Brewpubs: Caught in the Regulatory Crossfire

Brewpubs are strange hybrids. Because they span the no-man's land between the retail and supplier tiers, they are handled in unique ways by state regulatory agencies.

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How would you answer this multiple choice question: "I decided to open a brewpub because..."

  1. I love making beer and believe that a brewpub would be a great way for lots of people to relax and enjoy my beer with friends.
  2. I already operate a restaurant, and I believe that brewing our own beer would enhance its appeal and give us a competitive advantage.
  3. I just love government regulation and aspire for a career in a highly regulated industry.

Of course, choice (c) has no takers. You certainly didn't open a brewpub because you love being regulated! But, no matter whether you are a brewer or a chef at heart, you're certainly going to have to adapt to the reality of regulation if you wish to avoid rude surprises blocking your path to success in brewpub operation. You may feel like the worst of the regulatory burden is over when that big pile of application paperwork is finished and you finally receive the licenses you need to operate. You may think you're fully adapted to regulation when you've gotten a few ATF Brewer's Reports of Operation under your belt. But there's more—much more—where that came from.

Straddling the three tier system

Whether you're a passionate beer maker or an ambitious restaurateur, your decision to open a brewpub singles you out for more regulation than the "next guy." Your friends who either JUST brew beer or JUST operate a restaurant—but don't mix the two vocations—have an easier row to hoe with the government. "Why me?," you ask. While their businesses are heavily regulated too, their situations are more straightforward because each business stays neatly within its own tier in the "three tier" system of distribution. The three tier system, in case you aren't familiar with the term, is the marketing structure in which alcoholic beverages are sold by suppliers (manufacturers or importers) to wholesalers, by wholesalers to retailers, and by retailers to consumers. (Supplier, wholesaler, and retailer are the three tiers.)

The three tier system is firmly held in place by laws, adopted both on the federal level and by every state, which regulate how alcoholic beverages are marketed and how the various tiers of our industry interact. These laws are called "tied house laws," named after a practice in England where a retailer may be "tied" to a specific manufacturer, either through interlocking ownership or exclusive outlet agreements. Prior to Prohibition, "tied houses" were allowed in America, and their marketing practices promoted excessive consumption. (Brewery-owned pubs in the U.S. would offer "free lunch" to attract business and heavily encouraged the consumption of their proprietary brand of beer to defray the cost of the complementary meal. The eventual outlawing of tied houses led to the saying we are all familiar with today: "There's no free lunch.")

Hogtied by tied house

Brewpubs run against the grain of tied house regulation, because they are manufacturers acting like retailers (or, if you prefer, retailers acting like manufacturers). This kind of "cross dressing" has traditionally been expressly prohibited by tied house laws in every state. Therefore, as the brewpub concept has become more and more popular with the constituents in each state, the legislators in virtually every state (currently Mississippi is the last hold out) have had to pave the way with special legislation permitting the operation of brewpubs. The brewpub laws differ greatly from state to state, and each represents an exception to what is called "tied house restrictions."

If you look at the patchwork of the fifty United States, brewpubs are suppliers in some places and retailers in others. In some states, like Indiana, legislators have simply created an exception that allows a brewer to also operate a restaurant under an additional license, while keeping the privileges of the supplier license intact. (More frequently, however, states take away a privilege or two when granting an exception.) In other states, like Michigan, a special retail license has been established that permits restaurant licensees to brew their own beer. In California, the legislature did both! A small beer manufacturer (a supplier licensee) is allowed to hold an interest in up to six on-sale retail establishments—but must use wholesalers to supply beer to all but one of those restaurants. Then, for California licensees that don't fit within the six restaurant limitation, a new class of retail license has been created that allows a full service restaurant to brew its own beer.

Why were these exceptions necessary? First, the privileges of a traditional manufacturer's license are generally too narrow. Brewpubs don't want to serve just their own beer; they want to offer beer and wine from all sources, and often spirituous beverages as well. Second, the tied house laws in every state prohibit a manufacturer from holding any interest in a retail license (and vice versa). Yet brewpubs are often owned or partly financed by entrepreneurs who already own or finance non-brewing restaurants. Until statutory exceptions were enacted, in most jurisdictions just a drop of common ownership between the tiers was enough to poison a transaction.

Too little knowledge can be dangerous to your plans

Now that virtually all states have carved out a place for brewpubs in their regulatory scheme, does that mean Big Brother is watching out for you—in a benign sense of the term? In other words, have these special new laws resolved the regulatory Catch 22s that brewpubs would otherwise face? The good news is, yes, you can operate; the bad news is, you have to watch your step, and educate yourself so you know where to step boldly and where gingerly.

In each case where an exception has been made, the privileges that may be exercised under that exception are narrowly defined. Every brewpub operator needs to fully understand the law in his or her home state, and review it again whenever changes in operations are contemplated. For example, you may start out simply serving food and beverages at your brewpub. Later, you may wish to sell kegs and growlers for consumption elsewhere. Or you may get the urge to sell your beer to other restaurants. Since these activities were not in your original plan, you probably skimmed over those parts of the law quickly. Or you read them but since you never used them, you forgot exactly what they said! Does your license allow off-premise sales? Does your license allow any wholesale activity, and if so, can you sell direct to other retailers, or must you employ the services of the middle tier?

Knowledge of state laws is also essential when expansion is considered. Whether the expansion consists of taking on new investors, opening other brewpubs, or opening a non-brewing restaurant, you need to know your latitude. What type of interests in other licensed businesses may new investors bring along in their previous portfolio? Such tied house interests may be limited in type or in number, as it is with the small beer manufacturer's license in California.

If expansion beyond your home state is considered, either in the form of wholesaling or setting up other retail locations, you not only need to learn the laws of the other state you are entering, but also find out about any interactions between the laws. For example, some states' tied house laws look only at ties within their own states. Most states consider operations outside of the state, especially where a supplier type license is held out of state, and a retail license is held in state. In California, a company applying for a brewpub restaurant license (the retail version of brewpub license in that state) will be required to formally waive any rights it may have under licenses it holds in other states which allow it to sell directly to retailers!

When in doubt, consult an expert. I recommend either consulting directly with regulators in the state, if you feel comfortable in openly discussing your question with governmental agents, or with a specialist in alcoholic beverage law or compliance. If you consult with an attorney, be careful. The patchwork assembly of prohibitions and exceptions create legal land mines of apparently direct contradiction. Attorneys without specific experience in the area of alcoholic beverage regulation can easily misinterpret the laws based on reading them only. Experience, ready access to bureaucratic interpretation, and familiarity with precedents all contribute to understanding how the laws and rules apply in specific situations.

Where there's a will, usually there's a way. Often creative thinking, willingness to compromise, and skillful diplomacy will enable you to walk through walls that seemed to block your path. Occasionally, you need to get a lawmaker to rewrite the book for you. As the brewpub segment grows and matures, its regulation will continue to be dynamic for some time to come.