71st Annual Conference

“craft distilleries: be careful what they wish for”

Moderator: Lorraine LeeWashington State Liquor Control Board

Philip PrichardPrichards’ Distillery, Inc.

Robin J. BowenMcDermott Will & Emery

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National Alcohol Beverage Control AssociationSeminar IV - Craft Distilleries: Be Careful What They Wish For

Legal Overview

May 19, 2008

Robin J. Bowen

Alcohol Beverage Counsel

McDermott Will & Emery LLP

202.756.8139

rbowen@mwe.com

Who’s Interested?

Agricultural Interests

Tourism Interests

Advocacy Groups

Chambers of Commerce

Other AlcoholBeverageInterests

Small Business Constituents

Elected Officials

Potential Wish List

Licensing

Lower costs for entry Application Fees Renewal Fees BondsSpecial tailoring Type of production activities Limits on production volume Use of in-state agricultural productsAbility to hold multiple licenses Manufacturer Distributor Retailer

Sales & Distribution

Tastings Retail Off-premise sales to consumers from the

distillery premises and/or another location

On-premise sales to consumers (restaurant)

Direct sales and shipping to consumersWholesale Direct sales and shipping to retailers

What Is a Craft Distiller in the State of Washington?

Craft Distillery License License fee is $100 per year versus $2000 per year for a distiller license. Produce 20,000 gallons or less of distilled spirits. At least half of the raw materials used in production must be grown in the

State of Washington.

Sales & Distribution Off-Premise (Face-to-Face), may sell up to 2 liters of distilled spirits of its own

production per person per day at the distillery. On-Premise, eligible for a restaurant license. Tastings– Serve free samples of one-half ounce or less to persons at the distillery.

– Maximum total per person per day is 2 ounces.

What Is a Craft Distiller in New York?

Class D Distiller’s License (Farm Distillery) License fee is $128 per year versus $937 to $50,800 per year for other distiller

licenses. Produce 35,000 gallons or less of distilled spirits per year. Manufacture distilled spirits primarily from New York farm and food products.

Sales & Distribution Off-Premise (Face-to-Face), may sell distilled spirits of its own production to persons at

the distillery. On-Premise, eligible for a restaurant license. Tastings Wholesale

– May sell its distilled spirits to wholesale and retail licensees/permittees.– May sell its distilled spirits in bulk to wineries, farm wineries and other distillers.– Same wholesale rights as all other distiller licensees.

Constitutional Considerations: Commerce Clause

State laws violate the Commerce Clause if they mandate differential treatment of in-state and out-of-state economic interests to the benefit of in-state interests.

Granholm v. Heald, 544 U.S. 460 (2005).

Discrimination Analysis:

Discriminatory on its face – Michigan allowed only in-state wineries to ship directly to Michigan consumers.

Discriminatory in its effect – New York allowed in-state wineries to ship directly to New York consumers and required out-of-state wineries to establish a physical premise in New York in order to gain direct-to-consumer shipment rights.

Constitutional Considerations: 21st Amendment

The 21st Amendment empowers the states to regulate transportation, importation and use of alcohol beverages but not in a manner that is contrary to the Commerce Clause.

Granholm v. Heald, 544 U.S. 460 (2005).

The Court draws historical support for this conclusion from Wilson Act, 27 U.S.C. § 121, and Webb-Kenyon Act, 27 U.S.C. § 122.

Constitutional Considerations: Commerce Clause

If a state law violates the Commerce Clause by discriminating against out-of-state interests, does the law advance a legitimate purpose that cannot be adequately served by reasonable nondiscriminatory alternatives?

The state must prove that the discrimination is demonstrably justified and must provide “concrete record evidence” that the nondiscriminatory alternatives will prove unworkable.

The court applies heightened scrutiny in its review.

If a state statute is not clearly discriminatory (i.e., it serves a legitimate state interest and only burdens interstate commerce incidentally), the plaintiff must show that the burden on interstate commerce is clearly excessive.

Progeny of Granholm

Washington - Costco Wholesale Corp. v. Hoen, 407 F. Supp. 2d 1247, (W.D. Wash. 2005)

Delaware - Hurley v. Brady, 2006 U.S. Dist. LEXIS 69090 (D. Del. 2006)

Oklahoma - Action Wholesale Liquors v. Oklahoma Alcoholic Beverage Laws Enforcement Comm’n, 463 F. Supp. 2d 1294 (W.D. Okla. 2006), stay lifted and injunction granted, 492 F. Supp. 2d 1313 (W.D. Okla. 2007)

Kentucky - Cherry Hill Vineyards, LLC v. Hudgins, 488 F. Supp. 2d 601 (W.D. Ky. 2006)

Tennessee - Jelovsek v. Bresden, 482 F. Supp. 2d 1013 (E.D. Tenn. 2007)

Indiana - Baude v. Heath, 2007 U.S. Dist. LEXIS 64444 (S.D. Ind. 2007)

Maine - Cherry Hill Vineyard, LLC v. Baldacci, 505 F.3d 28 (1st Cir. 2007), aff’g, 2007 U.S. Dist. LEXIS 75741 (D. Me.) (adopting magistrate’s decision, 2006 U.S. Dist. LEXIS 51657)

Arizona - Black Star Farms, LLC v. Oliver, 2008 U.S. Dist. LEXIS 15242 (D. Ariz. Feb. 2008)

Post-Granholm Challenges - Licensing

Restrict direct shipping rights for wineries based on production limits.

Kentucky Direct shipping rights available only to small farm winery licensees producing 50,000

gallons/year or less. Applies to in- and out-of-state wineries. HELD: Nondiscriminatory. Benefit available to wineries that are similarly situated.

Arizona Direct shipping rights available to in- and out-of-state wineries with production of

20,000 gallons/year or less. HELD: Nondiscriminatory. Over 2,000 U.S. wineries eligible to take advantage of the

benefit.

Post-Granholm Challenges – Sales & Distribution

Off-premises sales allowed for in-state wineries but direct shipment prohibited for in- and out-of-state wineries.

Tennessee

HELD: Nondiscriminatory. The ability to purchase wine on winery premises and the ability to purchase wine through direct shipping are different in kind and reach (separate markets, not similarly situated).

Maine

HELD: Nondiscriminatory. Plaintiffs filed to show the regulatory scheme was discriminatory in effect.

Indiana

HELD: Nondiscriminatory. On-premise sales and out-of-state direct shipping are not related rights. On-premise sales provisions only codified an advantage that arises from geography. Plus state law permitted out-of-state wineries to obtain on-premise sales rights in non-winery venues (farmer’s market, expo, etc).

Post-Granholm Challenges – Sales & Distribution

Limit direct shipments of wine to two cases per customer per year.

Kentucky

HELD: Nondiscriminatory. “The Commerce Clause does not require that customers be convenienced.”

Post-Granholm Challenges – Sales & Distribution

Require a face-to-face transaction between the customer and the winery before direct shipment can occur.

Kentucky Required wine to be purchased in a face-to-face transaction at in- and out-of-state wineries before direct shipment. HELD: Discriminatory in effect. Principal sources of supply are not near Kentucky but are on the West Coast.

Statute was not saved on the basis of grounds of temperance, preservation of local option, protection of minors and revenue collection.

Indiana Required an initial face-to-face transaction to establish a direct shipment relationship between the winery and

consumer. HELD: Discriminatory in effect. Other more reasonable alternatives to verify age are available.

Arizona Required wine to be purchased in a face-to-face transaction at in- and out-of-state wineries before direct shipment HELD: Nondiscriminatory, facially neutral.

Post-Granholm Challenges – Sales & Distribution

Authorize direct sales to retailers by in-state wineries only.

Washington and Oklahoma

HELD: Discriminatory. State justification based on orderly distribution and tax collection were insufficient to save the statutes.

Are Control States at Risk if They “Favor” In-State Craft Distilled Spirits?

Market Participant Principle

Nothing in the purposes animating the Commerce Clause prohibits a State, in the absence of congressional action, from participating in the market and exercising the right to favor its own citizens over others.

Hughes v. Alexandria Scrap Corp., 426 U.S. 794, 810 (1976).

If a state is acting as a market participant, rather than as a market regulator, the dormant Commerce Clause places no limitation on its activities.South-Central Timber Development, Inc. v. Wunnicke, 476 U.S. 82, 93 (1984).

BUT, the State may not impose conditions, whether by statute, regulation, or contract, that have a substantial regulatory effect outside of that particular market. Id. at 97.

Are Control States at Risk if They “Favor” In-State Craft Distilled Spirits?

Wholesale/Retail – State is a market participant at both the wholesale and retail levels and can elect which brands it wants to sell. See Brooks v. Vassar, 462 F.3d 341, 354-57 (4th Cir. 2006).

Wholesale Only – State is a market participant at the wholesale level, but its decisions restrict retailer choice.

What This Really Means to You. . .

Clear evidence that your agency needs more funding.

Thank you.

71st Annual Conference