California’s Tied-House Trap
Standard Contract Terms Can lead to Liability in California’s Hospitality and Alcohol Sector
Have you ever signed an agreement with an indemnification clause requiring you to hold another party harmless for your negligent acts? What about a contract that requires you to add a third party as a beneficiary of your insurance policy? How about an agreement that requires a vendor to discount goods that are delivered late or improperly? Have you ever agreed to carry specific amounts or types of insurance in connection with a commercial transaction that you would not have otherwise carried? Have you been required to give a guarantee in connection with a purchase or sale?
Most attorneys consider contract terms like the above “standard.” No matter what industry you are in, you will likely find that your commercial agreements contain insurance requirements, remedies for improperly handled goods, indemnification requirements, and various guarantees. Such clauses are crucial and standard tools that parties use in commercial negotiations to allocate transaction risks. Yet, under California’s Tied-House rules (Cal.Bus.&Prof.CodeSec. 25500 et seq.) these standard contract terms are entirely illegal in agreements involving the purchase and sale of alcoholic beverages between alcohol retailers such as hotels, restaurants, and grocery stores, and alcoholic beverage producers and wholesalers. Such clauses can lead to significant fines, and suspension or revocation of your liquor license.
California, like many states, maintains a strict economic and legal separation between alcohol retailers, alcohol wholesalers, and alcohol producers through a complicated set of statutes and regulations collectively referred to as the “Tied-House” laws. A “Tide-House”1 was common pre-prohibition alcohol retailer that was owned and often operated by an alcohol producer. The pre-prohibition vertical integration of alcohol retailers and producers was so successful that it allowed alcohol producers to accumulate massive political and economic power, so much so that the alcohol industry effectively captured the federal government. Until the advent of individual income tax the federal government was funded almost entirely by taxes on alcohol. Accordingly, to protect its single largest funding source the federal government was extremely permissive with the alcohol industry. Arguably the permissive regulation of alcohol, and the problems that caused, lead to prohibition in the United States.
After prohibition ended, the federal government and many states sought to avoid repeating the pre-prohibition regulatory capture and to fight the organized crime that had then become entwined with the alcohol industry. They did so by banning the vertical integration that gave the alcohol industry so much power in the pre-prohibition area. The federal government and states, such as California, passed comprehensive, broadly worded statutes prohibiting “Tied-Houses” which created a three-tier system of alcohol producer licensees, wholesale licensees, and retail licensees. Taken together the Tied-House laws keep these tiers separate by prohibiting a plethora of, what would otherwise be standard, economic activities between the licensees of the three tiers. Unfortunately, these banned economic activities impacted many standard contract terms that allocate risk in commercial transactions.
To understand how the tide house statutes make standard contract terms illegal, it is useful to look at an example excerpt from the Tied-House statutes. Here is the portion of the California Tied-House statute that applies to off sale retail licensee (people selling alcohol for off site consumption):
§ 25502. Prohibited economic interests in off–sale general license
(a) No manufacturer, winegrower, manufacturer’s agent, California winegrower’s agent,rectifier, distiller, bottler, importer, or wholesaler, or any officer, director, or agent of any such person, shall, except as authorized by this division:
(1) Hold the ownership, directly or indirectly, of any interest in an off–sale license.
(2) Furnish,give, or lend any money or other thing of value, directly or indirectly, to, or guarantee the repayment of any loan or the fulfillment of any financial obligation of, any person engaged in operating, owning, or maintaining any off–sale licensed premises... (emphasis and italics mine)
Standard contract terms like insurance requirements, indemnification, and remedies form is handled shipments between offsite alcohol retailers and alcohol producers and wholesaler break the above rule because they constitute “thing[s] of value”. Typically, a “thing of value” is anything that is an economic detriment to seller and an economic benefit to purchaser which is transferred in connection with or to induce the purchase or sale of alcoholic beverages.2 Moreover, there are parallel statutes and rules that the apply penalties for this activity to the retailers as well as the producers.3
As an example of how seriously the California Department of Alcoholic Beverage Control (ABC) treats Tied-House violations, in a recent presidential administrative decision, the ABC forced the Anheuser-Busch company to pay a $400,000.00 settlement to avoid revocation of its license.4 The illicitly transferred “thing of value” that was the basis for the ABC’s complaint against Anheuser-Busch (and a small retail licensee) was a below market rate lease on one small, branded refrigeration unit in the retail licensee’s shop.5
Alcohol licensee’s often run into trouble because outside the context of enforcement by the Department of Alcoholic Beverage Control, it is difficult to see the parallels between transferring a “good” like the refrigeration unit in the above-mentioned case, and an indemnification clause. Yet under the Tied-House rules both are “things of value.” Therefore, a producer licensee is just as guilty of a Tied-House violation when it gives a below market lease on a refrigeration unit to a retailer, as a retailer would be if it required indemnification from producer in in vendor contract. Moreover, if an illicit contract term makes it into something like a licensee’s form vendor agreement, then each time that form agreement is executed the licensee incurs an additional Tied-House violation.
The unfortunate reality is that the hospitality and alcohol sectors can be extremely competitive and getting a competing business fined or its liquor license suspended or revoked is an effective way of shutting down competition. All it takes is one disgruntled party bringing an illegal agreement to the ABC’s attention to start the investigation.
So, how do you avoid Tied-House violations? Well, the best way is to have experienced California liquor counsel draft any agreement concerning the disposition of alcoholic beverages. Clients that are concerned that they may have already executed agreements containing violations should retain California liquor counsel to do a comprehensive review of their outstanding agreements and then engage in efforts to rescind and redraft any non-compliant agreement. If a Tied-House investigation is already under way experienced liquor counsel can provide representation during administrative proceedings and can usually negotiate a settlement that saves the operation of the license.
