Written by Alexis K. Mason & John P. Thomas, II
ENGAGING A HELPING HAND
contract distilling
I
magine the following scenario: You’ve finally decided to turn your passion for distilled spirits into a business. You’ve spent time studying different formulas and combinations of ingredients to find the perfect recipe for your new product. You’ve thought through the name, the label, and the logo for your new venture, but then you’re faced with the stark reality that setting up a distillery is expensive. Between the cost of the facility, the equipment, the ingredients, and the staffing, this venture will prove to be a massive funding challenge. This realization is not uncommon, which is why many new distilled spirits brands often turn to contract distilling. A new product can reach the market through contract distilling faster while avoiding the initial capital outlays that would burden most startups in their infancy. Contract distilling is a relationship through which a non-distiller (at times referred to as “the client” in this article) pays a contract distillery to produce spirits for them. This arrangement is particularly useful for entities that want to make distilled spirits products but don’t have the necessary capital, capacity, or permits. Through contract distilling, new market entrants can avoid undertaking all of these action items and instead engage an existing contract distillery to produce the new
market entrants’ distilled spirits products. Contract distilling offers a low-risk system where the client can test a product and brand, allowing more companies to bring their product to market. Under a contract distilling arrangement, the contract distillery typically is solely responsible for distilling the spirituous product, maintaining all of the distilling records, labeling the product using its name and address, obtaining necessary COLAs, obtaining a formula approval for the product, and paying the tax associated with removing the spirits from the distillery. The client would provide the recipes for its product to the contract distillery for production. The title to the distilled spirits would remain with the contract distillery until the tax is paid or the distilled spirits are removed from the distillery. Alcohol beverage regulators typically consider this arrangement an ordinary commercial business relationship. The structure of the operations under a contract distilling arrangement, as well as the requirement for each participant in the arrangement to obtain an alcohol beverage license, will depend on federal and applicable state alcohol beverage laws. Under federal alcohol beverage law, if the client will be responsible for distributing the product, it will be required to obtain a federal
Contract distilling is a relationship through which a non-distiller pays a contract distillery to produce spirits for them. W W W . ARTISANSPIRITMAG . C O M
wholesaler permit from the Alcohol and Tobacco Tax and Trade Bureau. In this structure, the client can purchase the finished distilled spirits product from the contract distillery and sell the product to licensed distributors as desired. The preceding is typically the best structure when the client wants to be involved in the supply or distribution process, receive proceeds from the sale of alcohol, and have its own distribution agreements. Notably, there are other structures for consideration through which the client would not have to obtain a federal wholesaler permit. For example, the contract with the distillery may be structured as a licensing arrangement through which the client is not involved and does not receive proceeds from the supply or distribution of the product. Rather, the client would license its intellectual property, including the recipe, brand name, and other elements, to the contract distillery and receive a licensing fee based on the use of the intellectual property. Otherwise, the contract distillery would be entirely responsible for distributing the product through its network of distributors. 41