Vol. 83, No. 3, March 2010
You don’t have to be an oenophile to tour California’s Napa Valley and want to bring back wine that you’ve never before seen. Or perhaps after skiing in Colorado and touring the state’s many breweries, you would like to send home some bottles of local craft beer. If you bought wine in California and brought it home in your suitcase, you would be committing a crime.1 In contrast, you can carry your beer home from Colorado in your suitcase, but there is no legal way to have the Colorado brewery ship it to your house.
The availability of a wide variety of distinctive alcohol products is becoming increasingly important to consumers. For example, brewpubs and tap houses offering a wide variety of craft beers have seen a rise in popularity, and in recent decades, annual wine consumption in the United States has doubled, with an increased interest in fine wine and a rapid expansion of boutique wineries.2 But the breadth of alcohol choices available to challenge and please the palate may be limited by the laws relating to alcohol-beverages distribution, particularly interstate shipping. For example, the wine of some boutique wineries with low production volume might be unavailable in traditional retail outlets but available online to consumers who have discovered the wine in a wine review, who are eager to taste rare wine, and who happen to live in a state where direct wine shipping is lawful.3
For better or worse, alcohol beverages are a significant part of Wisconsin’s culture and economy. Wisconsin has been known for a century for its breweries,4 and beer consumption at social gatherings and celebrations has long been a tradition. “Long before Wisconsin became America’s Dairyland, Wisconsin was a beer state. Brewing began in Wisconsin in the 1830s, and by the 1890s, nearly every community had at least one operating brewery. Breweries were as much a part of Wisconsin communities as churches and schools.”5 Today, Wisconsin has the fifth most breweries per capita in the United States among states with significant populations.6 Nor is Wisconsin a stranger to winemaking. The man dubbed the “Father of California Viticulture”7 got his start in Wisconsin, and Wisconsin, with about 60 licensed wineries, now has its own small but growing wine industry. In the past decade, there has also been increasing interest in local craft distilleries. “The craft distilling movement in the United States is in its very early stages … with new distillers debuting nearly every month. Some liken [it] … to the beginning of the micro-brewing revolution … or the development of the American wine industry in the 1960s and ‘70s. In the last couple of years, four Wisconsin distilleries have begun creating spirits, including gin, vodka, whiskey, rum and brandy.”8 The playing field on which a state’s alcohol-beverages producers compete against producers in other states is affected by each state’s alcohol-beverages distribution laws, a subject that has sparked interest and controversy for several years.9
The Three-tier System
Since 1933, when the 21st Amendment was ratified and Prohibition ended, the manufacture and distribution of alcohol beverages has been strictly regulated. Prohibition and its regulatory aftermath were in part premised on the perceived twin evils of alcohol: the view that alcohol is itself immoral, and the connection between alcohol and social ills like organized crime.10 This history seems far removed from the modern alcohol-beverages industry, but this history was a primary factor in shaping the three-tier system of alcohol beverage distribution that most states, including Wisconsin,11 use in some form. A strict three-tier system creates a wall between the industry segments of production, distribution, and retail sales. Brewers, wineries, and other alcohol-beverage producers can distribute their products only to independent, licensed wholesalers (also called distributors). These wholesalers then distribute the products only to independent, licensed retailers. Only licensed retailers can sell the products to the public. Thus, under a strict three-tier system, alcohol beverages must pass through both a licensed wholesaler and a licensed retailer before reaching the consumer. The three-tier system has been called a “vertical quarantine” because it establishes three vertical layers of alcohol-beverage distribution and mandates that no layer in the vertical hierarchy can act in the capacity of another.12 A strict three-tier system does not permit, for example, a tasting and purchasing room at a winery.
The three-tier system is not required by federal law and is a product not of the marketplace but of state legislative preference. Regulators have generally favored the three-tier system, and wholesalers have strongly promoted it. Arguments in favor of the three-tier system are that it facilitates efficient tax collection, aids in the enforcement of alcohol-beverage laws such as underage drinking prohibitions, and promotes orderly market conditions.13
However, santification of the three-tier system is not universal. California, Oregon, and Washington, which together produce 93 percent of the nation’s domestic wine, have each adopted a two-tier system in which wineries may sell directly to retailers, bypassing the wholesaler.14 The Seventh Circuit has described the “orderly market” argument in favor of the three-tier system as a “euphemism for reducing competition.”15 A strict three-tier system favors big producers and is not conducive to consumer choice. Because of economies of scale, it costs wholesalers less to distribute larger volumes of a brand than smaller volumes. The choices available to wholesalers are to refuse to distribute smaller brands, require larger mark-ups from the producer for distributing smaller brands, distribute smaller brands but allocate fewer resources to promoting them, or accept a lower return for distributing smaller brands.
The three-tier system puts smaller producers, particularly start-ups, at a disadvantage by narrowing the feasibly available distribution channels; in doing so, it limits the product selection available to consumers.16 According to an attorney who has represented vintners and retailers, “Whether a winery can get into the right distribution networks within a particular state or not can determine its success or failure. As the distribution industry has consolidated over the past two decades, locating a distributor and getting a favorable contract has become almost impossible in some states for small start-up wineries. This has led to criticism of the three-tier system and of the role played by wholesalers: that it limits diversity in wine selection and increases costs for all.”17 As the U.S. Supreme Court noted, requiring products to pass through licensed wholesalers and retailers may result in two extra layers of overhead, which increases the price to the consumer or decreases the wineries’ profit margins, and small wineries may even be unable to secure wholesalers for small shipments.18
According to the Family Winemakers of California (FWC), a trade association that advocates for open wine markets (and that is generally opposed by wholesalers’ associations),19 consumers are often unable to obtain small-volume, premium wines through the traditional wholesaler-retailer chain. Because the three-tier system is shaped like an hourglass, with thousands of wine producers at the top, significantly fewer wholesalers in the middle, and large numbers of retailers at the bottom, the bottleneck occurs at the wholesaler tier, giving wholesalers leverage. Wineries frequently produce both higher-volume wines for sale through traditional channels and smaller-volume, limited-production wines for sale to wine enthusiasts, but wholesalers prefer to sell higher-volume wines, rather than boutique wines, because it is more economical, so many wholesalers will not carry both a winery’s high-volume wines and its limited-production wines.20 The three-tier system can therefore create an impediment to hard-to-find or boutique wines reaching consumers.
The combination of changing attitudes toward alcohol, the steady advance toward a single national marketplace, and the explosion of e-commerce has led some consumers and producers to become frustrated with restrictions on alcohol-beverage availability and to challenge various state laws creating barriers to interstate alcohol shipping. In Granholm v. Heald,21 the U.S. Supreme Court, while overtly expressing support for the three-tier system, struck down interstate alcohol-shipping laws and implicitly created uncertainty about the degree to which the dormant Commerce Clause of the U.S. Constitution limits state discretion in regulating alcohol-beverage distribution. Lower court decisions interpreting Granholm are far from harmonious, and important cases decided in July 2009 and January 2010 add to the diverging trends among the federal courts.22 Although no published Wisconsin court decisions have interpreted Granholm, the case has influenced legislative efforts. This article reviews the Granholm decision and its progeny in the context of Wisconsin’s three-tier regulatory scheme.
The Granholm Decision
The Commerce Clause precludes states from discriminating against interstate commerce by enacting laws that burden out-of-state producers or shippers simply to give a competitive advantage to in-state businesses.23 The 21st Amendment to the U.S. Constitution, which repealed the 18th Amendment’s institution of nationwide prohibition, gives states broad authority to regulate the importation, distribution, and use of alcohol beverages.24 When the Commerce Clause and the 21st Amendment conflict, which overrides the other? The issue in Granholm was whether “a State’s regulatory scheme that permits in-state wineries directly to ship alcohol to consumers but restricts the ability of out-of-state wineries to do so violate[s] the dormant Commerce Clause in light of § 2 of the Twenty-first Amendment.”25 The Supreme Court found that the 21st Amendment was not intended to supercede the dormant Commerce Clause and that states may not discriminate against interstate commerce in alcohol beverages any more than they may discriminate against interstate commerce in other goods.26
Granholm involved challenges to Michigan and New York laws. Like Wisconsin, Michigan and New York have each established a three-tier system for alcohol-beverages distribution.27 Michigan law included an exception to the three-tier system, allowing in-state wineries but not out-of-state wineries to obtain a license to ship wine directly to Michigan consumers and thereby bypass the state’s wholesalers and retailers.28 New York law also included exceptions allowing in-state wineries to make direct sales to New York consumers on terms not available to out-of-state wineries. Unlike Michigan, however, New York allowed out-of-state wineries to ship directly to New York consumers if the out-of-state winery obtained a license and established an office and warehouse within the state.29
Aaron R. Gary, University of California-Davis 1992, Order of the Coif, is a legislative attorney with the Wisconsin Legislative Reference Bureau. He previously practiced business litigation and clerked for state supreme courts. Any opinions expressed in this article are solely those of the author.
The Court found that discrimination under the Michigan law was “obvious” and found the New York system no less discriminatory: the object and effect of both states’ laws was to allow in-state wineries to sell wine directly to consumers but to prohibit out-of-state wineries from doing so or to make such sales economically impractical, thereby giving in-state wineries a competitive advantage over out-of-state wineries.30 Requiring out-of-state wineries to have a physical presence in New York for conducting distribution operations, to gain the privilege of direct shipment to New York consumers, “is just an indirect way of subjecting out-of-state wineries, but not local ones, to the three-tier system. … The New York scheme grants in-state wineries access to the State’s consumers on preferential terms.”31 The Court held that states cannot require an out-of-state firm to become a resident so as to compete on equal terms and cannot mandate a three-tier system for out-of-state wineries but not in-state wineries.32
When state laws discriminate against interstate commerce or favor in-state economic interests over out-of-state interests, they face “a virtually per se rule of invalidity.”33 Nonetheless, a state law will not be invalid under the Commerce Clause, despite its discriminatory effect, if the state law advances a legitimate state purpose that cannot be adequately served by reasonable nondiscriminatory alternatives.34 The justifications offered by Michigan and New York for their discriminatory direct-shipping laws – to keep alcohol out of the hands of minors and to facilitate tax collection and orderly market conditions – were quickly dismissed by the Court.35 The Court concluded, “States have broad power to regulate liquor under § 2 of the Twenty-first Amendment. This power, however, does not allow States to ban, or severely limit, the direct shipment of out-of-state wine while simultaneously authorizing direct shipment by in-state producers. If a State chooses to allow direct shipment of wine, it must do so on evenhanded terms.”36
The majority opinion in Granholm garnered five votes. The remaining four justices joined in a sometimes biting dissent written by Justice Thomas. Justice Thomas criticized the majority for a “questionable reading of history” and for sanctioning discrimination at the wholesaler and retailer level while finding unconstitutional discrimination at the producer level.37 According to Justice Thomas, if it is permissible to require distribution through in-state wholesalers in all circumstances, the Michigan and New York laws, which simply allow some in-state wineries to act as their own wholesalers and retailers in limited circumstances, should be permissible.38 Justice Stevens wrote a separate dissent criticizing the majority for a disregard of history and for projecting contemporary values on the people who ratified the 18th and 21st Amendments, people who viewed alcohol not as an ordinary article of commerce but as lawlessness itself.39
The Supreme Court in Granholm took pains to assure its audience that the decision did not challenge or undermine the states’ three-tier systems for alcohol-beverages distribution.40 Despite its reassuring dicta, however, the Granholm decision might be seen as a brick thrown through the glass walls of the three-tier system, given that the Court seemed to hold that an imperfect three-tier system is in fact susceptible to being struck down under the Commerce Clause.
Granholm as Interpreted by the Lower Courts
Soon after Granholm was decided, the case of Costco Wholesale Corp. v. Hoen,41 and its legislative aftermath, sent shock waves through the alcohol-beverages industry. A federal district court, relying on Granholm, struck down as violating the Commerce Clause Washington-state laws that allowed in-state wineries and breweries to act as their own wholesalers and sell their products directly to retailers but required out-of-state wineries and breweries to distribute their products only through independent, in-state wholesalers.42 To remedy the situation, the court had to decide whether to allow out-of-state producers to sell directly to in-state retailers or to prohibit in-state producers from selling directly to in-state retailers. The court decided to “withdraw the self-distribution from in-state producers, rather than extending the privilege to out-of-state producers,” but the court stayed entry of judgment to give the state legislature time to act.43 The legislature responded, taking the opposite approach and extending the privilege of direct sales to out-of-state producers.44
Two recent federal appellate decisions interpreting Granholm, issued by the same federal courts of appeal whose cases were on appeal in Granholm,45 offer two contrasting tones. In Cherry Hill Vineyards LLC v. Lilly,46 the Sixth Circuit Court of Appeals, which had been affirmed in Granholm, seemed to have few reservations about following both the language and the spirit of the Granholm majority decision. The challenged Kentucky law allowed both in-state and out-of-state small wineries to obtain a license allowing the direct shipment of wine to Kentucky consumers and retailers if the purchase occurred in person at the winery.47 The Sixth Circuit found that although the law was facially neutral, it had a discriminatory effect because it was financially and logistically infeasible for Kentucky residents to appear in person at an out-of-state winery for each purchase, thus burdening out-of-state wineries and giving in-state wineries preferential access to the state’s consumers.48 The Sixth Circuit upheld the district court’s remedy, striking the “in-person” language from Kentucky law so as to allow both in-state and out-of-state wineries to direct ship wine into Kentucky.49 In Jelovsek v. Bredesen,50 the Sixth Circuit also struck down a Tennessee law allowing residents to obtain a winery license authorizing the winery to make retail sales on the winery premises, a privilege not afforded to out-of-state wineries, which were limited to distributing their wine through licensed wholesalers.51
In Arnold’s Wines Inc. v. Boyle,52 the Second Circuit Court of Appeals, which had been reversed in Granholm, seemed at times more sympathetic to the Granholm dissent than to the majority, especially in the concurring opinion written by Judge Calabresi. In this case, Indiana retailers challenged New York laws prohibiting out-of-state retailers from shipping directly to New York consumers while allowing in-state retailers to deliver to consumers’ homes.53 The court determined that the focus of the discrimination inquiry must be on the products and producers; that is, there is a fundamental difference between laws discriminating against out-of-state producers and those discriminating against out-of-state wholesalers and retailers.54 The court rejected the plaintiffs’ position, which it characterized as “a frontal attack on the constitutionality of [the] three-tier system itself.”55 Because alcohol beverages produced both in state and out of state had to pass through the same three-tier system, there was no discrimination.56 “Granholm validates evenhanded state policies regulating the importation and distribution of alcoholic beverages under the Twenty-first Amendment. It is only where states create discriminatory exceptions to the three-tier system, allowing in-state, but not out-of-state, liquor to bypass the three regulatory tiers, that their laws are subject to invalidation based on the Commerce Clause.”57 In an important footnote, the court, giving examples, expressed its reluctance to render a decision that would lead to absurd results in light of the complex regulatory structure of alcohol-beverage distribution.58
Like the Second Circuit, the Seventh Circuit seems to look askance at Commerce Clause claims relating to alcohol-beverage distribution. Before Granholm, the Seventh Circuit, in a fairly dismissive opinion, reached a conclusion opposite to that later reached in Granholm.59 More recently, in Baude v. Heath,60 the Seventh Circuit heard a challenge to Indiana’s direct-wine-shipment laws, which allow in-state and out-of-state wineries to ship to Indiana residents if the winery is not allowed to act as a wholesaler in any state (wholesale clause) and there is one face-to-face meeting with the purchaser to verify the purchaser’s age (face-to-face-meeting clause).61 The Seventh Circuit found that, while the wholesale clause was facially neutral, it was intended to and had the effect of favoring in-state wineries over out-of-state wineries. Under the clause, California, Oregon, and Washington wineries, which by state law may wholesale their own wine to retailers, are foreclosed from direct shipping their wine to Indiana consumers, but Indiana wineries, which cannot wholesale their own wine to retailers, may direct ship their wines to Indiana consumers.62 However, the Seventh Circuit concluded that the face-to-face meeting requirement, imposed on both in-state and out-of-state wineries, was facially neutral and neutral in effect and did not favor in-state wineries or disadvantage out-of-state wineries.63
In the latest Granholm-related case, Family Winemakers of California v. Jenkins,64 the First Circuit Court of Appeals held that a Massachusetts law, amended in 2006 in response to Granholm, continued to unconstitutionally discriminate against interstate commerce.65 The law allowed only small wineries (those producing 30,000 gallons or less of wine per year, but excluding nongrape “fruit wine”) to obtain a license authorizing the winery to simultaneously sell wine through one or more of three distribution channels: through wholesalers, directly to retailers, and by direct shipping to consumers. In part as a result of the fruit-wine exception, all 31 in-state wineries qualified as small wineries.66 In contrast, large wineries (those producing more than 30,000 gallons of grape wine annually) were not eligible for the license and had to choose between distributing through a wholesaler or directly shipping to consumers; they could not do both, and they could not sell directly to retailers. As a practical matter, large wineries were relegated to Massachusetts’s three-tier system if their wine was to be sold in any restaurant, bar, or liquor store.67 All large wineries, which produced 98 percent of U.S. wine, were out-of-state wineries.68
Rejecting as authority district court decisions reaching the opposite conclusion, the First Circuit found the Massachusetts law unconstitutional, concluding that the law’s gallonage cap had a discriminatory purpose and effect, that of benefiting in-state wineries and burdening their out-of-state competitors.69 The result of the cap was to give all in-state wineries distribution options that were not available to the vast majority of out-of-state wineries, thus enabling in-state wineries to gain market share against their out-of-state competitors.70 Moreover, the law’s “statutory context, legislative history, and other factors also yield the unavoidable conclusion that this discrimination was purposeful.”71 The court concluded that the 21st Amendment does not shield facially neutral but discriminatory state alcohol laws from Commerce Clause scrutiny.72
An examination of Wisconsin statutes reveals that many of the questions raised in those recent federal decisions interpreting Granholm are pertinent here in Wisconsin.
The Regulatory Scheme in Wisconsin
The Wisconsin Department of Revenue (DOR) issues permits for brewers, brewpubs, wineries, intoxicating-liquor manufacturers, rectifiers, and wholesalers, and out-of-state shippers. Wine may be produced and distributed under a winery permit or a manufacturer’s permit but, because of the advantages of the winery permit, all wineries in Wisconsin operate under a winery permit. A manufacturer’s permit is generally issued to producers of distilled spirits, such as brandy, gin, whisky, rum, and vodka. A rectifier is an intermediary that does not make distilled spirits or wine but that blends, purifies, or refines distilled spirits or wine or that bottles distilled spirits or wine made by others.73 As of August 2009, the DOR had issued approximately 60 winery permits, five manufacturer’s permits, five rectifier’s permits, and hundreds of out-of-state shippers’ permits.74
At the time Granholm was decided, Wisconsin was one of approximately 13 states that had reciprocity laws, of a type specifically criticized in Granholm,75 allowing direct shipments of wine to consumers whose states have reciprocity agreements. Only California, Oregon, and Washington entered into such agreements with Wisconsin.76 At that time, Wisconsin also allowed wineries and rectifiers to act as their own wholesalers,77 but did not authorize in-state wineries to ship wine directly to Wisconsin consumers. In light of Granholm, the legislature enacted 2007 Wisconsin Act 85, which made significant statutory changes.78 The Act replaced the reciprocity system for direct interstate wine shipping with a new permit system, consisting of a direct wine shipper’s permit, available to both in-state and out-of-state wineries. The Act also eliminated the ability of wineries and rectifiers to act as their own wholesalers but allowed in-state and out-of-state small wineries to form, between Oct. 1 and Dec. 31, 2008, a limited number of wholesale cooperatives. The Act also required retail sales to be made face to face with consumers at retail premises.
Despite these changes, Wisconsin law still treats out-of-state producers and in-state producers differently. To get its products into Wisconsin, an out-of-state winery, brewer, or distiller must obtain an out-of-state shipper’s permit. The out-of-state producer holding such a permit can then ship its products only to licensed Wisconsin wholesalers79 and cannot have an interest in any in-state intoxicating-liquor retailer or wholesaler.80 In contrast, an in-state winery holding a winery permit, which is available only to a Wisconsin resident,81 can obtain one retail license, for the winery premises or another location, at which the winery may sell at retail any wine, not just its own.82 Likewise, manufacturers’ permits and rectifiers’ permits, which are available only to Wisconsin residents,83 authorize the retail sale, without a retail license, of the manufacturer’s or rectifier’s own products made on the premises.84
An in-state brewer holding a brewer permit, which can be issued only to a Wisconsin resident or to a business entity that has appointed a Wisconsin resident as agent with full authority over all business operations,85 can obtain a municipally issued beer wholesaler’s license and act as its own wholesaler.86 In addition, the brewer can hold two retail licenses and has certain minor privileges not afforded out-of-state brewers.87 An in-state brewer might also elect to hold, in lieu of a brewer permit, a brewpub permit. Brewpubs can have up to six retail locations and can wholesale their own beer in limited quantities.88 (Wisconsin law also requires all alcohol beverages, including those shipped from out of state, to be unloaded and distributed from the in-state warehouses of Wisconsin wholesalers89 and requires retail sales to be made face to face with the consumer at the retail premises.90)
In summary, Wisconsin has an imperfect three-tier system. Wisconsin law offers to its resident producers certain advantages not afforded out-of-state producers, most notably the opportunity for brewers to act as wholesalers and the opportunity for brewers, wineries, and distillers to distribute their products directly to consumers through face-to-face, on-premises retail sales.
The guiding principle in Granholm is equality: states must treat in-state and out-of-state wineries equally. There is no reason this principle would not apply to all producers, including brewers and distillers. The courts have provided little guidance as to what degree, if any, of deviation from a strict three-tier system in favor of in-state producers is tolerable under the Commerce Clause. Wisconsin’s law, which provides in-state brewers with wholesaling privileges and in-state brewers, wineries, and distillers with retail-sales privileges, might be vulnerable to challenge in the Sixth Circuit, but the Seventh Circuit has always seemed more skeptical of such Commerce Clause challenges and appears less inclined to give Granholm an expansive reading. The Second Circuit, which seems to be philosophically aligned with the Seventh Circuit, included an important admonition in Arnold’s Wines, providing examples of the absurd results that might follow if Granholm were interpreted too broadly. Can there be bona fide equality between an in-state winery and an out-of-state winery with respect to retail sales to the state’s consumers? Does it make sense to treat a small brewpub, designed primarily for on-site brewing and consumption, the same as an out-of-state brewer with massive production and bottling capacity? As the court in Arnold’s Wines highlights in footnote 3, it is easier to talk about interstate equality as a general proposition than to give it meaningful effect in the sometimes Byzantine world of alcohol-beverages regulation.
To the extent that Wisconsin’s alcohol-distribution laws might be susceptible to challenge under Granholm, the judicial remedy would be uncertain. If a court found a constitutional violation as a result of “holes” in Wisconsin’s imperfect three-tier system, the court’s remedy might be to shore up those holes or it might be to create similar holes for out-of-state producers. Figuring out who would benefit and who would not from such a remedy is no simple task. For example, if a court found it unconstitutional for only in-state wineries to have retail-sales opportunities, the court might, in an effort to level the playing field, eliminate these retail-sales opportunities for in-state wineries or it might allow out-of-state wineries access to Wisconsin consumers by direct shipping without quantity limitations. The former approach would be detrimental to Wisconsin’s wineries, beneficial to Wisconsin’s wholesalers, and arguably detrimental to Wisconsin’s wine consumers. The latter approach might also be detrimental to Wisconsin’s wineries because of increased market competition from out-of-state wineries, detrimental to Wisconsin’s wholesalers, and arguably beneficial to Wisconsin’s wine consumers because it might facilitate a broader array of product choices.
As with the judicial remedy, any legislative change would involve tough policy choices and would necessarily disadvantage some industry participants. Some craft brewers operate on a razor-thin margin, and for them the savings from self-distribution could be the difference between surviving and going under.91 Tightening the three-tier system to eliminate the self-distribution option could be detrimental to small producers while benefitting wholesalers.
In Costco, the court determined that policy favored shoring up the breaches in Washington’s three-tier system by eliminating the advantages for in-state producers. The Washington legislature, however, took the opposite approach and extended these advantages to out-of-state producers, at the expense of the state’s wholesalers. After Granholm, the New York legislature reacted like the Washington legislature, expanding exceptions to the three-tier system to apply to out-of-state producers rather than eliminating the exceptions for in-state interests. A Virginia winery, one of the plaintiff wineries that prevailed in Granholm, saw as the result of its “victory” the legislative elimination of its ability to sell wine directly to retailers in its home state.92
In Wisconsin, recent legislative changes have both tightened and relaxed the three-tier system, eliminating some exceptions and creating new ones. Regardless of the resolution, any legislative change necessarily results in a negative impact on one industry segment or another. It might also affect those consumers who seek a wider variety of product offerings.