Direct shipping: is the three tier system at risk?

Modern Brewery Age, Sept 8, 2003 by Gary Ettelman, Keith B. Hochheiser

Wholesalers beware! There is a growing trend in the United States, fueled by the rapid development of the internet, for manufacturers to sell their wares directly to consumers. Log on to the internet and you can buy just about anything directly from the manufacturer. Proponents of e-commerce extol the virtues of convenience, greater selection and reduced prices. Distributors are already experiencing reduced sales, and it would be foolish to believe that the trend of direct shipping is anywhere near reaching its potential. Should beer wholesalers be concerned? You bet they should. Fortunately, however, beer wholesalers (and wholesalers of other alcoholic beverages) have a weapon that other wholesalers do not--the 21st Amendment to the Constitution. While the 21st Amendment clearly offers protection to wholesalers of alcoholic beverages, recent cases demonstrate that this protection is far from absolute.

The 21st Amendment, which repealed prohibition, grants to the States the right to regulate the importation, transportation, sale and use of alcoholic beverages within their borders. Historically, distributors of alcohol have been protected in two distinct but similar ways. First, States have enacted legislation establishing a three tier system of alcohol distribution. The first tier (the manufacturer) may only sell to the second tier (the wholesaler) which may only sell to the third tier (the retailer). Under the three tier system, consumers may only purchase from the third tier. Second, many States have enacted legislation which prohibits the direct shipment of alcoholic beverages to consumers.

In this column we will discuss (within the constraints of a brief article!) some recent cases dealing with "direct shipping" statutes, what the potential impact of these cases have on the continued viability of the three tier system and how two separate provisions of the Constitution--the 21st Amendment and the Commerce Clause--affect the issue.

Constitutional Background

Before prohibition, alcohol regulation was solely a State and local issue. Not surprisingly, there were significant differences in the policies of different States, with many States banning the sale of alcohol altogether. Clever suppliers, however, were able to avoid the impact of "dry State" legislation by setting up shop in a non-dry State and shipping their product to the dry State. Because regulation of interstate commerce was solely within the province of Congress, States were powerless to pass legislation restricting the flow of interstate commerce. Accordingly, suppliers were able to avoid such state legislation. In order to thwart the suppliers' end-run of state legislation, in 1913 the federal government passed the Webb-Kenyon Act which made it illegal for a supplier to sell or transport liquor in violation of State law.

Then, with the ratification of the 18th Amendment to the Constitution in 1919, the federal government imposed a "one-size fits-all" policy on the country. The 18th Amendment prohibited the manufacture, sale, or transportation of alcoholic beverages into, out of, or within any State. Prohibition came to an end in 1933 with the ratification of the 21st Amendment, which in general, scrapped the national policy, and allowed each State to individually regulate alcohol within their respective borders. Similar to the Webb-Kenyon Act, the 21st Amendment provides that the "transportation or importation into any State ... for delivery or use therein of intoxicating liquors, in violation of the laws thereof, is hereby prohibited."

It would appear that the 21st Amendment gave to the States unlimited power to regulate the importation, transportation and sale of liquor and the early cases on the subject mirrored that view. However, another provision of the Constitution, known as the Commerce Clause, which gives to Congress the right to regulate commerce between the States, has muddied the waters. Congress' power under the Commerce Clause has been broadly construed by the courts, to the point that Congress can enact legislation on nearly any matter, as long as a legitimate argument can be made that the matter travels in, or effects interstate commerce. Not surprisingly, the clashing of these diametrically opposed Constitutional provisions has spawned significant litigation.

The Supreme Court Steps In

The tug-of-war between the Commerce Clause and the 21st Amendment provisions can best be demonstrated by a look at the decisions of the United States Supreme Court. In State Board of Equalization of California v. Young's Market, a 1936 case and one of the first Supreme Court cases construing the 21st Amendment, the Court reviewed a California statute imposing a fee on beer imported from outside California, while exempting beer brewed inside the State from the fee. The Court upheld the statute, on the ground that the 21st Amendment exempted California from other Constitutional requirements, namely the Commerce Clause. More recent Supreme Court cases have, however, taken a different view.