Distribution contracts: What to know before you sign

Contracts are a fact of life. You sign them as an individual and that will hold true for your brewery the more you grow and expand. That being said, when it comes time to distribute, there are unique considerations required before signing the dotted line.

Distribution contracts have a special set of laws that govern what can and cannot be agreed to, the history of which can be traced to anti-monopolistic policies. Many brewers, unaware of the special waters they are treading, treat distribution contracts like any other contract. Unsurprisingly, distributors are also frequently as uninformed about what these special rules are, and it shows in the contracts they draft. This is a recipe for disaster down the road as breweries wish to adjust the distribution plans for their growing business.

Ending a contract

The most pressing issue usually is how breweries can end a contract with a distributor. A number of states have adopted cause-only rules. At the most basic level, the rule says you cannot end a contractual relationship with a distributor without “good cause.” Some states go even further and define what good cause means, while others allow individual parties to contract those meanings for themselves.

So what happens if you terminate a distribution contract without good cause? Under most state laws, the terminated distributor must be paid the fair market value of the distribution rights in relation to your particular brewery, including any goodwill that accompanies the relationship. If you are allowed to define what good cause can mean in the contract, then just about anything you want (and can convince the other party to agree to) is fair game. Simply write out a list of things that will constitute good cause in the contract, and that list will be binding. If you do not define good cause, then the fallback standard is usually impractically high, and your relationship with that distributor is generally not over until the distributor decides that it is.

Popular choices when defining good cause include: failure to pay within a certain time period, failure to maintain minimum orders, and failure to meet minimum shipping and handling requirements.

As an aside, it is worth noting that, as with all contracts, there are limits to what can be agreed upon. For example, every contract drafted within the United States is subject to the covenant of good faith and fair dealing. While the discussion of what that entails could be an entire article in itself, for now, know that everyone is legally bound to act honestly and fairly in his or her contracts. In a similar vein, some of the states that allow parties to define good cause for themselves restrict what can be agreed to even more tightly than good faith and fair dealing.

A handful of states require that good cause must be limited only to what is considered commercially reasonable. Commercially reasonable is a moving target, but courts have looked to a variety of factors in the past when attempting to pin it down. One of the more popular approaches is consistency is contracting. In other words, your contract in one state might be compared to your other distribution contracts to see if the standards being applied are reasonably consistent. If you manage to negotiate better-than-usual terms in your distribution contracts, courts examining the contract may want to see that these terms were achieved in exchange for something of equal value. A matter of quid pro quo, so to speak. Some states go so far as to mandate that similar distributors be treated similarly; this is generally referred to as anti-discrimination or non-discrimination.

Terminating without good cause

So what happens if you terminate a distribution contract without good cause? Under most state laws, the terminated distributor must be paid the fair market value of the distribution rights in relation to your particular brewery, including any goodwill that accompanies the relationship. Like good cause, some states dictate what is the fair market value and some allow the parties to decide for themselves.

Regardless, the means of calculating this fair market value needs to be spelled out in the distribution contract so that there is no confusion (or litigation) later on.

When allowed to define the value, different breweries have used different methods. One of the most popular approaches involves matching the profit for a certain number of months preceding the termination with a multiplier. How many months will of course vary based on the size of your brewery and the extent of distribution. Explicitly negotiate this with the distributor and include it, labeled as such, within the contract.

Other special considerations include specific notice requirements when attempting to terminate the contract, the distributor’s right to cure any deficiency in the relationship, exclusivity requirements for particular territories, and anti-waiver provisions.

Anti-waiver provisions accomplish several things. First, they void any out-of-state forum selection clause that the distribution contract has. Generally, parties can choose the law of any state they like regardless of where the parties are located or where the transactions are taking place. Certain states have decided that the regulation of alcohol distribution within its borders is so important that its own laws will govern irrespective of what the parties would prefer. Hence, distribution contracts in California, for example, will always be governed by California law, even if the parties agreed to use Colorado law instead. Note that many distributors are unaware of these rules and actually purport to waive this particular rule (sometimes explicitly, sometimes accidentally). Just know that, regardless of what the contract says when you sign it, if you are in an anti-waiver state, then that state’s laws will apply.

Not every provision mentioned above applies in every state. Some states have very simple distribution laws; some states have very complex distribution laws. This is an area fraught with potential litigation pitfalls, so it is important to consult an attorney before signing the contract. You may very well be spending the rest of your brewery’s life with this distribution company, for better or for worse, so be sure to put all of your cards on the table before you walk down the aisle together in commercial matrimony.

Candace L. Moon is a San Diego-based attorney who has spent the last four years dedicating her law practice to the craft beer industry. She has worked with over 100 craft breweries and craft breweries-in-planning nationwide, handling business entity formation, alcoholic beverage law, contract review, trademark law, as well as other legal needs. Her clients range from Green Flash and Drake’s to Jamil Zainasheff’s Heretic Brewing. Moon’s undergraduate degree is from the University of Virginia and her juris doctorate is from Thomas Jefferson School of Law in San Diego, Calif. She has been a member of the California State Bar since 2008 and the Brewer’s Association since 2009. Contact her at [email protected]; her website, www.CraftBeerAttorney.com; or her Twitter account,CraftBeerAttny.