Opening a traditional bricks-and-mortar winery can be complicated, expensive and time consuming. As an alternative, new vintners can elect to start a “nontraditional” winery, which allows them entry into the wine business without incurring the substantive acquisition and development expenses of a traditional winery.
The two basic structures of a nontraditional winery are the custom crush arrangement and the alternating proprietorship arrangement.
Custom Crush Arrangement
In a custom crush arrangement, the client (i.e., an aspiring vintner) pays the host winery to make wine to the client’s specifications. The client buys (or grows) grapes, delivers them to the host winery, and provides general instructions for producing and bottling the wine. The client may supervise the production, but the host winery is responsible for making the wine.
As the holder of a federal basic permit (i.e., a bonded winery), the host winery handles all production, recordkeeping and reporting to the Alcohol and Tobacco Tax and Trade Bureau, or TTB. In this type of arrangement, the client is not a bonded winery, does not own or lease a facility or equipment, and is not subject to any regulatory reporting requirements with respect to the winery premises.
The client is not required to hold fermentation or production licenses, and relies on the production permits and bond of the host winery until the wine is bottled, labeled and released by the host winery as “tax paid” (meaning that the federal excise tax on that wine has been paid, and the wine has been removed from the bonded premises) or the wine is transferred in bond to another bonded premise such as a warehouse.
Before the client can bottle or sell the wine, the TTB must approve the label for that wine by issuing a Certificate of Label Approval, or COLA. The host winery applies for and obtains a COLA for the client’s brand name. To obtain the COLA, the host winery must first adopt the client’s trade name, which may or may not be the same as the brand name, by adding it to the host winery’s federal basic permit. The label will reflect that the wine is “Produced and Bottled by (client’s trade name).”
In California, a custom crush client will typically obtain a Type 17 – Beer & Wine Wholesaler’s license, which allows sales of wine to other licensees (in state) for the purpose of resale, and a Type 20 – Off Sale Beer & Wine license, which, when held in conjunction with a Type 17 license, allows the sale of wine directly to consumers (in state) in a retail sales outlet and/or by telephone, Internet and mail order.
A client must also obtain a wholesaler’s basic permit from the TTB, which authorizes the client to sell wine that has been made for it to other wholesalers and retailers. Finally, a client must comply with state and federal tied-house regulations.
Although the custom crush arrangement allows aspiring vintners to enter the wine business relatively easily, there are some limitations to this structure. For example, the holder of a Type 17 license may not conduct wine tastings. and the custom crush client has limited rights to sell wine directly to consumers in other states as compared to licensed producers. In addition, many state tied-house exceptions are only available to licensed winegrowers and not wholesalers or retailers.
Alternating Proprietorship Arrangement
In a typical alternating proprietorship arrangement, an existing operating winery (the “host winery”) agrees to rent space and equipment to another wine producer (the “alternating proprietor”) to produce wine. This type of arrangement allows existing wineries to use excess capacity and gives new wineries an opportunity to begin on a small scale without investing in equipment.
In an alternating proprietorship, the use of the facilities alternates between the host winery and the alternating proprietor. Each winery (i.e., the host winery and alternating proprietor) may have a designated area dedicated to the exclusive use of the winery for the storage of its wine. The host winery and all alternating proprietors are separately bonded wineries, and each is responsible for its own production, recordkeeping, excise tax payments and label approvals.
In California, an alternating proprietor is required to obtain a Type 02 – Winegrower license, its own federal basic permit, and is solely responsible for its own winemaking, recordkeeping and reporting to the California Department of Alcoholic Beverage Control, the TTB and other governmental agencies, including the payment of excise taxes.
Since alternating proprietors (as independent producers) are eligible for the Small Producer’s Wine Tax Credit, which has the potential of reducing revenue to the government, the TTB carefully scrutinizes an alternating proprietorship arrangement to verify that the alternating proprietor is truly acting as a separately bonded winery rather than as a client of the host winery under a custom crush arrangement. In the custom crush situation, the excise tax is paid by the host winery, which, when it combines its own production with that of all its clients, might not qualify for the credit.
During the TTB’s review of an alternating proprietor’s application for a federal basic permit, the TTB will strictly evaluate the written agreement between the alternating proprietor and the host winery. The alternating proprietorship agreement should expressly state that the alternating proprietor is responsible for its own production, record-keeping, reporting, labeling and payment of taxes.
The agreement also should provide that the alternating proprietor will pay the host winery directly for its floor space, equipment use and, where applicable, personnel time and material consumed if the host winery is to provide services or materials. Pricing should be structured around rental of space and rates for specific services rendered.
Payment to the host winery should not be based on volume rates (tons, gallons or cases), a method of charging more appropriate for custom crush agreements. The TTB reviews all of these factors to determine if the arrangement is a true alternating proprietorship and not a custom winemaking relationship in disguise.
Although it is acceptable for the alternating proprietorship agreement to provide for the use of the host winery’s employees for certain services, it must be clear that such employees will be acting solely at the alternating proprietor’s direction or be hired directly by the alternating proprietor.
The contract should clearly state that the alternating proprietor is in control of, and responsible for, bottling under its permit, storing wine and removing wine from the bonded premises. The alternating proprietor must have absolute access to its bonded premises and its wine at all times. The agreement must also allow the TTB unfettered right of access to the bonded premises.
The alternating proprietorship arrangement is attractive to new vintners for a variety of reasons. As mentioned above, if the alternating proprietor’s production is less than 250,000 gallons, it will qualify for the Small Producer’s Wine Tax Credit.
Additionally, as the holder of a winegrower’s license in California, the alternating proprietor enjoys the same rights and privileges as a bricks-and-mortar winery holding the same license, including the right to conduct wine tastings and operate an off-site tasting room. Furthermore, the alternating proprietor has no obligation to comply with burdensome and expensive local regulations and use permit processes.
In conclusion, there are advantages and disadvantages to the custom crush arrangement and alternating proprietorship arrangement. New vintners must carefully consider a number of factors before deciding which structure to use. This can be a complex and confusing process, thus, speaking with a qualified attorney will help new vintners evaluate and determine which structure works best for them.
— John Haan is a senior associate at Rogers, Sheffield & Campbell LLP of Santa Barbara and chairman of the firm’s Wine Law Group. His practice is concentrated in the areas of business, real estate and wine law. A version of this article was first published in the September issue of Santa Barbara Lawyer. Click here to read previous columns. The opinions expressed are his own. This article is not intended to provide legal advice. For legal advice on any of the information in this post, click here for the form or phone number on the Rogers, Sheffield & Campbell Contact Us page.