Introduction

Consumers are increasingly interested in craft beer as a full-flavored, artisanal alternative to mass-market beer. But thanks to a 2013 law, Texas beer drinkers are about to find that many of the state’s small breweries have put expansion plans on hold and their favorite beers will be available in fewer markets around the state.

Texas cannot force craft brewers to give distributors property that the distributors never earned and do not deserve.

Distributors used to compensate brewers for the right to sell their beer in markets like Houston or Austin. However, under the new law, brewers are forced to give up their distribution rights to distributors for free. Even worse, distributors can then sell those rights to other distributors and pocket the money. Brewers need that money to grow their business and expand into new parts of Texas.

Texas cannot force craft brewers to give distributors property that the distributors never earned and do not deserve. This law has nothing to do with protecting consumers. It is a blatant transfer of wealth from brewers to distributors who got the law changed using political connections. But the Texas Constitution protects the property rights and economic liberty of entrepreneurs. Brewers should get to keep the value of the businesses they built. That is why three Texas craft breweries have sued the Texas Alcoholic Beverage Commission in state court to have the law struck down.

Three Breweries Epitomize the Remarkable Rise of Craft Beer in Texas

The Texas craft beer scene is thriving today. From Houston to El Paso and everywhere in-between, craft breweries have been on the rise. The three breweries involved in this case represent the passion, diversity and quality of the Texas craft beer scene.

Live Oak Brewing, based in Austin, Texas, has been brewing craft beer long before its current surge in popularity. Live Oak was established in 1997. Chip McElroy, the owner of Live Oak, offers a year-round line-up of four beers: Hefewiezen, Pilz, Big Bark Amber Lager and Liberation IPA. These beers are available only in kegs and can be found on draft in restaurants and bars throughout the Austin area.

Revolver Brewing is located on eight acres of land in the Texas countryside, 30 miles south of Fort Worth. Its physical setting reflects Revolver’s pride in producing beer that is distinctly Texan. Craft beer aficionados are probably familiar with Revolver’s perennial line-up of Blood & Honey Ale, Revolver Bock and High Brass Blonde Ale. These beers are sold in bottles and kegs in Dallas-Fort Worth and, recently, in Austin. Beer drinkers can also visit Revolver every Saturday for a brewery tour and tasting.

Peticolas Brewing is located in an industrial neighborhood near downtown Dallas. Owner Michael Peticolas and his crew of six employees can be found there every morning, brewing new batches of Velvet Hammer, Royal Scandal and Golden Opportunity. Peticolas beers are only available in kegs and can be found on draft at restaurants and bars throughout the Dallas-Fort Worth area. Peticolas offers bi-weekly weekend tours of its brewery.

Although their stories are all different, these breweries were built by the hard work, ingenuity and acumen of their owners and employees. Unfortunately, thanks to the new law, their future growth is uncertain. To understand how and why this law affects craft brewers, it is necessary to understand how alcohol regulation has worked since the end of Prohibition.

The Legacy of Prohibition and the “Three-Tier” System

When Prohibition ended in 1933, states passed laws creating what is known as the “three-tier” system for regulating the distribution of alcoholic beverages. Under this system, producers, distributors, and retailers—the three tiers of the supply chain—must remain independent from one another.[1] This means these businesses cannot share ownership interests or otherwise coordinate their activities.

Under the three-tier system, distributors are more than simple middle-men. In Texas and most other states, brewers above a certain size must contract with distributors for an exclusive, open-ended right to distribute their beer in a given territory.[2] For example, if Revolver Brewing wants to use a distributor to have its beer distributed in Houston, it is required to select one distributor. That distributor will be the only source of Revolver’s beer in Houston, and every bar, restaurant and liquor store will have to buy Revolver from that single source.

[IJ_related_case case=”4552″]

This territorial right is open-ended, meaning that Revolver has almost no ability to revoke it.[3] This amounts to a lifetime, exclusive franchise for the distributor. This right is also transferrable. Distributors can and do re-sell territorial rights to other distributors as they adjust their portfolios of beer that they offer to retailers.

Although most brewers (and all large brewers) use distributors, a brewer’s relationship with distributors changes as a brewery grows. Until it produces 125,000 barrels of beer per year, a brewery has two options: self-distribute or sign deals with distributors.[4] Breweries that produce more than 125,000 barrels must use distributors for everything. The breweries in this case produce fewer than 125,000 barrels per year and, thus, primarily self-distribute their beer locally and—at great effort and expense—to a handful of other markets.

Like most small breweries, Live Oak, Peticolas, and Revolver self-distribute locally using their own trucks and employees. For distribution to other parts of Texas, which is complicated and expensive, they would traditionally hire a distributor. However, they are unwilling to do so if it means giving their property—their distribution rights—for free to distributors. Their beer is not available in many parts of Texas as a direct result of the law they now challenge.

A New Law Forces Brewers to Give Their Territorial Rights to Distributors for Free

In 2013, Texas passed a law that prohibits brewers from negotiating with distributors for the value of their territorial rights. Instead, the law forces brewers to give those rights away for free.

Senate Bill 639, now codified at Texas Alcoholic Beverage Code §102.75(a)(7), says that “no manufacturer shall…accept payment in exchange for an agreement setting forth territorial rights.” Tellingly, the restriction does not prohibit distributors from accepting payment when they re-sell territorial rights to another distributor. Only brewers are prohibited from accepting payment. If a brewery does sell it territorial rights, it can lose its license to produce alcohol, which would put that brewery out of business.

Senate Bill 639 was passed over the objections of Texas brewers. The law was only supported by one group: distributors, who clearly stood to gain from its passage. The law’s impact was immediately understood by both brewers and distributors. Indeed, Michael Peticolas had been negotiating with distributors for territorial rights at the time the law was passed. After it passed, those negotiations abruptly ended.

Today, the Texas craft beer Renaissance faces an uncertain future. Breweries like Live Oak, Revolver and Peticolas will almost certainly continue to thrive locally, where self-distribution remains a viable option for small brewers. But their ability—and the ability of all craft brewers—to expand into other parts of Texas is in jeopardy. Since they can no longer receive compensation for their distribution rights, they do not have that money to invest in new staff and additional equipment so they can brew more beer. Unless the law is struck down, the end result is likely to be fewer Texas craft brewers in the future and less choice for consumers across the state.

National Perspective

These laws are spreading. The Texas law was passed in 2013. Kentucky adopted a similar law in 2014.[5] Distributors will almost certainly push for more states to adopt similar restrictions on craft brewers in the future.

These laws help distributors because the rise of craft beer has started cutting into distributors’ profits. For decades, distributors’ portfolios were relatively stable because most beer drinkers consumed mass-market beers like Budweiser, Coors and a handful of imports like Corona and Guinness. Distributors infrequently needed to acquire new territorial rights.

That dynamic has changed over the past decade. The Wall Street Journal recently reported that Americans are now buying more craft beer than Budweiser. Rather than making the investment necessary to keep up with consumer demand for craft beer, distributors convinced Texas and Kentucky to adopt laws to forcing brewers to give away these rights for free. This case aims to stop the expansion of such laws across the country.

The Plaintiffs

Live Oak Brewing, Revolver Brewing and Peticolas Brewing are Texas-based craft breweries. Live Oak Brewing is located in east Austin, Texas. Revolver Brewing is located in Granbury, Texas, approximately 30 miles south of Fort Worth. Peticolas Brewing is located near downtown Dallas.

The Defendants

The Defendants are the Texas Alcoholic Beverage Commission, the Commission’s executive director and members of the Commission, all of whom are sued in their official capacities.

The Legal Claims

Live Oak, Revolver and Peticolas Brewing have brought a constitutional challenge in Texas state district court in Travis County (Austin). Specifically, they claim that Texas cannot force them to give away their territorial rights—a part of their business—for free to distributors. They bring two claims: a takings claim under Article I, Section 17 of the Texas Constitution, which protects private property rights; and a substantive due process claim under Article I, Section 19 of the Texas Constitution, which protects economic liberty—the right to earn an honest living free from unreasonable government interference.

This case is about property, which can be more than a house or building. Property also includes valuable intangibles like a brand or the right to sell a product. In this case, the brewers claim that the Texas Constitution’s Takings Clause prohibits the government from unconstitutionally requiring them to give away their property as a condition of keeping their licenses to produce alcohol and stay in business. The government has no legitimate interest in requiring craft brewers to give distributors something that those distributors did not build.

This case is also about economic liberty. This law does not protect consumers. It simply gives politically connected distributors something for nothing and denies craft brewers the benefit of their hard work. The government cannot pass laws that do not protect the public and benefit one group at the expense of another. That is an illegitimate use of government power under the Due Process Clause of the Texas Constitution.

The craft brewers in this case are asking the court to declare the law unconstitutional and to permanently prohibit the Texas Alcoholic Beverage Commission from enforcing it.

About the Institute for Justice

The Institute for Justice is the national law firm for liberty and has represented African hair braiders, casket-making Catholic monks, rideshare drivers and other entrepreneurs in state and federal lawsuits nationwide. For more on the Institute for Justice and its work, visit www.staging.ij.org.

IJ’s National Food Freedom Initiative

This case is part of IJ’s National Food Freedom Initiative, which IJ launched in November 2013. This nationwide campaign brings property rights, economic liberty and free speech challenges to laws that interfere with the ability of Americans to produce, market, procure and consume the foods of their choice. IJ has won a free speech challenge to Oregon’s raw milk advertising ban and is currently litigating cases challenging restrictions on the right to grow front-yard vegetable gardens in Miami Shores, Fla., the right to sell home-baked goods in Minnesota and the right to call skim milk “skim milk” in Florida. Learn more at www.staging.ij.org/Food-Freedom.

[1] Texas Alcoholic Beverage Code § 102.01

[2] Texas Alcoholic Beverage Code § 102.51

[3] Texas Alcoholic Beverage Code § 102.74

[4] Texas Alcoholic Beverage Code § 12A.02

[5] Kentucky Revised Statutes § 244.605