September 26, 2024
Release the Goods: Court Finds Liquor Agent Acted in Bad Faith by Withholding Inventory From Supplier After Termination
The liquor industry in Alberta is governed by a unique system of laws, regulations and policies, directed by Alberta Gaming, Liquor and Cannabis (AGLC). This regulatory system mandates that those who manufacture liquor products (Suppliers) must use a registered liquor agent (Agent) to sell their products to market in Alberta. A similar system exists in British Columbia, as directed by the BC Liquor Distribution Branch (BCLDB). In both provinces, the Agent buys the product from the Supplier, and therefore owns the product until it is sold to market. This is unique when compared against the regulatory systems in other Canadian provinces, where the owner of unsold product is typically the provincial liquor regulator (e.g., the Liquor Control Board of Ontario).
What is not regulated by the AGLC or BCLDB is the terms of the relationship between Supplier and Agent or, more importantly, the process to be followed once that relationship ends. The authors of this article were counsel in a recent Court decision which now provides common law guidance on the dissolution of that relationship and the duties of good faith owed by the parties to one another.
Under AGLC and BCLDB policy, each Supplier must designate an Agent to sell each product the Supplier wishes to import and sell in Alberta or BC, respectively. Once a product is registered with a particular Agent, no other Agent can sell that product. Importantly, Suppliers cannot sell a product through a new Agent until their prior Agent has released or depleted all stock on hand in that particular product. This can be done by selling the product to market in the ordinary course or, more commonly, by agreeing to sell the product to the new Agent at a negotiated rate.
However, the regulators do not mandate that Agents must transfer remaining stock upon termination of their agency relationship, nor do they provide any recourse for Suppliers if an Agent refuses to release its products. This is reflective of the property rights the Agent has in the product it owns. The regulators will not get involved in disputes between Suppliers and Agents. The terms of such relationships, and their termination, are governed by the contract between the parties and common law principles.
This unique regulatory landscape creates vulnerability for Suppliers. Without a clearly worded contract, an Agent may refuse to sell or transfer their remaining inventory upon termination, and effectively prevent the Supplier from selling that product in the market indefinitely. This is exactly what happened in the recent Court of King’s Bench decision of Brown-Forman Corporation v Charton-Hobbs Inc[1].
JSS Barristers represented Brown-Forman Corporation (Brown-Forman) and its subsidiary, Benriach Distillery Company Limited (Benriach)[2], a Supplier of single malt Scotch products. In 2005, Benriach engaged Authentic Wine & Spirits Merchants Inc. (Authentic) as its Agent across Canada for all products in its portfolio. The contract between the entities was oral, and few express terms were discussed. In particular, the parties never discussed what would happen if Benriach terminated Authentic as its Agent. When that day came, Authentic refused to sell or transfer Benriach’s products to its new agent unless Brown-Forman agreed to Authentic’s demand for “severance”, thereby essentially blockading the Benriach products out of the Alberta and BC markets. JSS Barristers argued that this was a breach of Authentic’s duty of good faith in contractual performance, and the Court agreed.
The Court also provided guidance on the reasonable notice period required to terminate a distribution contract such as that at issue in this case.
The decision was not appealed.
Facts
The relationship began with a simple conversation and a “handshake deal”. The parties never discussed what would happen when the agency relationship was terminated. The only terms discussed were commercial terms relating to marketing and distribution of certain products.
In 2018, after being acquired by Brown-Forman, Benriach terminated its agency relationship with Authentic to consolidate the Benriach portfolio and Brown-Forman portfolio under a single country-wide Agent. Suppliers changing Agents (and vice versa) is a common occurrence in the industry, and consolidation frequently occurs after a smaller Supplier is acquired by a larger one.
Upon termination, Charton-Hobbs Inc. (Charton-Hobbs), the parent company of Authentic, contacted Brown-Forman and demanded a “severance” payment equivalent to fourteen months of Authentic’s average monthly earnings on the portfolio, plus full market value for the return of all inventory Authentic still had on hand.
At that time, Charton-Hobbs advised Brown-Forman that Agents have the power to freeze the final few cases of a product in the regulator’s warehouse, such that orders would not be processed, and inventory would not sell down to zero. Frozen inventory may not be ordered or sold; it remains in the regulated warehouses until unfrozen. The power to freeze inventory in this manner is typically used to perform a final count of the inventory on hand, so the parties can negotiate the proper value for transfer. This can typically be achieved in a few days. However, the freeze remains in place until the Agent lifts it, and as such, freezing the inventory indefinitely is possible. An indefinite freeze keeps inventory on hand registered to the terminated Agent, preventing the inventory from depleting to zero (which would allow the Supplier to change Agents without the prior Agent’s cooperation).
Brown-Forman had offered to pay six months of Authentic’s average monthly earnings and to buy any remaining inventory for full market value. Charton-Hobbs rejected this offer and continued to demand fourteen months and full market value for the inventory. Charton-Hobbs advised that the inventory would only be revisited if and when Brown-Forman would agree to the requested severance terms.
Meanwhile, Authentic directed that a few cases of Benriach’s core products be frozen in the AGLC and BCLDB systems. This prevented Authentic’s stock from depleting to zero while Authentic continued to demand fourteen months of severance, which ensured that Authentic could maintain its leverage in the negotiations. Effectively, Authentic held Benriach’s products hostage for ransom. (This is not a new tactic in this industry given the regulatory peculiarities: see, e.g., Peter Lehmann Wines Ltd v Vintage West Wine Marketing Inc[3].)
The Plaintiffs pursued a claim seeking return of the inventory and damages for lost sales over the three-year period that Authentic continued to hold inventory. Benriach alleged that by refusing to transfer the inventory to the new Agent for fair market value, and by freezing the inventory to prevent sales to deplete the inventory to zero, Authentic breached its duty of good faith in performance of its agency contract with Benriach.
Authentic counterclaimed for termination pay equivalent to fourteen months of its margins on the Benriach products — one month for every year it alleged it had worked as Benriach’s Agent.
Bad Faith in Withholding Products
The Court found that there is an organizing principle of good faith performance that requires a contracting party to “engage in honest, candid, forthright or reasonable contractual performance, so as not to undermine the legitimate interests of the contracting partner”.[4] This duty requires that contractual discretion be exercised reasonably and for the purpose for which it was conferred,[5] as in the Wastech line of authority on good faith contractual performance.[6] This duty extended to the performance of obligations which survive termination, sometimes referred to as post-contractual obligations.[7]
Given the oral nature of the agreement, the Court found it appropriate to imply terms regarding termination:[8]
[109] I find that the Western Canada Agreement granted Authentic the discretion, upon termination, to choose between transferring the Benriach Brand inventory to PMA or continuing to sell the inventory to the liquor boards. The purpose of this discretion is to enable Authentic to protect its required capital investment in the inventory, while allowing the supplier to continue to access the marketplace. Each choice also imposed an obligation upon Authentic, which survived the termination of the contract, just as Authentic’s discretion survived the termination of the contract. If Authentic chose to transfer the inventory, it would be required to do so at a commercially reasonable amount consistent with its capital investment. If Authentic chose to continue selling the inventory to the liquor boards, it would be required to take all commercially reasonable steps necessary for such sale. The purpose of having the discretionary power, is to permit an orderly transition of the inventory so that a product is not pulled from the marketplace simply due to a change in agency, to permit the agency to continue to profit from the inventory that it purchased and owned despite no longer being the appointed agency, and to permit commercial activity in the marketplace to continue.
Importantly, the Court noted that, if a terminated Agent could hold inventory until termination pay was made only to the satisfaction of the Agent, the industry would grind to a halt as it would completely prevent the Supplier from accessing the market.[9]
As Authentic had two options to dispose of the inventory upon termination of the agency agreement -- either sell it to the market or sell it to Brown-Forman -- the Court found that Authentic’s actions in freezing the inventory and rejecting offers for its transfer at full market value amounted to acts of bad faith:
[112] The evidence establishes that Authentic acted in two ways with the inventory, contrary to the purpose for which they had the discretion regarding the inventory. One, Authentic refused to sell the inventory to Benriach for a commercially reasonable price that Benriach agreed to pay. Two, Authentic also put some inventory of the Benriach Brands on hold, so that the inventory would not be reduced to zero and those Benriach Brands remained frozen out of the marketplace. The purpose of these actions was to exert leverage to obtain the severance Authentic felt was appropriate for the termination of the Western Canada Agreement.
[…]
[135] In both refusing to transfer the inventory at a commercially reasonable price and failing to take commercially reasonable steps to sell the inventory in the marketplace for the purpose of ensuring a desired notice period is provided, Authentic went well beyond the purpose for which it had discretion under the contract with respect to the inventory sold and, in doing so, breached the duty of good faith. Authentic had other options to pursue remedies for the failure of Benriach to provide reasonable notice. Instead, by exercising its discretion in the manner it did, Authentic undermined the interests of Benriach and substantially nullified the ability of Benriach to pursue the sale of the Benriach Brands in Western Canada: IFP Technologies, at para 191-193; Bhasin, at para 65; Wastech, para 71. By holding Benriach Brands hostage from the market, Authentic failed to meet the minimum standard of honesty and good faith in contractual performance, thus preventing Benriach from having “[...] a fair opportunity to protect their interests [...]” when the contract did not work out: Bhasin at para 86. This was contrary to the proper functioning of commerce in the liquor industry, in the context of the regulatory regime under which the parties were required to engage: Bhasin at para 60.
As a result, the Court ordered Authentic to pay damages for lost profits to Benriach in the amount of $846,248.40.[10]
Payment in Lieu of Notice of Termination
On Authentic’s counterclaim, Authentic claimed that reasonable notice of termination is required upon termination of an agency agreement. Where such notice is not provided, payment in lieu is owed. Brown-Forman admitted that some severance was required; the only dispute was the length of the notice period, and corresponding quantum of payment. Brown-Forman had provided Authentic with 47 days of actual notice. Authentic argued there was a standard practice in the liquor industry of providing one month of notice per year of service. Brown-Forman argued that no such standard exists, and the appropriate length of notice was determined on the specific facts of each case. Here, Brown-Forman argued that the proper notice period was six months.
The Court found no industry standard practice for notice, which varies depending on a number of factors.[11] The Court found that a notice period of 12 months or longer was exceptional, and most notice periods were shorter.[12] At common law, the following factors determine the notice period:
1. The type of business or industry involved: a complicated or highly specialized industry where it may take the agent years to find a similar product line tends toward a higher notice period. The Court found the liquor industry is not complicated or highly specialized, and Authentic did not have a whisky or Scotch specialization. Suppliers frequently change Agents, and Authentic began representing a new Scotch Supplier shortly after termination. This militated toward a lower level of notice;[13]
2. The duration of the relationship: Authentic represented Benriach for 13 years;[14]
3. The Agent’s dependency on the relationship in relation to its business as a whole: more dependency on the portfolio or a higher level of exclusivity would impact the Agent’s ability to replace the Supplier and would more significantly impact the Agent’s revenue. The relevant comparator is the size of the portfolio against the Agent’s entire product portfolio. Here, Benriach’s portfolio accounted for less than 8% of Authentic’s gross margins, and Authentic was largely focused on wine. The Court found that Benriach was not a significant part of Authentic’s business, and Authentic was not exclusively representing Benriach. This favoured a lower notice period;[15]
4. The sales force employed and resources maintained by the Agent for the Supplier’s portfolio: where the termination would result in layoffs or render equipment useless, that would suggest a higher notice period was required. Authentic did not hire sales staff specific to the Benriach portfolio, and no layoffs resulted from Authentic’s termination. This supported less notice;[16]
5. The acquisition and maintenance of inventory by the distributor: the longer it takes to dispose of inventory, the longer the reasonable notice period. Since Brown-Forman offered to buy the inventory for full market value at the time of termination, this factor favoured a lower notice period, notwithstanding that Authentic refused that offer;[17]
6. The time needed by the Agent to replace the portfolio: Authentic was always pursuing new business, and Suppliers frequently change Agents. The evidence therefore supported that Authentic could replace lost products in a brief time period, and this factor favoured a lower notice period;[18]
7. The commercial and regulatory climate for the product: where the regulatory environment requires Suppliers to have Agents, and therefore creates a constant demand for Agents, as is the case in the liquor industry, long notice periods are not common;[19] and
8. The investment of the Agent to market the product: Authentic’s investments in the marketing of the Benriach portfolio were reimbursed by Brown-Forman. Anything not reimbursed was part of the business and not unique to the Benriach portfolio. Sales were also on the decline at the time of termination. This factor therefore militated toward a lower notice period.[20]
Based on these factors, the Court determined that Benriach owed Authentic six months of notice for its termination, less 47 days of actual notice that had been given, resulting in payment in lieu of 4.5 months.[21] The Court also deducted the profits that Authentic should have made by selling its inventory in the ordinary course during the notice period.[22] In the result, payment in lieu of notice was calculated at $100,259.50.[23]
Key Takeaways
This decision is the first of its kind in the liquor industry in Canada, and particularly Alberta and British Columbia. It provides the first precedent which definitively states that withholding liquor products as a means to exert leverage in negotiations for termination pay despite offers from the supplier to pay a commercially reasonable price for the products is a breach of contract, compensable in damages.
Suppliers and Agents should consult this decision for guidance following termination, where the underlying contract does not dictate terms for the transition of inventory and payment in lieu of notice. This case is also an important reminder of the difficult issues that may arise when contracts lack clear terms. Suppliers and Agents who wish to avoid similar disputes should ensure they create clear contracts that address how termination of the relationship will be handled, both in terms of how remaining inventory will be transferred (and a calculation of its price), and how reasonable notice will be calculated.
This is a burgeoning area of law. If you are seeking legal counsel to deal with a similar situation, please contact the authors of this article: David Marshall at marshalld@jssbarristers.ca,
Ryan Phillips at phillipsr@jssbarristers.ca, and Emily Amirkhani at amirkhanie@jssbarristers.ca.
[1] Brown-Forman Corporation v Charton-Hobbs Inc, 2024 ABKB 261 [Brown-Forman].
[2] Brown-Forman and Benriach are referred to collectively as Brown-Forman in this article except where the context requires otherwise. It should be noted the Court found that the proper plaintiff was Benriach, who was a party to the distribution agreement, and not its parent company Brown-Forman. As such, the Court typically refers to the Plaintiff as Benriach throughout its decision.
[3] Peter Lehmann Wines Ltd v Vintage West Wine Marketing Inc, 2015 ABQB 481.
[6] Wastech Services Ltd v Greater Vancouver Sewerage and Drainage District, 2021 SCC 7.
[9] Brown-Forman at para 105 and para 108.
[10] Brown-Forman at para 208.
[11] Brown-Forman at paras 72-76.
[21] Brown-Forman at para 93 and para 172.
[22] Brown-Forman at paras 176-178.
[23] Brown-Forman at para 180.
Please note that JSS Barristers insights are provided for informational purposes only. They are not intended as legal advice or a legal opinion. Please contact authors or JSS Barristers if you would like to obtain legal advice on this or other legal issues.