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MERGING WITH OR ACQUIRING A BUSINESS IN THE ALCOHOL INDUSTRY
Regulatory Considerations and Plausible Implications MERGING WITH OR ACQUIRING A BUSINESS IN THE ALCOHOL INDUSTRY
New market entrants
There has been an increase in mergers and acquisitions activity (M&A) in the alcohol beverage industry in recent years. These transactions have resulted in the entry of various new players into the alcohol beverage industry, such as private equity investors and non-alcohol beverage companies. New market entrants may not be familiar with the complex regulatory framework that surrounds the alcohol beverage industry and potential limitations on future business endeavors. Private equity investors are typically highly diversified, so investing in a business that involves the sale of alcohol may be a relatively new pursuit that might represent a fraction of their overall interests. However, private equity investors should be aware of the implications of having an ownership interest in a business that sells alcohol. When considering merging with or acquiring a business involved in alcohol sales, it is crucial to have a full understanding of the cross-tier considerations and pre- and post-close licensure and qualification requirements imposed on this heavily regulated industry. This article will touch on such nuanced aspects of the alcohol industry regulations that frequently affect prospective transactions by new market entrants.
KNOW BEFORE YOU GO
When evaluating a potential transaction, one of the first questions should be whether consummating the transaction would violate any state or federal alcohol beverage control laws. Among the most important of these laws is the so-called “tied-house” law.
Before America’s failed experience with Prohibition (1920-1933), suppliers of alcohol beverages frequently exerted manipulative influence over retail outlets by “tying” themselves to the retailer through partial or total ownership, exclusive arrangements, or other business relationships that allowed the supplier to dictate the retailer’s actions. When Prohibition was repealed by ratification of the 21st Amendment to the United States Constitution, Congress passed the Federal Alcohol Administration Act (FAA Act) to create what is now commonly referred to as the three-tier system for alcohol industry regulation by the federal government as well as the states. The three-tier system structure provides for three independent levels for alcohol distribution:
1. THE SUPPLIER TIER,
Those industry members who manufacture directly or through importation supply alcohol beverages;
2. THE DISTRIBUTOR TIER, the middle tier of wholesalers who purchase alcohol beverage products from the suppliers and resell those products to retailers; and
3. THE RETAILER TIER, the licensees authorized to purchase alcohol beverages at wholesale from the distributors and resell those products to end-use consumers.
Under this three-tier system, a person or business generally is prohibited from having a direct or indirect financial interest in more than one “tier.”
Three-tier system compliance issues often arise in the context of private equity investors. If these investors have existing interests in one tier (e.g., an interest in a restaurant licensed as an alcohol beverage retailer), regardless how small, they may be precluded from obtaining an interest in another tier (e.g., a wholesaler or manufacturer) unless an applicable exception to the cross-tier interest prohibition exists.
Experienced alcohol beverage regulatory counsel should advise the private equity investor on any applicable exception to the tied-house rules that may permit the transaction to proceed. Alternatively, the private equity investor may have to consider relinquishing an alcohol beverage license in one of the two tiers or explore legislative changes that would create an exception to the cross-tier interest prohibition for the private equity investor’s two interests.
Other considerations when evaluating a potential transaction are the target’s alcohol license(s) and corresponding requirements. The FAA Act granted states the authority to regulate the sale and distribution of alcohol beverages within their state. Each state has adopted rules and regulations that, in many cases, vary from the rules and regulations passed in other states. In some states, local municipalities further regulate alcohol sales within its municipality (e.g., through limitations on the zoning districts in which alcohol may be sold or through additional local licensure requirements). This results in more than 50 agencies having jurisdiction, and imposing differing requirements (including licensure requirements) over alcohol beverage licensees.
Because of the heavy regulation associated with alcohol beverages, new market entrants should engage an experienced alcohol beverage regulatory attorney who can conduct comprehensive regulatory due diligence on the target company as well as advise on all applicable alcohol beverage rules and regulations. For example, pre-closing diligence should confirm the target company holds all requisite (where applicable) federal, state, and local alcohol beverage licenses, and that such licenses remain in good standing by avoiding enforcement action and complying with applicable sales tax, excise tax, and record keeping obligations.
Potential M&A candidates also need to be aware of the numerous filing and disclosure obligations imposed by federal, state, and/or local licensing agencies. When businesses licensed to sell alcohol beverages are involved, those obligations include pre- and/or post-closing change in ownership notification requirements for the target company in connection with consummation of the prospective transaction. These filing requirements can vary depending on the nature of the transaction, such as whether the transaction will be an equity or asset deal or result in a direct or indirect change in ownership of the licensee. Failure
If private equity investors have existing interests in one tier, regardless how small, they may be precluded from obtaining an interest in another tier unless an applicable exception to the cross-tier interest prohibition exists.
to submit these filings in a timely manner can adversely affect the target company’s operations, necessitating a cessation of the licensee’s alcohol-related operations until the requisite filings and disclosures are received, processed, and approved by the pertinent regulatory agencies. To this point, the transaction purchase agreement should be structured to ensure that change-in-ownership requirements imposed by alcohol beverage regulatory agencies are met on a timely basis. For example, if the transaction involves a licensed business operating in a jurisdiction where there are pre-closing change-in-ownership qualification requirements, the buyer should require the seller to provide written proof of such notification as a condition to close the transaction.
Notably, disclosure requirements also may arise in connection with updating alcohol beverage licensee information. For example, officers, directors (or managers or general partners, as applicable), and certain owners of the buyer usually have to be disclosed and may even be required to undergo a criminal background check and fingerprinting in connection with the alcohol beverage licensure process. These individuals typically cannot have certain historical issues (e.g., conviction of a felony or alcohol-related misdemeanor) or hold a direct or indirect financial interest in another tier. Finally, if the transaction involves the acquisition of a supplier or wholesaler, there may be change-in-ownership or consent requirements (or protections) imposed on the target company under applicable alcohol beverage distribution relationship laws, which are euphemistically referred to as alcohol franchise laws. These are state statutes that provide remedial protections to certain categories of alcohol beverage wholesalers relative to their relationships with the suppliers whose products they distribute. Although these so-called franchise laws will not derail a proposed merger or acquisition, they can impact materially the post-closing operations of the licensed business.
Given the various nuances in the alcohol beverage regulatory framework, it is critical that prospective buyers of alcohol industry members engage experienced alcohol regulatory counsel to guide them at all stages of the transaction. Once a transaction has closed, new market entrants should continue to engage said counsel to advise on how to operate the target company in a compliant manner under applicable alcohol beverage rules and regulations. For example, new market entrants that have historically operated in the beverage industry, but not in the alcohol beverage industry, will have to learn how their operations in the alcohol beverage industry must vary from their operations in the non-alcohol beverage industry. Many of the alcohol industry’s unique restrictions, e.g., limitations on how industry members may advertise products and interact with one another and the means by which alcohol beverage products may be sold, vary greatly from the regulations governing other streams of commerce, and often are far from intuitive.
Given the various nuances in
Alexis Mason is an Associate with GrayRobinson’s Nationwide Alcohol Beverage Law Group who practices trade regulation and compliance guidance associated with mergers and acquisitions in the alcohol industry. Mason’s experience includes work on multi-billion dollar beverage industry mergers, combining her corporate law and alcohol law acumen. Before joining the firm, she gained experience as in-house counsel for REEF Technology. While at REEF Technology, she conducted research to determine regulations applicable to certain business models in various jurisdictions and advised stakeholders regarding such regulations. Lauren Voke is an Associate with GrayRobinson’s Nationwide Alcohol Beverage Law Group. Prior to becoming an associate, Voke was a law clerk supporting the legal department of an international alcohol beverage company, where she developed a deep understanding of America’s three-tier alcohol beverage system, tied-house issues, trade practice compliance, and federal and state alcohol licensing. Voke counsels corporate clients on alcohol licensing and general regulatory compliance, with a focus on complex matters concerning alcohol, tobacco, food, marijuana and CBD, and gambling and sports betting activities. GrayRobinson’s Nationwide Alcohol Beverage Practice can be reached at (866) 382-5132 beveragelaw@gray-robinson.com.
