Three-Tier System Essentials: Distributor Relationships

When it comes to the three-tier system of beverage alcohol sales, there is perhaps no more important relationship than that between a beverage supplier and their distributors (also known as wholesalers). The support provided by distributors is invaluable in accessing a state’s market, from handling complex logistical arrangements to guiding a supplier on state laws to serving as a brand ambassador for the supplier’s products in the state.

Even more so, suppliers are often legally required to work with distributors to sell their products wholesale in a state.

This confluence of affects—the necessary services offered by distributors and the influence of state law—can make establishing a wholesaler relationship fraught for a supplier. If the supplier is not careful, they can end up stuck in an unhealthy pattern with their wholesaler, with their products sitting unsold and their brand weakened in the state.

The best advice for any supplier, whether a domestic producer or an importer, that is looking to distribute their products into a new state is to talk to their attorney. Direct, specific legal advice is critical for the supplier to understand what their obligations are and will be, what legal restrictions on their distributor relationship may be there, and how they can set up their wholesaler agreements to avoid future problems.

But there are some key things that a supplier should always keep in mind when building out their three-tier distribution partnerships, which will be discussed in the rest of this post.

What to look for in a distributor

There is no single answer for what makes an ideal distributor. There are so many considerations for a supplier to manage, from the specific products they sell, the consumers they want to reach and sales patterns in each state, that each supplier needs to determine for themselves which is the best wholesaler to work with.

Consolidation within the distributor tier has made this more challenging, especially for smaller suppliers, who may need a more specialized service to sell their products. But there are still options out there for suppliers, especially with the recent rise of new distribution services designed to enable better business-to-business interactions.

Most of all, a supplier needs to make sure that whichever distributor they work with, their distributor will be effective. The wholesaler will be the primary means for selling and handling the supplier’s products in the state, making it absolutely essential that the distributor will actively and knowledgeably market and sell the supplier’s products. The wholesaler will need to understand the product well and take care that it is presented to the best retailers in the best locations. And of course, the wholesaler will need to properly keepsafe the products that are in their hands and follow up with all of their reporting and tax obligations.

The importance of a strong contract

Suppliers need to make sure that they have a coherently written and thoroughly considered contract to best ensure that a distributor will be an active and effective partner. In the contract they can set out the terms of their agreement, establish clear expectations and outline conditions for if those expectations are not met.

Ideally, the supplier will never experience any trouble with their wholesaler and not need to invoke any of their contractual powers. But setting out those terms and conditions, the expectations and consequences, well ahead of any problems that may arise, will make dealing with those problems that much easier.

As such, working with an attorney who can help draft a specific distributor contract at the beginning of the relationship is absolutely necessary for all suppliers. Establishing a relationship with a handshake agreement, or simply signing whatever boilerplate contract a distributor sends over may seem friendly and simple, but doing so will more likely lead to future strife than having the seemingly difficult conversation up front. There are always unique situations and expectations that each side will bring when negotiating a wholesaler relationship, and making sure that your take on those things is heard and is put down in writing is absolutely essential.

The legal limitations of a distributor relationship

Entering a distributor relationship carefully and with full consideration is especially important in light of the many laws and regulations that restrict when and how suppliers can establish and change their distributor relationships. During the decades following Prohibition, particularly in the 1970s, many states adopted franchise laws and other rules surrounding interactions between suppliers and distributors, which place limits on how wholesaler relationships function in the state.

It is necessary again here to point out that, if you are in a conflict with one of your distributors or are otherwise dealing with a state’s franchise laws, talk to your attorney. Not only are these rules unique in each state, but they are complex and may require a number of very specific steps on your part. They should not be taken lightly or seen as a petty annoyance, and talking with an expert is critical for avoiding greater problems.

Franchise laws, as they work in beverage alcohol regulations, were originally intended to reduce undue influence in the industry by leveling out the power dynamics between large suppliers and small distributors. The fear was that some particular conglomerates, responsible for the vast majority of beer sales in the U.S., could lean on their wholesalers and force them to adjust contracts to cut prices, exclude competitors’ products, or otherwise privilege their products in the market. In response, franchise laws were enacted that, variably, may (among other things):

• Restrict the ability of suppliers to cancel or renegotiate existing contracts;
• require suppliers to make specific claims of malfeasance on the part of their distributors;
• require suppliers to give their distributors months to fix any problems; and
• require suppliers to receive direct permission from regulators to adjust their contracts.

Franchise laws are much more common in beer sales, but they are also out there for wine and spirits distributions. Often they are tied to other restrictions on establishing a distributor relationship, such as limiting the number of distributors who can carry a single brand or limiting the number of distributors a supplier can designate to operate in certain territories in the state.

This all underscores the need for suppliers and their wholesalers to be operating under good, clear contracts. While franchise rules may affect how a contract’s terms can be enforced, suppliers should do what they can in their contracts to set out specific terms and expectations that can be brought up in the future. For instance, a franchise law may require a supplier to prove “bad faith action” on the part of their distributor; but having established in their contract certain conditions that they agree constitute “bad faith action” can make addressing and fixing that problem much more straightforward.

The power dynamics of the beverage alcohol industry have greatly shifted over the past several decades. There is now a sea of smaller craft producers having to work with a greatly diminished pool of distributors, many of them extremely large and focused more on established brands that sell millions of gallons per year. This inversion perhaps undermines the original intent of franchise laws and should make regulators and legislators reconsider how they police distributor relationships going forward. Nevertheless, franchise laws are on the books in many states and suppliers need to be aware of them and the restrictions that may apply when they want to cancel or renegotiate an established distributor contract.

Work today to prevent future complications

Even if suppliers were not required by law to work with distributors, distributors would continue to play a critical and necessary role in the beverage alcohol industry. By acting as the face of a brand in a state and enabling the safe and efficient movement of products, wholesalers are one of the most important relationships that a supplier can have. Understanding how to establish and maintain an effective and friendly relationship is therefore critical for all suppliers. When a supplier considers the additional limits on their relationships that exist due to a state’s laws and regulations, can make this process seem all the more fraught. But taking a cleareyed and careful approach, and consulting with legal experts, can help ensure that potential pitfalls and heartaches are avoided.