Hot Topics in Hospitality Law

HOT TOPICS IN HOSPITALITY LAW

Sponsor: Young Lawyers Division CLE Credit: 1.0 Friday, June 22, 2017 11:20 a.m. - 12:20 p.m. East Ballroom C-D Owensboro Convention Center Owensboro, Kentucky

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The materials included in this Kentucky Bar Association Continuing Legal Education handbook are intended to provide current and accurate information about the subject matter covered. No representation or warranty is made concerning the application of the legal or other principles discussed by the instructors to any specific fact situation, nor is any prediction made concerning how any particular judge or jury will interpret or apply such principles. The proper interpretation or application of the principles discussed is a matter for the considered judgment of the individual legal practitioner. The faculty and staff of this Kentucky Bar Association CLE program disclaim liability therefore. Attorneys using these materials, or information otherwise conveyed during the program, in dealing with a specific legal matter have a duty to research original and current sources of authority.

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Kentucky Bar Association TABLE OF CONTENTS

The Presenter ...... i

Hot Topics in Hospitality Law ...... 1

Basic Principles of Kentucky Alcohol Regulation ...... 1

Recent Legislative Changes to Alcoholic Beverage Law ...... 9

Administration of Alcohol Laws and Regulations in Kentucky ...... 14

THE PRESENTER

Stephen G. Amato McBrayer, McGinnis, Leslie & Kirkland, PLLC 201 East Main Street, Suite 900 Lexington, Kentucky 40507-2001 (859) 231-8780 [email protected]

STEPHEN G. AMATO is a member of McBrayer, McGinnis, Leslie & Kirkland, PLLC in Lexington and practices in the areas of administrative law, alcoholic beverage regulation, business owner disputes, commercial and business litigation, employment law for employers, employment litigation, estate and trust litigation, hospitality and tourism law, human resources and policy training, mediation services and non-compete agreements. He received his B.A. from Transylvania University and his J.D. from the University of Kentucky College of Law, where he was associate editor of the Kentucky Law Journal. Mr. Amato is admitted to practice before the United States District Court for the Eastern and Western Districts of Kentucky and the United States Court of Appeals for the Sixth Circuit. He is a member of the Fayette County and Kentucky Bar Associations, Alliance of Alcohol Industry Attorneys and Consultants, National Association of Licensing and Compliance Professionals, Defense Research Institute, Kentucky Guild of Brewers, and Society for Human Resources Management. Mr. Amato serves as chair of the Board of Trustees for the Lexington History Museum.

ii HOT TOPICS IN HOSPITALITY LAW Stephen G. Amato

I. BASIC PRINCIPLES OF KENTUCKY ALCOHOL REGULATION

Since the end of Prohibition, states have traditionally dealt with the issue of Alcoholic Beverage Control ("ABC") laws in one of two ways, either through full state regulation of the sale of alcohol or through a three-tier system of production, distribution and sale. With the abuses of the industry fresh in their minds, policymakers after Prohibition set about finding ways to keep alcohol from becoming a societal problem through careful regulation. In Kentucky, the three-tier system is paramount, and that principle has been consistently affirmed by key court cases and legislation. These materials will provide an overview of the three-tier system in Kentucky with discussions of relevant cases and legislative changes.

A. The Three-Tier System

1. What it is.

a. The three-tier system divides the alcoholic beverage industry into three distinct segments, each restricted to a particular service:

i. Producers – brewers/distillers.

ii. Distributors.

iii. Retailers.

b. The three-tier regulatory system is based on an understanding that vertical integration in the industry (brewers/distillers owning distributors and retailers) could create entities so incredibly powerful that they could effectively grow beyond the influence of alcohol regulation. One of the side effects of this power would be to erode ABC laws and consistently push for deregulation.

c. No one tier controls another.

i. Tied-house laws – These laws ensure that the two top tiers can't control or influence the

1 bottom tier. Retailers can operate on a level playing field independent of the suppliers and distributors. Tied house laws:

(a) Prohibit each tier from owning an interest in another tier; and

(b) Prohibit suppliers and distributors from giving a retailer anything of value.

ii. Franchise laws – designed to level the playing field between suppliers and distributors and, similar to tied-house laws, protect the independence of distributors.

d. The system is likened to an hourglass instead of a pyramid – distribution, the center tier, is the constriction point that controls the flow of the system. Distributors are mandated to have an in-state presence. Retailers and distributors are the most subject to local accountability through:

i. Compliance checks.

ii. Audits.

iii. Community pressure.

2. The legitimacy of the three-tiered system:

a. Granholm v. Heald, 544 U.S. 460 (2005).

i. New York and Michigan had laws that allowed in-state wineries to ship wine directly to buyers, but prohibited out-of-state wineries from doing so. Out-of-state wineries and wine collectors sued.

ii. Plaintiffs argued the Dormant Commerce Clause prohibited the states from interfering with interstate commerce via these laws.

 Commerce Clause grants Congress power "[t]o regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes."

2 Dormant Commerce Clause doctrine suggests that states can't make anti- competitive laws against out-of-state entities without Congressional per- mission.

iii. States argued that the Twenty-first Amendment gives them pretty much carte blanche to regulate alcohol as they see fit.

• Twenty-first Amendment, Section Two: "The transportation or importation into any State, Territory, or possession of the United States for delivery or use therein of intoxicating liquors, in violation of the laws thereof, is hereby prohibited."

iv. Court held in favor of plaintiffs under Commerce Clause argument:

(a) "The Twenty-first Amendment's aim was to allow States to maintain an effective and uniform system for controlling liquor by regulating its transportation, importation, and use."

(b) "The decision to invalidate the instant direct-shipment laws also does not call into question their three-tier systems' constitutionality."

(c) "State policies are protected under the Twenty-first Amendment when they treat liquor produced out of state the same as its domestic equivalent."

(d) States "have broad power to regulate liquor under §2 of the Twenty-first Amendment." b. Manuel v. State of Louisiana, 2008 WL 1902437 (April 30, 2008 La. App. 3 Cir.):

"Without the three-tier system, the natural tendency historically has been

3 for the supplier tier to integrate vertically. With vertical integration, a supplier takes control of the manufacture, distribution, and retailing of alcoholic beverages, from top to bottom. The result is that individual retail establishments become tied to a particular supplier. When so tied, the retailer takes its orders from the supplier who controls it, including naturally the supplier's mandate to maximize sales. A further consequence is a suppression of competition as the retailer favors the particular brands of the supplier to which the retailer is tied – to the exclusion of other suppliers' brands. With vertical integration, there are also practical implications for the power of regulators. A vertically integrated enterprise- comprising manufacture, distribution, and retailing is inevitably a powerful entity managed and controlled from afar by non-residents.

The three-tier system was implemented to counteract all these tendencies. Under the three-tier system, the industry is divided into three tiers, each with its own service focus. No one tier controls another. Further, individual firms do not grow so powerful in practice that they can out-muscle regulators. In addition, because of the very nature of their operations, firms in the wholesaling tier and the retailing tier have a local presence, which makes them more amenable to regulation and naturally keeps them accountable. Further, by separating the tiers, competition, a diversity of products, and availability of products are enhanced as the economic incentives are removed that encourage wholesalers and retailers to favor the products of a particular supplier (to which wholesaler or retailer might be

4 tied) to the exclusion of products from other suppliers."

B. Ways that the Three-Tier System Is Enforced and Reinforced

1. KRS 243.110 – Incompatible Licenses.

a. Each kind of license shall be incompatible with every other kind of license listed in that section, and no person holding one can hold another (i.e., producer cannot have a distributor license).

b. This provision was strengthened in 2015 with regard to producers and distributors of malt beverages, shoring up a loophole created by case law years earlier.

c. 804 KAR 4:015 – Interlocking substantial interest between licensees prohibited.

 Interlocking substantial interests could be common officers, owners/partners, more than 10 percent of an ownership interest, or any other interest that provides the ability to control or influence decisions of an incompatible license holder.

2. KRS 244.602-.606 – Beer Franchise License.

a. No brewer or importer can require or request a distributor to pay the brewer, nor can they accept any money from the distributor in exchange for the right to distribute the alcohol.

b. Marketing fees are okay, though.

c. Prevents brewers from basically ever terminating or failing to renew a contract with a distributor absent severe breaches listed under the statute.

3. KRS 244.590 – Tied Houses Prohibited.

a. Brewers and distributors can't induce retailers to buy only their beer.

5 b. Statute lists multiple forms of prohibited inducement, such as guaranteeing a loan to the retailer or acquiring an interest in the property where the retailer conducts business.

4. KRS 244.600 – Commercial Bribery and Other Inducements Unlawful.

1. Employees, officers and other representatives of retailers cannot receive a benefit from a brewer without the consent of that person's employer/ principal.

2. Employees, officers and other representatives of retailers cannot be bribed to sell a brewer's beer to the exclusion of others.

C. Modern Trend – Compression – Producers Encroaching into Retail

1. Microbreweries –KRS 243.157 – Microbrewery license.

a. Permits licensee to sell malt beverages produced on the premises for on-premises and off-premises purposes without a distributor.

b. Must have:

i. Retail drink license;

 Can obtain NQ2 and quota drink licenses.

ii. Retail package license.

c. Can sell at fairs and festivals.

d. Subject to reporting requirements.

2. Small Farm Wineries – KRS 243.155 – Small farm winery license.

a. Permits small farm wineries to make and bottle wines, bottle wines produced at other small farm wineries, hold tastings subject to limits per patron, sell wine by the drink or by the package on the premises or at fairs and festivals.

b. If it is sold or consumed, it must be in wet territory.

6 3. Distillers – KRS 243.0305 – Souvenir package sales by licensed distillers – Sampling and sale of alcoholic beverages on premises of distillery.

a. Distillers may sell souvenir packages at retail up to 4 and a ½ liters per day.

b. Distillers may hold an NQ2 license to sell alcohol by the drink (recently changed from an NQ3 license).

c. May sell at fairs and festivals.

d. May provide samples up to 1¾ oz. of samples per visitor per day.

4. These licenses are exceptions to the three-tier system.

a. Allowing suppliers/producers to bypass distributors physically (although the transactions must take place financially and on paper) and retailers to become retailers themselves.

b. Vertical integration of small producers is allowed under this system.

c. There is an explosion of microbreweries, small farm wineries, and small distilleries, so this does put larger suppliers at a disadvantage, leading to some erosion of the three-tier system. So far, however, retailers haven't seemed to mind so much.

D. Key Kentucky Cases

1. Cherry Hill Vineyards, LLC v. Lilly (AKA Huber Winery, et al v. Wilcher, et al), 553 F.3d 423 (6th Cir. 2008).

Kentucky had a statutory scheme that prohibited out-of-state wineries from acting as distributors, even though in-state wineries were allowed to do so. In the wake of Granholm, plaintiffs filed suit against the state over the laws. The state quickly worked to amend the laws, requiring all sales of alcohol to be in-person with no direct shipping.

a. District court nullified new laws, effectively opening up direct shipping, subject to a two-case limit.

7 b. Sixth Circuit affirmed, holding that in-person sales effectively gave in-state sellers an advantage over out-of-state sellers and was illegal under the holding in Granholm.

c. KRS 244.165 declared unconstitutional.

d. Collapsed the supplier/distributor tiers slightly where wineries are concerned.

e. Today, direct shipping of wine up to two cases is permissible under KRS 244.255 if small farm winery has a license, whether in-state or out-of-state.

2. Maxwell's Pic-Pac, Inc. v. Dehner, Nos. 12-6056/ 6057/ 6182 (6th Cir. 2014).

Kentucky bars grocery and convenience stores from selling package liquor and wine, even though drug stores and others can do so. Plaintiff argued that this violated Equal Protection under both the U.S. and Kentucky Constitutions.

a. District Court agreed with the plaintiffs, but Sixth Circuit reversed.

b. "We conclude that reasonably conceivable facts support the contention that grocery stores and gas stations pose a greater risk of exposing citizens to alcohol than do other retailers. A legislature could rationally believe that average citizens spend more time in grocery stores and gas stations than in other establishments; people typically need to buy staple groceries (for sustenance) and gas (for transportation) more often than items from retailers that specialize in other, less-frequently-used products. Consider the district court's pharmacy example. Kentucky could believe that its citizenry visits grocery stores and gas stations more often than pharmacies – people can survive without ever visiting a pharmacy given that many grocery stores fill prescriptions."

c. Court once again gives great deference to state control over liquor laws.

8 II. RECENT LEGISLATIVE CHANGES TO ALCOHOLIC BEVERAGE LAW

A. Introduction

The hospitality industry has seen extensive growth and resultant legislative attention as Kentucky modernizes its alcoholic beverage control laws to capitalize on trends in popular taste and tourism. The past few years have seen all sectors of alcohol tourism expand in nearly unparalleled fashion, and all three tiers of the three-tier system have been moving to take advantage of this new climate. What follows are synopses of legislation that has had a major impact on the hospitality industry in recent years, as well as a brief discussion of a potential future trend that would impact alcohol retailers significantly.

1. 2017 – HB 100 and HB 183.

The Kentucky legislature took decisive action this year as it continues to take steps to modernize the alcoholic beverage industry. Two major initiatives were passed by both the House and Senate in March, and signed by Governor Bevin.

HB 100, sponsored by Representative Chad McCoy of Bardstown, is the smaller of the two bills in length – but it has a broad impact. The legislation has four components: 1) it aligns enforcement penalties that apply to retail sales across all licenses; 2) it allows distillers to conduct retail sales by the drink at fairs and festivals; 3) it allows retailers to purchase from private persons and then resell vintage spirits back to the marketplace; and 4) it further strengthens production standards for Kentucky bourbon.

HB 183 is an omnibus bill that was written and supported by the Department of Alcoholic Beverage Control (ABC) which creates clarity and consistency throughout Kentucky alcohol law and provides long-sought added benefits to many in the industry.

a. HB 100.

One of the main provisions of HB 100 makes a significant change in Kentucky's retail sales laws and puts Kentucky as a national leader for the sale of vintage spirits. The law will allow licensed package sellers to purchase "vintage" spirits from unlicensed individuals for resale to the public. The distilled spirits

9 must be in the original, unopened manufacturer's container; not owned by a distillery; and not otherwise available for purchase from a licensed wholesaler. The aim of this measure is to bring to market the rare, antique and vintage spirits that may be hiding in garages and attics, or being held by a private collector. If an individual discovers a rare or well-aged bottle of bourbon from a long-defunct distiller, possibly left over from a prior generation, that bottle can now be brought to the retail market. The retailer may then sell that vintage spirit by either the drink or the package. These unlicensed vintage spirits transactions must be reported to the ABC. This provision of the legislation will not go into effect until January 1, 2018, which will give the Department time to promulgate regulations overseeing the transactions.

Another component of HB 100 allows distillers to sell by the drink at fairs, festivals and other similar events in a wet territory. The original version of HB 100 also allowed sales by the package at these events, but a committee amendment removed the language during the legislative process. Small farm wineries have had the option to sell both by the package and by the drink at fairs and festivals for over a decade, and microbrewers gained the ability to do so in 2016. While this provision does not bring full parity with those producers, it may still prove a boon to Kentucky distillers who may now sell their products by the drink at these events.

Arguably the largest provision by scope is the third component of HB 100, which aligns penalties in lieu of license suspension across all license holders, if the suspension and penalty are related to retail activities of the license holder. This issue has come to the forefront as alcohol producers have gained latitude to provide retail sales in addition to production. Violations of various provisions in Kentucky alcohol law can result in license suspension, but license holders may pay a per diem penalty in lieu of suspension. Under the former law, retailers were subject to a penalty of $50 per day, while producers (distilleries, wineries and breweries) were subject to a penalty of $1,000 per day. The inequity in this penalty system came to a head when these producers began

10 engaging in retail activities in addition to production. For example, an underage purchase violation at a standard retailer would net a $50 per day penalty (with a standard fine levied by the Department of $2,500 or fifty days), but for a distiller engaging in the same activity at their retail space the penalty would be $1,000 per day. The new law aligns daily penalties for distilleries, wineries and breweries with retailers when the violation is a direct result of retail activity. This provision is especially timely in light of the expanded powers of the Department to suspend licenses under HB 183, discussed below.

Finally, the last component of HB 100 strengthens production standards for Kentucky bourbon by declaring that it must be produced from "grains which are cooked, fermented, and distilled in Kentucky." This provision further protects Kentucky as the one, true authentic home of bourbon. b. HB 183.

Representative Adam Koenig of Erlanger sponsored the omnibus provisions of HB 183, which are basically a wish list of provisions from the ABC with several other stray alcohol-related items added in. Many of the provisions of the bill are "clean-up" items that more clearly define duties and the roles of govern- ment or industry participants, including changes or additions to the definitions and roles of items such as "local administrator" or "investigator," or the removal of bond requirements for local administrators. The bill also gives the Department the power to issue advisory opinions and declaratory rulings, which should prove to be an invaluable tool to the Kentucky alcohol industry. Here are some of the key provisions in the omnibus bill:

i. HB 183 provides some guidance on local option elections, which are now allowed on the same day as other primary or general elections, and up to 150 days after the petition for a local option election was filed.

ii. The retail drink licenses of distillers are now NQ2, rather than NQ3, licenses, and the fifty-

11 seat minimum for holders of NQ2 retail licenses is abolished.

iii. Holders of NQ1 licenses may now hold sampling licenses, but outside of sampling by those with a license, retailers may not sell or give away alcohol for less than they paid (or the current wholesale cost) unless they have received approval from the ABC department.

iv. Employees of alcohol producers may sample the products produced by that manufacturer for purposes of education, quality control, and product development.

v. KRS 244.290 is amended to clarify how a locality may regulate the hours of sale and delivery of alcoholic beverages.

vi. The Department of Alcoholic Beverage Control has the broad authority to summarily suspend a license upon finding that the continued operation of a license holder during the pendency of a hearing would constitute a threat to public health or safety.

vii. This issue of small farm wineries being allowed to produce brandy (a distilled spirit) was finally resolved in this legislation. Small farm wineries are now allowed to apply for a distiller's license, which would allow them to manufacture brandy.

All the provisions of HB 100 and HB 183 become law on June 29, with the exception of the vintage spirits provision of HB 100 and modifications of KRS 244.590, which become law on January 1, 2018.

2. 2016 – SB 11.

Rather than a sweeping bill of changes, SB 11 represents incremental steps sought by the industry to foster increased economic impact and better tourism experiences through a step away from Prohibition-era regulations. Brewers, wineries and distillers all stand to benefit at least somewhat from the changes.

12 Distillers will substantially benefit from the law, with increases in sample sizes and package sales and the right to serve alcohol by the drink, depending on the jurisdiction. Package sale limits for distillers increased by 50 percent from three liters per visitor per day up to 4.5 liters. A distillery with a sampling license may now provide up to 1.75 ounces of samples per visitor per day, up from one ounce. The new law grants distilleries the ability to apply for an NQ3 license to be able to serve alcohol by the drink (this was changed to NQ2 in 2017's HB 183), and local option elections are available to authorize the sale of alcohol by both the drink and by the package at distilleries in dry or moist territories. Employees serving alcohol by the drink at distilleries have to undergo mandatory server training through the Kentucky Department of Alcoholic Beverage Control's Server Training in Alcohol Regulations ("STAR") program, the first statutorily- mandated training ever. The law also allows distillers to give free novelties or production by-products with a value of up to $75 during tours and charitable events, and distilleries are free to sample and sell souvenir packages of all types of distilled spirits, not just bourbon. These changes could have a transformative impact on the Kentucky Bourbon Trail, a centerpiece of Kentucky hospitality tourism.

Smaller craft producers also will benefit greatly from SB11. Under the law, small farm wineries and microbreweries both see their annual production limit double, an acknowledgment that these smaller producers are experiencing a surge of growth and becoming a staple of the Kentucky hospitality industry. Craft distillers are also eligible for a "craft rectifier" license that comes with requisite reduced state and local license fees.

Microbreweries gain the ability to sell their products by the drink or by the package at fairs and festivals, putting them on more even footing with small farm wineries. The law also gives "big" brewers the ability to open tap rooms and sell growlers – refillable containers of less than two liters.

On a more esoteric note, SB11 contains provisions allowing the licensing of public consumption of alcohol on "commercial quadricycles," which are large four-wheeled vehicles powered by pedaling patrons as they consume alcohol, effectively making them bars on wheels. The law also contains other general provisions that outlaw powder and crystal forms of alcohol, create a new NQ3 drink license

13 for bed and breakfasts, allow sales of bottled alcoholic beverages at events held under a special temporary alcoholic beverage license, and permit Sunday sales of alcohol in any city or county that passes an ordinance to do so. Finally, the law allows cities of any size to determine their own wet or dry status separately from the status of the county.

III. ADMINISTRATION OF ALCOHOL LAWS AND REGULATIONS IN KENTUCKY

Alcoholic Beverage Control ("ABC") laws are a somewhat unique creature in American legislation. Most common laws constitute restrictions on a broad field of freedoms granted to the people. Such laws place limited and specific restrictions on public behavior that has no limitation otherwise. ABC laws are largely the inverse of this concept. State regulation typically preempts all aspects of production, distribution and retail sale of alcohol, creating a regime that instead grants specific exclusions to the outright prohibition on these activities for limited numbers of producers, distributors and sellers. These laws form a strict regulation regime at the state level, but local policies can tighten this regulation even further.

State regulations and regulators are mirrored at the local level. There are dual licensing and regulation schemes at both levels in many jurisdictions, with state and local administrators. This also means there is dual enforcement from these individuals with roughly similar authority. The difficulty for alcoholic beverage industry participants then becomes not only compliance with two similar schemes of regulation, but the divide that occurs when the schemes don't entirely line up. This creates a patchwork of ABC regulation that can be difficult to navigate, especially for companies that have establishments in multiple jurisdictions within and among the various states. This is evident in areas of regulation such as server training, which is mandatory in some districts. Some in-house server training courses may fulfill local requirements in one jurisdiction, while others may require STAR training supplied by the state.

Every business that crosses jurisdictional lines, especially larger regional and national companies with multiple locations, faces a patchwork of rules and regulations that vary from jurisdiction to jurisdiction, and all understand that they must learn and adapt to local rules. That being said, alcoholic beverage regulation is a completely different beast legislatively, and with such intense regulation of the industry, piecemeal restrictions and added regulatory hurdles at the local level only serve to substantially burden cross-jurisdictional business.