brewer’s overall market strategy. But such contracts are governed by a specific body of law that sets distribution agreements apart from other types of contracts. In many states, there are laws and regulations that provide default terms or specify what parties can and cannot agree to. This leads to a somewhat unusual result—even if a contract plainly expresses the parties’ agreement, the law may intervene and significantly alter the business relationship. These statutory provisions can lead to disaster if a brewer outgrows its distributor’s capacity, or if the brewer’s relationship with the distributor sours. It is important for brewers to understand the law governing these contracts so they know what they’re getting into.
Brewers selling their own products from a tasting room are generally accustomed to a good deal of discretion over their retail pricing strategy. However, once a brewer engages a distributor, it becomes very difficult to control shelf price. Distributors and retailers will both need to include their margins on the product. Further, New York, like many states, prohibits producers from dictating the price at which a distributor may resell.
Without a well-thought-out pricing strategy, a brewer may find that their products are priced out of the market. Obviously, the price a brewer charges the distributor will be a key element of the overall pricing formula. Distribution agreements typically provide that brewers have the sole right to determine the price at which products are sold to distributors. However, state laws intervene here as well. For example, in New York a brewer may change its prices only once every 180 days.
A distribution agreement needs to align a distributor’s interests with the brewer’s in a way that will maximize value for both parties, while complying with applicable state laws. Often, this will involve negotiating binding sales goals and preserving the right of the brewer to terminate the agreement if the distributor fails to achieve those goals. As discussed below, this approach is not without its own set of issues.
Typically, a distributor will have exclusive rights to sell the brewer’s products in a given territory. Ideally, exclusivity motivates the distributor to invest in marketing and development of the market for the brewer’s products. But what happens if the distributor doesn’t invest and sales are disappointing?
Many states have enacted laws restricting brewers’ ability to terminate distribution agreements. Essentially, these laws require that brewers have “good cause” to terminate a distribution agreement—regardless of whether the contract states that the brewer has the right to terminate the agreement. Some states specifically define “good cause” by statute; others leave it to the parties to define in the agreement.
In New York, small brewers (less than 300,000 barrels) are not required to establish good cause, but are required to pay fair market value for the distribution rights. Brewers should carefully lay out the means of calculating fair market value using a methodology that will pass legal muster. Doing so may avoid costly litigation in the future.
These are just some of the issues brewers need to consider. A distribution agreement needs to address sales terms, risk of loss, marketing strategy and expenditures, intellectual property and a host of other issues. Brewers need to carefully consider these terms before engaging any distributor—it may be difficult to change terms or get out of the contract later on. Brewers should also make sure they are well advised regarding the particular state laws that may apply. Even if the distribution agreement is perfectly clear on certain terms, state law may override the parties’ agreement.