After every Craft Beer Law class I teach at McGeorge, I select one or two papers to publish on this blog. This year’s first victim is Chloe Fisher. Chloe is an outstanding student, law review editor, and generally a great writer. In this article, she explores several constitutional issues with the way California regulates the distributor-manufacturer relationship. Enjoy –DC (note the formatting gets wonky when pasting writing here through no fault of Chloe’s).
A Constitutional Issue Is Brewing: How California’s Franchise Laws Violate the First Amendment
Last year Seismic Brewing became involved in a legal battle with Reyes Holdings, the largest beer wholesaler in the country. Bill Swindell, Sonoma County Brewer in Major Legal Battle with Wholesaler Amid Competition Concerns in $9 Billion California Beer Market, ProBrewer (Oct. 8, 2021) https://www.pressdemocrat.com/article/north-bay/sonoma-county-brewery-in-major-legal-battle-with-wholesaler-amid-competitio/. Reyes brought a breach of contract suit against Seismic related to the termination of a distribution agreement. Id. Seismic’s challenges in terminating its distribution contract is a common issue among craft breweries. Daniel Croxall, Independent Craft Breweries Struggle Under Distribution Laws that Create a Power Imbalance in Favor of Wholesalers, 12 Wm. & Mary Bus. L. Rev. 401, 403 (2021) (“Current statutes make it all but impossible for an independent craft brewery to terminate—legally or financially—a distribution contract after execution.”)
This challenge of ending a distribution contract arises because distributors have gained and maintained market power. John Szymankiewicz, Beer Law: What Brewers Need to Know 281–282 (2017). Distributors have gained market power due to increased consolidation and anticompetitive behavior. Quentin Barbosa, Don’t Tell Me What to Say: How AB 1541 Impacts the Freedom of Speech in Beer Distribution Contracts 52 U. Pac. L. Rev. 257, 258 (2021). Further, state’s laws often favor distributors. Id. In California, various laws dictate certain terms, favorable to distributors, which must be present in distribution contracts. Cal. Bus. & Prof. Code §§ 25000.5–25000.9. California’s franchise laws—which specify terms craft brewers must include in distribution contracts—do not align with traditional commercial speech policies; therefore, the government should not be able to compel such terms within a contract.
California’s Franchise Laws
California utilizes a tiered system to prevent any one tier of the alcohol supply chain from having too much control. Thomas Gerhart, Undermining the Law: How Uninformed Legislating Helps Big Beer Erode California’s Tied-House Laws 51 U. Pac. L. Rev. 25, 30 (2019). Generally, the three tiers—manufacturing, distribution, and retail—must remain separate. Id. While California allows manufacturers to self-distribute their products, many breweries still rely on distributors if the brewery plans to expand to locations where it is not feasible to self-distribute. Barbosa, supra, at 261. Therefore, brewers often still need to contract with distributors in order to grow. Id.
Franchise laws dictate specific contractual terms that must exist in a distribution contract. Brian Anhalt, Crafting a Model State Law for Today’s Beer Industry, 21 Roger Williams U. L. Rev. 162, 164–65 (2016). These required terms tend to favor distributors. Id. Therefore, beer manufacturers are often at a disadvantage simply by contracting with a distributor. Id.
California’s franchise laws include dispute resolution protections, territorial protections, transfer protections, and termination protections. Cal. Bus. and Prof. Code §§ 25000.2–25000.9. The dispute resolution protections require a successor beer manufacture to arbitrate the issue of fair market value if it terminates a contract. Cal. Bus. and Prof. Code § 25000.2. California also requires brewers to grant distributors exclusive rights to distribute within a specified sales territory. Id. at § 25000.5. These laws also protect a distributor’s ability to transfer or assign distribution rights to another wholesaler. Id. at § 25000.9. In fact, a “beer manufacturer who unreasonably withholds consent or unreasonably denies” the distributor’s ability to transfer or assign distribution rights is liable to the wholesaler. Id. The final protection California awards distributors is termination protection. Id. at § 25000.7. A brewer cannot terminate a distribution contract “solely for a beer wholesaler’s failure to meet a sales goal or quota that is not commercially reasonable under the prevailing market conditions.” Id. Manufactures and wholesalers entering into a distribution agreement cannot waive these franchise laws. Drew Thornley, Opening the Taps of Freedom to Distribute Alcohol: An Overview of State Alcohol Regulation in the United States and Recommendations for Reform, 52 U. Pac. L. Rev. 821, 828 (2021).
The First Amendment and Freedom of Speech
The First Amendment generally protects an individual’s freedom of speech without interference from the government. U.S. Const. amend. I. The First Amendment also prevents the government from compelling speech. Martin Redish, Compelled Commercial Speech and the First Amendment, 94 Notre Dame L. Rev. 1749, 1749 (2019). Certain types of speech, such as commercial speech, receive less protection than other speech under the First Amendment. See, e.g., Bigelow v. Virginia, 421 U.S. 809, 809 (1975) (suggesting commercial speech receives some protection under First Amendment).
The Compelled Speech Doctrine
For the government to compel speech, it faces a high burden. Dayna B. Royal, Resolving the Compelled-Commercial-Speech Conundrum, 19 Va. J. Soc. Pol’y & L. 205, 208 (2011). Generally, cases involving compelled speech apply to situations regarding political or ideological expression. Id. The Court has examined compelled speech in several cases. Id. at 208–209.
In 1943, the Supreme Court first addressed the concept of compelled speech in West Virginia State Bd. of Edu. v. Barnette. 319 U.S. 624, 642. In Barnette, the local Board of Education required all students and teachers salute the flag in public schools. Id. Individuals who were Jehovah’s Witnesses challenged the Board of Education’s policy requiring a flag salute on First Amendment grounds. Id. at 629. The Court held that the Board’s policy was a form of compelled expression and therefore, unconstitutional. Id. at 642. The Court reasoned that the government’s role was to act as a voice of the people, not the other way around. Id. at 641 (“We set up government by consent of the governed, and the Bill of Rights denies those in power any legal opportunity to coerce that consent.”).
The Court again examined compelled speech in Wooley v. Maynard. 430 U.S. 705 (1977). In Wooley, the litigant, a practicing Jehovah’s Witness, challenged New Hampshire’s requirement that noncommercial vehicles display a license plate with the motto “Live Free or Die.” Id. at 707. The litigant argued the license plate motto ran afoul of his moral, religious, and political beliefs. Id. The Court ultimately held the state could not compel individuals to display a license plate with that specific motto. Id. at 717. The Court, in analogizing Wooley to Babette, reasoned that requiring individuals to display the license plate motto forced an individual to adhere “to an ideological point of view he finds unacceptable.” Id. at 715. In doing so, the state violated the purpose underlying the First Amendment. Id.
More recently, the Court issued a plurality opinion in Pacific Gas and Elec. Co. v. Public Utilities Com’n of California (“PG&E.”) 475 U.S. 1, 1 (1986). In PG&E, the Court addressed whether the Public Utilities Commission of California (“Commission”) can require a private company to include third party speech in billing envelopes, even if the private company disagrees. Id. at 4. Here, the Court stated that such a requirement burdened the company’s First Amendment rights. Id. at 20. The burden existed in part because Commission required the company to associate with other speakers’ viewpoints. Id.
The policy underlying compelled speech involves considering both speaker and listener interests in that particular speech and its relationship to the First Amendment. Royal, supra, at 212. However, when compelled speech is at issue, the speaker’s interests predominate over the listener’s interest so that the speaker can maintain “freedom of mind.” Id. at 209–10. For a speaker to maintain this freedom, the government cannot force an individual to convey a message the speaker disagrees with. Id.
The Commercial Speech Doctrine
Commercial speech receives less protection under the First Amendment. Royal, supra, at 212. While the Court has struggled to specifically define commercial speech, the Court agrees on a key characteristic. Id. at 213–14. Generally, commercial speech involves the proposition of a commercial transaction. Zauderer v. Office of Disciplinary Counsel of Supreme Court of Ohio, 471 U.S. 626, 637 (1985) (citing Ohralik v. Ohio State Bar Ass’n, 436 U.S. 445, 455–56 (1978)).
Currently, when determining whether the government can regulate commercial speech, the Court applies the Central Hudson four-part test. Royal, supra, at 215. First, the Court looks to whether the speech at issue concerns lawful activity and is not misleading. Central Hudson Gas & Elec. Corp. v. Public Service Com’n of New York, 447 U.S. 557, 566 (1980). Second, the Court considers if the government has asserted a substantial interest. Id. at 568–69. If the government has asserted a substantial interest, then the Court evaluates whether the regulation directly advances that interest. Id. at 569. Finally, the speech restriction must not be more excessive than necessary. Id. at 569–70.
The policy behind commercial speech involves both speaker and listener interests, with the listener’s interests predominating. Royal, supra, at 216. In commercial speech, the listener’s interest is greater because society has a strong interest in promoting the dissemination of commercial information. Id. By spreading commercial information, society is better able to make informed economic decisions. Id.
California’s Franchise Laws Conflict with First Amendment Principles
California’s franchise laws dictate various protections for distributors that parties must include in distribution contracts. See generally Cal. Bus. & Prof. Code §§ 25000.2–25000.9. While the Supreme Court has not definitively decided whether contracts constitute speech, the Ninth Circuit has suggested that contracts are speech. Barbosa, supra, at 263. Distribution contracts resemble commercial speech because parties enter these contracts intending to create a business transaction. Zauderer, 471 U.S. at 637 (citations omitted); Nordyke v. Santa Clara County, 110 F.3d 707, 710 (9th Cir. 1997). However, policy reasons suggest that distribution contracts may differ from traditional commercial speech. Rodney Smolla, The Meaning of the “Marketplace of Ideas” in First Amendment Law, 24 Comm. L. & Pol’y 437, 438–441 (2019) (discussing the Court’s application of the marketplace of ideas metaphor to First Amendment caselaw).
California’s Franchise Laws Fall Somewhat Short of Commercial Speech
California’s various franchise laws—implementing transfer, territorial, and termination protections—set out required terms for distribution contracts. Cal. Bus. & Prof. Code §§ 25000.2–25000.9. The three-tier system generally requires the manufacturing and distribution tiers to remain separate. Gerhart, supra, at 30. Although California brewers can self-distribute their beer, they often enter distribution contracts as a means to expand their business. Croxall, supra, at 413. When a brewer plans to expand its sales territory, that brewer must contract with a distributor to distribute its products, unless the brewer plans to self-distribute. Id. Accordingly, franchise laws impact speech between beer manufacturers and beer distributors by requiring certain unwaivable terms within a distribution contract. Cal. Bus. & Prof. Code §§ 25000.2–25000.9.
While distribution contracts involve speech relating to a business transaction, distribution contracts do not conform with the policy underlying the government’s ability to regulate commercial speech. Royal, supra, at 221 (suggesting the principal justification behind commercial speech stems from value to consumers). The Court has held that the government often has an interest in regulating, or even compelling, certain forms of commercial speech. See e.g., Zauderer, 471 U.S. at 651. Such interests include ensuring that advertising or other disclosures are factual. Id. The Court emphasized that a state’s interests in regulating commercial speech is to protect deception of consumers. Id. Essentially, the listener interest in such a case is the key policy underlying the government’s ability to regulate commercial speech. Royal, supra, at 216.
However, the emphasis on the listener that underscores the justification for lower First Amendment protection of commercial speech does not exist in beer distribution contracts. Royal, supra, at 216. Distribution contracts are agreements between a beer manufacturer and beer distributor. Szymankiewicz, supra, at 281. Therefore, a general audience does not exist. Id. at 281–82 (stating that distribution agreements create a relationship between the brewer and the distributor). Without a general audience, society’s interest in promoting the free flow of commercial information also does not exist. Royal, supra, at 216.
Further, the interest in preventing deception of consumers is not at issue in beer distribution contracts. Croxall, supra, at 414 (discussing distributors are large, sophisticated companies that successfully lobby the state legislature in their favor). Beer distributors are not equatable to general consumers because distributors are not likely to face deception from a beer manufacturer. Szymankiewicz, supra, at 281 (emphasizing the power imbalance between big distributors and small brewers). Instead, beer distributors are some of the largest, most sophisticated companies in the nation. Ilana Davis, Study Shows Just 4 Global Companies Produce 79% of Beer Sold in U.S. Grocery Stores, Vinepair (Oct. 21, 2021), https://vinepair.com/booze-news/4-companies-dominate-beer-market-us/ (referring to Big Beer distributors as “conglomerates”). Beer distributors also wield great power over manufacturers due to consolidation within the distribution tier. Croxall, supra, at 409–10. Accordingly, the interests relevant to regulating commercial speech are not present with regards to regulating beer distribution contracts. Szymankiewicz, supra, at 282 (stating laws generally protect the distributor rather than the manufacturer).
The Government Should Not Compel the Terms of a Distribution Contract Because Such Contracts Do Not Conform to the Underlying Policies of Commercial Speech
Distribution contracts do not fit the policy underlying commercial speech; therefore, the government should not be able to compel such speech. Royal, supra, at 216. Generally, the government can compel commercial speech to protect consumers. Redish, supra, at 1759–60. In a distribution contract, consumer interests are a nonissue, thus the government should face a high burden to justify compelling specific contracts terms. Szymankiewicz, supra, at 281 (indicating distribution contracts involve the manufacturer and distributor). If courts hold the government to this higher burden to justify its franchise laws, the government likely will be unable to demonstrate a sufficient interest. Royal, supra, at 218 (discussing strict scrutiny applies to content-based speech, whereas intermediate scrutiny applies to commercial speech). The government would have to convince a court that the interest of protecting distributors—which already have an advantage when negotiating distribution contacts—is a strong one. Barbosa, supra, at 268–70 (increasing the government’s burden with the level of scrutiny).
California’s franchise laws require certain terms that manufacturers and distributors must include in distribution contracts. Cal. Bus. & Prof. Code §§ 25000.2–25000.9. These laws provide distributors dispute resolution protections, territorial protections, transfer protections, and termination protections. Id. These protections favor the distributor and harm the craft brewer. Barbosa, supra, at 258–59.
The California Legislature, in enacting these laws, has compelled manufacturers to agree to certain terms if the manufacturer chooses to enter a distribution agreement. Anhalt, supra, at 163–64. While the government often has some ability to regulate commercial speech, the government faces a high burden when compelling speech. Royal, supra, at 208, 212. Distribution contracts are not true commercial speech, because the legislature’s required distributor protections do not conform with the underlying policy of commercial speech despite the fact that the contract itself pertains to a commercial transaction. Id. at 212–13. Accordingly, California’s unwaivable franchise laws are likely unconstitutional because the government has forced brewers to agree to certain, unfavorable terms in order to enter a distribution contract. Id. at 208 (“[T]he First Amendment grants a right against compelled expression.”).