You are a shopping center owner with a plenary license for the consumption of alcohol who wishes to lease space to a restaurant operator in the center’s prime location. As part of the business deal, you agree to sell your liquor license to the tenant. You provide in the lease that you as landlord have a right of first refusal to re-purchase the liquor license for an established price in the event of tenant’s default or if the tenant attempts to sell its restaurant to an unrelated party. Five years later, the restaurant tenant defaults and you seek to exercise your right to re-purchase the license and request that the tenant take the necessary steps to obtain approval of the transfer from the appropriate authorities. However, your tenant refuses. Are you entitled to specific performance of your right of first refusal requiring the tenant to apply for the license transfer?

Until recently, the answer in New Jersey was a harsh no. For decades, the New Jersey courts held that a contract for the transfer of a liquor license was unenforceable. The rationale used by the courts was that specific enforcement of a private contract impinged on the exclusive authority of the governmental bodies granted by statute to approve a liquor license transfer. The practical effect of this judicial rule was that a contract purchaser of a liquor license had no viable deterrent against a seller who simply decided to renege on his promise to transfer the license. In other words, the seller was excused from acting or dealing in good faith. But, in the case of Kalogaras v. 239 Broad Avenue, LLC, decided June 16, 2010, the New Jersey Supreme Court overturned this long-standing precedent in holding that a contract for the transfer of a liquor license can be enforced against a defaulting party on the principle of implied good faith and fair dealing.

The Kalogaras decision marks a major departure from earlier Appellate Division cases that generally took a hard-line view on the enforceability of contracts concerning liquor license transfers. This arose from a strict interpretation of the Alcoholic Beverage Control Act (ABC Act), which requires a license for the sale of alcoholic beverages for consumption on or off the licensed premises. The ABC Act deems a liquor license not to be property that can be sold or transferred except with the approval of the Division of Alcoholic Beverage Control (ABC) or other issuing authorities such as municipalities.

The reasoning for denying specific performance of a contract was best expressed in the 1983 decision of Rte. 73 Bowling Center, Inc. v. Aristone, in which the plaintiff sought enforcement of a right of first refusal to purchase a tavern business and liquor license from a tenant. The agreement contained no express provision conditioning the transfer on the approval of the ABC. In denying specific performance, the Appellate Division explained that the ABC must have unfettered discretion as to whether to approve or deny a transfer without having to consider the possessory rights of a third party under a private contract. In the court’s view the grant of specific performance to enforce a third party’s contract right gave rise to a "shadow of control" over the license contrary to the purposes of the ABC Act. Based on this reasoning, the court held that "it is settled law in this state that specific performance may not be granted for a contract transferring a liquor license."

Two years later in Darrah Food Services, Inc. v. Lambertville House, Inc., a different Appellate Division panel revisited the Rte. 73 Bowling Center holding and somewhat softened its impact. In Darrah, the plaintiff contracted to lease a restaurant and tavern and was given the option to purchase the premises and license from the owner. Unlike the situation in Rte. 73 Bowling Center, the agreement provided that the owner was required to use best efforts to transfer the liquor license attached to the property and that the transfer was specifically conditioned on the approval of the ABC. Focusing on the fact the parties expressly agreed to cooperate in securing the license transfer, the Darrah court explained that the Rte. 73 Bowling Center holding should not be read to limit contracts that in no way impinge upon the discretion of the ABC. It reasoned that the absolute discretion afforded the ABC or local authorities under the statute was not thwarted by allowing parties to contract to cooperate and apply for a license transfer. In effect, the Darrah court introduced a magic words test to decide the issue. If the agreement to transfer the license was specifically contingent on the approval of the governmental authorities, it could be enforced by the courts. If no language existed, then the contract was unenforceable under the Rte. 73 Bowling Center principle.

The confusion created by the Rte. 73 Bowling Center and Darrah decisions was evident in Kalogaras where the trial court and Appellate Division reached completely opposite determinations. In Kalogaras, brothers Nick and Gus owned a diner with a liquor license. Their business relationship deteriorated after 25 years resulting in a separation of their business interests in the diner. Gus purchased Nick’s interest for $2 million, paying him partially in cash and by giving a purchase money note payable over a ten-year period. The agreement of sale also provided that if Gus sold the business while any portion of the mortgage note remained unpaid, Nick retained a right of first refusal on any sale of the business including the liquor license. Three years later, Gus entered into an agreement to sell the diner together with the liquor license to Kim. The agreement provided that Gus would execute and deliver documents as necessary and appropriate to carry out the license transfer to Kim, that Kim agreed to comply with all laws affecting the license, and the parties agreed to use their diligent efforts to consummate the transaction. The agreement did not expressly state that the transfer of the license was contingent on the approval of the ABC. After learning of the proposed sale, Nick negotiated to sell his right of first refusal to a third party and then together they exercised the right of first refusal. Gus countered by terminating his sale agreement with Kim, and Nick sued for specific performance of the right of first refusal.

The Chancery Court granted judgment in favor of Nick on his request for specific performance and ordered Gus to cooperate with Nick in seeking a transfer of the liquor license. The court determined that the condition precedent of prior governmental approval was implied within the contract, although the contract was silent on the issue. The Appellate Division disagreed, concluding that Rte. 73 Bowling Center was the proper precedent to apply instead of Darrah because the parties did not make the transfer of the liquor license explicitly contingent on the approval of the ABC.

The Supreme Court reversed the Appellate Division decision and reinstated the judgment of the Chancery Court. Based in part on the review of decisions in other states, particularly California, which has a license statute similar to New Jersey’s, the court concluded that whether a contract for the sale of a liquor license includes a specific provision conditioning the transfer on securing the necessary governmental approvals was immaterial to the enforcement of the contract. Rather, the court determined that the better, more principled rule of law was that the ABC approval was an implied condition of the contract and, subject to that condition precedent, a transfer of a license can be specifically enforced to the extent the parties are required to act in accordance with the implied covenant of good faith and fair dealing. The court went on to state that to interpret the decision of Rte. 73 Bowling Center otherwise was error.

The court found no rational basis to immunize a liquor license agreement from the well-established contract principles of good faith and fair dealing. Therefore, a contract buyer of a liquor license may obtain specific performance against the seller of the license requiring that the seller act in accordance with the implied covenant of good faith and fair dealing and cooperate in the transfer of the license.

The court acknowledged that, even after cooperating in good faith, the parties to a liquor license contract may nevertheless be unable to secure the necessary governmental approvals to transfer the license. Accordingly, the court suggested that contracts should separately allocate the consideration for the liquor license from other assets or otherwise provide for the severability of the liquor license provisions from the rest of the contract to guard against a court invoking the doctrines of novation, impossibility of performance or using its equitable powers to re-write the terms of the contract.

In issuing the Kalogaras decision the New Jersey Supreme Court has finally eliminated the uncertainty that has overshadowed the enforceability of liquor license contracts. Going forward, New Jersey businesses should feel more comfortable with entering into business arrangements involving the purchase and sale of liquor licenses.