Consolidation: an offer you can refuse—but may want to accept

Modern Brewery Age, July 21, 2003 by Gary Ettelman, Keith B. Hochheiser

It is certainly no secret that brewers have been aggressively seeking to consolidate their domestic distribution channels. Typically, when a brewer decides to consolidate, their first step is to encourage one or more of their distributors to sell their distribution rights to the brewers chosen survivor. Indeed, some brewers can be quite emphatic in their "encouragement." Fortunately, wholesalers do have a choice. In most circumstances, when the brewer "offers" you an opportunity to sell your distribution rights to one of your competitors, you do not have to accept. Wholesalers have a "bundle of rights" which typically protect them from "without-cause" termination. These rights were the subject of a previous article that appeared in this publication. However, for various reasons, a wholesaler may be well-served by agreeing to sell or swap its distribution rights to a particular brand. In addition, there are always instances where a wholesaler simply wants to buy or sell distribution rights to a brand in the absence of any brewer influence. Either way, it is important for wholesalers to understand the legal nature of the transaction and to have appropriately drafted agreements to protect themselves from unwanted and unintended results and to make sure they get what they have bargained for.

The Right to Assign

In transactions involving the sale of the right to distribute individual brads (otherwise known as an "assignment") a variety of legal issues arise between and among the buyer, the seller and the brewer. The first issue that must be considered, is whether the seller has the right to assign the distribution rights to the brands. The starting point for this inquiry is the distribution agreement. If the distribution agreement does not expressly prohibit assignment; i.e. if it is either silent on the topic or if there is no written distribution agreement, the general rule is that the distribution agreement will be freely assignable without the consent of the brewer. There are, however, some important exceptions to this role. The most important of these exceptions in the context of the beer industry is that a contract may not be assigned if the brewer can establish that: (1) the brewer has a "substantial interest" in having the original party perform the contract; or (2) the assignment would "materially change" the duty of the brewer, or "increase materially the burden or risk imposed" on the brewer.

The second level of inquiry is any state franchise or "beer statute" in your jurisdiction. Often times such statutes include provisions which, in essence, prohibit a brewer from "unreasonably" withholding its consent to a request for permission to assign. Generally, the reasonableness of a brewer's decision will depend upon two factors, the capability and the credit worthiness of the proposed assignee. Accordingly, even if your distribution agreement purports to give the brewer the absolute right to withhold its consent to a proposed assignment; there may be a controlling statute which gives you the right to assign.

It is absolutely essential, however, that you verify that you have the right to sell (either with or without brewer consent) before you pursue the transaction. A distributor that attempts to make an assignment in violation of its distribution agreement or who fails to obtain the required consent of the brewer under the distribution agreement, will be in breach of the agreement giving the brewer the right to terminate either under the distribution agreement or state law.

Drafting the Contract

After you determine that you have the right to sell, it is time to prepare the contract. There are many issues to be dealt with in an agreement relating to the sale of distribution rights which will change depending upon the particular circumstances of each deal. The following are examples of some of the more pertinent issues.

A. Assignment of Rights v. Assignment of the Distribution Agreement: A Meaningful Distinction.

If the transaction is structured as an assignment of the distribution agreement, there are significant, automatic and probably unintended liabilities for both the assignor (seller) and assignee (buyer). As an example, the seller automatically guarantees to the brewer the buyer's future performance under the distribution agreement. Likewise, the buyer automatically assumes all outstanding obligations under the distribution agreement, including obligations relating to the seller's past performance. It is important to note that these obligations arise by operation of law. Accordingly, them obligations apply even if the assignment documentation is silent on those issues.

In light of the foregoing, the best procedure is to assign the rights to distribute the brand (as opposed to the distribution agreement) and to obtain an acknowledgment from the brewer and the purchasing party that simultaneous with the making of the assignment, the old distribution agreement will be terminated. The buyer will then have to obtain a new distribution agreement from the brewer.