A Modest Proposal – Adopt the federal rule on Tied-House liability in California

While Congress no doubt anticipated agency vigilance, we cannot agree that the legislature meant to allow enforcement actions on the basis of the Bureau's unsubstantiated beliefs; if the Bureau suspects that a particular inducement places retailer independence at risk and thus that the inducement is proscribed by the FAAA, it must provide substantial support backing up its suspicion--at least where, as here, the anticompetitive nature of the inducement is nowhere apparent on its face. In this regard, our view accords with that of the Seventh Circuit in Foremost: "[A] mandate to address real threats in their incipiency is not an instruction to disregard the distinction between friend and foe; it is not a mandate to control weeds by scorching the earth." Justice Ginsberg’s decision in Fedway Associates v. Bureau of Alcohol, Tobacco and Firearms, 976 F.2d 1416 (DC Cir. 1992) (quoting Foremost Sales Promotions, Inc. v. Director, Bureau of Alcohol, Tobacco and Firearms, 860 F.2d at 239 (7th Cir.1988)).

What, you ask, does this have to do with Booze Rules?

Well, right now there are several California “tied-house” cases at various levels of the hearing and appeal process where the principles articulated by Justice Ginsberg are very relevant.

In the two or so dozen “Bottlerock 2013” accusations filed by the ABC against the defendant suppliers, the ABC charged a “thing of value” violation for paying a sponsorship fee to an unlicensed festival organizer (an LLC).  Despite the ABC issuing a temporary special event license for the event following full disclosure of the sponsorship agreements, once the event was over, an ABC investigator found out (through an arduous records search in Sacramento) that the Bottle Rock Festivals LLC executives had individual passive minority investment interests in a real estate investment trust.  The REIT, it was discovered through a search of internal non-public ABC records, owned a 20% interest in the Uptown Theatre, a Type 41 (wine and beer) licensed venue in the City of Napa. These REIT interests (one executive was the trustee of a trust - not an interest, in fact - and in the other owned less than a 1% interest) were not only truly minor, non-controlling (and impossible to find even by reference to the ABC’s license database) but were unknown to the sponsoring wineries.

In fact, the interests would not have even mattered to the wineries had they known of them because (in the cases we tried) the wineries were not marketing their wine to the Uptown Theatre. Moreover, no wineries were participating in or sponsoring the artist after parties that were held at the Uptown Theatre (the after-parties were disclosed to the ABC before the festival) and the event organizers had no clue that their involvement with the Uptown was a problem for anyone because they were not involved in any way in operating or managing the Uptown Theater.

If this sounds confusing it is because it is confusing: the stretch that had to be made by the ABC  to make any connection between the sponsorships and the Uptown theatre was positively Kafkaesque (“marked by a senselessdisorienting, often menacing complexity”). Regardless of how it’s viewed, however, there is no argument with the proposition that no winery involved with the festival was trying to control or affect the Uptown Theater through corrupt or anti-competitive activity.

These facts were not contested by the ABC in the hearings. What was contested is the standard of liability.  The ABC currently maintains that the tied house liability standard is strict and that knowledge of the relationship between the vendor being engaged and a retail account, or any actual corrupt or anti-competitive connection between the wineries sponsorship funds and the retail licensee, is not necessary for a violation to be found. And, indeed, that is what the ABC held to be the law in the decisions now being appealed.

In the Grape Escape accusations (see: The Grapes Escaped), the accused wineries and breweries used social media (Facebook, Tweets, etc.) to communicate the proper name and logo of a long-standing Sacramento non-profit event. The accused suppliers were simply telling their consumers that they were going to be at the event.  The charged violation was that the title sponsor of the event was a retailer and, therefore, the ABC asserted, the use of the event logo with the name of the retailer was a “thing of value” to that retailer regardless of whether or not the winery or brewery sold its wine or beer to that retailer.  

The fear and apprehension among suppliers after the ABC accusations were filed (which caused many suppliers to discontinue their participation in the longstanding event) resulted in this year’s event being cancelled. The sponsoring organization (the Sacramento Convention and Business Bureau) has as a result been effectively prohibited from soliciting title sponsorship funds (which historically supported the event, and benefitted the entire Sacramento region) from any licensed retailer.

According to the ABC, these sponsorships and advertisements violate the California tied-house law because the law must be strictly (and rigidly) interpreted without regard to proof of knowledge, actual tangible benefit to the retail licensee, any actual anti-competitive effect or any corrupt motive or purpose.  There was no argument made by the ABC in any of cases that the acts charged (sponsoring a music festival and using social media to inform consumers about an event where the winery was pouring wine) encouraged or abetted any anticompetitive or corrupt activity. Rather, the ABC’s argument goes, the mere fact that the direct or indirect (in the Bottlerock cases) relationship exists violates the mandate of the statute.

This should strike fear in the heart of every licensee in this state.

The obvious consequences are that every vendor relationship entered into by the winery (or other licensed supplier, including distillers and breweries) must be analyzed for upstream direct or indirect tied house connections to a licensed retailer. Otherwise the winery (and the retailer) is always at risk of a violation. The consequences of a violation are significant. Besides the potential risk of a license suspension (or revocation for a repeat offender) once a winery or other supplier is convicted of (or pleads guilty to) a violation of the tied house laws that becomes a reportable prior conviction on every out of state shipper and DTC permit filed or renewed from that moment on by the winery.  Failure to report the violation is usually a violation in the other states because almost all application forms require accurate disclosure under penalty of perjury. It is for this reason that many Bottlerock and Grape Escape defendants are pursuing their remedies through the administrative hearing process, which may end up in the appellate courts. That is a long, arduous and expensive process and, while it is playing out, normal commercial activities are being conducted under a cloud of risk.

This brings us back to Justice Ginsberg. Fedway was a landmark decision where the principles upon which all tied-house laws going back to Prohibition are based were reviewed and analyzed.  In Fedway, the crime charged was giving consumer goods to retailers in exchange for purchasing more products.   The analysis focused on whether or not the “crime” actually encouraged the sort of corrupt practices that the tied-house laws were originally intended to prevent.  Justice Ginsberg found that the actions of the supplier in Fedway did not rise to the level of a corrupt practice and were, in fact, a form of quantity discount, a perfectly legitimate sales and marketing tool.

Her reasoning was that the tied-house laws (as adopted by Congress following Prohibition) were intended to prevent supplier domination and control of retail accounts through practices (such as unlimited credit, consignment sales, hidden ownership interests, free goods and actual bribery – pay to play) that were corrupt and anti-competitive.  As she found, the tied house laws were not intended to punish normal business practices that did not involve corrupt or anti-competitive practices.

The result of this 1992 case was the 1994 adoption of federal regulations interpreting the Federal Alcohol Administration Act. The newly enacted regulations required proof of actual corrupt conduct in order for the agency to bring a disciplinary action against a licensee. See: 27 CFR 6.151 to 6.153.

The federal authorities have now used these FAA Act regulations successfully for over 20 years to challenge conduct they consider to be corrupt or anti-competitive.

Our question:  why can’t California establish a similar standard?

The ABC Act is supposed to be “liberally construed” to benefit the people of the state:

Section 23001: This division is an exercise of the police powers of the State for the protection of the safety, welfare, health, peace, and morals of the people of the State, to eliminate the evils of unlicensed and unlawful manufacture, selling, and disposing of alcoholic beverages, and to promote temperance in the use and consumption of alcoholic beverages. It is hereby declared that the subject matter of this division involves in the highest degree the economic, social, and moral well–being and the safety of the State and of all its people. All provisions of this division shall be liberally construed for the accomplishment of these purposes

Because the ABC Act is intended to foster the “economic…well-being” of the State and “all its people” (“the people” includes wineries, breweries and distillers, who are responsible for much of the current economic well-being of this state) licensees should not be deprived (by virtue of a strict liability test that does not permit a defense) of the right to prove that the act they are accused of committing does not involve corrupt activity and anti-competitive activity.

Moreover, we believe that in cases where the ABC seeks to penalize truthful commercial speech (including in social media), the ABC is required to prove that the penalty would substantially further one of the state’s legitimate interests, i.e., that the speech has an actual anti-competitive or corrupt effect.

The standard currently being applied by the ABC (strict liability without regard to the facts or proof that corrupt activity was involved) has created a climate of fear and apprehension that is inhibiting normal commercial activity, the use of social media and the ability of licensees at all levels to connect with each other for normal commercial purposes.

Thus, unless the ABC is willing to interpret its mandate in accordance with Section 23001 of the ABC Act (which it can do if it wants to  – the ABC has great discretion in the exercise of its statutory mandate), we modestly propose a new section of California law modeled after the successful federal regulation emanating from Justice Ginsberg’s Fedway decision.

Here is our suggested language, modified specifically for California and tracking 27 CFR Part 6.153 in concept and effect:

Criteria for determining regulatory liability for tied house thing of value violations.

The criteria specified in this section are indications that a particular practice, which would include the furnishing of a thing of value by a supplier to a retailer not otherwise exempted by this Chapter, subjects the participants to regulatory liability for violating this Chapter.  A practice need not meet all of the criteria specified in this section in order to subject the participant to regulatory liability.

(a) The practice restricts or hampers the free economic choice of a retailer to decide which products to purchase or the quantity in which to purchase them for sale to consumers.

(b) The supplier obligates the retailer to participate in the promotion to obtain the supplier's product.

(c) The retailer has a continuing obligation to purchase or otherwise promote the suppliers product.

(d) The retailer has a commitment not to terminate its relationship with the supplier’s with respect to purchase of the industry member's products.

(e) The practice involves the supplier in the day-to-day operations of the retailer. For example, the supplier controls the retailer's decisions on which brand of products to purchase, the pricing of products, or the manner in which the products will be displayed on the retailer's premises.

(f) The practice is discriminatory in that it is not offered to all retailers in the local market on the same terms without business reasons present to justify the difference in treatment.

Justice Ginsberg was right when she said that “[a] mandate to address real threats in their incipiency is not an instruction to disregard the distinction between friend and foe; it is not a mandate to control weeds by scorching the earth.

The regulated alcoholic beverage industry is not the foe of the ABC. The entire industry is invested in preventing corruption. However if the ABC is unwilling to make distinctions between corrupt activity and normal business practices, and insists on the blind bureaucratic application of statutes dating back to the 1930’s, then we must ask the Governor, our elected representatives and our courts to instruct the ABC to apply its discretion in support of the industry and not to punish licensees for normal commercial conduct that actually fosters a healthy alcoholic beverage industry in California.