Diageo and Major Brands Settle Franchise Law Dispute
This is the way most franchise law litigation ends: not with a bang, but with a whimper. After over a year of legal jostling, Diageo and Major Brands have apparently reached settlement, according to Missouri news outlets.
Suppliers trying to terminate their relationship with a Missouri distributor should closely review a state court opinion issued in the same case in response to Major Brands’ preliminary injunction motion. In that opinion, the court found that Missouri’s franchise law does not necessarily apply to all alcohol beverage distribution agreements. Instead, the court concluded that, “A liquor distributor who seeks to invoke the protections of [Missouri’s Franchise Law] must show (1) an arrangement, (2) in which a person grants to another a license to use a trade name, trademark, service mark, ‘or related characteristic,’ (3) in which there is a community of interest in the marketing of goods, and (4) which involves a relationship of liquor wholesaler and liquor supplier.” See also Missouri Beverage Co. v. Shelton Bros., Inc., 669 F.3d 873 (8th Cir. 2012).
Smaller producers trying to get out of a franchise relationship may be able to argue that no “community of interest” exists, so long as they make up only a small portion of the distributor’s portfolio. Major Brands successfully argued (in the preliminary injunction stage) that because Diageo brands accounted for 23% of Major Brand’s total revenue, a community of interest existed, and Missouri’s franchise law applied. There is, however, no clear minimum threshold that would consider sufficient to prove the existence of a community of interest.
Franchise Law Trial Begins in Missouri
After 18 months of discovery and motion practice, Diageo and Missouri distributor Major Brands will have their day in court to determine if state franchise law prevents Diageo from terminating its Missouri distribution agreement.
In March 2013, Major Brands brought suit in Missouri state court against Diageo and its new Missouri distributor, Glazer’s, claiming that the alcohol beverage producer’s attempt to terminate the distribution agreement violated state’s franchise law. At the time of the attempted termination, according to Major Brands, Diageo products accounted for 23% of the distributor’s gross revenues.
Jury selection began on Monday, September 15. We will continue to provide updates as the case unfolds.
A Closer Look at BCG’s Franchise Law Study
The Boston Consulting Group (BCG) recently released a study finding that the U.S. beer market is “open, freely competitive and driven by consumer choice.” BCG concludes its study by imploring lawmakers to be “skeptical of complaints (legal or otherwise) that the marketplace favors only large players.” In other words, BCG appears to argue that regulators should maintain the status quo and uphold state franchise laws.
For the reasons outlined below, regulators should be wary of any overreaching claims of the BCG study and closely examine the anti-competitive effects of franchise laws.
CELEBRATES COMPETITION AT SUPPLIER TIER; IGNORES LACK OF COMPETITON IN WHOLESALE TIER
BCG cites the tremendous growth in the number of craft breweries in the U.S. over the past twenty-odd years as proof that the U.S. beer market is open and competitive. BCG attributes this success to what it touts as the “open U.S. beer-distribution system.”
But the presence of a high-level of competition in the supplier tier does not necessarily mean there is sufficient competition in the distributor tier. By all accounts, the number of wholesalers continues to shrink. Moreover, many states have imposed franchise laws that insulate wholesalers from competition by making it exceedingly difficult for alcohol beverage producers to sever ties with underperforming wholesalers.
Any assessment of competition in the alcohol beverage industry must assess competition at each tier: producers, wholesaler, and retailer. By focusing solely on competition amongst producers and avoiding an assessment of the wholesale tier, BCG’s study falls short.
RELIES ON HYPOTHETICAL “CLOSED” SYSTEM; FAILS TO ANALYZE IMPACT OF DIFFERENT FRANCHISE LAW REGIMES
BCG’s study centers on a comparison of the average delivery and sales costs under two different types of distribution systems that BCG identifies as the “open” and “closed” systems. Under the “open” system, wholesalers are independent from suppliers and are free to carry both large and small producers in their portfolio. In comparison, in a “closed” network, only products produced or sanctioned by a major brewer could be part of a wholesaler’s network.
BCG calculates that the average delivery and sales cost for craft beer distribution to large grocery stores in a closed network is three-times more than in an open network. Accordingly, craft brewers benefit from franchise laws, since such laws maintain wholesaler “independence” and prevent large suppliers from extracting advantages from distributors at the expense of craft brewers.
The problem with the open vs. closed dichotomy is that it gives the impression that there is no other alternative. But not all states impose franchise laws, and some states have much less restrictive forms of franchise laws. Given the great degree of variation among state alcohol beverage regimes, BCG could have conducted a comparison of distribution costs in states that have varying sorts of franchise law regulations. Instead, however, BCG’s study rests on a hypothetical and fictitious “closed” distribution.
ENTIRELY SILENT ON IMPACT OF FRANCHISE LAWS ON CONSUMERS.
BCG’s study also falls short in that it fails to take into consideration the impact of franchise laws on consumer choice and retail prices. Although BCG states that “consumer preferences have been the main engine” driving growth of craft beers, it makes no effort to determine if strict franchise law states offer more choice and cheaper prices for consumers.
The debate over franchise laws in the alcohol beverage industry continues to grab headlines in a number of states. In March, the New York Times published an anti-franchise law op-ed authored by the co-founder and President of Brooklyn Brewery and a member of the board of directors of the Brewers Association. This summer, the South Dakota’s legislature is conducting a review of alcohol distribution systems.
BCG’s study helps highlight some of the arguments wholesalers will rely on in claiming that states should not repeal or alter alcohol beverage franchise laws. But the study has many shortcomings, and regulators should be skeptical of any arguments that suggest that this report conclusively finds that franchise laws benefit small producers.