Antitrust Law Daily Wrap Up, FRANCHISING & DISTRIBUTION—S.D. Ohio: Beer distributors entitled to injunction stopping terminations under Ohio alcoholic beverages law, (Oct 17, 2013)

By Peter Reap, J.D., LL.M.

Beer distributors Tri County Wholesale Distributors, Inc. and the Bellas Company d/b/a Iron City Distributing were entitled to a preliminary injunction stopping Labatt USA Operating Co., LLC and affiliated entities from terminating their distribution rights because the question of whether §1333.85(D) of the Ohio Alcoholic Beverage Franchise Act (the “Franchise Act”) applies to written contracts, an issue on which the merits of the dispute turned, had been accepted for and was pending discretionary review by the Ohio Supreme Court, the federal district court in Columbus, Ohio, has decided (Tri County Wholesale Distributors, Inc. v. Labatt USA Operating Co., LLC, October 16, 2013, Marbley, A.). In addition, the other requirements for preliminary injunctive relief were satisfied.

Background. As an entity that supplies alcoholic beverages to distributors in Ohio, Labatt USA Operating is a “manufacturer” of beer and flavored malt beverages, as that term is defined in the Franchise Act, Ohio Rev. Code § 1333.82(B). Tri County and Iron City entered into written distribution agreements with Labatt USA Operating in 2010 and 2011, respectively. The distributors alleged that the Distribution Contracts provided them with an exclusive and indefinite right to distribute certain brands of beer and alcohol (the “Specified Brands”) in their respective territories. Each Distribution Contract purportedly limits the reasons for which Labatt USA Operating may terminate the Distributor.

Prior to 2008, the Labatt family of brands was imported into the United States by InBev USA. In 2009, pursuant to a Final Judgment in an antitrust suit by the Justice Department, the newly-formed Labatt USA Operating purchased specified assets of InBev USA. In connection with the sale, Labatt USA Operating acquired the sub-license for all of the trademarks and beer recipes for the Labatt family of brands in the United States. Labatt USA Operating does not own or operate brewing assets and does not brew any alcoholic beverages. Rather, pursuant to a contract between Labatt USA Operating and Molson Canada 2005 (“Molson”), Molson manufactures Labatt and Labatt Blue Light in Canada. High Falls Operating manufactures all other Specified Brands.

Labatt USA Operating, as well as all sub-licensees of the Specified Brands except for Molson, is indirectly wholly owned by Defendant North American Breweries Holdings, LLC (“NAB Holdings”). Prior to December 11, 2012, all membership interests in NAB Holdings were owned by three entities, collectively “KPS” or the “KPS entities.” KPS therefore controlled the rights to distribute the Specified Brands in the United States.

By a Unit Purchase Agreement dated October 25, 2012, Defendant Cerveceria Costa Rica, S.A. (“CCR”), through its affiliate CCR Breweries, Inc., contracted to buy 100% of the membership interests in NAB Holdings from the KPS entities (the “KPS/CCR Transaction”). Below the level of NAB Holdings, the various operating and licensing entities retained the same corporate structure they had prior to the KPS/CCR Transaction. Following the KPS/CCR Transaction, the Distributors continued to order the Specified Brands from Labatt USA Operating, and the Specified Brands continued to be invoiced to the Distributors by Labatt USA Operating.

On March 7 and March 11, 2013, Iron City received letters from CCR purporting to terminate the Distribution Contract between Iron City and Labatt USA Operating. On March 11, 2013, Tri County received a letter from CCR purporting to terminate the Distribution Contract between Tri County and Labatt USA Operating. The sole basis on which the defendants relied to terminate the Distributors’ distribution rights was the successor manufacturer provision of the Franchise Act, Ohio Rev. Code §1333.85(D).

Both termination letters stated: “[W]e hope, as a wholesaler with many years in the industry, you can appreciate that our decision was difficult, but necessary, in order for our company to remain competitive in the market.” The termination letters did not reference any breach of the Distribution Contracts or violation of state law by the Distributors, or any of the specified grounds for termination referenced under Section 6.0 of the Distribution Contracts.

The Distributors filed a breach of contract action against the defendants. The Distributors also sought a declaratory judgment that the defendants may not terminate their existing distribution franchises with Labatt pursuant to O.R.C. § 1333.85(D), or in the alternative, declaratory judgment that O.R.C. § 1333.85(D) so-applied would constitute an unconstitutional taking. Finally, the Distributors asserted claims for certain compensatory payments described in O.R.C. § 1333.851. The Distributors subsequently moved for a preliminary injunction to enjoin the defendants from terminating their distribution rights with respect to the Specified Brands.

Preliminary Injunction

When determining whether to grant a preliminary injunction, the court must balance the following four factors: (1) whether the movant has shown a strong likelihood of success on the merits; (2) whether the movant will suffer irreparable harm if the injunction is not issued; (3) whether the issuance of the injunction would cause substantial harm to others; and (4) whether the public interest would be served by issuing the injunction.

Likelihood of success on the merits. The Distributors argued that CCR’s termination of their franchise agreement violates the Ohio Alcoholic Beverage Franchise Act (the “Franchise Act”), O.R.C. §§ 1333.82-87. The Franchise Act provides generally that “no manufacturer or distributor shall cancel or fail to renew a franchise…for other than just cause and without at least sixty days’ written notice.”

The Sixth Circuit, in an unpublished opinion, Tri-County Wholesale Distributors v. The Wine Group, Inc., No. 10-4202, 2012 WL 2478357 (6th Cir. June 29, 2012), reviewed a preliminary injunction that enjoined a manufacturer from terminating a distribution franchise for business reasons alone. In predicting how the Ohio Supreme Court would apply O.R.C. § 1333.85, the Sixth Circuit concluded that the distributor had a “near certainty” of success on the merits where the termination reflected “a manufacturer’s unilateral determination that it could make more money if the franchise were terminated.”

The defendants did not allege that the Distributors breached their contracts or violated the Franchise Act in such a way as to provide just cause for the termination of their franchises. Rather, they relied on O.R.C. § 1333.85(D), which permits a “successor manufacturer” to terminate a franchise, other than for cause, under certain circumstances.

Although the Franchise Act defines the term “manufacturer,” it does not define the term “successor manufacturer.” The court had previously explained that the prohibitions found in § 1333.85(B) were instructive with respect to the legislature’s intent to prohibit certain conduct and its understanding of the term “successor manufacturer.” An entity can only qualify as a “successor manufacturer” under subsection (D) if one of the situations in subsection (B) does not apply. There four situations that, under § 1333.85(B), never constitute just cause and preclude the application of (D) are: (1) failure of a party to take action that would result in a violation of federal or state law; (2) restructuring, other than in bankruptcy, of a manufacturer’s business; (3) unilateral alteration of the franchise by a manufacturer for a reason unrelated to any breach of the franchise or violation of R.C. §§ 1333.82 and 1333.86; and (4) a manufacturer’s sale, assignment, or other transfer of the manufacturer’s product or brand to another manufacturer over which it exercises control.

Here, subsection (B)(1) did not apply because there was no allegation that the defendants sought to terminate the Distributors for refusing to take action that would result in a violation of federal or state law, the court held. Subsection (B)(3) has been interpreted by courts to prohibit the unilateral termination of a franchise for business reasons, where there has been no breach of the franchise agreement or violation of state law. As discussed above, however, subsection (D) creates an exception to this general rule for “successor manufacturers.” The language of subsection (B)(3) did not shed any light on the types of transactions to which the “successor manufacturer” exception applies, the court noted.

In contrast, the situations described in subsections (B)(2) and/or (B)(4) do present concrete fact patterns that can be contrasted with a “successor manufacturer” transaction.

Subsection (B)(2) applies to the restructuring, other than in bankruptcy, of a manufacturer’s business. The KPS/CCR Transaction did not simply give a new structure or organization to the entities at issue, but instead replaced the entity at the top of the organizational chart. Accordingly, the KPS/CCR Transaction was not properly considered a “restructuring” governed by § 1333.85(B)(2), the court determined.

Subsection (B)(4) concerns “a manufacturer’s sale, assignment, or other transfer of the manufacturer’s product or brand to another manufacturer over which it exercises control.” Here, the KPS/CCR Transaction resulted in the sale and transfer of 100% of the membership interests in NAB Holdings from the KPS entities to the CCR-owned entity CCR American Breweries, Inc. As such, it was undisputed that the KPS entities no longer have any direct or indirect power to govern the management and policies of NAB Holdings or any of its subsidiaries, including Labatt USA Operating, its sub-licensees, and sub-contractors.

Accordingly, there could be no argument that Anheuser-Busch/InBev retains any control of the Specified Brands. The KPS/CCR Transaction could not be viewed as merely a transfer of the manufacturer’s product or brand to another manufacturer over which the previous manufacturer exercises control. The KPS/CCR Transaction therefore did not fall within the scope of subsection (B)(4).

The court now turned to the question of whether CCR otherwise qualified as a “successor manufacturer.” Subsection (D) defines a “successor manufacturer” transaction as one whereby a new entity “acquires all or substantially all of the stock or assets of another manufacturer through merger or acquisition or acquires or is the assignee of a particular product or brand of alcoholic beverage from another manufacturer.”

The relevant inquiry for the purposes of subsection (D) was whether there has been a change, through acquisition or merger, in the entity that exercises ultimate control over the brands at issue, the court noted. That question was answered in the affirmative: in purchasing 100% of the membership interests in NAB Holdings, CCR did acquire complete control over the Specified Brands, according to the court. Therefore, the Distributors were unlikely to succeed on the merits of their argument that CCR is not a “successor manufacturer” for the purposes of O.R.C. § 1333.85(D).

Whether the contracts precluded termination. The Distributors also argued that, even if CCR was a “successor manufacturer” under the meaning of O.R.C. § 1333.85(D), the Distribution Contracts at issue precluded CCR from terminating their franchises on that basis. Because the Distribution Contracts impose separate duties from those imposed by the Franchise Act, the Distributors contended that § 1335.85(D) did not obviate the manufacturer’s need to comply with its contractual obligations.

However, the provisions on which the Distributors relied directly conflicted with a successor manufacturer’s right under § 1333.85(D) unilaterally to terminate a franchise without just cause. Thus, to the extent that any language in the Distribution Contracts entirely precluded application of § 1333.85(D), that language was void and unenforceable, the court ruled.

Thus, the Distributors could not rely on the termination provisions of the Distribution Contracts to nullify the rights of a qualified successor manufacturer under § 1333.85(D) to terminate a franchise without cause. The Distributors were not likely to succeed on the merits of their argument that the Distribution Contracts precluded a successor manufacturer from terminating pursuant to O.R.C. § 1333.85 absent a basis under the contract for such termination.

Application of § 1333.85(D) to written franchises. The Distributors also argued that O.R.C. § 1333.85(D) only applies to distributors who do not have a written contract following the successor manufacturer transaction. In the Distributors’ view, § 1333.85(D) did not apply here because the written Distribution Contracts survived the KPS/CCR Transaction. The question of whether § 1333.85(D) applies to written contracts had been accepted for discretionary review by the Ohio Supreme Court, but was not yet decided. As such, the questions as to the merits of the Distributors’ argument against application of § 1333.85(D) to written franchise contracts weighed in favor of granting a preliminary injunction at this stage.

Unconstitutional taking. Finally, the Distributors argued that, if § 1333.85(D) grants manufacturers a right to terminate unilaterally a franchise agreement without cause or a contractual basis, that would constitute government-compelled forfeiture of the Distributor’s private property for the sole benefit of a private entity, the successor manufacturer.

The parties agreed that the termination rights conferred by § 1333.85(D) were not an award for public use. Thus, if the operation of § 1333.85(D) could be properly characterized as a taking, it would not be constitutional. The defendants advanced two arguments as to why the operation of § 1333.85(D) did not constitute a taking. First, they argued that there is no government action here. Second, they argued that § 1333.85(D) did not actually seize or impair property rights.

The defendants were likely to succeed on the merits of their argument that the defendants’ termination of the Distribution Contracts pursuant to O.R.C. § 13333.85(D) did not constitute government action. Further, the defendants were likely to succeed on the merits of their argument that the application of O.R.C. § 1333.85(D) to written distribution contracts did not constitute an unconstitutional taking under either the Ohio or United States Constitutions.

Irreparable harm. The Distributors submitted affidavits averring that, if the defendants were permitted to terminate their Distributor Contracts, the Distributors would lose substantial sales and suffer other irreparable harm. The Specified Brands accounted for approximately 41% of Tri County’s beer sales and 19% of Iron City’s beer sales. In other cases involving beer distribution franchises purportedly terminated under the “successor manufacturer” provisions of §1333.85(D), this court and others found that comparable facts demonstrated sufficient irreparable injury to warrant the issuance of injunctive relief.

Moreover, the defendants apparently intended to seek a court order under § 1333.851(B)(5), allowing them to pay their last offer of diminished value to Distributors and to withdraw the brands 90 days after the filing of the complaint in this case. It would be virtually impossible for the parties and the court to litigate fully the merits of the Distributor’s claims even within 90 days of this order. Thus, injunctive relief was appropriate to maintain the status quo in the interim, the court decided. Indeed, relief preserving the status quo was particularly warranted here because the parties agreed that an Ohio Supreme Court of Ohio decision in favor of the distributors would result in judgment for the Distributors in the matter sub judice.

In light of the above, considerations of irreparable harm weighed in favor of issuing a preliminary injunction.

Harm to others. The Distributors argued that the requested injunctive relief would have no detrimental effect on the defendants. In support of this proposition, the Distributors explained that they have successfully sold the Specified Brands for many years, and that the defendants had made no complaint about the Distributors’ promotion and distribution of the Specified Brands.

The defendants’ response in opposition to the motion for preliminary injunction did not challenge the Distributors’ conclusions in this regard. Thus, this factor weighed in the Distributors’ favor.

Public interest. The Distributors argued that the public interest would be harmed if injunctive relief was not granted because, if they lost the Specified Brands, they could have to lay off some portion of their approximately 50-person staff. The Distributors also argued that disruption of their retailer relationships and distribution channels would harm the public’s ready access to the Specified Brands. The defendants did not challenge either of these conclusions and they were entitled to some weight, the court reasoned.

Perhaps the most compelling public consideration here, however, was the public’s interest in the enforcement of the relevant provisions of the Ohio Revised Code, according to the court. Thus, issuing an injunction in this case would serve the public interest by ensuring that the defendants’ termination of the Distributor’ franchises comported with Ohio law.

The case is No. 2:13-CV-317.

Attorneys: Christopher Haas (Squire Sanders LLP) for Tri County Wholesale Distributors, Incorporated and The Bellas Company. James B Niehaus (Frantz Ward LLP) for Labatt USA Operating Company, LLC, Cerveceria Costa Rica, S.A. and North American Breweries Holdings, LLC.

Companies: Tri County Wholesale Distributors, Incorporated; The Bellas Company; Labatt USA Operating Company, LLC; Cerveceria Costa Rica, S.A.; North American Breweries Holdings, LLC

Cases: FranchisingDistribution OhioNews