Annual Report on the Food and Beverage Industry: Recent Trends and Outlook

by McGuireWoods LLP

The food and beverage industry has experienced significant change in recent years. New technological developments are enhancing the way food producers track food safety issues, food-labeling remains a hot-button issue, and new entrants into the grocery business are rapidly changing traditional food distribution models. The industry can expect further momentum on each of these fronts in the year ahead.

Developments in Blockchain Technology

By Steve Gold, Partner

It is unusual that a trend to watch in food safety would be one that primarily involves arcane information technology developments, but that is exactly the case in 2018. As a result of several initiatives begun in 2017 by technology companies and large food industry participants, applications of blockchain technology to food supply chain management and safety traceability are likely to gain attention this year.

“Blockchain” refers to a variety of techniques, popularized for the bitcoin cryptocurrency, for maintaining a ledger of information consistently across multiple computers on a decentralized network. While applications such as its use as a financial ledger are more well-known, the disparate global components of a food ingredient supply chain make food safety a highly promising application of the technology, and make the technology something to watch for food safety.

The practical and legal issues related to developing blockchain technology will be complex. On one hand, blockchains can enhance privacy and security because they use encryption techniques for storage and access authorization, and they can improve access to information by providing a method for multiple parties to access a database without the need to rely on a central authority. Blockchains are thought to be faster and more secure than traditional database methods for distributed applications. On the other hand, deployment of any new technology widely across the food supply chain will take time and expense, and the system relies on new methods and new technologies that may be unfamiliar.

The technical claims about features of blockchains must be carefully scrutinized by lawyers. While technologists assert that blockchains are immutable, these descriptions are incomplete. Aside from the ever-present threat of hacking of any computer system, several highly publicized events belie these features. On at least two occasions, on two different blockchains, a centralized group controlling the software of a blockchain was able to change the contents or function of a blockchain to correct a flaw. While those were beneficial changes, they make clear that in certain circumstances, blockchains can be changed.

The growth of blockchains for food safety may also be hampered by regulatory developments in other fields, particularly the cryptocurrency applications that were the founding development of the technology. Despite its promise to enhance food safety information access, the technology and investment in it may be hampered as the U.S. regulatory community turns its attention on restraining the excesses and frauds occurring with so called “initial coin offerings” that use a blockchain as a vehicle to raise funds for new businesses.

The legal implications of any blockchain initiative should be carefully considered, with a broad perspective. Technology, intellectual property, open source software and federal financial regulation issues abound.

What to Expect With California Prop 65 in 2018

By Dana Palmer, Senior Counsel

Regulations adopted by California’s Office of Environmental Health Hazard Assessment (OEHHA) in August 2016 become operative on Aug. 30, 2018. While the long-awaited regulations address several topics, the key change affects the style of warnings that must be given when a product, menu item or work space, for example, exceeds safe harbor thresholds or otherwise requires a warning. Instead of the old warning style that did not specify the chemical that triggers the warning, the new warning requires specification of the Prop 65-listed chemical (or chemicals) and a web address where a consumer or employee can find out more information about the warning and why it exists. The new warning also features a triangle and exclamation point to further draw attention to it. Here is an example warning for a product containing arsenic above the safe harbor level:

Food and Beverage Outlook 2018

The new warnings become mandatory for products manufactured on and after Aug. 30, 2018, but businesses would be smart to act well in advance of that date to revise existing warnings. As with other areas of Prop 65, the new warning requirements will likely be well enforced by private plaintiffs.  In addition to these new warning requirements, there are new specific warnings for alcoholic beverages, food and non-alcoholic beverages, prescription drugs, dental care, wood dust, furniture products, diesel engines, vehicles, recreational vessels, enclosed parking facilities, amusement parks, petroleum products, service stations and vehicle repair facilities, and designated smoking areas.

Finally, the new regulations put the burden of Prop 65 compliance primarily on product manufacturers, rather than downstream distributors or retailers, though manufacturers can enter written agreements to have downstream entities comply. There are several other issues addressed by the new regulations of lesser importance.

While the new regulations impose different requirements, at the same time Prop 65’s scope will only continue to widen in 2018 as new chemicals are listed. The most recent proposed listing concerns TRIM® VX, a  metalworking fluid used as a lubricant and coolant liquid for cleaning tools and parts during cutting, drilling, milling, and grinding.  In the pesticide sector, despite pending challenges in state and federal court to derail the listing of glyphosate (none of which have had success yet), OEHHA in the meantime finalized its safe harbor level on April 10, 2018 at 1,100 micrograms per day.

Food Labeling Update

By Ben Abel, Associate

One ongoing dispute in the world of food labeling has been the U.S. Food & Drug Administration’s efforts to define the term “natural.” After years of refusing to wade into the debate, the FDA last year extended the comment period for proposed rulemaking over the term “natural” to April 26, 2017. Since the closure of the comment period in April, the FDA has yet to provide any formal rule or guidance on the term. As a result, a number of cases pending the agency’s seemingly imminent decision remain stayed.

In October, FDA Commissioner Scott Gottlieb seemed to indicate in an interview in The Wall Street Journal that he would like to see the FDA enforce “natural” claims on a case-by-case basis, suggesting that the FDA’s ultimate rule or guidance may be standards-based and limited in scope and pre-emptive effect.

The lack of guidance from the FDA did not stop plaintiffs from filing “natural”-related claims. In the second half of 2017, McGuireWoods tracked at least eight newly filed class-action suits related to the term “natural” used on labeling, and tracked another four cases that settled “natural” claims, costing defendants (and perhaps consumers) potentially more than $5 million combined. For each filed case, there may be many unfiled and individually resolved matters.

Slack-fill suits also remained popular last year, though they have yet to result in any serious judgments or settlements. In the second half of 2017, McGuireWoods tracked at least eight newly filed class-action slack-fill suits, but did not track any slack-fill settlements.

Holdings from three class actions before the 9th Circuit may result in an increase in class actions filed in California’s already-popular “food courts.” In Briseno v. ConAgra Foods, Inc., 844 F.3d 1121 (9th Cir. 2017), the 9th Circuit declined to apply an “administrative feasibility” standard as a prerequisite to class certification under Federal Rule of Civil Procedure 23. As a result, putative class members may not need to reliably demonstrate class membership.

Next, in Robins v. Spokeo, Inc., 867 F.3d 1108 (9th Cir. 2017), the 9th Circuit found a class representative plaintiff’s intangible harm sufficient to provide Article III standing for a class action over the defendant’s alleged violation of the Fair Credit Reporting Act.

Finally, under Davidson v. Kimberly-Clark Corp., 873 F.3d 1103 (9th Cir. 2017), the 9th Circuit held that California consumers may seek injunctive relief regarding product labeling even if they testify that they are unlikely to again purchase the allegedly misbranded product. Taken together, Briseno, Robins and Davidson likely suggest that class-action claims in California federal courts may increase in 2018 as prospective plaintiffs find favorable case law in the 9th Circuit.

Finally, the scheduled announcement on the U.S. Department of Agriculture’s proposed rule regarding bioengineered food will likely affect litigation in the second half of 2018. Under the National Bioengineered Food Disclosure Standard, passed by Congress in 2016, the USDA is required to implement specific rules regarding a number of issues, including disclosure of genetically modified organisms in food, by July 2018. In August 2017, the comment period for the rule closed. In 2017, GMO litigation remained popular amongst plaintiffs and the USDA’s rules should provide some clarity. Any proposed rule should also pre-empt a recent spate of cases seeking to challenge GMO-related labeling based on animal products from animals allegedly being fed feed containing GMOs. See Reilly v. Chipotle Mexican Grill, Inc., No. 16-17461, 2017 U.S. App. LEXIS 19278 (11th Cir. Oct. 4, 2017); Podpeskar v. Dannon Co., No. 16-cv-8478 (KBF), 2017 U.S. Dist. LEXIS 198948 (S.D.N.Y. Dec. 3, 2017).

Amazon’s Acquisition of Whole Foods and What It Means for the Grocery Industry

By: Kate Hatcher, Partner, and John Hoke, Associate

In June 2017, Jeff Bezos’ Inc. acquired Whole Foods for $13.7 billion. The significance of this transaction to the grocery industry cannot be understated. As one market commentator noted “twenty years from now, Wall Street traders will look back and surely remember where they were when it happened.”

Shortly after the acquisition closed, Amazon slashed prices at Whole Foods to increase in-store shopping — some prices decreased by as much as 40 percent — and Amazon now offers all of its Amazon Prime members a 5 percent discount on groceries purchased at Whole Foods. Amazon also began offering many of Whole Foods’ private label products on its website, and some Whole Foods locations sell Amazon products, such as Kindle and the Echo (Amazon’s voice-controlled speaker system).

More significantly, however, are Amazon’s plans to use its acquisition of Whole Foods to conquer the online grocery delivery business. Amazon recently announced that its Amazon Prime subscribers will be eligible for free, two-hour grocery delivery from Whole Foods. Amazon is piloting this delivery program in four cities — Austin, Cincinnati, Dallas and Virginia Beach — but it plans to expand this service throughout the United States in 2018.

In response to this new Amazon-Whole Foods juggernaut, grocers have undertaken a flurry of M&A activity to ensure they can compete with Amazon’s ability to deliver groceries on-demand. Not long after Amazon completed its acquisition of Whole Foods, Target acquired grocery delivery service Shipt for $550 million. Texas-based grocer H-E-B recently acquired a delivery service called Favor and, in 2016, Walmart acquired, which has a strong online grocery business. Albertsons, Safeway, Costco and Kroger also recently inked deals with Silicon Valley startup Instacart, which provides home-delivery grocery services. In an interview with Forbes, Instacart CEO Apporva Mehta, a former Amazon employee, described the Amazon-Whole Foods deal as a “thermonuclear bomb against the entire grocery industry” and noted that “when we look back [the Amazon-Whole Foods deal] may have been the turning point for Instacart.” Notably, Instacart recently raised an additional $200 million, which boosted its valuation to $4.2 billion.

With Amazon’s acquisition of Whole Foods, the online grocery delivery business is increasingly shaping up to be a battle of Amazon against everyone else. Margins in the grocery industry are slim, and brick-and-mortar retailers recognize their survival depends upon their ability to adapt to changing consumer habits by marketing their products online and providing speedy, reliable and cost-effective delivery services. It remains to be seen whether traditional grocers will be able to compete with Amazon on price and convenience but, less than a year after Amazon’s acquisition of Whole Foods, the landscape for the grocery business has irrevocably changed.

M&A Outlook in the Food and Beverage Industry

By Brad Austin, Partner

The appetite for food and beverage M&A remains strong. Valuations are high, but significant capital is ready to be put to work alongside debt from lenders looking for transactions. Thus, it’s likely dealmakers will continue to search for opportunities, both high and low, and buyers will continue to look downstream more and more, considering smaller franchisees, emerging brands and new ideas.

Industry trends may help shape buyer activity. Many consumers are looking for more than just organic and there is specific demand for items such as “plant-based” goods, and more tailored or unique items. Such “emerging brands” historically were difficult for investors to consider; however, large food and beverage companies have formed their own venture capital and/or private equity funds to consider these opportunities.

Looking at restaurant M&A by itself, buyers are looking for brands and concepts that provide growth. A concept with 10 or fewer units may sound small, but if the concept can be easily repeated in new markets, expect buyers to consider it.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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