The Lebamoff Michigan case: Are courts chipping away at the defense that laws are made to maintain the integrity of the three-tier system?

 

Lebamoff, an Indiana retailer, sued the State of Michigan because it could not obtain a license to sell and ship its products from Indiana to Michigan customers. Michigan develop a license, a Specially Designed Merchant License (“SDM”), which allowed a license holder to deliver directly to Michigan consumers using a common-carrier, their own vehicles, or a third-party provider. Only in-state retailers could obtain a SDM and Lebamoff as an out-of-state retailer was ineligible for the license.

Lebamoff claims that the Michigan statute, M.C.L. Section 436.1203, which prohibited it from obtaining the SDM, violated its rights under the Commerce Clause and the Privilege and Immunities Clause. Lebamoff sought an injunction to prohibit Michigan from enforcing the law.

 

Takeaways

In a rather unique analysis, the court held that allowing in-state retailers to ship breaks the hermetically-sealed three-tier system and hence its integrity. To the court allowing in-state shipping was an exception that broke the three-tier system and makes it harder to justify a 21st Amendment position.

In a recent case, Missouri Broadcasters Association v. Taylor, no. 2:13-CV-2792-MDH (decided on June 28, 2018, Western District of Missouri),  the court held the integrity of the three-tier system was not maintained because there were so many exceptions. Juxtaposed to Lebamoff, these exceptions were easily discernible. These exceptions included allowing retailers to manufacturer and allowing wine manufacturers to ship wine to consumers and act like retailers.

The Lebamoff court’s view that the integrity of the three-tier system was compromised by creating an exception that allows retailers to sell directly to consumers via federal express instead of via the retailer’s physical location, seems to be at odds with the Missouri case which deals with the blending of the tiers.

Does the court view a retailer acting in a modern way as creating an exception to the three-tier system and does this principle apply to the other tiers?

An opposing view in support of the Lebamoff court would state that by shipping a retailer is performing functions of a distributor and a supplier. And that its expanded activities is encroaching on these tiers, so may be like the Missouri Broadcasters Association case, it stands for the proposition that the blending of tiers breaks the integrity of the three-tier system no matter how tangential or small the difference seems.

Finally, the other takeaway is that the court follows the precedent of Byrd and holds that Granholm applies to retailers.

 

Why is this case important?

So what is the importance of this case? On the specific factual basis this case will probably be deemed irrelevant. The United States Supreme Court granted cert. on the Byrd case, so the Supreme Court will probably decide whether out-of-state retailers can ship to in-state customers.

The 6th Circuit will probably not hear this case on appeal because of Byrd.

So then why should we care about this case and why am I writing about it? Because like the Missouri Broadcasters Association case, we have another case which questions the validity and integrity of the three-tier system, and potentially weakens the 21st Amendment’s defense against a Commerce Clause challenge.

This string of cases leaves us with some interesting questions such as, does any break from the strict traditional three-tier system mean the defense of maintaining the three-tier system is dead as a valid defense? And what will future courts deem as an exception to the three-tier system, I don’t think many people foresaw in-state wine shipments as an exception to the three-tier system!

 

Legal Analysis

The court looked first at the Commerce Clause issue under the auspice of the Dormant Commerce Clause. It indicated that there is a two-fold inquiry for a Dormant Commerce Clause analysis: 1. Whether a statute directly regulates or discriminates against interstate commerce;  or 2. whether its effect is to favor in-state economic interest over an out-of-state economic interest.

If the plaintiff proves discrimination, the law will only survive if it advances a legitimate local purpose that can’t be achieved by an alternative means.

The court ruled that Lebamoff met its Commerce Clause burden because the law discriminates in favor of in-state interest. The SDMs are only issued to businesses located in Michigan, and a non-resident can not obtain the license and exercise the privileges of delivering wine to Michigan customers.

 

Michigan arguments against discrimination

Michigan argued against discrimination on two specific grounds; 1. The Michigan statue did not discriminate because it allowed a non-resident such as Lebamoff to open an in-state retail location and obtain a SDM and with it the benefits of delivering product to Michigan customers; and 2. Allowing Lebamoff to ship wine to customers would allow it to bypass the three-tier system.

The court dismissed Michigan’s first claim, which allowed Lebamoff the benefits of the SDM if they physically located in Michigan, because  in the court’s view past precedent shows that many courts are suspicious of statutes that require business operations be performed in a specific state, in order to obtain the benefits of the statute. Especially when it is more cost effective for the activity to be performed elsewhere, as opposed to physically residing in the state.

The court also disagreed with Michigan’s position that a favorable ruling would allow Lebamoff to bypass Michigan’s three-tier system, something Michigan retailers are not permitted to do.

The court’s main point of contention was that “Michigan departed from a hermetically-sealed three-tier system when it chose to permit its wine retailers to join the digital marketplace and engage in direct shipping to consumers.”

The court further stated that Michigan created a consumer market that “implicated interstate commerce in a manner above-and-beyond that of a traditional three-tier system.”  Then the state created a market that closed off “this Michigan sized portion of American interstate commerce to out-of-state competitors.”

The court held that this method allowed Michigan to favor their own interest and violated the Dormant Commerce Clause. Hence in the court’s view the justification for discrimination was invalid.

21st Amendment analysis

The court did not believe that the Michigan statute was closely related to the powers reserved by the 21st Amendment that it could withstand a Commerce Clause challenge.

The major question in this case is “whether discrimination against interstate commerce on the retailer tier- as opposed to the producer tier at issue in Granholm-is forbidden by the Commerce Clause or sanctioned by the 21st Amendment.”

The court reached a decision on this by deciding whether Granholm was limited to the producer tier or extended to the retailer tier. In the court’s view, not expanding Granholm to the retailer tier is incompatible with the 6th Circuit’s decision in Byrd. (This Distrcit Court is under the jurisdiction of the 6th Circuit).

Further, the court looked at whether the interest in developing the statute are closely related to the powers reserved by the 21st Amendment that the statute could survive a Commerce Clause challenge. In the court’s view the state does not demonstrate that permitting in-state retailers to ship directly to consumers while not allowing out-of-state retailers to do the same is inherent in the three-tier system.

The court opined that the state has the option afforded by Granholm to shut off wine shipments and make it a closed three-tier system. But when it allows retailer direct to consumer shipping, it creates an exception to the three-tier system. And when it carves out this exception, it must do so without resorting to economic protectionism.  Thus, the 21st Amendment powers do not extend to maintain protectionist laws from a Commerce Clause challenge.

 

Failing the 2nd prong of the Commerce Clause, were their reasonable alternative available

To survive a Commerce Clause challenge a facially discriminatory statute will be upheld if it advances a legitimate purpose that can’t be served by reasonable alternatives.

The state proffered four reasons for the statute and why it had to deny out-of-state retailers the right to ship into the state.

  1. Administrative Overburdening

The state argued that it couldn’t regulate the nationwide wine retailers that it estimates at 338,000, and that many of the retailers would not apply for a license. Hence, they would have a large unregulated market of wine in the state. Lebamoff argued successfully that only a tiny amount of retailers would apply for the license and that the cost of shipping would prevent the market from becoming over-saturated.

The state did not demonstrate that no reasonable alternative exist for this problem. In the court’s view, the state could tighten regulations with other non-discriminatory requirements or increase application fees.

 

  1. Youth access

Michigan stated that out-of-state deliveries would substantially increase the risk of minors receiving alcohol. The issue was settled in Granholm that out-of-state manufacturers shipping would not substantially increase the risk of minors receiving alcohol. The state did not prove that replacing wineries with retailers will make a significant difference. Further, the state could utilize records from shippers and other reasonable methods to combat this problem.

 

  1. Tax Collection

The state believes that collecting tax would be unworkable. The court disagreed and noted that Michigan could take alternative measures. For example, Michigan could require retailers to post a bond for tax, and now that Wayfair was decided, an out-of-state retailer could demand the consumer pay tax.

 

  1. Product Safety

Michigan’s position was that alcohol was safe based on state and federal regulations. Michigan did not demonstrate that keeping the retailers from shipping into the state served this purpose. The state also did not demonstrate that it doesn’t have alternative means such as barring shipments of suspect wines or collect and testing wines.

 

Privilege and Immunities Clause

Because the court decided the issue on Commerce Clause grounds, it did not examine whether a Privilege and Immunities Clause violation existed.

 

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