Originally Published in Krost, Baumgarten, Kniss & Guerrero Newsletter - February 2014.
Do you want to be part of the booze business in California? Or do you already have a liquor license but are unclear on what you're allowed to do? We're here to help.
This article provides a brief summary of the regulatory framework and industry structure of the alcoholic beverage industry in California. Readers should keep in mind that there is a federal regulatory framework as well, and that there are detailed California "trade practice" issues that affect many retail licensees in this State, but they are beyond the scope of this summary.
Following the repeal of Prohibition and the adoption of the 21st Amendment to the U.S. Constitution, the alcoholic beverage industry in this country became subject to regulation by the various states. California chose to regulate the industry based upon a "three tier" system: manufacturers (i.e., breweries, wineries and distilleries), distributors (i.e., wholesalers and importers), and retailers (i.e., those who sell to consumers). At the retail level, licenses are issued for "on-sale" locations (i.e., ones where consumers drink the alcoholic beverages on-site, such as restaurants and bars) and for "off-sale" locations (i.e., ones where consumers may not drink on-site, such as grocery and liquor stores).
At its most fundamental level, a member of each industry tier must be licensed and must sell or buy beverage alcohol to or from a licensed member in the same or different tier. This was due to questionable practices that occurred before and even during Prohibition (e.g., "speak-easies", "disorderly houses" and "tied-houses"(*1)). The California Legislature also sought to prevent vertical integration of the industry so, as a general rule, a member in one tier of the industry cannot have a significant interest (whether directly or indirectly) in the business of another tier.
In California, the manufacture, distribution, storage and sale of alcoholic beverages are regulated by the Department of Alcoholic Beverage Control (the "ABC"), and the ABC is charged with enforcing the Alcoholic Beverage Control Act and the regulations promulgated under that Act. The mission of the ABC is to "administer the provisions of the Alcoholic Beverage Control Act in a manner that fosters and protects the health, safety, welfare, and economic well being of the people of the State."This statement essentially boils down to balancing the promotion of temperance, on the one hand, with economic growth, on the other. But this balancing act is not always an even proposition. As many regulators will tell you, "alcohol is different" and, as such, the ABC disfavors situations where there is a possibility of overconsumption by consumers and/or sales to minors.
The ABC's Headquarters is in Sacramento, and it has two Division Administrative Offices (Northern Division in Sacramento and Southern Division in Cerritos). In addition, each Division has a series of District Offices, of which there are 21 throughout the State. Each District Office has jurisdiction over a predetermined area, and most license applications are filed at the District Office with jurisdiction. Unfortunately, there often is inconsistency among the District Offices regarding application requirements (although the ABC's administration has been trying to address this). What this means is that the ability to work with different District Offices is critically important – especially to businesses that will have multiple locations in California.
Highly Regulated, High Cost and High Risk Industry
As anyone who has attempted to obtain a liquor license in this State can tell you, this is a highly regulated industry with high start-up costs and significant business risk. Each license is not only unique to a specific licensee, but also to a specific location. As such, an applicant must show the ABC that it owns or otherwise has a right to occupy its proposed premises. In situations involving leases, this can be a bit tricky — tenants may not want to sign on the dotted line until they are certain they will obtain a license. As a result, potential licensees are well advised to demand a liquor license contingency in their leases (which allow them to walk away if the ABC refuses to issue the license (or authorize the transfer of an existing license)).
In addition, for manufacturers and distributors, there are (among other things) onerous record-keeping and inventory requirements, as well as labeling, storage and transportation issues. For retailers, there are not only significant costs for the licenses themselves(*2), but also the risk of selling alcohol to minors (including to underage decoys used by law enforcement(*3)), serving obviously intoxicated patrons and possibly keeping a disorderly house (particularly if employees or patrons are dealing in (or using) narcotics on site).
While the ABC is a State agency, there are always local governmental issues to consider as well. For example, an applicant needs to comply with local zoning requirements for its location. Unless the location is zoned for a beverage alcohol use, then Conditional Use Permits ("CUPs" and "CUBs") may be required from local planning departments. In addition, in most instances the ABC will ask local law enforcement if the issuance or transfer of a liquor license for a particular location will result in the potential for increased crime. Locations that are near schools, churches, playgrounds or youth facilities also present special challenges. Even if these challenges are not present, even if no CUP or CUB is needed, and even if local law enforcement has no objections to the granting of a license, the ABC will still entertain protests from the general public with respect to the issuance or transfer of a liquor license(*4).
Dealing with the ABC is no walk in the park, either. You'll need to be prepared to submit detailed information on your business entity, and any owners (direct or indirect) that hold 10% or more of the equity in that business. This 10% threshold applies even to so-called "passive" investors (such as minority shareholders of a corporation, limited partners in a partnership or non-managing members in a limited liability company). Certain individuals in the organization will be required to be "qualified" by the ABC, which means that they will be required to provide detailed personal information (for background checks), and be fingerprinted. If the ABC determines that any such individual is "unqualified" (i.e., that his or her interest in the liquor license may be "contrary to public welfare and morals"), then s/he may be required to either reduce or give up entirely his or her interest in the enterprise. All of the entities and individuals required to be qualified will be subject to the tied-house rules, meaning that none of them can have an interest in more than one of the three tiers in the industry. The bottom line is that no one should go into this business in California unless s/he is willing to be on the "grid".
Once you obtain a license, you will still face significant operating costs. Due to the three tier system, licensed retailers generally may only buy from licensed distributors, so retailers' purchases of alcoholic beverage inventory will be subject to the distributors' markups. In addition, the ABC may impose conditions on your license — at retail, these could be limited operating hours (e.g., not necessarily to the standard hours of 6:00 a.m. to 2:00 a.m.), restrictions on the type of entertainment you may have, a requirement that a specified percentage of your gross revenues comes from sources other than alcohol sales, etc. Finally, insurance will be required. At the retail level, on-sale licenses are well advised to have "Dram Shop" insurance in addition to their other coverages.(*5) Despite what you may have heard, "Dram Shop" liability still exists in California (although it has a narrower scope than before). Under current State law, owners of bars, restaurants and liquor stores can still face criminal misdemeanor charges (which carry penalties of 6-12 months in county jail, a minimum $1,000 fine, or both) and be held liable for civil damages to an injured third party where such owners serve a minor who is visibly intoxicated.
Once you obtain a license, you will also need to spend a decent amount of money to remain compliant with California law. Although not technically required, we always advise our retail clients to take steps so that their employees and personnel are well-versed in California law as it relates to sale and service of alcohol. The ABC offers free training in this regard, under the auspices of its "Licensee Education on Alcohol and Drugs" (L.E.A.D.) programs. The cost of noncompliance can be steep, as the ABC has law enforcement powers to impose fines and to suspend and even revoke a liquor license. The penalties for sales to minors are especially stiff — the first violation carries a 15 day license suspension and/or a fine up $3,000; a second violation within 36 months carries a 25 day suspension and/or fine up to $20,000; and a third violation within 36 months results in an automatic revocation of the license. Retailers who have had a license revoked in this manner cannot qualify for a new ABC license for at least a year. The lesson here is that you can't assume that once you're licensed, and you think you're operating above-board, that all is well. The bad behavior of employees and patrons, and even routine changes to your ownership structure, all may play a role in a licensee's obligations to the ABC.
I've probably scared the beejeebers out of you by this point (which is probably good, since this industry isn't for the faint of heart). But for those of you who are willing to move forward into this industry, here are a few tips to remember:
Get advice early to avoid problems later. It's always more cost effective to set things up correctly, rather than to pay someone like me to try and clean up an ugly mess.
Be proactive, and work with the ABC and local officials (including local law enforcement). Remember, good corporate citizenship can go a long way in keeping you off of the ABC's radar screen.
As mentioned previously, never sign a lease without a liquor license contingency. You don't want to be stuck with rent payments for a business that doesn't hold the requisite licenses and permits.
Spend the time and money to educate and train your employees and staff – and take advantage of the ABC's L.E.A.D. programs. While you can't root out all the bad apples, you certainly help your cause if things go awry and you can show the ABC that you have a formal policy in this area.
This article is only the tip of the proverbial iceberg in California booze law, which is a vast and often complex area. To extend the metaphor, if you don't gain a good understanding of what lies beneath the surface, your business may go down like the Titanic. So, if you have any questions or concerns, we're more than happy to speak with you.
(*1) A "speak easy" was an establishment that illegally sold alcohol during Prohibition. A "disorderly house" is an establishment that constitutes a public nuisance, a disturbance of the peace or where other crimes occur. A "tied-house" traditionally referred to a public house (pub, bar) that was required to buy at least some of its beer from a particular brewery or pub company. This was in contrast to a "free house", which was able to choose the beers it stocks freely. Today, "tied-houses" refer to beverage alcohol businesses that are vertically integrated.
(*2) The cost of retail licenses vary as to type (On-Sale vs. Off-Sale) and as to the kind of privileges conferred (beer, wine and distilled spirits vs. beer/wine only.). Prices and availability are highly dependent upon the location of the premises and local market forces (i.e., supply and demand), and can vary widely from County to County. The only exception to this is the ABC's "Priority Drawing" lottery, which only occurs once a year and has stringent requirements for participation.
(*3) The use of underage decoys is expressly permitted under the Alcoholic Beverage Control Act. (*4) The public is notified by not only a Public Notice that is posted at the premises, but also by a publication in a newspaper or periodical of general circulation in the area where the premises are located.
(*5) "Dram Shop" insurance generally covers liability claims relating to service of alcohol to visibly intoxicated persons or minors who subsequently cause death or injury to third-parties (i.e., those not having a relationship to the restaurant or bar) as a result of vehicular crashes or other accidents.