Soon to come to your Local Supermarket– Instant Redeemable Coupons of the digital age!

New technology is difficult to use in the alcoholic beverage industry because old laws and regulations don’t accommodate new ideas. Today, however, we report a feel-good story.

Last year (2016) Governor Brown signed SB-1032, which prohibited wine supplier licensees from offering supplier-funded instant rebate coupons (“$1 Off at the register!”) at retail accounts. This brought wine suppliers into promotional equality with beer suppliers, who lost instant rebates in 2014.  Point of sale instant rebates, it was argued, benefitted large suppliers at the expense of smaller, craft producers.  Large retailer demand for IRC programs as a condition of carrying the product also worried the supplier tier.  Dueling IRC’s were increasingly becoming a very expensive competitive weapon.  The regulatory concern was that retailer redemption practices were prone to abuse because the redemptions went through the retailer.

This year, the California Legislature, recognizing that new technologies justify amendments to existing laws dealing with marketing promotions, added digital rebates to the list of permitted alcohol supplier marketing tools.  Digital rebates differ from instant rebates in several ways; the most important being that redemption is accomplished without running the money through retail accounts.

On October 2, 2017, Governor Brown approved AB-1722 and it is now law in California.  Business and Professions Code § 25600.3, which defines coupons and outlines what are permissible rebate practices, was amended to include “electronic or digital rebates” in the list of permitted alcohol supplier marketing tools.  The “iBotta bill,” as some call it, refers to one new mobile application that offers electronic digital rebates that can be redeemed during a sale without retailer involvement. We expect there will be more digital coupon vendors very soon.

AB-1722 also closed a promotional work-around in the earlier law that allowed beer and wine suppliers to continue to fund instant rebate coupons for non-alcohol products.*  New section 25600.3 now refines the definition of “coupon” to include a discount on the purchase of any item, whether it is an alcoholic beverage, or not.

Electronic digital rebates are a new and exciting tool for consumer engagement, and we expect more tools of this nature to come into existence as the technology to bring suppliers and consumers together at the point of sale develops. Think about the act of scanning a register receipt resulting in a consumers account being credited for a significant portion of the purchase price. Coupon clipping will be ancient history.

The new world of digital coupon clipping begins on January 1, 2018.

*We’ve received a few questions on whether this amendment impacts spirits suppliers, and their ability to offer cross-promotional instant rebate coupons for non-alcoholic products.  Spirits suppliers can breathe a sigh of relief, as their privileges remain unchanged after this refinement of the definition of “coupon.” Spirits suppliers are still permitted to offer “discount[s] or rebate[s] on the purchase of any item so long as no nonalcoholic beer, beer, malt beverages, or wine products are advertised or promoted by these licensees in connection with the discount or rebate.” Business and Professions Code Section 25600.3(c)(4)(B).

The License Piggyback Dilemma – If it Sounds Too Good to be True, it Probably is

However one happens upon the wine industry (love of wine, retirement from a lucrative profession into the countryside to grow premium wine grapes or just good luck), the subject of doing business in a regulated space becomes an issue sooner rather than later. Wine production and sales are subject to a dizzying mix of regulation at the federal and state level, enough to frighten even the most dedicated and well-funded. While regulation cannot be avoided, many people figure there must be an easier way to get started than by locating a facility and applying for the complicated licenses and permits.

Unfortunately, it’s not that simple. This blog post explores the dangers inherent in many of the common work-around solutions brought to us. Do these questions sound familiar?

“I don’t have licenses of my own, but can’t I just use a winery’s licenses to make my wine and get the products to market?”

“I sell a winery my grapes and they make the wine and sell it. Can’t I just have them use my name on the bottle, sell the wine and we split the profits?”

“I have my grapes custom crushed. Can’t I just use the winery’s DTC permits to service the 30 plus states in which I may not legally sell wine?”

These questions all refer to “license piggyback” scenarios, where one winery’s licenses are being used to incubate a new wine brand, or leverage markets foreclosed to non-licensees.

The Problematic Relationship

The problem with any “license piggyback” solution is the same problem facing third party provider (TPP) marketing websites: you cannot “avail” yourself of the privileges of someone else’s license. Specifically, licensees cannot share profits with non-licensees, and unlicensed persons and entities cannot take title to, or sell, alcoholic beverages without a license appropriate to the relationship. This has been ruled on by the California ABC and the New York SLA, and the principle is universal throughout the US alcohol regulatory system. Combine these restrictions with the proliferation of new brands from people using the marketing power of their famous names, and wineries who blithely provide services to their grape growing friends and neighbors for a cut of the profits, and it is easy to see how problematic relationships are born from well-intentioned business deals.

Custom Crush Arrangements

Brand owners are sometimes new to the alcohol beverage industry and its morass of legal restrictions, and do not realize that they need a license to sell wine. They sign standard custom crush agreements with wineries, which mandate somewhere in the fine print (too long; didn’t read) that the brand owner have the licenses to take title to the product. The winery doesn’t follow up, the brand owner cuts a check and moves product to a warehouse, then sells it either direct to consumers, or to a distributor and back into the three tier-system. If the winery allows its license to be used, it has made an unlawful sale and the brand owner has engaged in the purchase and sale of wine without a license. Those are criminal acts under the express terms of the California ABC Act. That is not good for peace of mind or (maybe, we could be wrong about this) running for political office.

Wineries should make sure that their custom crush clients have licenses to take title to the product wineries manufacture for them as part of the vetting process during contract negotiations (either that or they intend to drink the wine themselves, or give it away).

For brand owners, custom crush agreements are necessary if the plan is to obtain licenses to sell the wine at wholesale, or direct to consumers such as with the Type 17/20 license combination in California. If the goal is ultimately to become an alternating proprietor (AP) with a winery license, or an actual winery, we recommend this approach for brand incubation before committing to production equipment and the costs and complexities of an AP or a facility.

For the scenario where a custom crush 17/20 intends to take advantage of the winery’s DTC permits, the relationships between the parties must be carefully structured to operate within the confines of the law, with the winery retaining title to the wine shipped under its permits, and the 17/20 acting as a TPP. This requires a good, clear, contract. A good contract provides a mechanism to not only resolve disputes between the parties, it prevents an aggrieved party in a later dispute from claiming that the underlying relationship was unlawful and therefore the contract between the parties is unenforceable.

Full Service Route to Market Contracts

Sometimes, wineries themselves are not aware of the limitations on their own license privileges and their relationships with non-licensees. We have seen well intentioned wineries offer their clients a full suite of services, including winemaking, brand consulting and turn-key route to market strategies for a cut of the profits from wine sales.

The tricky aspect of these relationships is that ABC has not drawn a clear line distinguishing lawful arrangements from unlawful ones. Wineries can provide services to licensees and non-licensees alike, including brand strategy and consulting services. Wineries cannot perform services that amount to renting out their licenses, and they cannot share profits with non-licensees. Therefore, the extent to which these contracts are lawful is fact specific, and depends on what exactly the contract terms specify.

Licensing/Marketing Agreements

Another approach for brand owners is to never take title to the product, and instead sign Licensing/Marketing Agreements with wineries. These agreements (variations of the TPP relationship) license the brand owner’s intellectual property to the winery, and the brand owners receive compensation for providing marketing services to the winery to facilitate distribution of the products. The arrangements are a good choice for those who cannot hold supplier/wholesale tier licenses, or those who don’t want to bother. There are, however, limitations with this approach. Principally, the prohibition on profit sharing with non-licensees necessitates careful structuring of the compensation portion of the agreements between brand owners and wineries to ensure they don’t cross the regulatory line.

Enforcement

And now the $64,000 question, is this an enforcement priority for ABC? What is the potential liability? Regarding the former question, we are seeing California ABC investigate these relationships with increasing frequency, and we expect more inquiries into these relationships as ABC and the federal authorities understand the number of problematic relationships out there.

The potential liability question is more complicated. ABC has jurisdiction over licensed wineries, and actions against winery licensees have taken the form of fines and license suspensions (revocation is on the table for egregious or deliberate violators). ABC, however, does not have jurisdiction over non-licensees, and would have to engage another agency such as the Attorney’ General’s office to prosecute non-licensees for the sale of alcohol without a license (a criminal misdemeanor in California). This makes it harder for ABC to follow-up on non-licensees, but they could find an example as a warning to the industry. No one wants to be that example.

The other form of liability is contractual responsibility for the failed relationship; and damages. While who a court would find liable if a dispute occurs is a fact specific exercise, that one party was licensed and the other wasn’t would probably resolve for the unlicensed party on the theory that the licensee (as the one responsible for compliance) should have known better.

Another complicated question arises if the unlicensed entity becomes licensed, or is seeking licenses, when the ABC comes knocking. ABC’s Trade Enforcement Unit could hold up license issuance pending an investigation, could ultimately deny licensure based on the unlawful relationship and could file an accusation after the license issues to seek fines and penalties short of revocation.

Best Practices

As with most business endeavors, there is no one-size fits all approach regarding contract winemaking, AP agreements, TPP agreements or brand development. Every situation is unique, and requires a different structure to best utilize the strengths of each party to the venture. Each relationship must be considered carefully in the context of the parties’ goals to comply with the regulations applicable to licensees, and to the prohibitions against selling alcohol without a license.

That all being true, if the new wine industry member takes the time to analyze the goals it has against properly structured relationships, the process will be relatively painless (lawyers and regulators notwithstanding), and should be a lot fun.

A timely message from our Florida colleagues on the tied house laws, the three-tier system and the need for reform

 One of our close friends in Florida, Marbet Lewis of Greenspan Marder, recently penned an article about the need for reform of the tied-house laws in Florida. Marbet focused on the craft brewing industry and the difficulty of the small producer to develop its business in a time of overall consumer desire to experience authentic small brands.  She was speaking about craft distillers and craft brewers in Florida, but she could just as well be speaking about small wine, beer and spirits producers in California, Texas, Illinois, New York and throughout the US. 

While the industry benefits from the basic framework and ideology of tied house laws, our modern economy demands more targeted exemptions and special classifications to both promote and regulate growth – Marbet Lewis.

Marbet’s thesis is that our world of outdated tied house laws interferes with the healthy inter-tier relationships that benefit consumers and the industry; this includes access to investment capital and (especially in craft distilling) direct and effective access to customers via marketing channels and direct to consumer permits.  Her call for targeted “exemptions” as versus the system of special interest exemptions should resonate with all forward-thinking industry members.

 Enjoy Marbet’s fine article here.

ABC Declaratory Rulings – A Modest Proposal Whose Time has Come

By John Hinman and John Edwards

The Problem – New Technology and Process Innovation

Today’s alcoholic beverage industry is marked by technological and process innovation at every level, and in ways that were unfathomable even a decade ago. Information retrieval, accounting systems, ordering and delivery systems, social media and other new technologies pose challenges for regulators around the country attempting to fit new initiatives into statutes and regulations enacted in an earlier era. 

The regulatory challenge usually involves determining what the controlling statute or regulation means in the context of the business facts presented. The problem with quick conclusions is that facts are often not presented clearly or in an orderly fashion, which results in difficulty for both the agency and the business attempting to discern if the new business falls within the permitted activity portions of the ABC Act. 

What a statute or regulation means in the context of approving or prohibiting creative industry programs is always a challenge – new technologies usually do not neatly fit into the narrow legislative and regulatory enactments crafted for a different time. 

That results in a system where approval of new and innovative business concepts, often ones that are permitted by other states or the federal government, are routinely denied, or are undertaken under a cloud, which impacts regulators, investors, managers and licensees.

Many regulators take the position that whatever process or innovation is sought cannot be permitted unless the legislature has expressly permitted it. However, sponsoring legislation is an expensive and time consuming process and new legislative exceptions often create more problems than they solve. 

The Solution – Create a Forum for Program Analysis; NY does it and so can California

We propose a solution where the burden is on the new technology or system developer to prove to the ABC that the system is legal, and to provide an efficient forum for presenting that case.

This was brought home in a recent (January 19, 2017) declaratory ruling by the New York State Liquor Authority approving the Instacart internet marketing platform and product delivery protocols in New York.  The importance of the ruling to Instacart and those using similar marketing platforms and delivery protocols cannot be overstated.

Significant investment of time and money in a marketplace can only be justified by industry member (and service provider) confidence that what they are doing will not threaten the licenses of the participants in the system or, worse yet, expose the participants to criminal charges for violating the state alcoholic beverage laws (for example, all violations of the California ABC Act are statutory criminal misdemeanors, and that could conceivably include liability for aiding and abetting the offense).

New York is one of many states that have a specific alcoholic beverage declaratory ruling procedure.  California, however, has no specific procedure for obtaining rulings on alcoholic beverage business proposals.  The lack of such a procedure hobbles innovation and introduces unjustifiable and unnecessary risk into the process of investing in, and managing, California businesses.  Given the importance of the industry to the State, California’s regulation of alcohol can and should be made more transparent and should provide guidance on which industry members can rely.

Creating a Declaratory Rulings Protocol – it can be done

California has an administrative ruling statute that provides for declaratory rulings (through an agency not used by the ABC). We propose that the authorizing statute be amended to specifically include the ABC, to provide for ABC Appeals Board review of the ABC’s action in accordance with the California Constitution, and to provide for designating rulings as “precedent.”

Here is our proposed language. Please note that the Section 1 exclusion of the ABC from the general Government Code section is what allows the Section 2 inclusion of the ABC into the new procedure that we propose.  That’s how the Government Code works.

Section 1

Government Code Section 11465.10 is hereby amended as follows:

Subject to the limitations in this article, an agency, other than the Department of Alcoholic Beverage Control, may conduct an adjudicative proceeding under the declaratory decision procedure provided in Sections 11465.10 to 11465.70 of this article.

Section 2

The following sections are added to Article 14 of the Government Code:

Section 11465.80

(a) Any person may file a Petition with the Department of Alcoholic Beverage Control for a declaratory decision with respect to the applicability to any person, property, or state of facts of any statute or rule enforceable by the Department.

(b) Petitions for a declaratory ruling by the Department shall:

(i) Contain a statement of the declaratory ruling requested;

(ii) Include a concise statement of the state of facts or uncertainty with respect to which a declaratory ruling is required and may include a statement by the petitioner of the outcome sought and the reasons therefor; and

(iii) be filed with the Department and directed to the attention of its General Counsel.

(c) The Department of Alcoholic Beverage Control shall reject any Petition for a declaratory decision as to which any of the following applies:

(i) The Petition does not comply with requirements of subsection (b) of this section;

(ii) The decision would substantially and directly prejudice the rights of a person who would be a necessary party and who does not consent in writing to the determination of the matter by a declaratory decision proceeding;

(iii) the Petition presents a matter that is the subject of pending administrative or judicial proceedings.

(d) Unless the Department of Alcoholic Beverage Control rejects a Petition pursuant to subsection (c), the Department shall:

(a) Publish the Petition on its website; and

(b) Provide a period of not less than 30 days for interested parties to file comments with respect to the relief requested and a period of not less than 10 days for the petitioner to file responses to the comments of interested parties; and

(e) The Department of Alcoholic Beverage control may, in its discretion, schedule a public hearing on the issues presented by any Petition for a declaratory decision, at which it may permit the introduction of evidence.

(f) The Department shall issue a ruling on the Petition in writing within not less than 80 days after the date of the filing of the Petition.

(g) The Department shall designate each of its rulings on Petitions for a declaratory decision as Precedent and index all such precedents, including any subsequent rulings thereon by the Alcoholic Beverage Control Appeals Board or any court, as precedent pursuant to Government Code Section 11425.60.  The index and all rulings on Petitions for a declaratory ruling shall be published on the Department’s website.

Section 11465.90

The ruling issued by the Department shall constitute a “decision” within the meaning of Bus. & Prof. Code Section 23080.  The Petitioner or any person who filed comments with the Department may appeal the ruling to the Alcoholic Beverage Control Appeals Board pursuant to Bus. & Prof. Code Sections 23080 to 23089.

The Key Concept – Create a body of decisional law - Precedent

The most important word in this proposal is “precedent.” 

Precedents in the purest sense are examples of how the statutes and regulations are applied in actual cases. As precedents are developed they create a body of law that can be relied upon by legal practitioners, industry members and trade associations alike.  This removes uncertainly and provides an avenue for a reasoned consideration of new and innovative proposals against a background of established examples that can be used to guide conduct. 

Please note that under our proposal a petition could not be filed with the ABC after a violation has already occurred and an accusation or other proceeding initiated.  That, as well as assuring that the ABC retains essential discretion to approve or disapprove proposals, assures the integrity of the ABC’s accusation process, and insures that the ABC's other powers are not compromised.

The ultimate result will be a body of published decisions that every industry member and service provider can rely upon in making important investment and business decisions, and a mechanism for seeking illumination in those situations where the answers are unclear.  That would enable continued innovation and provide the kind of certainty that one of the most important industries in California deserves.

It’s a win-win.

More on FDA Inspections - Breweries, Distilleries and Questions

BY:  Barbara Snider, Erin Kelleher and John Hinman

We received some great comments and questions regarding the recent (May 22, 2017) blog “Why the FDA is Inspecting Wineries.”

One of the most common questions was “does the FDA inspect breweries and distilleries?  The answer is a resounding yes. If you are a brewery or a distillery, revisit the original post for more detail.

Breweries and Distilleries.

The bottom line is that the rules are the same for all alcoholic beverages.  Most breweries and distilleries, like wineries, sell their products through general commerce and therefore, must register with the FDA and follow the same Good Manufacturing Practices.  All domestic companies must register unless they are considered a “retail food establishment” or “qualified facility” and are exempted from registering as described below in more detail.

Breweries and distilleries, like wineries, are also exempt from Subpart C (Hazard Analysis and Risk-based Preventative Controls) and Subpart G (Supply-Chain Program) but like wineries, must comply with Subparts A and B (related to sanitary conditions and training of employees in personal hygiene) and Subpart F (recordkeeping).

Breweries and distilleries are also subject to FDA inspections and the best practice is to be aware and prepared.  Therefore, the advice and brief checklists provided in the May 22nd blog apply equally to them. 

The one difference for breweries and distilleries is the disposal of spent grains from the manufacturing process.  In 2014 the FDA caused much consternation with its proposed rule that would require breweries and distilleries wishing to send the spent grain for animal feed to additionally comply with the hazard and risk analyses and a supply chain program under the Animal Food regulations.  (This would be in addition to complying with the human food regulations with which all alcoholic manufacturers must comply). 

The good news is that the FDA listened to the outcry against adding this additional regulatory burden and the current rule provides that processors already implementing human food safety requirements do not need to implement additional preventive controls when simply supplying a by-product (wet spent grains) for animal feed.  Breweries and distilleries are expected to assure that there is no physical contamination of the spent grain before shipping.  For example, contamination by placing trash or cleaning chemicals into the container holding the spent grain.  General sanitary conditions apply to transporting the spent grains for animal feed.

It is important to note, however, that any processor who further “processes” the spent grain for use as animal food (for example, drying, pelleting, heat-treatment) must additionally comply with the Animal Food Good Manufacturing Practices which include developing hazard and risk-analyses and developing preventative controls. 

The brewery or distillery may choose which path to take.

How does the FDA exemption for “Retail Food Establishments” apply to wineries, breweries and distilleries?  

We had many questions about how the exemption (which is not exactly a model of clarity) works.  The exemption as it applies to producers (such as wineries in the initial post but also including breweries and distilleries in this post) is very narrow.

The FDA exemption from the registration requirement is for producers that can demonstrate its primary purpose is to sell product directly to the consumer and that sells more than 51% of their product “out the front door” (“Retail Food Establishments”).  So, the question is whether a producer’s business operations are such that it meets the definition of “Retail Food Establishment.” 

First, even though the initial blog was written for wineries, because all alcoholic beverages are “food,” those breweries or distilleries that may qualify as a “retail food establishment” could possibly also fall under this narrow exception. 

As part of the implementation of the Food Safety Modernization Act (“FSMA”), the FDA amended and expanded the definition of “Retail Food Establishment”.  The official definition of a “retail food establishment” in the Code of Federal Regulations is:

“Retail food establishment means an establishment that sells food products directly to consumers as its primary function. The term “retail food establishment” includes facilities that manufacture, process, pack, or hold food if the establishment's primary function is to sell from that establishment food, including food that it manufactures, processes, packs, or holds, directly to consumers. A retail food establishment's primary function is to sell food directly to consumers if the annual monetary value of sales of food products directly to consumers exceeds the annual monetary value of sales of food products to all other buyers. The term “consumers” does not include businesses. A “retail food establishment” includes grocery stores, convenience stores, and vending machine locations.  A “retail food establishment” also includes certain farm-operated businesses selling food directly to consumers as their primary function.” (Highlighting and emphasis added.)

Therefore, any winery, brewery, distillery that can qualify as a “retail food establishment” demonstrating that its primary purpose is to sell its product directly to consumers will be exempted from the FDA registration requirement. 

This means that the annual monetary value of sales of food products directly to consumers must exceed the annual monetary value of sales of food products to all other buyers (at least 51% direct to consumer sales).  The term “consumers” does not include businesses unless (as discussed below) you operate within in a small local area in the same state (truly local businesses) and can be characterized a “Qualified Facility.” 

The FDA determined that all “direct-to-consumer sales” (DTC) including Internet and mail order sales are included as part of the calculation to determine whether the primary purpose is to sell directly to consumers.  The FDA stated that there is no requirement that DTC must be a face-to-face sale.  Therefore, sales proceeds from Internet and mail catalog DTC sales may be used in the calculation to determine that the primary function is to sell directly to consumers.  Sales made at farmers’ markets, consumer events, directly from tasting rooms and the like are also considered in the calculation. 

Further, while the earlier blog discussed the size requirement needed to qualify as a “retail food establishment” (less than 11 employees) in adopting the final rule, the FDA did away with any employee size requirement to qualify for the retail food establishment exemption stating:  “Even if some establishments that use mail, catalog, and Internet orders in determining their primary function are larger establishments and can reach consumers on a national level, we do not believe that is inconsistent with section 102(c) of FSMA, which does not specify that FDA’s amendment to the retail food establishment definition only pertains to establishments of a specific size.”  

The principal criteria the FDA will use in determining if an establishment qualifies as a “retail food establishment” is whether its primary purpose is to sell its product direct-to-consumer. The FDA’s basic test is whether an establishment’s annual monetary value of sales of food products directly to consumers exceeds the annual monetary value of sales of food products directly to all other buyers, i.e., more than 51% of its sales are direct-to-consumer.

This appears to be another benefit of the alcoholic beverage industry move to DTC (practically and legislatively) where possible. 

“Qualified Facilities”.

We did receive a comment asking us to explain what “Qualified Facilities” means.  This very narrow exemption from the FDA registration requirement applies only to very small businesses that principally operate locally.  Very briefly, a “qualified facility” status applies to those facilities that sell product to consumers, restaurants or “retail food establishments” located in the same state and not located further than 275 miles from the qualified facility.  There are also monetary limits on the value of product sold during the prior 3-year period (less than $500,000 adjusted for inflation).  Attestations and documentation are required.  Should anyone desire more information on this, please call the FDA, your trade association representative, or your attorney.

Recall Procedures.

We received some inquiries asking whether a winery (or brewery/distillery) needs to develop a “Recall Plan” in the case there is need for the recall of the product.  The first point to make is that the TTB has primary control over any recalls for alcoholic beverages and does not require a company under its jurisdiction to prepare a Recall Plan.  While it might be a good idea and a good business practice to have a plan of action regarding what to do if you need to recall a product from the market, know that it is not required by the TTB and the FDA cannot impose that requirement (at least not yet!). 

You should feel comfortable if the FDA inspector asks about your recall plan and you don’t have one (although we do encourage adoption of a recall plan as a basic best practice). 

Conclusion – Be Compliant!

We encourage our clients and friends to approach FDA compliance in the same orderly way that they approach all compliance topics.  There should be an officer or manager of the facility charged with the principal responsibility of compliance with operating regulations – whether labor and employee related, production facility related (use permits and equipment safety under OSHA for example), alcohol production and sales related (ABC, TTB and local state OSS permits) or food product related (FDA and local food service requirements for example). 

The smaller the enterprise of course the more the burden falls on fewer people.  That is also why we encourage checklists and spending quality time with your industry trade associations, who have a vested interest in making sure that their members know the rules.

This is a complex issue with many moving parts.  We encourage you to contact your trade association representative or your attorney with your questions before you get that call informing you that the FDA inspector is on the way.