Complete Coverage of Hearing Testimony

FILED MARCH 18, 2010

Dear Client:

Today the House Judiciary subcommittee on Courts and Competition Policy minutes ago just concluded its hearing on "Legal Issues Concerning State Alcohol Regulation." As you'll recall, the brewers in particular felt it was a gamble for the NBWA to usher along such a hearing in anticipation of laying the groundwork for a bill to create a "federal fix" for states' primacy in alcohol regulation, particularly as it relates to the dormant Commerce Clause and antitrust exemptions -- under the "box of chocolates" and "waking a sleeping giant" argument. Read on and I'll let you decide if it was worth it.

It was a fashionable affair -- everybody was there: including people from A-B, MillerCoors, NBWA, Beer Institute, Brewers Association, Wine Institute, Diageo, Wine America, Heineken USA, TTB, and a hodge podge of other politicos, giving a measure to the importance each gives to such a hearing.

THE POLITICIANS. First, the Congressmen testified. Basically, from the wholesalers point of view, it was a split between those who wanted more state control, and those that didn't.

First we have Rep. Bobby Rush, from Illinois. Rep. Rush was clearly on the side of the wholesalers. He acknowledged that this issue wasn't on his front burner until he discovered that A-B is suing the state over the Illinois Liquor Control's denial of a wholesaler license. "Illinois has one of the strongest alcohol regulations in the nation.....But many observers believe that this case and ones like it will have a profound effect on Illnois and other states....I submit there are broader aspects.... as a local alderman [in Chicago in the past] I came to appreciate the local control of alcohol voting a local area dry. My objective is not to protect wholesalers.....but to protect my constituents.... the industry is going toward deregulation. Rep. Rush says that there could be an averse "effect on minority ownership of alcohol wholesalers....deregulation would have an adverse effect on minority ownership....there is significant value in having non-passive state role in regulation of alcohol..... Should Congress decide to act, it should be to clarify the state's role in alcohol regulation."

However, Rep. Mike Thompson of California disagrees. Coming from wine country, perhaps that's not surprising. "Wholesalers would have you tip the scale completely in favor of state control....that would disadvantage two groups, American small businesses and American consumers," he said. He said that wholesalers are asking Congress to declare "wholesalers as winners and wineries and brewers as losers" which would create "less choice for consumers and unfairly hurt producers....All 50 states make wines....they support well over a million jobs....The 21st Amendment does not trump the rest of the Constitution.... It must be balanced with the Commerce Clause.... and Sherman Act." He also warned against comparing the US to the UK, saying it's like comparing apples to lemons. He concludes by saying, "don't give one side, the wholesalers, the power [over producers and consumers]."

Rep. Steve Cohen of Tennessee says that as a state lawmaker in years past, he came to admire the three-tier system. "The three-tier system has done a good job of supporting the 21st Amendment's goals of temperance and an orderly market. Unfortunately many states have faced deregulatory challenges [from the courts]." Rep. Cohen said that if we allow systematic deregulation of the alcohol industry by the courts to continue we "already have a idea of what our regulatory system will look like" down the road: The UK. "In Tennesee they say, if it ain't broke, don't fix it."

Then came Rep. George Radanovich, the vintner from California. He came down squarely against the NBWA's draft legislation that is "floating around Congress in connection with this hearing, and it's a long, broad, and frankly outrageous wish-list," he said, not mincing any words. He urged members of the committee to keep an open mind to see if the draft promotes "innovation or market protection." [Ed. Note: We point out that this hearing was not supposed to be about the proposed legislation, although it's not surprising that it came up].

He said it's difficult to market wine because of the "diversity in state laws, the diversity would be greater without a federal framework." He maintains that there is "no three-tier system," as in 39 states in-state wineries can self-distribute. "In California a number of wineries can not prosper without self-distribution," he said. "I ask you to be on the side of state's rights but rights measured against" the federal oversight and the Constitution. "They ask a lot but what they ask for is not justified. There must be extraordinary reasons for the states to get a free pass" from the Constitution.

DORMANT COMMERCE CLAUSE: One of the major themes of the hearing was the possibility of Congress creating a federal exception for the states regarding alcohol regulations from the dormant Commerce Clause. Remember, the Commerce Clause (and Granholm's reading of it) says that states can't create laws which discriminate between in-state and out-of-state entities, despite the 21st Amendment which (theoretically at this point) gives states sovereign power over alcohol regulation. This has put at risk self-distribution and franchise law carve-outs for craft brewers and wineries, wholesaler residency laws (anti-branch laws), bans on out-of-state retailers shipping into states, among other common state regulations.

Perhaps the clearest testimony on this point was Jim Ho, Solicitor General of the State of Texas, working for the state AGs office, and an esteemed constitutional lawyer in private practice previously.

While Jim said he "doesn't have a dog in this fight" as it pertains to "the merits of any such legislation" that may come down the pike from distributors, he did express the need and the precedent for such legislation, mainly because the sheer volume of litigation in the alcohol industry clearly shows that there is at best a vacuum in what Congress' intent is and at worst mass confusion about the level of powers states have with regards to alcohol.

Says Jim: "It is heavily litigated, because there is a heated debate about the meaning of previous acts of Congress--including various federal statutes, as well as the 21st Amendment to the U.S. Constitution. These cases involve constitutional objections to these state laws. But make no mistake: This is a unique area
of constitutional litigation--I say that because Congress has the power to step in and resolve the litigation itself, at any time."

This is the so-called "federal fix" that distributors seek. Jim goes on to explain: "In most areas of constitutional litigation, a party objects to a federal, state, or local law--a court determines whether or not that law is constitutional--and that word is final, subject only to review by a higher court, or reversal by a constitutional amendment. In this unique area [of alcohol], however, Congress can seize the reins, and decide for itself whether a constitutional challenge should succeed or fail, simply by passing a federal statute."

Why? Because of the "dormant" nature of the dormant Commerce Clause. "Courts have consistently construed this provision to have two components. First, it contains an affirmative grant of power to Congress to regulate interstate commerce. Second, it also contains a silent but implicit, or negative, limit on the power of states to regulate commerce. It is this second prong that is known as the 'dormant Commerce Clause.' This doctrine can be used to invalidate state laws that purport to regulate commerce--an area that Congress has the constitutional power to reserve for its own regulatory authority."

Okay, so now that we have the law lesson, what does it mean? Wait for it, impatient nelly. Jim explains: "There is a catch. Courts invoke the dormant Commerce Clause as a constitutional limit on state power. But they do so only because they are presuming that Congress would prefer that states stay out of certain areas of regulation. This judicial presumption has important implications for our discussion today--because it is only a presumption about what Congress wants. Congress can make its actual views known to the courts. And if Congress does so, courts will follow." That's the money shot.

Jim says that there is so much litigation, and it is so hotly contested, because "different judges have different judgments about what they think Congress wants in this area." However, if "Congress were to state its views with vivid clarity, that would go a long way toward ending litigation--ending what the New York Times once called the "wine wars.""

He sums it up by saying, "The views I express here are not remotely controversial within the community of constitutional lawyers....This is pretty much a settled issue... To the contrary, courts across the country have repeatedly acknowledged that, if Congress speaks clearly, it can eliminate entirely constitutional challenges to state laws under the dormant Commerce Clause.... If Congress does choose to speak, the courts will listen."

During Q&A says, "If it ain't broke, don't sue."

REGULATOR SPEAKS. Nida Samona, chair of the Michigan Liquor Control Commission, pointed out that alcohol is special and requires regulation to be sold in the "public interest." She gave as summary of Granholm v Heald, which struck down Michigan's laws banning out-of-state wineries from shipping direct to consumers, and the out-of-state retailer lawsuit. Michigan lost both suits, the last one in contrast to other federal court decisions. But it forces Michigan to include "expensive and uncertain litigation" and she is "asking Congress to step in and to address it" so it can stop.

CRAFT BREWER SPEAKS. Steve Hindy's testimony is important as he is the only person testifying who's job is within the industry. Steve explained how the three-tier system works, and acknowledged that it currently works pretty well for craft brewers -- "The three-tier system is not broken" -- although it is getting increasingly difficult, with distributor consolidation, to get access to market for some brewers. But Steve says the right to self-distribute is crucial. "Without the right to self-distribute, it is doubtful we could have established our business." While Steve said he "understands those concerns" of the beer wholesalers, he doesn't "see any need for drastic change in the balance between state and federal authorities that has served the public for many years. There has been talk of ceding federal control of alcohol beverage regulation to the states. That would be a disaster for small brewers and consumers. Separate state regulations on formulation, labeling, or advertising would be incredibly expensive for all brewers." Steve then gave the example of the courts striking down the special New York specific UPC codes [Ed. Note: we note that was a recycling issue on all beverage containers, not an alcohol regulation issue per se]. Steve says that laws like post-and-hold and price affirmation could "reappear to the detriment of brewers, consumers, and competition." Plus other regulations that could lower the drinking age or raise it at the state level could "create confusion and chaos."

Steve also says the country has made "significant progress" in reducing alcohol abuse without the need for changes. "It is not clear, to me at least, what a radical change in the federal-state balance would do to these very positive trends."

Steve then goes to what the craft brewers truly need, and that's franchise law relief. "In some states, non-performing wholesalers sit on our brands to insure their competitors do not get them. Talk about stifling competition. Beer distributors have significant clout in all state legislatures, and there is fear among small brewers that a switch to exclusive state regulation would only exacerbate this problem." Steve reiterated that "we want to see that system [three-tier] continue without radical changes that could harm the interests of American consumers who responsibly enjoy our products."

COMPARING TO UK ALSO BIG THEME. Pam Erickson of Public Action Management testifies, citing from a report she authored, that the UK system is not the way to go. "It is indeed apples to oranges... While in the US the alcohol market is "systematically regulated", the UK has followed "the path of gradual deregulation to a point where the society treats alcohol the same as any other product. All forms of alcohol--beer, wine and spirits--are sold almost everywhere and can be purchased 24 hours a day."

She writes, "We have a comprehensive alcohol regulatory system..... The primary the use of multiple policies that have prior scientific evidence of effectiveness implemented in a systematic way. Such policies need to address many items, not just one factor in alcohol. Price, availability, industry practices, the drinking context, drunk driving, youth consumption and enforcement are all important.....marketplace regulation must be aimed at preventing large quantities of cheap alcohol, readily available and heavily promoted."

If we have a court system that challenged our regulations, we "could be severally deregulated..... I worry about the slow, drip drip drip, of deregulation." She also warned against big chains making alcohol too cheap and available.

She concludes: "Unbridled and unrestrained free market forces, once unleashed, are very hard to control. Americans must be very clear about the fact that alcohol is a different product that cannot be sold just like any other commodity."

NBWA SUBMITS WRITTEN TESTIMONY. While not testifying in person, the NBWA's Craig Purser issued written testimony to the hearing. Regarding the threat to the three-tier system, Craig writes that the threat is "very real." He adds, "To put this in perspective we should note, of the Fortune 50 companies in the US, 16 of them are alcohol retailers. This includes several so called "big box" stores, grocery chains and other companies. This growth is not necessarily a negative development but is worth noting as it relates to a very real issue: market power. Bigger market participants are able to apply economic pressure on producers and distributors that provide challenge to these increasingly global power retailers. This has many concerned as several large retail giants are flexing their muscle in the marketplace and attempting to challenge existing state alcohol regulations. In the supermarket context, the Food Marketing Institute has noted "To earn a dollar, supermarkets would rather sell a $1 item 100 times, making a penny on each sale, than 10 times with a dime markup." Public policy has not thoroughly examined the concerns of this model in the sale of alcohol."

The other threat is litigation. Says Craig, "over 25 states been sued by private interests challenging state liquor laws. Most of these challenges use two legal instruments in ways Congress did not intend for them to be used: the dormant Commerce Clause and the nation's antitrust laws. Both veins of litigation present challenge to the public's interest."

We've already talked about the Commerce Clause, but regarding antitrust, Craig writes: "License restrictions, three-tier requirements and separation of the tier laws are primary state regulatory tools. Because of the universal understanding related to alcohol's unique attributes as an intoxicating beverage, price regulation is another tool that states have to balance competition with regulation. Price regulations include but are not limited to credit restrictions, minimum mark-ups, prohibitions on below cost sales and quantity discount limitations." Craig cites the Costco and Trone cases. "The spate of litigation is creating problems for the states and uncertainty for the industry. It is our recommendation that Congress review these threats to the American alcohol regulatory system and advance a legislative solution that addresses this ongoing litigation under the dormant Commerce Clause and the antitrust laws."

VOICE AGAINST ANTITRUST EXEMPTIONS. Darren Bush, associate professor of law at the University of Houston and the expert in electricity deregulation, puts forth the argument that state regulation "utterly fails to do more than present an aura of regulation to otherwise private activity, to the detriment of consumers and distributors of alcohol, and how such activity is undeserving of antitrust immunity." Darren says that it is "extremely difficult for a plaintiff to challenge anticompetitive restraints when the state is involved." He cites a case in California where price posting was legal, but it wasn't monitored closely by the state, which encourages "tacit or overt collusion." He adds: "The national policy in favor of competition cannot be thwarted by casting such a gauzy cloak of state involvement over what is essentially a private price fixing arrangement," he writes. "The burden of proof should be put" upon those seeking to change "our Magna Carta."

CONTROL STATES WEIGH IN. Meanwhile, the National Alcohol Beverage Control Association, representing the control state jurisdictions, sent in a simple one page resolution to the hearing chairman which said, in part, "in the last ten years a majority of states have faced litigation in which their ability to effectively regulate alcohol within their borders has been threatened; and...litigation diverts needed state resources away from effectively regulating alcohol and preventing misuse of this unique product." Therefore, NABCA "supports federal laws, regulations and policies that reaffirm the right of states to regulate alcohol as they deem appropriate."

So there you have it -- that's the run-down on today's hearing. More on Q&A tomorrow. What do you think? Was it worth it?

Until tomorrow, Harry

"I fear that all we have done is to awaken a sleeping giant."
-Japanese Admiral Isoroku Yamamoto

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