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.