Fulfillment House Licensing: The new way to undermine direct to consumer shipping
How Licensing fulfillment houses will create an administrative octopus and threaten to kill off avenues for direct-to-consumer shipping.
Direct-to-consumer (DTC) shipping of wine greatly increased during COVID. Conventional wisdom indicates the growth of DTC shipping will ride the wave of momentum and steadily rise over the coming years. Although conventional wisdom is often right, it can’t account for state governments threatening DTCs growth potential in an underhanded way.
Recently, Alabama, Kansas, and Tennessee enacted legislation to license fulfillment houses. Further, the Uniform Law Commission (ULC), which desires to draft model legislation for the states to utilize in stopping illegal wine shipments, is proposing to license fulfillment houses.
A fulfillment house works on behalf of client wineries and provides services, mainly storage and packing services. A winery sends its product to a fulfillment house for storage, and when a customer places an order, the winery requests that the fulfillment house take a bottle out of storage, pack it in a box, and prepare the package for common carrier pickup.
The fulfillment house is paid by the winery for its services and does not derive any funds from the customer who ordered the product in another state. The fulfillment house is only doing business at its location and typically does not do business in any other state.
Even though the fulfillment house performs no business activity in a state, the states and the ULC are proposing licensing measures under the guise of stopping illegal shipments of wine. However, these laws will negatively impact the growth rate of the DTC marketplace and serve no sound regulatory purpose.
The market impact of fulfillment house licensing.
The licensing of fulfillment houses would become an unmitigated disaster. It would turn an entity that provides value added services to the DTC wine industry into an administrative octopus that is performing useless administrative functions for no good apparent reason.
Under the fulfillment house laws and the ULC’s draft version, to become licensed a fulfillment house would either need to consent to jurisdiction or appoint the Secretary of State as its agent. As a state has no jurisdiction over a fulfillment house based on its business activity, it would need the fulfillment house to consent to jurisdiction.
Once a fulfillment house submits to jurisdiction as a condition for obtaining a license, they are required to submit tax and legal filings. There is no lawyer I know would tell a client submitting to jurisdiction that it shouldn’t file all legal and tax obligations.
So, let’s take a situation where fulfillment house licensing went nationwide in all 50 states, which is what the Uniform Law Commission desires.
The legal and compliance burden would put some fulfillment houses out of business and keep many from going into business
The irony is the fulfillment houses would have zero tax liability returns, since they would make no income in the states, yet still be obligated to file. Since their clients ship all around the country, any place the wine goes could obligate a filing.
With over 11,000 sales tax jurisdictions, and also including the corporate income and franchise tax filings, you could see how the compliance burden becomes unbearable. Throw in the fact that many states impose a minimum filing fee, and fulfillment houses are paying a tax liability that doesn’t even exist, all because they were required to submit to jurisdiction.
And yes, on top of it, they may need to file legal papers to do business in these states.
The fulfillment house business would change overnight and be destroyed. It would go from focusing on providing value added services to keeping up with numerous compliance obligations.
This business change, proposed not by the market but by new laws, would cause upheaval in the DTC wine market. This will in the end lead to fulfillment house consolidation, where only a few players will be able to service the demand of suppliers. Which of course will lead to higher prices for small suppliers and less service. To so small suppliers the cost may not justify the need to engage in DTC shipping, which of course would negatively impact DTC wine shipping.
Why the need to license fulfillment houses?
Proponents of fulfillment house licensing believe it is necessary to stop the illegal shipment of wine. They believe, without hard evidence presented, that illegal shipments of wine originate from fulfillment houses and it is impossible to track these fulfillment house shipments, because these entities are not subject to state regulatory and licensing requirements. Under their theory, an unlicensed winery can ship its product using a fulfillment house, and get around state regulatory requirements by using an unregulated entity. Which in their eyes means the unlicensed winery hides its illegal activity via a fulfillment house!
Speaking to many fulfillment house executives, they have indicated to me that shipping illegal wine does not make for a healthy business model and is not a practice they engage in. In fact, they request that a winery utilizing their fulfillment house provide the winery shipping permit for a specific state.
Why licensing fulfillment houses is not necessary?
What’s most problematic about the movement to license fulfillment houses is it’s not necessary. Alex Koral of Sovos wrote a great piece in Wine Industry Advisor about an alternative to a licensing regime. Mr. Koral proposes a system where the direct shipper and the common carrier are required to report a tracking number. As Mr. Koral states, “When both the carriers and the DTC shippers are required to report a shipment’s tracking number, it can identify the licensed source of each shipment and dispel the erroneous concern over illegal shipments from fulfillment houses.”
In other words, the tracking number solution addresses the illegal shipping issue without imposing the burden of licensing on the fulfillment house.
What this is all about?
If a compliance expert like Alex Koral knows there is a simple solution and published this view, then the others who push for fulfillment house licensing must also understand this concept. However, even when armed with this understanding, they are still pushing the narrative that fulfillment house licensing is the only necessary way to stop illegal shipping, when clearly it is not.
This fulfillment house licensing movement is meant to suppress the growth of DTC wine shipping by eliminating as many players as possible from the fulfillment house industry. Further, it is meant to change the fulfillment houses and take their focus away from their business and focus on unnecessary activities.
In the end, those that perform well in life are focused on a narrow activity, licensing fulfillment houses proposes to turn this concept on its head and require an entity focus on many activities that provide no value. Sometimes liquor just upends conventional wisdom!