Empire Wine Strikes Back: A Shipping Showdown

A New York court may soon decide whether the New York State Liquor Authority (NYSLA) overstepped its jurisdiction when it took action against an in-state retailer for sending booze to customers outside the state. On August 1, 2014, NYSLA charged Albany wine store Empire Wine with “improperly” shipping wine directly to consumers in 16 other states. The maximum penalty, according to NYSLA’s Notice of Pleading, is revocation of Empire’s off-premises retail license and forfeiture and revocation of its bond. Empire responded today by suing the agency in the Albany County Supreme Court.

With its complaint, Empire has initiated an Article 78 proceeding under New York law, which is a judicial challenge to a government agency's decision. Empire also seeks a declaratory judgment stating that NYSLA “lacks the jurisdiction and authority to restrict, regulate, or interfere with the shipment of wine to Empire’s customer outside the State of New York.” If NYSLA’s charges satisfy the Article 78 requirement that the challenged decision be final[1] (or fall within some exception to this requirement), it’s game on. Empire graciously sent me a copy of the complaint and memorandum of law. NYSLA's Notice of Pleading is included as Exhibit B to the complaint.

There are a few things to keep in mind if you follow this litigation. One is the nature of the legal landscape for alcoholic beverages, including what’s known as the three-tier distribution system. Another is judicial precedent. Nearly a decade ago, the U.S. Supreme Court held that states cannot treat direct wine shipments from wineries in other states less favorably than they treat intrastate direct shipments. This is not exactly on point with Empire, but it is instructive. Perhaps the most important consideration for those who enjoy wine and those who make a living producing or selling it is the practical implications of the outcome of this case. Let’s take a look at each of these related topics in turn.

The Tenacious Three-tier Distribution System

In many states, a wine grape’s journey from vine to table includes a trip through what is known as the three-tier distribution system. Under this framework, the state’s liquor authority issues licenses for the production, distribution, and retail sale of alcoholic beverages. Generally, no entity can hold more than one type of license at a time, hence the three tiers. Before a bottle of Merlot reaches the dinner table, it passes through a distributor and a retailer.

The three-tier system is a legacy of the Prohibition era, when liquor producers who doubled as bar owners were perceived as “pushers” of alcohol who turned good citizens into drunks. The system is the subject of heated debate, primarily between distributors on one side and consumers and producers on the other. Wine consumers, who are increasingly comfortable with e-commerce, want to take advantage of the Internet to access a wider variety of wines than they would otherwise be able to obtain—and at lower prices than they would otherwise pay. They are also accustomed to the convenience of delivery, ordering everything from clothing to prescription medications online.

Consumers and some producers resent the three-tier system, viewing the middleman as one of many obstacles in an overly cumbersome legal and administrative environment. Distributors argue that they play a vital role in minimizing sales to minors, preventing monopolies, and collecting taxes. According to Wine & Spirits Wholesalers of America, a distributors' trade association, wholesalers account for more than 63,000 jobs paying $4.95 billion in wages. [WSWA 2013: “The Economic Impact of the Wine and Spirits Industry in the United States” available here.] Regardless of which side you fall on, the system is here to stay—at least for the foreseeable future.

Granholm v. Heald

In 2005, the U.S. Supreme Court issued its decision in Granholm v. Heald, a case arising from two state laws and three separate lawsuits. At the time, both New York and Michigan law allowed in-state wineries to ship wine directly to in-state consumers, while making it substantially more burdensome for out-of-state wineries to do so. A California winery challenged the Michigan law, while a Virginia winery owner and a California winery owner filed separate suits challenging the New York law. On appeal, the federal courts issued opposing opinions (a situation sometimes referred to a “circuit split”). The cases were consolidated by the Supreme Court.

In a 5-4 opinion, the Supreme Court held that the laws discriminating against out-of-state wineries violated Article I, Section 8 of the U.S. Constitution, which vests Congress with the power “[t]o regulate Commerce with foreign Nations, and among the several States, and with the Indian tribes.” [U.S. Const., Art. I, Section 8.] The Supreme Court has inferred from this “Commerce Clause” a corollary known as the “Dormant Commerce Clause” doctrine. Under this doctrine, the Constitution prohibits states from enacting laws that interfere with interstate commerce even in the absence of federal legislation. In other words, just because the feds are silent about interstate wine shipment doesn't mean the states can legislate on the topic.

In Granholm, the Court plainly stated that the Commerce Clause prohibits states from “enact[ing] laws that burden out-of-state producers or shippers simply to give a competitive advantage to in-state business.” [Granholm v. Heald, 544 U.S. 460, 472 (2005).] The Court also dispelled any doubt as to the interplay between the Commerce Clause and the Twenty-first Amendment (the Amendment that repealed Prohibition), holding that the Amendment does not permit discrimination against interstate commerce.

As a result of Granholm, many states were forced to modify their direct shipping laws. Some went the route of liberalization, affording out-of-state wineries the same privileges as in-state wineries. Others imposed greater restrictions on in-state shipment to eliminate discrimination. Michigan prohibited direct shipment altogether.

Empire Wine

In Granholm, the Supreme Court examined regulation of direct, in-state shipment to consumers by out-of-state producers. The Empire Wine case presents a different but related issue. Here a retailer (not a producer) was penalized by its home state for shipping directly to out-of-state consumers. Furthermore, as Empire points out in its petition and complaint, “there is no New York statute or regulation expressly prohibiting the shipment of wine to customers in other states,” and “[NY]SLA expressly allows New York wine retailers to sell and ship wine directly to customers within the State of New York.” NYSLA claims to derive its authority from one of its own regulations setting forth the grounds for revocation of a license or permit. According to this regulation, NYSLA can revoke a license:

(n) For improper conduct by the licensee or permittee, and if a corporation, by an officer, director or person directly or indirectly owning or controlling 10 percent or more of its stock, or an officer, director or person directly or indirectly owning or controlling 10 percent or more of the stock of any parent, affiliate or subsidiary of such licensed corporation, whether such conduct was on or off the licensed premises, and which conduct is of such nature that if known to the authority, the authority, in its discretion, could properly deny the issuance of a permit or license or any renewal thereof because of the unsatisfactory character and/or fitness of such person.

[9 N.Y.C.R.R. 53.1(n).] “Improper” is not defined, but the key here is that NYSLA can revoke a license for the same reasons for which it may deny a license, and these reasons are largely within the agency’s discretion. Empire challenges this regulation as unconstitutionally vague, because it does not put the reader on notice that shipping to out-of-state consumers carries a penalty. Would you know, from reading this rule, that out-of-state shipment is prohibited? I wouldn’t. And does NYSLA have the authority or duty to enforce the laws of other states? What about when those states are not enforcing their own laws?

What's next?

Empire’s case is significant for both the constitutional questions that it raises and for its potential impact on the market for New York retailers. If the court holds that NYSLA has the jurisdiction and authority to regulate shipments of wine by New York retailers to out-of-state consumers based on current law, 49 out of 50 U.S. markets will be closed off to local retail sellers. This is not an economically desirable outcome. Those who, like Empire, have been shipping to consumers in other states for years, will have to modify their business models. While I can’t imagine the court holding that NYSLA has authority to restrict interstate commerce in this way, there may be some surprises with respect to the regulation cited by the agency.  Let’s see what develops.

[1] Pursuant to N.Y. C.P.L.R. 7801(1), the contested decision must be final. A decision is final when: (1) the agency’s position is definitive; (2) the position inflicts actual injury; and (3) no further agency action can remove or lessen the injury. [Essex County v. Zagata, 695 N.E.2d 232, 235 (1998).] There are few exceptions to the finality requirement, such as when the agency’s action is challenged as beyond its powers. [See e.g., Dineen v. Borghard, 100 A.D.2d 547, 548–49 (2d Dept. 1984) (holding that the exhaustion rule “need not be followed when an agency’s action is alleged to be unconstitutional or wholly beyond its powers.”)