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Volume 14, Number 6 July/August 2005
More Wine, Less Whining
Commerce Clause trumps state statutes
By John McGee
Several industries, including sellers of products as diverse as alcoholic beverages,
cigarettes, automobiles and caskets, have for years used the legal system to
create for themselves what they would call a protected niche but what others
would call an oligopoly. The legal arguments used to sustain these oligopolies
have become as aged as the wine they attempt to protect, but one by one the
walls are tumbling down.
In a continuing series of cases begun in February of 2000, wine consumers and
out-of-state wine sellers challenged several state laws restricting the sale of
alcoholic beverages. Despite a spirited defense of these laws by state attorneys
general protecting their statutes and alcohol wholesalers protecting themselves,
as well as decades of precedents favoring the industry, defense motions to
dismiss the cases were denied and consumers prevailed, often by summary
judgment. The demand created by e-commerce, with its promise of lower prices,
made direct shipping rules an issue of national importance.
The Supreme Court struck down these rules (5-4) in mid- May in the consolidated
cases of Granholm v. Heald, Michigan Beer & Wine Wholesalers Association v.
Heald, and Swedenburg v. Kelly. Granting that the states have broad power to
regulate liquor under the 21st Amendment, the court refused to allow states to
ban,
or
severely
limit,
the
direct
shipment
of
out-of-
state
wine while
simultaneously authorizing direct shipment by in-state producers. New York and
Michigan regulations that discriminated against out-of-state wine producers were
voided under the Commerce Clause.
CALENDAR
When the 21st Amendment repealed Prohibition in 1933, most states adopted a
three-tier system of manufacturers, wholesalers and retailers and prohibited any
one owner from investing in more than one tier. This prohibition keeps
manufacturers from owning a retail license, thus preventing them from selling
directly to consumers and allegedly keeping mobsters out of the liquor business.
It also keeps small wineries from selling directly to consumers. There are 2,000
wineries with 7,000 different wines in the United States; most are too small to
produce enough wine to attract wholesalers, so they rely heavily on direct sales to
consumers. There have been stories in the media of wine being shipped in
unmarked boxes, customers giving fake addresses, and shipments of "Olive Oil" in
plain brown wrappers being mailed all over the country.
Making direct purchase by consumers from out-of-state illegal may or may not
deter mobsters, but it clearly serves to limit consumer choice and protect wine
wholesalers. By voiding the New York and Michigan regulations, the court has told
the states that they may no longer force out-of-state wineries to participate in
their three-tier system — that economic protectionism is not a valid reason to
discriminate. Wholesalers and their allies in various state governments may keep
their strict system of licensing so long as the restrictions do not discriminate
against out- of-state purchasers. States do not, in other words, have sovereign
regulatory power under the 21st Amendment.
One of the first legal challenges, Dickerson v. Bailey, was brought by wine
drinkers in Houston against the administrator of the Texas Alcoholic Beverage
Commission (TABC), alleging that restrictions in the Texas alcoholic beverage code
that kept them from purchasing wines directly from out-of-state suppliers limited
their participation in interstate commerce and thus violated the Commerce Clause
of the U.S. Constitution. Texas, of course, requires consumers to purchase only
from licensed retailers, who may purchase only from licensed wholesalers, who
must purchase only from licensed producers.
The threshold question was the same as in any Commerce Clause challenge: Does
the challenged statute discriminate on its face against interstate commerce and in
favor of local businesses, thereby rendering it per se invalid, or does it regulate
commerce evenhandedly with only incidental effects on interstate commerce? If
the statute does not discriminate on its face, then a balancing test is applied to
determine its constitutionality, and the court should uphold the statute unless the
burden it places on interstate commerce is clearly excessive in relation to its
benefits. The plaintiffs in Dickerson claimed the three-tier system of liquor
licenses in Texas impeded the free flow of goods from one state to another and
was therefore per se illegal under the "dormant" Commerce Clause of the
Constitution.
The wholesalers and the state argued that the three-tier system regulates
commerce evenhandedly, with only incidental effects on interstate commerce, and
therefore any discrimination was demonstrably justified by a valid factor unrelated
to economic protectionism. The regulation was defensible, they argued, because
of the 21st Amendment's grant to states of broad powers to regulate the
transportation and importation of alcohol for delivery and use within their borders.
Fears about large companies with monopolistic tendencies dominating all levels of
the alcoholic beverage industry were trotted out. If wineries used catalogs or the
Internet to sell their products, they argued, Texas might lose total control over
the import and distribution of alcoholic beverages within its borders. The proper
taxes might not be collected; shippers might ship to dry areas of the state; sales
of alcoholic beverages to minors might increase. They cited language from the
1936 Supreme Court Young's Market case indicating that the 21st Amendment
essentially repealed the Commerce Clause where liquor regulation was concerned.
The plaintiffs, however, had done their homework. An FTC report concluded that
states that allow direct shipping have procedural safeguards against shipments to
minors and report "few or no problems" with these shipments.
Court decisions after 1936 suggested that states could avoid problems with direct
sales by:
requiring purchases to be made by credit card,
requiring a sizable minimum purchase,
requiring age verification by the seller through faxed identification and delivery
only to an adult identified in the identification document,
requiring labeling of products on the outside of shipping wrappers, or requiring
age verification of the recipient by the transporter.
Moreover, trade associations representing alcohol manufacturers had already
agreed to submit to state licensing and tax collection requirements if direct
sales were allowed. Moreover, many states already allowed direct interstate
shipment of wine — collecting taxes by requiring a permit in order to ship
wine into the state.
The district court easily determined that the Texas Alcohol Beverage Code
discriminated against interstate commerce by favoring in-state economic
interests at the expense of out-of-state interests. But did the 21st
Amendment "repeal" the Commerce Clause in connection with alcohol
regulation, saving the statutes from invalidation? Not, said the court, if
reasonable, nondiscriminatory alternatives could be found to address the
state's interests in taxes and dry areas.
Since there are many alternatives for collecting taxes on out-of-state wine
sales and there are criminal laws that prohibit the sale of alcoholic beverages
to minors and those in dry areas of the state, the state failed in its attempt
to prove that the local benefits justified the Commerce Clause violation and
the total ban on direct shipments to consumers was over-inclusive. Texas
consumers were allowed to purchase wines directly from out-of-state sellers
and ship wines purchased elsewhere to their homes in Texas.
The 21st Amendment, appropriately narrowed and modified by 60 years of
opinions, was no longer sufficient to save the regulations from invalidation
under the Commerce Clause. Judge Harmon rebuked the defendants for
relying on older cases that "fail to reflect the marked evolution of law in this
area" and concluded that there was "no temperance goal served by the
statute since Texas residents can become as drunk on local wines or wines of
large out-of-state suppliers able to pass into the state through its distribution
system, and available in unrestricted quantities, as those that, because of
their seller's size or (other) constraints, are in practical effect kept out of
state by the statute."
Judge Harmon's Dickerson decision partly relied on a broad holding in a
contemporaneous Indiana case that the 21st Amendment does not immunize
state liquor control laws from invalidation under the Commerce Clause. When
the Indiana case was reversed by the Seventh Circuit as a direct challenge to
the entire three-tier distribution system, Dickerson was reopened for
consideration. Both parties revised their arguments and prepared to return to
the courtroom.
Meanwhile, the Texas legislature got involved by passing the Texas Wine
Marketing Assistance Program Act, with the expressed purpose to "assist
Texas wineries in capturing a greater part of the market for wine, at the
expense of out-of-state wineries."
This left no doubt that the intent of the statute was economic protectionism.
In-state wineries were exempted from the three-tier system by permitting
them to deal directly with Texas consumers in both selling and shipping
wines. In contrast, Texans could not personally bring into the state more than
three gallons of wine purchased from an out-of-state vintner. Texas wineries
were also permitted to ship directly to a Texas consumer any wine sold to
him, but out-of-state wineries were prohibited, under the threat of criminal
penalties, from shipping any alcoholic beverage directly to any Texas
resident.
On reconsideration, the new Texas regulatory scheme fared no better with
Judge Harmon. The state was engaging in "economic determination" by
applying its regulatory scheme to favor local producers over out-of-state
producers. The new statute was discriminatory and violated the dormant
Commerce Clause; it was not "saved" by the 21st Amendment. The 21st
Amendment does not allow states to control alcohol any way they like — they
must treat the importation of liquor similarly to the way they treat in- state
sales of liquor. The judge actually challenged Judge Easterbrook's Seventh
Circuit opinion for using terms like "orderly market conditions" ("a euphemism
for reducing competition and facilitating tax collection") and "express grant of
plenary power" ("this reveals his own leaning").
She even asserted that the Seventh Circuit's deference was based on a
flawed interpretation of the Constitution because it did "not even mention the
burdens on small out-of-state wineries or consumers that might result from
the regulatory process, thus ignoring the last 40 years of Supreme Court
cases balancing the dormant Commerce Clause and the 21st Amendment."
The Fifth Circuit likewise showed little patience with the state's reformulated
argument that the plaintiffs were attempting to overthrow the entire threetier system and establish an unregulated national market in wine. The court
even accused the state of misrepresenting the central legal issue of the case,
noting that the TABC's worries about a totally unregulated market arose only
after the Seventh Circuit decision.
The Fifth Circuit accepted the wineries' express disavowal of any attempt to
overturn the three-tier system and declared itself in conformity with the
Seventh Circuit, which had qualified its approval of the Indiana system with
the words "unless the state has used its power to impose a discriminatory
condition on importation." Since the Texas requirements clearly imposed
discriminatory conditions on out-of-state wineries, Judge Harmon's injunction
was upheld and when the state decided not to appeal further it had to pay
the plaintiff's attorney fees of $160,000.
By September of 2000, district courts in seven states had concluded that
alcoholic beverage statutes were in violation of the dormant Commerce
Clause. Florida and the District of Columbia upheld the statutes anyway,
finding them a constitutional exercise of sovereign regulatory power under the
21st Amendment even though they "may have protectionist overtones." Other
states found mixed motives, some legitimate and some protectionist, with the
legitimate motives outweighing the burden placed on interstate commerce.
Still other states declared their otherwise unconstitutional statutes "saved" by
the 21st Amendment.
According to the Wall Street Journal, some states made it easy to order wine
online, some made it tricky, some remained tough, and there were seven
states where bypassing wholesalers was sometimes a felony. After the
wineries' legal campaign got under way, Virginia, North Carolina and other
states followed Texas' lead and permitted direct shipping, but only by in-state
wineries.
Meanwhile, the Institute for Justice filed Swedenburg as a national test case
in New York, the second-largest wine market after California, against four
large liquor wholesalers on behalf of small wineries and consumers, arguing
that the state's direct shipment laws violated the Commerce Clause. The
Institute refers to restrictions on direct shipment as "the oldest gambit of
American politics: economic protectionism" designed to "preserve the
monopoly of liquor wholesalers who control all out-of- state wine..."
Restrictions on interstate wine shipping, they allege, make it impossible for
out-of- state wineries to ship wine to New York consumers, thereby
trammeling their economic liberty. New York claimed that its absolute power
under the 21st Amendment to regulate the distribution of alcohol insulates it
from any constitutional attack.
In an opinion echoed later by the Supreme Court and with national
ramifications for Internet commerce, the court voided New York's ban on
direct shipments as violative of the Commerce Clause, agreeing to allow "only
those restrictions which directly promote temperance." The wineries' victory
celebration, however, was premature.
Granting that the direct shipment ban "would be a problem" if the goods
involved were not alcohol, the Second Circuit joined four other circuits in
rejecting any analysis that "unnecessarily limit(s) the authority delegated to
the states through the clear and unambiguous language of the 21st
Amendment." In an opinion that would later be repeated by dissenters on the
Supreme Court, the Second Circuit held that the 21st Amendment "repealed"
the Commerce Clause wherever regulation of liquor is concerned. The legal
history of Prohibition was used to show that the Commerce Clause was not
intended to restrict any state regulatory scheme focusing on the importation
of liquor and that "changes in marketing techniques or national consumer
demand for a product do not alter the meaning of a constitutional
amendment."
By ruling that states may not use alcohol distribution laws to bar out-of-state
competitors from shipping wine while allowing local wineries to ship directly
to consumers, the Supreme Court "has not diminished the 21st Amendment;
it has merely reinforced its earlier position." It still recognizes that the 21st
Amendment makes liquor special and that the states have valid regulatory
concerns. The court has merely rejected the notion that the 21st Amendment
somehow "immunizes" states from the Commerce Clause.
In his dissent from what he calls a "confused mismash elite opinion," Justice
Thomas argues that concerns about the application of the Commerce Clause
to liquor regulation have been displaced not only by the 21st Amendment but
by the express language of the Webb- Kenyon Act that prohibits any
"shipment or transportation" of alcoholic beverages "into any state" when
those beverages are "intended, by any person interested therein, to be
received, possessed, sold, or in any manner used . . . in violation of any law
of such state." This, he says, authorizes states to discriminate. A separate
dissent by Justice Stevens insists that the will of Prohibition-era drafters be
honored even though applying the Commerce Clause "may represent sound
economic policy and may be consistent with the policy choices of the
contemporaries of Adam Smith who drafted our original Constitution."
If consumers are to be allowed access to the wine market at all, then they
must be able to access the direct market via the Internet. States will continue
to strictly regulate alcohol and most regulations (possibly even a total ban on
shipments of wine to consumers) will be upheld, so long as they do not
discriminate. The Supreme Court has merely held that states do not have the
right to discriminate in order to overcome trade barriers and that it will
invoke strict scrutiny of any purportedly legitimate local purpose.
The court's 1984 holding in Baccus that "The central purpose of the 21st
Amendment was not to empower states to favor local liquor industries by
erecting barriers to competition... State laws that constitute mere economic
protectionism are not entitled to the same deference as laws enacted to
combat the perceived evils of unrestricted traffic in liquor" has become "If a
state chooses to allow direct shipment of wine, it must do so on evenhanded
terms" in 2005.
The establishment of a common market for wine sales will increase
opportunities for small wineries to tap major markets, increase choices for
consumers and lower prices. E-commerce will be furthered by having common
rules for what can be sold over the Internet, and regulatory matters such as
tax collection and sales to minors can be handled in less intrusive ways than
banning all out-of-state sales.
States have always tried to erect statutory barriers to shield their merchants
from the rigors of competition and that is exactly what the Commerce Clause
was enacted to prevent; indirect trade barriers to preseve an oligopoly will
not work in the age of globalization and the Internet. Consumers demand
access to products at the lowest cost and this may force certain industries to
change their business practices to insure they are pro- consumer,
nonprotectionist — and as efficient as possible.
McGee is a professor at Texas State University, in San Marcos, Texas. His email is [email protected].
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