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“The Legal Buzz”

DIRECT SHIPPING PART II:
A BIG VICTORY FOR DISTRIBUTORS IN THE SECOND CIRCUIT

by Gary Ettelman, Esq. and Keith B. Hochheiser, Esq.

In our September 2003 Legal Buzz column we offered our opinion that, contrary to the doom and gloom pundits who have all but pronounced the 21st Amendment dead, we believed the 21st Amendment was “still alive and kicking”. We further opined that as long as the States exercise the power granted to them under the 21st Amendment in a non-discriminatory manner, statutes regulating the importation and distribution of alcohol within their borders are not likely to be upset.

In a major victory for wholesalers of alcoholic beverages, on February 12, 2004, in the case of Swedenburg v. Kelly, the United States Court of Appeals for the Second Circuit agreed with our sentiment. In Swedenburg, the Second Circuit overturned a District Court decision which had previously held unconstitutional a New York statute that prohibited direct shipment by out-of-state wineries to consumers in New York but permitted in-state wineries to obtain retail licenses which enabled them to sell and ship directly to consumers.

The Second Circuit focused on the fact that the regulatory scheme in New York, including licensing requirements for distributors, fell “squarely” within the grant of authority contained within the 21st Amendment. The only issue remaining, according to the Second Circuit, was whether the statute discriminated unfairly. A key factor for the Swedenburg Court was the ability of the out-of-state winery to apply for and obtain a New York license to distribute and sell in New York, although to do so the out-of-state supplier would have to establish and maintain a physical presence in New York. The Court determined that since the statute in issue allows all licensed wineries, whether in-state or out-of-state, to sell directly to consumers, the statute was non-discriminatory. As a result, the court found the statute did not violate the Commerce Clause.

The Second Circuit was unswayed by the argument that the regulation unfairly discriminated against out-of-state producers, because in order to quality for a state retail license, they would have to incur substantial costs that in-state producers would not. Noting that “[t]he Twenty-first Amendment is unequaled in our constitutional experience”, the Court determined that “business efficiency must give way to valid regulatory concerns in this unique area of commerce.” Stated in simpler terms, the Court has determined that the 21st Amendment grants to the States unique powers that the States do not enjoy in other areas of commerce. Those powers give the States the right to regulate the importation and distribution of alcoholic beverages within their borders in ways that they could not with respect to any other commodity.

An Unavoidable and Historical Conflict.

The Commerce Clause grants to Congress the right to regulate all interstate commerce. On the other hand, the 21st Amendment grants to the States the right to regulate the importation and distribution of alcoholic beverages within their borders. In today’s global economy, it is virtually impossible to conduct any business which does not affect interstate commerce. Indeed, virtually every state liquor statute has some impact on interstate commerce. Hence, the table has been set for the battle between the powers of the States under the 21st Amendment and Congress’ authority under the Commerce Clause.

Since the passage of the 21st Amendment in 1933, there has been litigation over this inevitable conflict. Our first article detailed some of that history. Now, the battleground has moved to direct shipping statutes. On the one hand, you have powerful groups, representing consumers and vintners, arguing that America will be a better place if Joe America can log on to the Internet on his computer in New Jersey and order his favorite cabernet directly from a vintner in Napa Valley. Equally strong and passionate are the distributors, states rights activists and the States themselves, who portray direct shipping as the beginning of the end of the ability of States to regulate the importation, distribution and consumption of alcoholic beverages. Unfortunately, until the Supreme Court rules on the issue, there can be no resolution.

Will the Supreme Court Grant Certiorari?

In our view the greatest potential of the Second Circuit decision is that it presents an opportunity for the Supreme Court to grant certiorari and determine the direct shipping issue once and for all. Appeals to the Supreme Court, however, are not as of right. Rather, it is wholly within the sound discretion of the Supreme Court whether or not to grant the right to appeal; in legal parlance, granting a writ of certiorari. Thus far, the Supreme Court has not granted certiorari on any of the direct shipping cases. The burden is on the appealing party to demonstrate to the Supreme Court why the issue is of great importance. A significant factor in this regard is whether there is a split in authority at the Circuit Court level.

Prior to the Swedenburg case, five other Circuit Courts of Appeals had decided direct shipping cases, i.e. cases involving a regulatory scheme which prohibited out-of-state wineries from selling wine directly to consumers while permitting local wineries to do so. Four of the Circuits struck down the regulatory schemes in question, while only one, in a somewhat suspect opinion, sustained the challenged regulation. This is precisely the reason that many experts within the alcoholic beverage industry started impersonating Chicken Little with cries of “the 21st Amendment is falling”. With only one Circuit Court of Appeals decision extolling the virtues of the 21st Amendment in relation to the direct shipping cases, there was, and frankly, still is, cause for concern. However, with the Second Circuit weighing in on the side of the 21st Amendment, there is far greater support for the argument that the 21st Amendment is still a powerful ally in the struggle between competing state and federal interests. More importantly, there is a growing chasm between the Circuits thereby increasing the likelihood that the Supreme Court will take the case.

Looking Into our Crystal Ball.

So, what does this most recent case mean? The short answer is that it is too early to say what the full effect of the decision will be. Obviously, for those of you presently conducting business under the New York statute, the decision is profound. Unless and until the Supreme Court says otherwise, in-state wineries may sell directly to consumers, while out-of-state wineries may not unless they establish a presence in New York and obtain the necessary license. The decision also has the potential to impact issues under the 21st amendment beyond the direct shipping cases; this, however, is a topic for another day. The ultimate potential of the case is that it presents a golden opportunity for the Supreme Court to be heard on the issue.

Of course, the big question is, ‘What will the Supreme Court do?’ Well, we certainly were not shrinking violets when we disagreed with the popular viewpoints being espoused by industry authorities, who claimed that the 21st Amendment was dead and buried and the three-tier system was next. We firmly stated our belief that the 21st Amendment will continue to be a vital and powerful tool for lawmakers when it comes to regulating the importation and distribution of alcoholic beverages within their borders. Now that we know the Second Circuit Court of Appeals feels the same way, we certainly are not going to change our view.

Given the current membership of the Supreme Court, if and when they do grant certiorari in a direct shipping case we believe that consistent with the Court’s prior decisions, this Court will aggressively support the powers granted to the states under the 21st Amendment and not lightly set aside any regulation passed under that authority. We believe that the Supreme Court will follow precedent it established in earlier 21st Amendment cases and hold that so long as the statute being contested is a direct exercise of the power granted to the States under the 21st Amendment, it is not subject to Commerce Clause scrutiny unless the statute represents “mere economic protectionism”. In other words, our money is on the Second Circuit to withstand the scrutiny of the Supreme Court if certiorari is granted.

Act – Don’t React.

So, does that mean that distributors should just sit back and wait for the Supreme Court to rule? Of course not! The key to success and, indeed, life is to always be proactive and keep one step ahead of the competition. Take responsibility for protecting your distribution rights.

Have your distribution agreements reviewed carefully by counsel and always strive to obtain “exclusive distribution rights”, as opposed to some lesser grant. As the holder of exclusive distribution rights, you can contractually preclude your supplier from distributing directly, even if direct shipping is otherwise legal. If your agreement only appoints you as a “sole distributor” in a given territory, the supplier may still argue, and perhaps successfully, that while it can not appoint another distributor in your territory, it has the right to sell directly as a supplier.

Be active in your state associations. Do whatever you can to encourage the passage or amendment of legislation which prohibits direct shipping but is not discriminatory against out-of-state suppliers.

Take affirmative steps to create intellectual property rights which may effectively prohibit a supplier from competing with you. Don’t wait for someone else to fight your battle, get out there and help yourself!