Wisconsin Lawyer: A Web of Regulations Starting a Brewery:

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    A Web of Regulations
    Starting a Brewery

    Producing beer requires the knowledge and skill of brewers. It also requires lawyers, to ensure that the brewery’s owners can legally mill, mash, boil, ferment, cap, chill, label, and sell the beer.

    Jeffrey M. Glazer

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    brewery kettlesAll the cool kids are doing it. Starting breweries, that is. To call craft beer1 a juggernaut undersells the industry. As recently as the early 1980s, Wisconsin was home to only seven breweries. Seven. You could count all the breweries in the state on the hand of a polydactyl. The low-water mark came in 1978 – there were only 89 breweries in the entire country.2 Today, according to recent numbers from the Wisconsin Brewers Guild, there are more than 120 just in Wisconsin.3

    Lawyers are probably not the least bit surprised to learn that beer is highly regulated. What might surprise you, however, is the tangled web of federal, state, and local laws unique to virtually every single jurisdiction where a brewery might be located. Indeed, activities and products that might be completely legal in one state, for example, homebrewing or brewpubs or even high-alcohol beer, might be illegal in a neighboring state. This article untangles some of the knotty legal issues confronting startup breweries here in Wisconsin.

    The Three-tier System

    Every state in the country has implemented some form of the “three-tier system.” This framework provides the default rule for the entire system; any exception to this default rule must have a statutory basis. However, the exceptions to the three-tier system are so numerous that they probably swallow the rule. A few of the major exceptions are discussed throughout this article.

    The three-tier system is a statutory framework that prohibits any entity in any one tier from performing the functions of the other tiers. The three tiers are manufacture, distribution, and
    retail sales. Thus, manufacturers cannot distribute or sell at retail; distributors cannot manufacture or sell at retail; and retailers cannot manufacture or distribute. Some of the more well-known exceptions include taprooms (manufacturing and retail) and brewpubs (also manufacturing and retail, and sometimes distribution, too).

    The Three-Tier System: A Regulatory Framework for the Manufacture, Distribution, and Retail Sale of Beer

    Three-Tier System infographic

    Agency Authority

    Each tier of the three-tier system is regulated by overlapping agency authority. An agency of the U.S. Department of Treasury called the Alcohol and Tobacco Tax and Trade Bureau (TTB) regulates the manufacturing and distribution tiers. In Wisconsin, the Department of Revenue (DOR) regulates the manufacturing, distribution, and retail tiers. The Wisconsin Department of Agriculture, Trade and Consumer Protection (DATCP) regulates food-manufacturing facilities. Local municipalities, usually through an Alcohol Licensing and Review Committee (ALRC), regulate the retail tier, and through zoning regulations may have something to say about where a brewery, brewpub, or distributor can be located.

    This article focuses on the manufacturing tier. Brewers in Wisconsin must receive both a brewer’s notice from the TTB and either a brewery or brewpub permit from the DOR. Breweries and brewpubs must be inspected by the DATCP. Brewpubs, in addition to the TTB-issued brewer’s notice and DOR-issued brewpub permit, also must get a restaurant permit from the Wisconsin Department of Health Services (DHS), a Class “B” license for the retail sale of beer for the restaurant, a “Class B” license for restaurant liquor sales,4 and a “Class C” license for the restaurant’s wine sales from the local ALRC.

    Why So Much Regulation?

    Most beer-related regulation is concerned with three subjects: taxes, tied houses, and transparency. Most of the federal and state statutes and regulations related to the production of beer are about the payment of excise taxes.5 Agencies track the excise tax payers by issuing permits to qualified entities.6 Another concern of the statutes and regulations is preventing the existence of “tied houses.”7 The final major concern of the federal statutes and regulations is transparency and is enforced through labeling (including recipe and formula approvals, if necessary) and advertising regulation.8 Federal alcohol law also deals with, among other things, bribery, consignment sales, importing, and exporting.

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    Jeffrey Glazer outlines the regulatory framework for beer in Wisconsin; the rules brewers and brewery owners must navigate to get their products from the drawing board to shelves and taps.

    Taxes. The collection of excise taxes underpins most of the laws and regulations concerning the manufacturing of beer. The federal government collects $7 per barrel9 of beer for the first 60,000 barrels, and $18 per barrel for each barrel over 60,000.10 The state of Wisconsin collects another $2 per barrel, minus $1 per barrel for the first 50,000 barrels if the brewery produces less than 300,000 total barrels per year.11 For a state that produced more than 10 million barrels of beer in 201412 (MillerCoors alone accounted for almost 8 million barrels), this is a lot of money for the state and federal government.

    Tied Houses. The next major set of statutes and regulations deals with the regulation of tied houses. Neither federal nor state law explicitly defines a tied house. In 1988, the Wisconsin Attorney General issued an opinion on tied houses that defines the tied-house laws’ purpose:

    “‘Tied-house’ laws are designed to prevent the integration of retail and wholesale outlets, and to stop manufacturers, wholesalers and distributors from owning or controlling retail outlets. … The object and intent of Wisconsin’s ‘tied-house’ law is: [T]o prevent manufacturers and wholesalers from acquiring complete or partial control of specific Class ‘B’ retailers, directly by owning them or indirectly by creating financial or moral obligations. The purpose is clearly to assure the freest competition in the industry by preventing monopolistic practices and, to divorce entirely the wholesaler from the Class ‘B’ retailer.”13

    Thus, the tied-house laws are intended to prevent cross-ownership between tiers – particularly the manufacturing and retail tiers.

    Transparency. The final major group of statutes and regulations relate to labeling and advertising. Closely related to, but distinctly different from, labeling and advertising is trademark law. All these issues – labeling, advertising, and trademarks – are intended to protect consumers from unfair and deceptive practices.

    The three-tier system is a statutory framework that prohibits any entity in any one tier from performing the functions of the other tiers.

    Alcohol is a dangerous but enticing product and prohibited to those under age 21. As such, a strong sense of governmental paternalism comes through in labeling and advertising regulations.14 These laws and regulations prohibit deceptive practices primarily by setting standards and disclosures. Examples include labeling beer “organic,” setting consistent weights and measures, and disclosing the corporate name of the bottler and any importer, if relevant. Numerous regulations set standards for food safety and disclosure of additives, coloring agents, sulfites, allergens, and other harmful or noxious substances. Finally, if the beer is made using nonstandard processes or ingredients, the brewery must even submit the recipe for approval by the TTB.15 [Editor’s Note: Please also see “What’s for Supper? Trending Issues in Food and Beverage Law” in this issue.]

    There is considerable overlap in labeling and advertising with additional requirements set by the Food and Drug Administration (FDA).16 Labeling, advertising, and trademarks are not governed by Wisconsin law, except for a marking law17 and state trademark law to the extent it is useful.

    Starting a Brewery in Wisconsin

    The entire regulatory process for starting a brewery takes, on average, four to seven months.18 Before starting the regulatory process, first the brewery must lay some groundwork: form an entity, find financing, find a location, and order the equipment. Most breweries are formed as limited liability corporations (LLCs) or “C” corporations (C corps). Even though who can own a brewery might be difficult to establish, entity formation is generally straightforward.

    Financing might be less straightforward. A 10-barrel packaging brewery located in an industrial park can require between $400,000 and $1 million in startup costs, not including operating capital. Brewpubs of any moderate size are similarly priced; while equipment costs are usually lower, buildout costs (including the cost of the restaurant portion of the facility) usually make up the bulk of the expenses. With foreign manufacturers entering the market, some start-up costs, if not waiting lists, have dropped considerably from even a few years ago, when equipment prices were double what they are today.

    The Licensing Process

    The first step in the licensing process is to submit an application for a brewer’s notice to the TTB. However, the TTB will not accept an application until the brewery owners have secured a location, drawn up a floor plan, and ordered equipment. The application packet addresses a wide range of issues. As part of the application process, the TTB will perform a background check on anyone holding greater than a 10 percent interest in the brewery. Also, the brewery is required to hold a surety bond covering its operations, in particular the obligation to pay excise taxes.19 A TTB officer will review the building plan and equipment to ensure that “[b]rewery buildings [are] arranged and constructed to afford adequate protection to revenue and to facilitate inspection by appropriate TTB officers.”20

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    From blogging to brewing law, Jeff Glazer recounts how he got his start representing a number of craft breweries in Wisconsin.

    Once the brewery or brewpub obtains a brewer’s notice, it is time to submit an application to the DOR for a brewery or brewpub permit. The brewery may request the DOR to conduct a preliminary review or issue a written opinion if there are any issues that might present a problem. If the brewery will apply for a brewpub permit, the restaurant may apply for its restaurant licenses and Class A, Class “B”, “Class B”, or Class C licenses from the local ALRC at any time. This might be useful for clients that want to get doors open and generate revenue during the application process.

    Brewery Versus Brewpub.  The most important regulatory decision that a brewery’s owners must make is whether to obtain a brewery permit or a brewpub permit. A brewery is a manufacturing facility for fermented malt beverages. A brewery typically, but not always, has a bottling line and distributes exclusively to retail outlets in multiple package sizes – for example, both bottles and kegs. A brewpub, on the other hand, is a restaurant with a brewery in it.

    As a result, the legal frameworks for breweries and brewpubs are different, and they are regulated under different state statutes. Fortunately, brewpubs can convert to a brewery permit, and vice versa, as may be strategically and operationally convenient. The TTB does not care about the distinction between breweries and brewpubs, except to the extent the ability to “afford adequate protection to revenue” is affected.

    Breweries. Breweries are governed by Wis. Stat. section 125.29. The most important topics that section 125.29 deals with are who can be an owner of a brewery, which activities are permitted, and self-distribution. Brewpubs are governed by Wis. Stat. section 125.295.

    There are some major restrictions about who can own an interest in a brewery. The statutes prohibit issuance of a brewery permit to any person holding a Class A or  Class “B” license, a brewpub permit, or a wholesaler’s permit.21 As mentioned above, starting a brewery can be expensive. Today, bank lending for breweries is far more available than it was even a few years ago. However, for breweries financing through equity, the statutes limit who those investors can be. The DOR has taken a zero-tolerance policy to these license restrictions.

    Thus, the brewery cannot have any equity holders who also own any interest in a brewpub, restaurant, tavern, liquor store, grocery store, or any other similar license. (“Retail licensee” is the jargon used in the industry). Lest you think the workaround is simply to have the retail licensee lend the money to the brewery or lease building space to the brewery instead of taking an equity interest, Wisconsin statutes also forbid that.22

    Jeffrey GlazerJeffrey Glazer, Chicago-Kent 2004, is a clinical assistant professor at the University of Wisconsin Law & Entrepreneurship Clinic, where he and law students assist numerous breweries, wineries, cideries, and distilleries to start their businesses. He has represented breweries since 2007 and was a cofounder of Madison Craft Beer Week.

    www.glazerlegal.com

    The second major set of restrictions relates to the activities of the brewery.23 Breweries may manufacture beer, store beer, and sell beer to a wholesaler. Breweries may have up to two taprooms or restaurants – one on site and one off site – and offer free sampling. Unlike a brewpub, the brewery’s restaurants cannot serve liquor. Moreover, breweries can sell in their taproom or restaurant only beer “that [has] been manufactured on another brewery premises in this state ….”24 Finally, breweries that produce 300,000 barrels per year or less may self-distribute provided the brewery follows most of the rules that apply to wholesalers generally.25

    Brewpubs. Similarly, the brewpub statutes govern who may own an interest in a brewpub, the activities of a brewpub, and self-distribution.26 A brewpub group, a collection of brewpubs under common ownership and control, together may not produce more than 10,000 barrels (“barrel cap”) or hold more than six brewpub permits. As with a brewery permit, holders of a brewpub permit may not have any interest in a Class A, Class “B,” “Class B,” Class C, brewery, or wholesaler’s license or permit. There is an exception for permits and licenses held by a restaurant on the brewpub premises.

    A brewpub may manufacture, store, or ship beer from its brewpub premises. While the brewpub may brew beer on each of its premises,27 it must run a restaurant on all of its premises. More specifically, if the brewpub does brew beer, it must brew all the beer within the brewpub group. This may seem tautological, but the practical implication is that a brewpub is not permitted to contract with another brewery to brew, or bottle, its beer (called “contract brewing”). Contract brewing is a common method for breweries to find extra capacity instead of expanding, save start-up costs by not investing in bottling equipment, or experiment with production of different brands or package sizes.

    Brewpubs are also permitted to self-distribute, although the rules are slightly different than for breweries.28 Recall that brewpub permits have a barrel cap. Brewpubs may distribute through a distributor up to the barrel cap minus any quantity served and sold by the brewpub group; however the brewpub may only self-distribute up to 1,000 barrels of the 10,000 barrel total.

    Distribution

    While there are a whole host of other restrictions,29 an important subset revolves around distribution of a brewery’s or brewpub’s brands.30 If the brewery or brewpub chooses to enter into a relationship with a distributor, the agreement must be in writing. The agreement must identify a designated sales territory.31 Distribution within that designated sales territory is exclusive, meaning that no other entity can distribute the designated brands in the area, including the brewery or brewpub itself.

    The good news is that distribution agreements can usually be terminated for any, or no, reason. But, there is a catch: the “successor wholesaler” is required to compensate the “terminated wholesaler” for the fair market value of the brands.32 In practice, fair market value is usually a multiple (typically between four and seven times; sometimes less, sometimes more) of the terminated wholesaler’s gross revenue for the brands. Finding a successor wholesaler that is willing to pay the price might make termination of the distribution arrangement functionally impossible.

    Conclusion

    There is no one-size-fits-all advice that can be given to clients that want to start a brewery. The prohibitions arising out of the tied-house laws, in particular, can be frustrating when a client is relying on funding from a source that holds an interest in retail licenses.

    The long fingers of alcohol regulation reach into almost every aspect of production and operations for the client. Lawyers must be prepared to help clients think through not only the legal issues but also how the legal issues will influence fundamental business model decisions such as whether to be a brewery or brewpub or to self-distribute or not.

    Keep in mind, this article only discusses the law as it applies in Wisconsin; each state is similarly complex in its own unique ways. The tangled web of federal, state, and local statutes, regulations, and ordinances makes virtually every brewery unique.

    Endnotes

    1 Everyone has their own definition of what “craft beer” means and for the purposes of this article it isn’t really relevant. But, if you are interested, the Brewers Association, the national lobbying and industry group for craft brewers, has a definition that you can read and debate with your friends. Brewers Association (last visited Feb. 8, 2016).

    2 Brewers Association (last visited Feb. 8, 2016).

    3 The Wisconsin Brewers Guild does not publish these numbers. However, in correspondence with Mark Garthwaite, executive director of the Wisconsin Brewers Guild, this was the number I was given as of October 2015. The Brewers Association puts the number of craft breweries, at the start of 2015, at 97. Brewers Association (last visited Feb. 8, 2016).

    4 That is not a typo. “Class B” licenses permit liquor sales, while a Class “B” license permits beer sales. Cf. Wis. Stat. § 125.26 (Class “B” licenses) and Wis. Stat. § 125.51(3) (“Class B” licenses). Many municipalities issue “Combination Class B” Licenses which cover beer and liquor.

    5 27 C.F.R. pt. 25.

    6 27 U.S.C. § 204.

    7 27 U.S.C. § 205(b); 27 C.F.R. pt. 6.

    8 27 U.S.C. §§ 213-219a; 27 C.F.R. pt. 7; see also 27 C.F.R. pts. 13 (labeling proceedings), 16 (health warning statements).

    9 31 gallons. A keg is one-half a barrel, so there are two kegs in one barrel.

    10 Alcohol and Tobacco Tax and Trade Bureau (last updated May 22, 2015).

    11 Wis. DOR (Feb. 11, 2015).

    12 Compiled using numbers published by the DOR (Jan. 21, 2016).

    13 77 Op. Att’y Gen. 76, 77 (1988).

    14 See, e.g., 27 C.F.R. § 7.29(f) (“Labels shall not contain the words ‘strong’, ‘full strength’, ‘extra strength’, … likely to be considered as statements of alcoholic content.”) There is an exception for a category of beer called “Strong Ale.”

    15 27 C.F.R. §§ 25.55–.58.

    16 See, e.g., 27 C.F.R. § 7.22(b)(7) (requiring labeling of the presence of aspartame “in accordance with the Food and Drug Administration … regulations”).

    17 Wis. Stat. § 125.32(7).

    18 www.ttb.gov/nrc/average-days.shtml (last updated Dec. 10, 2015). As of October 2015, permits submitted through the online system were averaging 143.86 days to process.

    19 27 C.F.R. §§ 25.91-.98.

    20 27 C.F.R. § 25.31.

    21 Wis. Stat. § 125.29(2)(a), (5).

    22 Wis. Stat. § 125.33(1)(a). No brewer may furnish money, or any other thing of value, to any retail licensee for the benefit of any retail licensee. The brewer cannot take such actions directly or indirectly. “Indirectly” has been interpreted to include even arm’s-length leases between the brewery and the retail licensee.

    23 Wis. Stat. § 125.29(3).

    24 Wis. Stat. § 125.29(3)(g).

    25 See Wis. Stat. § 125.29(3m)(b) (self-distributing breweries must follow the same laws as distributors related to Wis. Stat. sections 125.33 and 125.34).

    26 Wis. Stat. § 125.295.

    27 Wis. Stat. § 125.295(2)(a)2. (“If the applicant holds more than one permit issued under this section, the applicant is not required to manufacture fermented malt beverages on each premises for which a permit is issued under this section.”).

    28 Wis. Stat. § 125.295(1)(g).

    29 See, e.g., Wis. Stat. § 125.33.

    30 Wis. Stat. §§ 125.28, 125.33, 125.34.

    31 Wis. Stat. § 125.34(1)(c).

    32 Wis. Stat. § 125.33(10).