When the Framers created the U.S. Constitution, one of their primary goals was to eradicate parochial restrictions that impeded free trade among the states. The Constitution created a national free-trade zone in which states were no longer permitted to erect protectionist trade barriers to the detriment of consumers in their own states and producers in other states. The mechanism that was designed to ensure against such trade barriers was the Interstate Commerce Clause in Article I, section 8.
More than 200 years later, barriers remain and they continue to throttle free trade of a product enjoyed by millions of Americans: wine. For the economic protection of liquor wholesalers who control the distribution and sale of alcohol, 24 states have laws prohibiting the direct shipment of wine from out-of-state wineries to consumers. In some states this consensual activity is a felony. These laws discriminate against out-of-state producers in favor of in-state producers who may sell and ship wine directly to consumers. Such laws make a mockery of the Framers’ constitutional design, severely impair economic opportunities for small wineries and Internet retailers, and stifle the ability of law-abiding consumers to purchase their favorite wines.
The issue has major ramifications for the Internet, especially as wine sales grow. In 2003, the shipment of domestic and international wine in the United States increased five percent to a record 627 million gallons with California wine shipments accounting for 417 million gallons (67 percent), also a record. Since 1990, adult per capita spending on wine has increased to $33 from $12. And from 2000 to 2003, more than 6 million additional adult Americans have become regular wine drinkers. But because of arcane trade barriers among the states, this figure only skims the potential opportunities. There are more than 2,000 small and family-owned wineries in the U.S. and Internet retailers and winery websites provide unprecedented opportunities for them to reach new customers and for consumers to order their favorite wines. In New York, for instance, before laws were passed to allow in-state direct sales and shipping there were only 19 wineries in the state; today, there are more than 160. Other states have seen similar growth in the wine trade and open direct shipping promises to aid this growth even more.
Swedenburg v. Kelly, a federal lawsuit filed by the Institute for Justice in the Southern District of New York, is a major test case challenging such protectionist laws. New York is the second largest wine market in the United States, after California. Its laws forbid direct shipment of wine from out of state to New York consumers, while permitting New York wineries to ship directly to these same consumers. The laws are designed to preserve the very profitable government-imposed monopoly by which wholesalers control the distribution and sale of all out-of-state wine in the State of New York. The lawsuit, on behalf of small wineries in Virginia and California, as well as New York wine consumers, seeks to put an end, once and for all, to such protectionist and discriminatory laws.
On November 12, 2002, Judge Richard Berman of the U.S. District Court for the Southern District of New York declared New York’s law unconstitutional. On December 10 of that year, he enjoined the State from enforcing its direct-shipping ban, but stayed that injunction pending appeal. On February 12, 2004, the 2nd U.S. Circuit Court of Appeals reversed the District Court conclusion, but affirmed that the advertising ban violated the First Amendment. On May 24, 2004, the U.S. Supreme Court accepted review of Swedenburg v. Kelly; the case will be heard in December 2004.
Barriers from Coast to Coast
While more than half the states and the District of Columbia allow wine to flow across their borders with modest restrictions, 24 states have laws forbidding the sale of out-of-state wines directly to consumers. The trade-barrier states impose severe penalties for violations of the law. Five states—Florida, Kentucky, Maryland, Tennessee and Utah—make such shipments a felony. Felony laws have been under consideration in at least 10 other states. In many of the prohibitionist states, consumers who visit wineries in other states cannot even lawfully ship wine to themselves back home.
The remainder of the states either allow direct shipments to consumers or are “reciprocity” states, allowing direct shipments only from states that also permit direct shipments.
Meanwhile, most if not all of the states that prohibit direct shipments allow wineries in their own states to sell directly to consumers. States like New York, for example, allow direct intrastate wine shipments from in-state wineries ; others permit producers to sell directly to consumers at the wineries.
The primary beneficiaries of these laws are large and powerful wholesalers. Indeed, the vast majority of wineries oppose the protectionist laws in their own states because they understand that similar laws in other states limit their ability to expand their customer base. Wholesalers, however, have lobbied hard for direct shipping laws because the laws allow them to control distribution and sales of out-of-state wines. Some states are so willing to avoid free trade that they have sacrificed the interests of in-state wineries and consumers. In New Jersey, the legislature recently scrapped a law allowing only in-state wineries to direct ship after non-New Jersey wineries sued to open up direct shipping for all wineries. The result is direct shipping for no one.
Most states have what is called a “three-tier” system of alcohol distribution: producers may lawfully sell only to wholesalers, who sell to retailers, who sell to consumers. The wholesalers siphon about 18 to 25 percent of the price at which wines are sold to retailers.
Whatever the utility of this system in other contexts, it does not work well for many wine producers, the vast majority of which are quintessentially small, family-run businesses. Of the 2,000 wineries in the United States, about 20 produce 90 percent of all the wine produced. In recent years, the number of wineries—particularly small boutique wineries—has expanded dramatically. At the same time, the wholesaling industry has become increasingly concentrated, with the number of wholesalers declining from 5,000 in 1950 to 600 today.
The impact is greatest on small wineries. Of the more than 25,000 wine labels in the United States, only about 500 of those labels are available in a robust wine market. Small winemakers cannot gain access to most wholesalers, for whom it does not make economic sense to handle small quantities of wine. Small wineries often have a substantial number of enthusiasts around the country—but unless they are allowed to ship directly to consumers, the three-tier distribution system means they are shut out of most markets altogether.
The Internet offers enormous potential to match wine producers and consumers. Numerous retailers, wineries and auction houses sell wine over the Internet. But restrictions on interstate shipments to consumers compel Internet retailers either to adopt cumbersome arrangements with wholesalers who act as middlemen yet add nothing but time and expense to the process , or simply to refuse to ship to prohibitionist states altogether. Pressure from prohibitionist states has led shippers such as Federal Express and United Parcel Service to refuse to transport wine to many states.
Taxes & Temperance: Hollow Arguments from the Liquor Lobbyists
The principal people calling for a continuation of the liquor cartels are the wholesalers themselves, led by Juanita Duggan, the former chief lobbyist for the tobacco industry’s Philip Morris Companies who is now the Arlington, VA lobbyist for Wine & Spirits Wholesalers of America—the wholesalers D.C. lobbying group.
The wholesalers assert two justifications for prohibitions of direct sales: loss of state tax revenue and sales to minors.
With regard to sales over the Internet, Congress has enacted a moratorium on taxes of products shipped across state lines. Obviously, wineries will comply with whatever valid tax laws are in effect. But the fact that at the present time states cannot legally tax products that are shipped across state lines, unless there is a corporate presence in that state, cannot justify prohibiting wineries from gaining access to consumers in that state.
But within states that have considered legislation to open their markets, the liquor distributor industry has used its massive resources to form front organizations like Americans for Responsible Alcohol Access to squelch legislation that would allow consumers to obtain their favorite wines over the Internet. A case in point is New York. Over the past several years, the New York Legislature has considered various changes to its statutes, from making direct shipments a felony to joining the ranks of reciprocity states. Gov. George Pataki vetoed deregulation legislation several years ago. However, in 2004, Governor Pataki included within his state budget a proposal to allow carefully regulated direct interstate shipping to New York consumers. The bill enjoyed strong bipartisan support, including from U.S. Sens. Charles Schumer and Hillary Rodham Clinton. But after furious industry lobbying, the provision quietly was removed from the final budget approved in August 2004.
Likewise, concerns about underage purchases cannot sustain discriminatory trade barriers. Children simply do not order expensive wines using their parents’ credit cards and then sit around for days waiting for them to be delivered to their parents’ doorstep. Moreover, the Wine Institute, an advocacy group, has helped pass laws in 15 states requiring warning labels to be placed on all packages of alcohol shipped directly to consumers: “Contains Alcohol, Adult Signature (over 21) Required.” Just as minors would be carded at a liquor store if they tried to purchase wine, they would be carded at their doorstep if they tried to purchase wine on the Net. The Coalition for Free Trade has proposed model legislation addressing both the tax and access-to-minors concerns. And, if wineries break state laws, they can have their federal license revoked.
Recent sting operations in Massachusetts and Washington State revealed that the liquor distributor industry is pulling out the stops to preserve its multibillion dollar cartel, leading up to this winter’s U.S. Supreme Court clash over discriminatory state bans of direct interstate wine shipments to consumers. They’ve teamed up with state liquor officials and the likes of Phyllis Schlafly’s Eagle Forum to conjure up the image of teens growing drunk on $30-bottle chardonnays obtained through a few clicks of a mouse.
That may be how it works in the context of cyberspace stings, but not in the real world. Anyone who has a teenager, or who ever has been one, knows that young people primarily drink beer. And they obtain it, all too easily, by producing fake ID’s or having older friends purchase it at the local liquor store.
By contrast, a young person ordering from a winery in states that allow direct wine shipments would have to obtain a credit card, produce an adult identification at time of purchase, pay shipping costs, await an unspecified period of time for delivery of a shipment marked “Adult Identification Required,” arrange to accept delivery when an adult is not present, and present adult identification again upon delivery.
The relevant numbers produced by the State of New York in defense of its ban on direct shipments are 16,000 and zero. The first is the number of reported complaints of underage access through heavily regulated retail stores over a five-year period. The second is the number of complaints of underage access through direct shipping outside the sting context over that same period. In fact, in New York when direct shipping was permitted to in-state wineries, there were no laws requiring adult signatures or particular delivery requirements. The wineries themselves instituted these practices in order to ensure that minors did not gain access to wine.
Likewise, the Federal Trade Commission found that the 26 states that permit and regulate direct interstate shipments of wine to consumers report no significant problems with underage access. By contrast, bans on direct shipping in two dozen states substantially reduce the selection of wines, increase prices, and deprive states of tax revenues.
It is plain that the real motivation behind the prohibition laws is not temperance, but protectionism. After all, the same concerns that would apply to interstate direct shipments of wine should apply to intrastate sales or shipments. But many states allow intrastate sales and shipments of wine by producers to consumers and they have experienced no problem with sales to minors. Such outright discrimination betrays the invidious—and unconstitutional—motivation behind the trade barriers.
The New York Controversy
New York is the second-largest wine market in the United States. It is also one of the largest wine-producing states. But state laws effectively bar most out-of-state wineries from the marketplace, preventing New York consumers from lawfully obtaining some of their favorite wines and severely impairing potential sales for small wineries outside New York. The only beneficiaries are New York liquor wholesalers.
The New York statutes are blunt: “No alcoholic beverages shall be shipped into the state unless the same shall be consigned to a person duly licensed hereunder to traffic in alcoholic beverages.” The law specifically forbids both shipments by wineries and transportation by common carriers. In fact, consumers can’t even purchase wine in other states and ship or even carry back to their own homes in New York. Those who unlawfully ship wine are guilty of a misdemeanor and subject to fine, imprisonment or both. Consumers may, however, purchase wine outside the United States and ship it back to their home, but in many cases they may not do so from their neighboring state.
Enforcement of the discriminatory laws by New York officials has been strict. In 1997, former Attorney General Dennis Vacco launched a sting operation in which minors illegally purchased alcohol over the Internet. Vacco used the episode to argue for strict enforcement of the direct shipping prohibition—although he could not name a single instance of minors buying alcohol over the Internet in New York before the sting. Meanwhile, threats against common carriers have raised concerns that Federal Express and others may not ship wine in New York.
An effort to lift the ban and allow regulated direct interstate shipments of wine to consumers passed the New York Legislature overwhelmingly in 1995, but was vetoed by Gov. George Pataki at the behest of liquor distributors. The four largest liquor distributors in New York intervened in the Swedenburg case to protect their monopoly.
The prohibition hurts not only out-of-state wineries and New York consumers who cannot order their products, but the approximately 160 New York State wineries, who cannot sell to consumers in states with “reciprocity” laws. John Dyson, former deputy mayor of New York City and chairman of Millbrook Winery, says that the restrictions have eliminated 13 percent of his winery’s gross profits. “The truth is that the three-tier system fails to distribute the wines of our state’s small and midsize wineries,” Dyson says. “If we don’t have an alternative route, some of our wineries will go out of business. That route is direct shipment to the customer.”
The plaintiffs in the current lawsuit are two out-of-state wineries and two New York wine consumers who have been prevented from doing business because of the prohibitionist laws.
Juanita Swedenburg opened Swedenburg Winery in Middleburg, Va., in 1987. The family farm also produces beef cattle in addition to 15 acres of grapes. Swedenburg produces fewer than 2,000 cases of wine per year, of which 90 to 95 percent is sold at the winery. Mrs. Swedenburg shipped wines extensively in the 1980s and early 1990s, but has been forced to substantially curtail such shipments because of draconian state laws.
David Lucas opened The Lucas Winery in Lodi, Ca., in 1978. The winery produces fewer than 2,000 cases of wine each year. Most of the wine is sold on-site to tourists and others who visit their winery, and Lucas has built a tasting room for just that purpose. Lucas maintains a website and a mailing list of customers from across the United States and would like to sell as much of his wine via direct shipping as possible.
The wineries are joined by two of their patrons as consumer plaintiffs. Cortes DeRussy lives in Bronxville and is in the auto finance business, and has ordered out-of-state wines over the Internet. Robin Brooks-Rigolosi is an independent businesswoman who joined the suit when she was a law student at the Benjamin N. Cardozo School of Law in New York City. The consumer plaintiffs are wine enthusiasts who have attempted to order wines from the plaintiff wineries for direct shipment, furnishing proper identification that they are adult consumers. However, due to the New York laws, the wineries were compelled to decline their orders.
The defendants are the members of the New York State Liquor Authority, sued in their official capacities, along with the four largest liquor distributors who intervened to defeat the law.
Swedenburg v. Kelly was filed on February 3, 2000, in the U.S. District Court for the Southern District of New York. The lawsuit proceeded upon three well-established constitutional principles: the right to engage in interstate commerce free from discriminatory state legislation, the right to earn an honest living in other states on the same terms and conditions as the residents of those states, and freedom of commercial speech.
Those constitutional principles apply even to the 21st Amendment, which repealed Prohibition. Among other provisions, the 21st Amendment states, “The transportation or importation into any State . . . for delivery or use therein of intoxicating liquors, in violation of the laws thereof, is hereby prohibited.”
The amendment’s early interpretation gave the states broad latitude to regulate interstate shipments of alcoholic beverages. Indeed, the states still may freely regulate alcohol—they can even prohibit its use. What they cannot do is to discriminate against out-of-state producers in so doing.
The U.S. Supreme Court made that principle clear in the landmark case, Bacchus Imports, Ltd. v. Dias, in which it invalidated a Hawaii exemption from excise taxes for certain alcoholic beverages produced in-state. The Court found that the Commerce Clause limits the states’ power to regulate alcohol by forbidding discrimination against out-of-state producers. As the Court declared, “[O]ne thing is certain: The central purpose of the [21st Amendment] was not to empower States to favor local liquor industries by erecting barriers to competition.” The Hawaii law was not designed to promote temperance but “mere economic protectionism.”
Subsequently, courts faced with challenges to state alcohol distribution laws have looked beyond the purposes of such laws: if they are genuinely designed to promote temperance, they are encompassed within the states’ powers under the 21st Amendment; if they are discriminatory, they are not designed to promote temperance. The New York law, by prohibiting direct shipments from out-of-state producers while allowing them from in-state producers, violates the rights of both the wineries and consumers.
Likewise, the Privileges and Immunities Clause in Article IV of the U.S. Constitution forbids states from denying to citizens of other states the rights or opportunities available to citizens of their own states. A threshold liberty protected by the Privileges and Immunities Clause is the freedom to earn an honest living. The courts repeatedly have invalidated laws that unduly obstruct freedom of enterprise. The New York laws, which prohibit out-of-state wineries from directly selling their products to New York consumers, violate the rights of the proprietors of the out-of-state wineries to engage in legitimate enterprise.
However, on February 12, 2004, the 2nd U.S. Circuit Court of Appeals agreed with the plaintiffs in Swedenburg and struck down New York’s wine advertising ban under the First Amendment, even though the court upheld the discriminatory direct shipping ban. That portion of the court’s decision is not on appeal before the U.S. Supreme Court.
The recent trend in the law, however, is moving sharply in the direction of free trade. Federal appeals courts in the 4th (North Carolina), 5th (Texas), and 6th (Michigan) Circuits have struck down direct shipment bans; the 11th (Florida) overturned a district court decision upholding a ban and remanded the case for further consideration; and the 2nd (New York) and 7th (Indiana) have upheld them. In addition to the IJ case, the U.S. Supreme Court also agreed to hear a similar wine case arising out of Michigan. In that decision, the U.S. 6th Circuit Court of Appeals ruled that the 21st Amendment must be read in concert with the Commerce Clause, stating, “It is clear that the Michigan statutory and regulatory scheme treats out-of-state wineries differently, with the effect of benefiting the in-state wineries.”
IJ Economic Liberty & First Amendment Successes
The lawsuit was brought by the Institute for Justice, a nonprofit public interest law firm that represents individuals, free of charge, when their essential liberties have been violated by government.
The Institute for Justice litigates in support of fundamental individual liberties, including economic liberty—the right to earn a living free from arbitrary or excessive government regulation. IJ has scored significant victories on behalf of entrepreneurs and in the process has opened up long-closed markets. These important victories include:
Craigmiles v. Giles—In 2003, a federal appeals court upheld a lower court ruling that found Tennessee’s government-imposed cartel on casket sales was unconstitutional. This is the highest pro-economic liberty court decision since the New Deal.
Farmer v. Arizona Board of Cosmetology—In 2003, the Institute for Justice Arizona Chapter (IJ-AZ) filed a lawsuit on behalf of African hairbraider Essence Farmer seeking to dismantle Arizona’s onerous cosmetology regime, which required braiders to attend 1,600 hours of courses that taught nothing about braiding. Inspired by IJ-AZ’s advocacy, a new law in Arizona now exempts hairbraiders from the State’s outdated cosmetology scheme and Essence will soon be operating Rare Essence Braiding Studio.
Clutter v. Transportation Services Authority—IJ represented independent limousine drivers who defeated Las Vegas’ Transportation Services Authority and entrenched limousine companies that had stifled competition. Through IJ’s litigation, the once-closed market was opened in 2001.
Cornwell v. California Board of Barbering and Cosmetology—IJ represented JoAnne Cornwell, creator of the Sisterlocks technique of hair locking, in defeating California’s cosmetology licensing requirement for African braiders in 1999.
Ricketts v. City of New York—IJ helped commuter vans fight a public bus monopoly that would not allow the vans to put people to work and take people to work in underserved metropolitan neighborhoods in New York City. As a result, hundreds of new independent vans are operating in New York.
Jones, et. al. v. Temmer, et. al.—Leroy Jones, Ani Ebong and Girma Molalegne opened Freedom Cabs, Inc., in Denver in 1995 after IJ helped them overcome Colorado’s protectionist taxicab monopoly. Stemming from pressure in the court of public opinion created by their lawsuit, the state legislature enabled Freedom Cabs to become the first new cab company in Denver in nearly 50 years. Jones’ testimony also contributed to the breakdown of government-sanctioned taxicab monopolies in Indianapolis and Cincinnati.
Uqdah v. D.C. Board of Cosmetology.—Although they lost in court, Taalib-Din Uqdah and his wife Pamela Ferrell prevailed in the court of public opinion in 1993 against the District of Columbia, which eliminated a 1938 Jim Crow-era licensing law for African hairbraiders when the District deregulated cosmetology after their lawsuit.
The Institute also fights to protect First Amendment freedoms. IJ recently won federal court victories prohibiting the Commodity Futures Trading Commission from requiring registration of Internet investment newsletters and ended the ban by the City of Redmond, Wash., on commercial portable signs. IJ is currently challenging California’s Department of Real Estate’s demand that online real estate advertising companies must obtain brokers licenses to advertise properties in California. (Newspapers have no similar restrictions.) In February 2004, in a case litigated by IJ, the 3rd U.S. Circuit Court of Appeals ruled the government-compelled speech program that forced dairy farmers to pay for “Got Milk” advertisements was unconstitutional.
Lead counsel for the Institute for Justice is Clint Bolick, IJ’s co-founder and strategic litigation counsel, who has won several federal court decisions challenging governmental barriers to entrepreneurship. Bolick formerly served with the U.S. Department of Justice, Civil Rights Division and received his law degree from the University of California at Davis, where he also developed a strong appreciation for wine.
IJ Senior Attorney Steve Simpson is the other principal member of the litigation team. Simpson has also worked on a number of First Amendment and economic liberty cases for the Institute, including IJ’s successful federal challenge to the government-imposed “got milk” advertising campaign. Before joining IJ, Simpson worked as an associate attorney at Shearman & Sterling in New York and Arlington, VA He graduated from New York Law School.
Serving as local counsel is Lance J. Gotko, a partner at Friedman Kaplan & Seiler LLP in Manhattan. Together, the IJ team vows to uncork freedom for small wineries and their patrons.
For more information, contact:
John E. Kramer
Institute for Justice
901 N. Glebe Road
Arlington, VA 22203