Supreme Court Rules in Internet Wine Sales Case

May 16, 2005. The Supreme Court issued its 5-4 opinion [73 pages in PDF] in Granholm v. Heald, and consolidated cases, holding that Michigan's and New York's regulatory schemes that permit in-state wineries directly to ship alcohol to consumers, but restrict the ability of out-of-state wineries to do so, violate the dormant commerce clause.

While the facts of these cases involve wine sales, this opinion will make it easier for businesses that engage in electronic commerce to challenge the constitutionality of state protectionist statutes that discriminate against internet based commerce. Also, this case is notable because, the states have a stronger case for restricting commerce in wine than in other products and services, because the 21st Amendment grants states special powers to regulate alcohol sales.

However, the impact of the opinion may be limited, to the extent that Michigan and New York discriminated only against out of state direct sellers (such as internet based sales). A state may avoid the consequences of this opinion simply by not carving out an exception for its in state direct sellers.

Background. This is the consolidation of three case, Granholm v. Heald (No. 03-1116), Michigan Beer & Wine Wholesalers v. Heald (No. 03-1120), and Swedenburg v. Kelly (No. 03-1274). See, story titled "Supreme Court Grants Certiorari in Internet Wine Sales Cases" in TLJ Daily E-Mail Alert No. 905, May 26, 2005.

The U.S. Court of Appeals (6thCir) issued its opinion in Heald v. Engler on August 28, 2003. The Court held that Michigan's alcohol sales statute violates the dormant commerce clause.

The U.S. Court of Appeals (2ndCir) issued its opinion [28 pages in PDF] in Swedenburg v. Kelly, on February 12, 2004. The District Court had held that a New York statute prohibiting out of state wineries from selling directly to New York residents, such as via the internet, violated the Commerce Clause of the Constitution. The Appeals Court reversed, holding that New York's statute is a permissible exercise of authority granted to states under the 21st Amendment, thus rejecting the Commerce Clause challenge. See, stories titled "2nd Circuit Rules in Internet Wines Sales Case" in TLJ Daily E-Mail Alert No. 840, February 19, 2004; and "Court Holds New York's Ban on Internet Wine Sales Is Unconstitutional" in TLJ Daily E-Mail Alert No. 551, November 18, 2002.

Opinion of the Court. The Supreme Court concluded that "both States discriminate against interstate commerce in violation of the Commerce Clause, Art. I, §8, cl. 3, and that the discrimination is neither authorized nor permitted by the Twenty-first Amendment. Accordingly, we affirm the judgment of the Court of Appeals for the Sixth Circuit, which invalidated the Michigan laws; and we reverse the judgment of the Court of Appeals for the Second Circuit, which upheld the New York laws."

The Court wrote that "Michigan and New York regulate the sale and importation of alcoholic beverages, including wine, through a three-tier distribution system. Separate licenses are required for producers, wholesalers, and retailers. ... the three-tier system is ... mandated by Michigan and New York only for sales from out-of-state wineries. In-state wineries, by contrast, can obtain a license for direct sales to consumers. The differential treatment between in-state and out-of-state wineries constitutes explicit discrimination against interstate commerce."

The regulatory schemes of Michigan and New York affect all direct sales. However, the Court noted that internet sales is an important component of direct sales. It wrote that "Technological improvements, in particular the ability of wineries to sell wine over the Internet, have helped make direct shipments an attractive sales channel." The Court also quoted the Federal Trade Commission's (FTC) July 2003 report [139 pages in PDF] titled "Possible Anticompetitive Barriers to E-Commerce: Wine": "interstate direct shipping represent the single largest regulatory barrier to expanded e-commerce in wine".

The Court held the Michigan and New York regulatory schemes unconstitutional under the commerce clause. Article I, Section 8, of the Constitution provides that "The Congress shall have Power ... to regulate Commerce with foreign Nations, and among the several States ..."

The dormant commerce clause, which the Court applied in this case, is the judicial concept that the Constitution, by delegating certain authority to the Congress to regulate commerce, thereby bars the states from legislating on certain matters that affect interstate commerce, even in the absence of Congressional legislation. Although, the opinion of the Court does not expressly state that this case is decided under the dormant commerce clause. However, the cases cited by the majority, the reasoning of the majority opinion, and the dissents, make clear that this is a dormant commerce clause case.

The Court wrote that "Time and again this Court has held that, in all but the narrowest circumstances, state laws violate the Commerce Clause if they mandate ``differential treatment of in-state and out-of-state economic interests that benefits the former and burdens the latter.´´ ... This rule is essential to the foundations of the Union. The mere fact of nonresidence should not foreclose a producer in one State from access to markets in other States. ... States may not enact laws that burden out-of-state producers or shippers simply to give a competitive advantage to in-state businesses." (Citations omitted.)

The Court added that "The rule prohibiting state discrimination against interstate commerce follows also from the principle that States should not be compelled to negotiate with each other regarding favored or disfavored status for their own citizens. States do not need, and may not attempt, to negotiate with other States regarding their mutual economic interests."

It continued that "Laws of the type at issue in the instant cases contradict these principles. They deprive citizens of their right to have access to the markets of other States on equal terms. The perceived necessity for reciprocal sale privileges risks generating the trade rivalries and animosities, the alliances and exclusivity, that the Constitution and, in particular, the Commerce Clause were designed to avoid. State laws that protect local wineries have led to the enactment of statutes under which some States condition the right of out-of-state wineries to make direct wine sales to in-state consumers on a reciprocal right in the shipping State.

The Court noted that "California, for example, passed a reciprocity law in 1986, retreating from the State’s previous regime that allowed unfettered direct shipments from out-of-state wineries. ... Prior to 1986, all but three States prohibited direct-shipments of wine. The obvious aim of the California statute was to open the interstate direct-shipping market for the State’s many wineries. ... The current patchwork of laws -- with some States banning direct shipments altogether, others doing so only for out-of-state wines, and still others requiring reciprocity—is essentially the product of an ongoing, low-level trade war." (Citations omitted.)

The Court then concluded that "The discriminatory character of the Michigan system is obvious. Michigan allows in-state wineries to ship directly to consumers, subject only to a licensing requirement. Out-of-state wineries, whether licensed or not, face a complete ban on direct shipment. The differential treatment requires all out-of-state wine, but not all in-state wine, to pass through an in-state wholesaler and retailer before reaching consumers. These two extra layers of overhead increase the cost of out-of-state wines to Michigan consumers. The cost differential, and in some cases the inability to secure a wholesaler for small shipments, can effectively bar small wineries from the Michigan market. The New York regulatory scheme differs from Michigan’s in that it does not ban direct shipments altogether. Out-of-state wineries are instead required to establish a distribution operation in New York in order to gain the privilege of direct shipment. ... This, though, is just an indirect way of subjecting out-of-state wineries, but not local ones, to the three-tier system." (Citations omitted.)

The Court next rejected the arguments of Michigan and New York that the regulatory schemes in these case are permissible because wine sales, and alcohol sales generally, are a special case, because of the 21st Amendment.

Section 2 of the 21st Amendment provides, in part, that "The transportation or importation into any State, Territory, or possession of the United States for delivery or use therein of intoxicating liquors, in violation of the laws thereof, is hereby prohibited." That is, it prohibits, as a matter of federal Constitutional law, violation of a state's laws regarding the transportation or importation of alcoholic beverages into that state . It thus confers upon the states some authority to regulate interstate commerce in alcoholic beverages.

The Court reviewed at length the history of pre-prohibition regulation of alcohol sales, prohibition, and repeal of prohibition, and concluded that "the Twenty-first Amendment does not supersede other provisions of the Constitution and, in particular, does not displace the rule that States may not give a discriminatory preference to their own producers." It added that "State policies are protected under the Twenty-first Amendment when they treat liquor produced out of state the same as its domestic equivalent."

Justice Clarence Thomas wrote a long dissent (at pages 41-73), that was joined by Rehnquist, Stevens and O'Connor, that challenges this 21st Amendment analysis. The reasoning of this dissent can only be pertinent to regulation of alcohol sales. It will have no bearing on other types of restraints on e-commerce.

The majority, having concluded that Michigan and New York discriminated against interstate commerce, and that the 21st Amendment offers no excuse, then concluded that "We still must consider whether either State regime ``advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives.´´" In particular, the states argued that their regulatory schemes protect their states against the harms associated with underage drinking.

The Court was unimpressed. It wrote that "The States provide little evidence that the purchase of wine over the Internet by minors is a problem. Indeed, there is some evidence to the contrary. A recent study by the staff of the FTC found that the 26 States currently allowing direct shipments report no problems with minors’ increased access to wine. ... This is not surprising for several reasons. First, minors are less likely to consume wine, as opposed to beer, wine coolers, and hard liquor. ... Second, minors who decide to disobey the law have more direct means of doing so. Third, direct shipping is an imperfect avenue of obtaining alcohol for minors who, in the words of the past president of the National Conference of State Liquor Administrators, “ ‘want instant gratification.’ ”" (Citations omitted.)

The Court added that barring only out of state sales is no way to protect against underage drinking.

In addition to underage drinking, the states argued that their regulatory regimes are necessary to enforce tax collection. However, the Court rejected this argument also. It held that the states already have adequate remedies under federal and state laws for collecting tax revenues. It wrote that "The States have not shown that tax evasion from out-of-state wineries poses such a unique threat that it justifies their discriminatory regimes."

The Court wrote in conclusion that "States have broad power to regulate liquor under §2 of the Twenty-first Amendment. This power, however, does not allow States to ban, or severely limit, the direct shipment of out-of-state wine while simultaneously authorizing direct shipment by in-state producers. If a State chooses to allow direct shipment of wine, it must do so on evenhanded terms. Without demonstrating the need for discrimination, New York and Michigan have enacted regulations that disadvantage out-of-state wine producers. Under our Commerce Clause jurisprudence, these regulations cannot stand."

Stevens Dissent. Justice Stevens wrote a short dissent (at pages 37-40), that was joined in only by Justice O'Connor. Like Justice Thomas, Justice Stevens addressed the 21st Amendment. He wrote that "The New York and Michigan laws challenged in these cases would be patently invalid under well settled dormant Commerce Clause principles if they regulated sales of an ordinary article of commerce rather than wine. But ever since the adoption of the Eighteenth Amendment and the Twenty-first Amendment, our Constitution has placed commerce in alcoholic beverages in a special category."

However, Stevens also wrote more broadly "Today many Americans, particularly those members of the younger generations who make policy decisions, regard alcohol as an ordinary article of commerce, subject to substantially the same market and legal controls as other consumer products. That was definitely not the view of the generations that made policy in 1919 when the Eighteenth Amendment was ratified or in 1933 when it was repealed by the Twenty-first Amendment."

Thus, Justice Kennedy, and those who joined him, are members of the younger generation.

Perhaps more significantly, he suggests that the majority makes a "policy" decision, rather than a judicial interpretation.

Reaction. The Institute for Justice represented the plaintiffs in Swedenburg v. Kelly. The IJ's Clint Bolick stated in a release that "This landmark ruling is a victory for consumers and small businesses and a defeat for economic protectionism. It demonstrates that in the era of the Internet, the Court will vindicate the principles of free trade that made this country great."

The IJ's Chip Mellor stated that "This victory is about much more than wine -- it is about the freedom of small businesses to operate without arbitrary and anti-competitive government regulation getting in their way. Now that we have set this important precedent, we'll work to expand on it to help other entrepreneurs who face similar government-imposed good-old-boy networks. This is an important step, but it is only one step in the Institute for Justice’s long-term national campaign to advance economic liberty -- the right to earn an honest living."

Analysis of Supreme Court Voting. This is a five to four opinion. Justice Kennedy wrote the opinion for the Court. He was joined by Justices Scalia, Souter, Ginsburg and Breyer. Justice Thomas wrote a lengthy dissent that was joined by Chief Justice Rehnquist, and Justices Stevens and O'Connor. Justice Stevens also wrote a separate dissent, that was joined by Justice O'Connor.

The vote did not break down along ideological lines. Those who more often defend free enterprise split. Notably, Justice Thomas and Chief Justice Rehnquist opposed the free enterprise outcome in this case. Defenders of states rights also split. Justice Scalia opposed states rights in this case.

As Justice Stevens hinted in his dissent, the Supreme Court split along lines of age and seniority. The "younger generation" overturned the state regulatory regimes.

The three most senior members of the Court (Rehnquist, Stevens and O'Connor) voted together in the minority. The more junior members, with the exception of Justice Thomas, formed the majority.

This may bode well for future constitutional challenges to protectionist state statutes that burden electronic commerce. Three of the members of the minority may soon retire from the Supreme Court.