The Fight Over State Laws Favoring In-State Alcohol Purveyors: Do Such Laws Violate the Dormant Commerce Clause?
A Federal District Court in New York Says No, But May Well Be Wrong

Late last month, a federal district court in New York handed down an important ruling in the ongoing national battles over state laws that favor in-state purveyors of alcohol and disfavor out-of-state entities. In Arnold's Wines v. Boyle, a federal district judge upheld a statute that gives retailers located in New York the right to sell, deliver and transport wine directly to New York consumers, but denies that right to retail businesses - such as the Indiana wine retailer who brought suit - that are located outside the state.

The ruling and the key issues it raises are not going away anytime soon, and will likely have to be considered by the Supreme Court down the road.

The Problem of State Discrimination and the Dormant Commerce Clause Norm

Many states have laws that - either on their face, or in their foreseeable practical effect -- benefit in-state producers, wholesalers, or retailers of alcohol, to the disadvantage of out-of-state competitors. Ordinarily, these laws would run afoul of what constitutional lawyers call the "dormant Commerce Clause."

In dormant Commerce Clause cases, the Supreme Court has held that the federal Constitution's Commerce Clause, which authorizes Congress to regulate commerce "among the several states," is more than a grant of power. Rather, according to the Court, the Clause also contains an implicit prohibition, insofar as the Clause reflects America's intent to be an integrated and unbalkanized economic whole generally free from parochial tariffs and other barriers to trade that states might erect to try to protect their local industries from out-of-state competition. Thus, according to Court doctrine, if state laws that discriminate against out-of-state firms are ever to be upheld, it must be because of Congressional permission or some other unusual and compelling circumstance.

As I will explain, dormant commerce clause principles would seem to doom New York's law discriminating against out-of-state wine retailers - despite the federal district judge's ruling last month to the contrary. Thus, we might see this ruling rejected by the U.S. Court of Appeals for the Second Circuit or even, eventually, by the U.S. Supreme Court.

The Wrinkle of the Twenty-First Amendment

Cases like Arnold's Wine may ultimately interest the high Court in part because dormant Commerce Clause issues have proven to be distinctively complicated and divisive in the alcohol context. In the alcohol-regulation setting, states often invoke another part of the Constitution - the Twenty-First Amendment -- to defend what would otherwise be a Commerce Clause violation.

Passed in 1931, the Twenty-First Amendment repealed the Eighteenth Amendment (which had mandated Prohibition) and also said that "[t]he transportation or importation into any State, Territory, or possession of the United States. . . of intoxicating liquors, in violation of the laws thereof, is hereby prohibited."

Read literally, the Twenty-First Amendment might confer a power on each state to regulate alcohol importation and distribution any way it wants, free from constitutional limits that otherwise might apply. However, that is not the way the Supreme Court has interpreted it.

The Court has had to examine the intersection between the dormant Commerce Clause idea and the Twenty-First Amendment a number of times. Two years ago, in the seminal case of Granholm v. Heald, the Court appeared to send a message that while the Twenty-First Amendment may indeed empower states in some ways, it does not trump the anti-discrimination, anti-balkanization norm of the Commerce Clause.

What the Supreme Court Held in Granholm

In Granholm, the Court invalidated laws from Michigan and New York that allowed in-state, but not out-of-state, wineries to make sales directly, rather than through wholesale and retail distributors, to in-state customers.

The States had argued that the Twenty-First Amendment authorized or permitted this kind of discrimination against interstate commerce. However, the five-member majority (Justices Kennedy, Scalia, Souter, Ginsburg and Breyer) read the Twenty-First Amendment as conferring upon states only that authority that Congress had tried to confer by passing the Wilson Act and the Webb-Kenyon Act prior to the adoption of the Twenty-First Amendment. Because nothing in either of these Acts had purported to give states freedom to discriminate against out-of-state alcohol producers, in violation of Commerce Clause norms, then neither, said the Court, did the Amendment license such discrimination.

The federal district judge in the recent Arnold case in New York properly acknowledged the importance of Granholm. Nevertheless, the judge held that Granholm's ban on state discrimination against out-of-staters applied only to state laws regulating producers of alcohol, not laws (such as the one at issue in the recent New York case) that regulated wholesalers or retailers.

These latter two tiers of the so-called "three tier system" of alcohol distribution (encompassing producers, wholesalers and retailers, respectively), the judge suggested, remained untouched. Indeed, the court said, the Supreme Court majority's language in Granholm tended to confirm - not rebut - claims of residual state power over the wholesale and retail tiers, even as the Granholm Court invalidated the Michigan and New York laws regulating producers.

How Should Granholm Apply in the New York Case?

The New York judge's interpretation of Granholm is, I believe, in error. To be sure, there is some loose language in Granholm -- in particular, its statement that "[t]he Twenty-first Amendment ... empowers [a state] to require that all liquor sold for use in the State be purchased from a licensed in-state wholesaler." Still, this stray sentence cannot be understood to overcome the central message and holding eminating from the rest of the Granholm opinion and analysis -- namely, that the Twenty-FirstAmendment does not authorize states to discriminate against out-of-state entities in the alcohol business.

Indeed, of particular relevance is Granholm's discussion of why New York's physical- presence requirement for wine producers ran afoul of that anti-discrimination value and was thus invalid. Here's what the Granholm majority said about the requirement contained in the New York law at issue in that case - the requirement that, to obtain a license to sell in-state, a wine producer (that is, a winery) must have a physical presence in the state and open a branch office and warehouse in New York:

"For most wineries, the expense of establishing a bricks-and-mortar distribution operation in 1 State, let alone all 50, is prohibitive. . . . We have viewed with particular suspicion state statutes requiring business operations to be performed in the home State that could more efficiently be performed elsewhere. New York's in-state presence requirement runs contrary to our admonition that States cannot require an out of state firm to become a resident in order to compete on equal terms."

Note that when the Court decried the evils of a local-operations requirement, it did sofor all "business operations" and "firms" -- not just for producers. Put another way, its language encompassed all three tiers of the system, not just one.

Granholm, then, is simply one application of a broader anti-discrimination principle that protects sellers and resellers just as much as it does producers. Thus, nothing in the analysis or language of Granholm would seem to drawthe distinction New York tries to draw in the Arnold case between discrimination against out-of-state producers (which Granholm invalidated) and discrimination against out-of-state retail sellers (which is what is involved in the present case.)

Nor is there any basis for a distinction between producers, on the one hand, and wholesalers and retailers, on the other, in the text of the Twenty-First Amendment itself. The Amendment speaks of state power over "transportation" and "importation," but draws no distinction based on who is doing the transporting or importing.

If Granholm's reading of the Twenty-First Amendment does not authorize a state to discriminate against an out-of-state importing producer, then why should an out-of-state importing retailer fare differently? They both are importers, after all.

Making Sense of Granholm's Stray Language

What, then, are we to make of the Supreme Court's reference in Granholm to the ability of a state to require the use of "in-state" licensed wholesalers? Certainly, we should not read that phrase to gut and render meaningless all the rest of Granholm. Instead, "in-state" should simply be read to mean licensed by the particular state. That is, licensed to do business in the state (that accounts for theCourt's admittedly careless use of the word"in.") Under this interpretation of the Court's decision, a State isfree to require the use of wholesalers (or retailers, for that matter), and require that the wholesalers or retailers be licensed by and in that state.

A state licensing law could insist that wholesalers or retailers, in order to be licensed, comply with financial restrictions, to have a clean track record of compliance with regulations and tax laws, to have experience in the business of alcohol reselling, and so on. Indeed, the licensing scheme could also require that the licensee submit its products to state-employed inspectors to maintain quality control, and even that the licensee pay for the costs of administering those inspections -- which might be higher if the inspector has to travel out-of-state, or if the alcohol must be shipped from out-of-state to an in-state inspection site before being distributed within the state. (That is what the Supreme Court, in an earlier case, said cities that were worried about the quality of out-of-city produced milk should do instead of mandating that all milk sold in the city be produced within local boundaries.)

However, and importantly, the licensing criteria for alcohol wholesalers and retailers cannot include requirements - such as the insistence on an in-state bricks-and-mortar presence, or a requirement of in-state citizenship -- that either are designed to, or in fact systematically do, treat out-of-state entities worse than in-state entities.

That, at least, is the lesson from Granholm that I think most constitutional law professors and students took. But we'll probably see what the federal appellate judiciary thinks soon enough.