Title of Regulation: 3VAC5-50. Retail Operations (amending 3VAC5-50-220).

Statutory Authority: §§ 4.1-103 and 4.1-111 of the Code of Virginia.

Public Hearing Information: No public hearing is currently scheduled.

Public Comment Deadline: January 21, 2022.

Effective Date: February 7, 2022.

Agency Contact: LaTonya D. Hucks-Watkins, Senior Legal Counsel, Alcoholic Beverage Control Authority, 2901 Hermitage Road, Richmond, VA 23220, telephone (804) 213-4698, FAX (804) 213-4574, or email latonya.hucks-watkins@virginiaabc.com.

Basis: Section 4.1-103 of the Code of Virginia enumerates the powers of the Alcoholic Beverage Control Authority Board of Directors, which includes the authority to adopt regulations and to do all acts necessary or advisable to carry out the purposes of Title 4.1 of the Code of Virginia. Section 4.1-111 of the Code of Virginia provides the board with the authority to adopt reasonable regulations to carry out the provisions of the Alcoholic Beverage Control Act (§ 4.1-100 of the Code of Virginia) and to amend or repeal such regulations.

Purpose: The Virginia Alcoholic Beverage Control Authority recognizes that the regulation needs to be revised because current trends in compensation structure of management agreements involves management companies being paid a percentage of the income from the business that they manage. The authority is often met with resistance when trying to enforce this provision of the regulation because it is not indicative of how most companies operate. The goal is to create another exception to the general rule that will allow for a percentage-based payment while still giving the authority the ability to hold the licensee liable for any violations committed by the management company, which serves the public welfare, and also enforce a reasonable cap on the percentage of income from the licensed business that a management company may receive as payment.

Rationale for Using Fast-Track Rulemaking Process: This is not anticipated to be controversial because it is a requirement only applicable to licensees that choose to use management agreements, which the majority of licensees do not. (Out of over 20,000 licensees, a few more than 700 actually use management agreements.) The changes represent the current industry-acceptable method of payment for companies that utilize management agreements.

Substance: The amendments create an additional exception to the general rule that a licensee may not let another person receive a percentage of the income of the licensed business or have any beneficial interest in such business. Presently, the regulation allows an exception to the general rule where the percentage-based payment is a franchise fee or a rent payment. The revision allows percentage-based payments to management companies and promoters hired by the licensee to handle operational duties on behalf of the licensee provided that the management company or promoter receives less than 10% of the business income and the authority is provided a copy of the contract indicating that the management company or promoter is an agent of the licensee for the purposes of exercising the privileges of the license, and the licensee is liable for any violations of the Alcoholic Beverage Control Act (§ 4.1-100 et seq. of the Code of Virginia) or Alcoholic Beverage Control Authority regulation.

Issues: The primary advantage to the public and the Commonwealth is that this amendment will allow the regulation to catch up to current business trends while still maintaining control over who can receive percentage-based payments from licensed entities, limiting the amount of these payments and maintaining administrative liability for entities that are not within the exception created by this provision. There are no perceived disadvantages to the public or the Commonwealth.

Department of Planning and Budget's Economic Impact Analysis:

The Department of Planning and Budget (DPB) has analyzed the economic impact of this proposed regulation in accordance with § 2.2-4007.04 of the Code of Virginia (Code) and Executive Order 14 (as amended, July 16, 2018). The analysis presented represents DPB's best estimate of these economic impacts.¹

Summary of the Proposed Amendments to Regulation. The Virginia Alcoholic Beverage Control Authority Board of Directors (Board) proposes to allow percentage-based payments to management companies and promoters hired by the licensee to handle operational duties on behalf of the licensee, provided that the management company or promoter receives less than 10% of the business income.

Background. Currently, the regulation prohibits percentage-based payments to third parties except for two instances where the percentage-based payment is a franchise fee or a rent payment. The purpose of the general prohibition against the percentage-based payments is to prevent otherwise unqualified individuals from operating a licensed business (e.g., hidden ownership).

The proposed changes would create an additional exemption to the general rule and thereby allow percentage-based payments to a management company or promoter if the payment is less than 10% of the business income. According to the Virginia Alcoholic Beverage Control Authority (Authority), compensation structures in management agreements based on the percentage of income for a licensed business have been more common in recent years. Examples of such agreements include operation of a restaurant in a hotel or operation of a food-court business in a mall. In such situations, a party may own the location and may wish to reap most of the profits from that location but may not have the business expertise to run it in instances where alcoholic beverages are served. The 10% threshold is rooted in the statutory disclosure requirements whereby an ownership percentage above the threshold is subject to background checks.²

Estimated Benefits and Costs. It is not unusual for an entity or an individual to have the capital or real estate needed to start a business that requires an alcoholic beverage license but to lack the experience needed to run such a business. The proposed regulation would accommodate such entities or businesses by allowing them to hire other individuals or entities with expertise to run such businesses based on a percentage of revenues. Currently, the Authority does not tolerate such compensation structures, and once identified, the licensees are usually forced to modify their licenses to reflect a status as joint owners, which triggers a need for all owners to comply with the ownership requirements (such as background checks and liability) as is already required for the primary licensee. The joint license requirements currently discourage this type of business model by imposing requirements on an individual who or entity that has the expertise to run such a business but may lack the capital or the real estate to operate it.

Other requirements will remain in place that would likely help prevent the abuse of this new exception. These include the 10% threshold on percentage-based payments and the requirement that the Authority be provided a copy of the contract indicating that the management company or promoter is an agent of the licensee for the purposes of exercising the privileges of the license and the licensee is liable for any violations of Title 4.1 (the Alcoholic Beverage and Cannabis Control Act) or of Board regulations that may be committed by the management company or promoter.

In summary, the proposed amendments would remove a barrier to forging partnerships by allowing capital or real estate resources to work with operational expertise while minimizing the risk of hidden ownerships or violations of laws and regulations.

Businesses and Other Entities Affected. According to the Authority, there are 20,648 licensed businesses in the Commonwealth. Of these, 713 currently utilize management agreements. A subset of the 713 licensees are most likely to take advantage of the newly available percentage-based compensation structure. None of the licensees appear to be disproportionately affected.

The Code of Virginia requires DPB to assess whether an adverse impact may result from the proposed regulation.³ An adverse impact is indicated if there is any increase in net cost or reduction in net revenue for any entity, even if the benefits exceed the costs for all entities combined. As noted, the percentage-based payments represents a new business friendly compensation structure option. Thus, no adverse impact is indicated.

Small Businesses⁴ Affected.⁵ The proposed amendments do not appear to adversely affect small businesses.

Localities⁶ Affected.⁷ The proposed amendments do not introduce costs for local governments.

Projected Impact on Employment. To the extent the proposed allowance for percentage payments help start new businesses, a positive impact on employment can be expected.

Effects on the Use and Value of Private Property. To the extent the proposed allowance for percentage payments help start new businesses, a positive impact on asset values of parties on both sides of the agreement and on the value of real estate involved may be expected. The proposed amendments do not appear to directly affect the real estate development costs.

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¹Section 2.2-4007.04 of the Code of Virginia requires that such economic impact analyses determine the public benefits and costs of the proposed amendments. Further the analysis should include: (1) the projected number of businesses or other entities to whom the proposed regulatory action would apply, (2) the identity of any localities and types of businesses or other entities particularly affected, (3) the projected number of persons and employment positions to be affected, (4) the projected costs to affected businesses or entities to implement or comply with the regulation, and (5) the impact on the use and value of private property.

²See §§ 4.1-222 and 4.1-225 of the Code of Virginia.

³Pursuant to § 2.2-4007.04 D: In the event this economic impact analysis reveals that the proposed regulation would have an adverse economic impact on businesses or would impose a significant adverse economic impact on a locality, business, or entity particularly affected, the Department of Planning and Budget shall advise the Joint Commission on Administrative Rules, the House Committee on Appropriations, and the Senate Committee on Finance. Statute does not define "adverse impact," state whether only Virginia entities should be considered, nor indicate whether an adverse impact results from regulatory requirements mandated by legislation.

⁴Pursuant to § 2.2-4007.04, small business is defined as "a business entity, including its affiliates, that (i) is independently owned and operated and (ii) employs fewer than 500 full-time employees or has gross annual sales of less than $6 million."

⁵If the proposed regulatory action may have an adverse effect on small businesses, § 2.2-4007.04 requires that such economic impact analyses include: (1) an identification and estimate of the number of small businesses subject to the proposed regulation, (2) the projected reporting, recordkeeping, and other administrative costs required for small businesses to comply with the proposed regulation, including the type of professional skills necessary for preparing required reports and other documents, (3) a statement of the probable effect of the proposed regulation on affected small businesses, and (4) a description of any less intrusive or less costly alternative methods of achieving the purpose of the proposed regulation. Additionally, pursuant to Code § 2.2-4007.1 of the Code of Virginia, if there is a finding that a proposed regulation may have an adverse impact on small business, the Joint Commission on Administrative Rules shall be notified.

⁶"Locality" can refer to either local governments or the locations in the Commonwealth where the activities relevant to the regulatory change are most likely to occur.

⁷Section 2.2-4007.04 defines "particularly affected" as bearing disproportionate material impact.

Agency's Response to Economic Impact Analysis: The Virginia Alcoholic Beverage Control Authority concurs with the Department of Planning and Budget's economic impact analysis.

Summary:

The amendments create an additional exception to the general rule that a licensee may not let another person receive a percentage of the income of the licensed business or have any beneficial interest in such business. The new exception allows percentage-based payments to management companies and promoters hired by the licensee to handle operational duties on behalf of the licensee provided that the management company or promoter receives less than 10% of the business income and the authority is provided a copy of the contract indicating that the management company or promoter is an agent of the licensee for the purposes of exercising the privileges of the license and the licensee is liable for any violation of the Alcoholic Beverage Control Act (§ 4.1-100 et seq. of the Code of Virginia) or Alcoholic Beverage Control Authority regulation committed by the management company or promoter.

3VAC5-50-220. Interests in the businesses of licensees.

Persons to whom licenses have been issued shall not allow any other person to receive a percentage of the income of the licensed business or have any beneficial interest in such business; provided, however, that nothing in this section shall be construed to prohibit:

1. The payment by the licensee of a franchise fee based in whole or in part upon a percentage of the entire gross receipts of the business conducted upon the licensed premises, where such is reasonable as compared to prevailing franchise fees of similar businesses; or

2. Where the licensed business is conducted upon leased premises, and the lease when construed as a whole does not constitute a shift or device to evade the requirements of this section:

a. The payment of rent based in whole or in part upon a percentage of the entire gross receipts of the business, where such rent is reasonable as compared to prevailing rentals of similar businesses; and

b. The landlord from imposing standards relating to the conduct of the business upon the leased premises, where such standards are reasonable as compared to prevailing standards in leases of similar businesses, and do not unreasonably restrict the control of the licensee over the sale and consumption of alcoholic beverages; or

3. The payment by the licensee of a management fee based in whole or in part upon a percentage of the entire gross receipts of the business conducted under the license where the licensee has contracted with a management company or promoter to perform operational duties on behalf of the licensee, provided that:

a. All payments to any management company or promoter are less than 10% in aggregate of the gross receipts of the business conducted under the license; and

b. The licensee provides the Alcoholic Beverage Control Authority (authority) a copy of the contract between the licensee and the promoter that identifies the management company or promoter as an agent of the licensee for the purposes of exercising the privileges of the license and holds the licensee liable for any violations of the Alcoholic Beverage Control Act (§ 4.1-100 of the Code of Virginia) or authority regulation committed by the management company or promoter.