71 st Annual Conference “craft distilleries: be careful what they wish for” Moderator: Lorraine Lee Washington State Liquor Control Board Philip Prichard Prichards’ Distillery, Inc. Robin J. Bowen McDermott Will & Emery

Boston Brussels Chicago Düsseldorf Houston London Los Angeles Miami Munich New York Orange County Rome San Diego Silicon Valley Washington, D.C. Strategic alliance with MWE China Law Offices (Shanghai) © 2008 McDermott Will & Emery LLP. McDermott operates its practice through separate legal entities in each of the countries where it has offices. This communication may be considered attorney advertising. Previous results are not a guarantee of future outcome. National Alcohol Beverage Control Association Seminar IV - Craft Distilleries: Be Careful What They Wish For Legal Overview May 19, 2008 Robin J. Bowen Alcohol Beverage Counsel McDermott Will & Emery LLP

Who’s Interested? Elected Officials Small Business Constituents Other Alcohol Beverage Interests Chambers of Commerce Advocacy Groups Tourism Interests Agricultural Interests

Potential Wish List Licensing Lower costs for entry  Application Fees  Renewal Fees  Bonds Special tailoring  Type of production activities  Limits on production volume  Use of in-state agricultural products Ability 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 consumers Wholesale  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: 21 st Amendment The 21 st 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 (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 (S.D. Ind. 2007) Maine - Cherry Hill Vineyard, LLC v. Baldacci, 505 F.3d 28 (1 st Cir. 2007), aff’g, 2007 U.S. Dist. LEXIS (D. Me.) (adopting magistrate’s decision, 2006 U.S. Dist. LEXIS 51657) Arizona - Black Star Farms, LLC v. Oliver, 2008 U.S. Dist. LEXIS (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, (4th Cir. 2006). Wholesale Only – State is a market participant at the wholesale level, but its decisions restrict retailer choice.

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71 st Annual Conference