Non-Alcoholic Beverage Companies and Independent Distributors: Lawsuits in the Making?

SpandorfEver since Coca-Cola first contracted with independent bottlers in the 1890s, a three-tier distribution model linking producer, independent distributor, and retailer has been the preferred one for beverage producers. That’s for good reason: the system is smart and efficient. Independent distributors know the local retail market, invest their own money in warehouses and delivery vehicles, and hire the boots-on-the-ground workforce needed to sell, transport, stock, and merchandise products in their local territory.

But while the system has considerable advantages, it also comes with significant legal risks – risks that are generally not well appreciated by the multi-billion-dollar non-alcoholic segment of the beverage industry, an expansive sector that includes everything from soft drinks to bottled water and water beverages, 100% juice and juice drinks, and “New Age” drinks like sports drinks, energy drinks, and ready-to-drink coffees and teas.

It is well known that contracts between producers of alcoholic beverages and their independent distributors are subject to extensive state regulation. Less understood are the network of state laws – sometimes called “relationship laws” – designed to protect local, independent distributors of non-alcoholic beverages. These laws can expose non-alcoholic beverage producers to lawsuits and significant liability, as a number of major non-alcoholic beverage brands have discovered, learning lessons the hard way. For example:

• A SoBe beverage distributor servicing a territory in Northwest Arkansas and Oklahoma successfully sued its supplier, South Beach Beverage, for wrongful termination under the Arkansas Franchise Practices Act and recovered more than $1 million in lost future profits and attorneys’ fees based on its operations in both states.

A Wisconsin distributor of Glacéau brand products sued its supplier for violating Wisconsin’s Fair Dealership Law after Coca-Cola acquired the supplier and decided to end the distribution arrangement and distribute Glacéau products through its own network. While the supplier ultimately defeated the statutory claim, the victory took four years in court and an appeal to the Seventh Circuit.

After Nestlé Water chose not to renew its contract with the company that had exclusively distributed Great Bear, Poland Spring, and Deer Park water in parts of New Jersey for the last 60 years, the distributor sued for violation of the New Jersey Franchise Practices Marketing Act. Nestlé Water recently prevailed, but only after defending multiple rounds in court.

Relationship law litigation has a high nuisance value. Even when the supplier wins, it is often a pyrrhic victory as these are highly fact-intensive cases, making them expensive and time-consuming to defend. Furthermore, the stakes are high: affected distributors may be able to recover their lost profits and attorneys’ fees and secure injunctions that preserve the status quo. Some relationship laws may even extend remedies to a distributor’s out-of-state operations. A supplier’s ignorance of state relationship laws offers no legal defense. And, as in any chain, one disruptive lawsuit can spawn copycat litigation.

There are many potential landmines for non-alcoholic beverage producers under state relationship laws. Some states require good cause to terminate a distribution agreement – even when the parties negotiate a terminable-at-will contract, or one requiring the supplier to pay the distributor a break-up fee. Some states limit good cause to a distributor’s breach of a material and reasonable contract provision.

A number of state laws expressly forbid a supplier from taking actions that “diminish” or “impair” the value of the distributorship or from substantially changing the distributor’s “competitive circumstances.” Some states forbid suppliers from restricting a distributor’s right to sell its business, and some forbid suppliers from discriminating in the terms offered to similarly situated distributors.

Statutory protections override contract provisions to the contrary. This is true even when a distributor is represented by independent legal counsel and negotiates special terms for itself.

The patchwork of state relationship laws may hinder the ability of non-alcoholic beverage suppliers with nationwide distribution networks to make system-wide changes in all markets. For example, some state laws may prevent a supplier from unilaterally changing territory and authorized trade channel assignments even when the contract expressly gives the supplier these rights.

Even within a single state, distributors who derive a significant percentage of their total revenue by selling the supplier’s brands – typically 20 percent or more – may be regulated while multi-line distributors whose branded sales fall below this threshold are not.

Not infrequently, non-alcoholic beverage producers discover these state laws the hard way – belatedly, only after seeking to terminate an independent distributor without cause or impose system-wide modifications to the distribution program pursuant to express contract authority. Non-alcoholic beverage suppliers must know which states have relationship laws, and the limitations that these laws impose, before terminating or initiating other regulated conduct with their independent distributors in that state.

Unhappy distributors also often rely on a variety of other claims besides state relationship laws to challenge terminations and supplier conduct, including breach of contract, constructive termination, breach of the implied covenant of good faith and fair dealing, fraud, as well as state unfair trade practice laws. But, unlike state relationship laws, none of these claims will succeed when the parties’ contract specifically authorizes the supplier’s action.

What the parties call their relationship is irrelevant to whether a state relationship law applies. Adding to the confusion, relationship laws in Arkansas, Connecticut, Delaware, Mississippi, Missouri, New Jersey, Nebraska and the Virgin Islands include “franchise” in the title of their relationship law even though the laws are broadly written to cover ordinary non-alcoholic beverage distribution arrangements that do not qualify as franchises under classic definitions.

The moral of the story is that state relationship laws cannot be waived between a non-alcoholic beverage producer and its distributors, and they apply no matter what the parties actually call their relationship. Failing to understand these laws carries significant risk, and the best way to mitigate these risks and avoid the nuisance of litigation is to know about these laws and act accordingly ahead of time.

Copyright 2015 by Rochelle Spandorf. Rochelle Spandorf is a California State Bar Certified Specialist in Franchise and Distribution Law and a partner in the Los Angeles office of Davis Wright Tremaine LLP where she advises, among others, beverage producers regarding expansion strategies and independent distribution and dealer arrangements.