In a historic vote, Pennsylvania’s House of Representatives passed HB 790 on March 21, marking the first time since the repeal of prohibition that legislation aimed at the privatization of wine and liquor sales has made its way through the Pennsylvania General Assembly.

While the topic of alcohol privatization has received renewed political traction with Governor Tom Corbett’s announcement that he would fulfill a campaign promise to move the state out of the wine and liquor business, HB 790 represents the first detailed account of what such a plan might entail. As drafted, HB 790 provides a sweeping overhaul of the current distribution of alcohol within Pennsylvania with a focus on moving the state toward a more integrated system of liquor, wine and beer sales.

Among other issues, such integration raises two significant questions: (1) How will the sale of liquor and wine, both at the wholesale and retail level, be integrated with the existing system for beer distribution; and (2) what degree of legal protection should be given to those who pay for and obtain the right to supply liquor and wine to retailers? The focus of this article is HB 790′s attempts to answer these two important questions.

Beer, Wine and Liquor

Unlike liquor and wine, beer in this state has been sold in most instances through a private, three-tiered system of manufacturers (such as brewers or suppliers), wholesalers and retailers. Presently, the sale of beer together with wine and liquor is explicitly prohibited by statute at both the wholesale and retail level. The dismantling of this segregated system of alcohol distribution is one of the key drivers behind HB 790, as numerous studies and polls have demonstrated consumers’ preferences for one-stop shopping when purchasing alcohol.

In moving toward an integrated system, however, important issues must be tackled regarding the rights and business interests of hundreds of Pennsylvania’s small businesses that currently distribute beer at either the wholesale or retail level and which, in many instances, have been doing so through family-run companies for the past 80 years. HB 790 seeks to address the needs of these businesses in a number of ways.

First, with regard to beer distributors that represent the retail tier of beer distribution in the state, HB 790 provides that they will have the exclusive right, for the first full year after the legislation is enacted, to purchase one of the 1,200 newly established wine and spirits retail licenses. Beer distributors will also be afforded the sole right to operate facilities that sell beer, wine and liquor, in contrast to other licensees that shall only have the right to sell wine and liquor.

Moreover, HB 790 provides significant financial incentives for beer distributors that are not available to other licensees through heavily discounted initial licensee fees and the option, again on an exclusive basis, to finance the license fee over a 48-month period.

For example, a beer distributor is only required to pay a $30,000 fee to obtain a wine license in a county of the first or second class, whereas a non-beer distributor must pay $165,000 for the same license. Finally, HB 790 seeks to address the longstanding complaint of beer distributors that under the current law they are only allowed to sell beer in 24-packs or cases. Beer distributors have argued that their inability to sell lesser volumes such as six-packs, 12-packs or growlers puts them at a distinct commercial disadvantage vis-a-vis other retail operators, such as licensed bars or restaurants for customers who do not want to buy an entire case of one particular beer. Under HB 790, beer distributors would be able to sell beer in these smaller quantities.

With regard to beer wholesalers, HB 790 provides a somewhat different approach. Presently, beer wholesalers are prohibited from owning beer distributor licenses or any kind of wine or liquor licenses. At the beer retail level, this prohibition maintains the integrity of the three-tiered system.

Under HB 790, however, a beer wholesaler has the option of either obtaining a wine and spirits wholesale license or pursuing a wine and spirits retail license. In other words, beer wholesalers can choose whether they want to integrate their existing wholesale operations to include the purchase and resale of wine and liquor or they can pursue the acquisition of a wine and liquor retail license, but not both.

If a wholesaler chooses to obtain a wine and spirits retail license, it is afforded the same financial incentives and opportunities as beer distributors — namely, the opportunity to buy the retail license at a discounted rate and pay for the license within a 48-month period. However, in so choosing, a beer wholesaler runs the risk that a beer distributor that is currently one of its customers with regard to the sale of beer may now be one of its direct competitors regarding the sale of wine and liquor.

While not perfect, HB 790 clearly sets forth a vision for how to move the state forward toward the integrated sale of all alcohol products while at the same time protecting the rights and interests of an important portion of Pennsylvania’s business community.

Franchise Protections

In addition to outlining a vision for consolidating the sale of wine and liquor with beer, HB 790 also provides direction for how these rights, once obtained, will be protected.

Presently, the Pennsylvania Liquor Code provides significant protection for beer wholesalers from the unilateral termination of their distribution rights. In particular, the Pennsylvania Malt and Brewed Beverages Act provides that beer wholesalers’ rights under agreements with manufacturers may not be modified, canceled, terminated or rescinded except for good cause. As a result, Pennsylvania has distinguished itself as one of the leading jurisdictions for the protection of beer wholesalers’ franchise rights. Because the commonwealth has historically functioned as the state’s wine and liquor wholesaler, there has not been any need to determine whether such protections should be mirrored with regard to the distribution of wine and liquor.

If, however, Pennsylvania does privatize and license wine and spirits wholesalers, the question becomes what degree of legal protection these wholesalers will be afforded. As currently drafted, HB 790 demonstrates that the state is committed to protecting the franchise rights of wine and spirits wholesalers, albeit on terms that are different than those provided to the state’s beer wholesalers.

Under HB 790, the Department of General Services is charged with establishing procedures and standards to govern the relationship between wine and spirits wholesale licensees and manufacturers, as well as the terms upon which that relationship may be terminated. However, in establishing such procedures and standards, HB 790 requires that in the event a wine and spirits wholesale licensee does not consent to a proposed termination or transfer of its distribution rights, the manufacturer may only terminate or transfer the rights upon payment of reasonable compensation.

While not as protective as the "good cause" provision for beer wholesalers, the requirement that a manufacturer must pay reasonable compensation when terminating one of its wine or liquor wholesalers recognizes and protects the investments — both monetary and in the form of goodwill — that wholesalers necessarily bring to the sale of a manufacturer’s brand of wine or liquor.

Unfortunately, the term "reasonable compensation" is not defined in HB 790, which may cause problems when disagreements arise between wholesalers and manufacturers as to what constitutes a fair price for the wholesaler’s distribution rights.

To avoid this issue, other jurisdictions with similar franchise statutes have defined this term to clearly state that reasonable compensation requires more than a simple calculation of lost profits. For example, Michigan requires that a manufacturer pay a terminated wholesaler reasonable compensation for the diminished value of the wholesaler’s business, including goodwill. Virginia also requires, as part of reasonable compensation, payment for the goodwill of the wholesaler’s business, which is recognized as providing a value over and above the fair market value of the wholesaler’s lost profits.

Moreover, many other jurisdictions have specified the dispute resolution process a wholesaler and manufacturer must follow when they cannot agree on reasonable compensation. In some instances, the matter is directed to the courts of that jurisdiction, but the growing trend has been to direct these valuation disputes to arbitration. While not suitable for every dispute, arbitration presents a good alternative for wholesalers and suppliers that want to move toward a quick resolution before adjudicators with experience valuing franchise rights and their associated goodwill, while at the same time minimizing the amount of time and money that would be required to navigate through the judicial system.

Given the significant value at stake in such terminations — often in the millions of dollars — these factors should be considered and explicitly spelled out either in future iterations of HB 790 or through regulation. •

Alva C. Mather is a litigator in the Philadelphia office of Hangley Aronchick Segal Pudlin & Schiller. She concentrates her practice on commercial disputes with a particular focus on alcohol law and franchise litigation. She can be reached by email at amather@hangley.com.