Issue link: http://winesandvines.uberflip.com/i/867389
46 WINES&VINES September 2017 DISTRIBUTOR MARKET 2017 the distributor's gross profit from sales of the brand ranging from one to as much as five times or more annual gross profit. A termina- tion fee is not necessarily a bad thing, as it provides the supplier with certainty regarding the cost of exit. In fact, a termination fee provi- sion is often preferable to relying on the state's franchise law, which often requires suppliers to pay the terminated distributor "fair market value," a notoriously ambiguous phrase that encourages litigation. We recommend consulting with your counsel and checking that state's franchise laws prior to agreeing to a fee. We generally insist upon no more than one time annual gross profit when negotiating these provisions, but the amount of a reasonable liquidated damage fee varies both state by state and by supplier volume of sales within the state (higher volumes generally trans- late to lower liquidated damage multiples). Monitor relationship Track performance: Suppose you are success- ful in getting a franchise state distributor to sign your agreement. The agreement tracks the lan- guage of that state's franchise statutes regarding good cause and allows for termination in the event of failure to perform. Does this guarantee you can terminate a non-performing distributor, provided you are willing to diligently follow the franchise state's requirements regarding notice, opportunity to cure and so on in the event of distributor performance failure? By no means. The right to terminate a distributor for fail- ure to perform is meaningless unless the winery tracks the distributor's performance. The most common mistake suppliers make regarding dis- tributor relationships in franchise or open states is to relax their vigilance once the distributor has been appointed and fail to keep a paper trail of the distributor's performance, communica- tions with the winery, sales and depletion ef- forts, promotional activities and the like. While it is true that distributors are loathe to commit to depletion numbers and often may refuse to do so, wineries can still establish sys- tems for tracking performance, require regular sales and depletion reports, schedule at least quarterly meetings with distributors (including at least one face-to-face meeting annually) in which both sides agree to certain sales and pro- motional efforts and—above all—put everything in writing. A distributor meeting evaluation form is vital for this purpose (our firm routinely pro- vides such forms to our clients for this reason). Emails can be critical in this regard: they can be your best friend or your worst enemy when it comes to tracking distributor performance in the event of a dispute. We have many suppliers who come to us with tales of distributors who are ignor- ing their brands, avoiding their phone calls and generally foreclosing any opportunity for achiev- ing the winery's sales goals in that territory. But when we begin to collect the paper trail of the relationship, frequently we find emails in which the winery has complimented the distributor on its performance, failed to note distributor deficien- cies and let slide opportunities for pointing out weaknesses in performance. In these cases, the email correspondence has generally weakened if not seriously undermined the winery's case for termination with cause in that territory. Watch for termination opportunities Certain situations or events can create "termina- tion opportunities," even in franchise law states. Sale of distributor: Franchise laws that ad- dress the sale of a distributor to another distribu- tor generally state that the brands follow the sale. However there is often a window of op- portunity in many franchise states, because the distributor is required by the franchise law to notify its suppliers of its impending sale and seek their approval. Suppliers in turn are usually required by this same law to grant the approval, so long as the successor distributor meets the reasonable requirements of the supplier. While in practice this often means the supplier has no choice but to go along with the sale, a new distributor that carries many-fold more brands than the existing distributor—and in particular that carries brands that compete directly with the supplier's brands—may provide the winery with grounds to object to the sale. This justifies a re- quest to the new distributor to furnish important basic information about its organization, other brands, financial strength and manpower. If nothing else, the impending sale creates a moment in which the supplier has rare leverage as the new distributor seeks to woo all suppliers of the prior distributor and convince them it is dedicated to their success. Frequently we have used this moment to get franchise state distribu- tors to sign written agreements with terms as fa- vorable to the supplier as franchise laws will allow. Wrongful sales outside of territory: One of the few restrictions placed on distributors in many franchise states is the prohibition against selling a product outside of the territory designated to it for that particular product. Despite this, it is not unusual to hear about distributors that are selling products in coun- ties to which they were not appointed—or even selling the product into neighboring states. The latter usually violates more than one state's alcoholic beverage laws and provides a poten- tial opportunity for the supplier. For practical purposes we often help our suppliers use this opportunity to trade out their brands with another distributor (see below) or negotiate a termination with a modest settle- ment fee rather than use the wrongful sales as grounds for a termination with cause action— the latter is usually costly, protracted and often unsuccessful in these states. Egregious behavior: Sometimes the dis- tributor's actions are so outrageous that even the franchise state's court is appalled. If you have a distributor that's a really bad actor, it's worth consulting with your counsel before concluding it's hopeless because you are in a franchise state. For example, we have a small winery client whose wines were being distributed in a particu- lar franchise state. One year, the winery intro- duced some new varieties and brands into the portfolio. But when the winery provided a pre- sentation of the new wines to the distributor in that state, it was informed that the distributor had established its own "tasting panel" that found the winery's new wines did not pass muster under the panel's dubious criteria, and that the distribu- tor was not willing to carry the new wines. When the winery humbly (I know, it is gall- ing, isn't it?) asked to take those new wines to another distributor in that state, it was told no. Because the distributor had made it legally impossible for the winery to sell its new wines in that state, the producer terminated for cause under that state's franchise law provisions. When the distributor—as we expected— filed a complaint in state court against such termination, the judge threw the distributor out of court. The takeaway? There can be jus- tice, even in a franchise state, although admit- tedly you might need to have a hair-raising tale like this one to obtain a swift verdict. LET THE BUYER BEWARE I t is important to note that any written agreement is not necessarily superior to no agree- ment in franchise states (or any state for that matter). More often than not, distributor- drafted distribution agreements include provisions that tie up the supplier's brands (in- cluding any future brands and often future territories) in perpetuity, omit any performance requirements, deny the supplier any right to terminate—not just for a distributor's failure to perform, but often for any reason at all—and include termination penalties of multiple times the distributor's gross profit. With these kinds of agreements, a supplier may be better off relying on the paltry pro- tections afforded by that state's franchise law rather than giving away those meager pro- tections under the terms of the distributor's version of a distribution agreement. This will depend on the agreement and the laws of the applicable state. We recommend wineries consult legal counsel to help them determine how to proceed under these circumstances.