“Better Late Than Never”-- Judge in Illinois Dismisses 201 Sales Tax Cases against Retailers

Is This the End of the Road for Steve Diamond's One-Man Crusade to Become Wealthy from Suing the Wine Industry?

By John W. Edwards II and John Hinman 

We have been reviewing the progress of the Illinois “Whistle-Blower” sales tax on shipping fees cases for well over a year while the cases have been pending [Illinois Qui Tam Lawsuits - Private Enforcement of a State Claim: A Bonanza for a Plaintiff's Lawyer & a Rip-Off of Retailers; IL Attorney General’s Office Announces Intention to Dismiss False Claims Act Against Liquor Retailers; IL Finally Offers Certainty & Relief for Victims of Sales Tax Lawsuits, but Prompt Action is Required in Pending Cases; Relief at Last! IL Moves to Fix the Sales Tax Lawsuits Against Out-Of-State Sellers But Proposes to Penalize Wineries & Retailers That Ship Without Permits]. 

We are now pleased to report that the end of the line for the plaintiff appears to be getting closer.  The plaintiff Chicago law firm headed up by Steve Diamond had most of his cases against retailers dismissed last week. Diamond has been enriching himself for ten years through “settlements” with out-of-state producers and retailers (in recent years involving many producers and retailers of alcoholic beverages) by claiming a failure to pay sales taxes on shipping and handling charges paid by Illinois residents who purchase wine from out of state retailers and wineries for shipment to their homes, and then suing the producers and retailers on behalf of the state.   His scheme, at least as it involves retailers and producers without Illinois permits or licenses, may finally be ending.

Illinois Attorney General Lisa Madigan moved to dismiss 201 cases against out-of-state retailers in the trial court of Cook County.  The cases included many that were still “sealed,” meaning that the State had not decided whether to intervene.  The Attorney General had previously moved to dismiss 350 other cases filed by Diamond.  The Attorney General’s motion to dismiss these 201 cases asserted that that they were “unlikely to be viable…because the relator’s [Diamond’s] complaints contained no allegations that the defendants had any presence in Illinois that could establish tax liability.” What this means is that without a state license or a state direct shipping permit (which establishes an agreement to submit to the jurisdiction of the state), or affirmative acts of marketing to Illinois residents, the seller was not doing business in Illinois and therefore could not be sued in Illinois. The motion was granted by the trial court on May 23, 2016.

Diamond opposed the Attorney General’s motion.  The Court ruled, however, that Illinois law provides discretion to the Attorney General to dismiss qui tam (Latin for “whistle blower”) cases brought on behalf of the State. The court said that the decision to dismiss can be overruled only upon a showing of “glaring bad faith” by the Attorney General.  Left unsaid, of course, was what the result should be when it is shown that Diamond has acted with “glaring bad faith.”

Diamond can appeal the trial court’s decision.  However, given the uniquely high standard of proof that Diamond must meet (“glaring bad faith” by the Attorney General), the prospects for a successful appeal appear bleak.  That is very good news for those that have been brought kicking and screaming into the Illinois courts by Diamond – their ordeal may finally be coming to an end!

Looking inside the decision of this court, however, we see the application of a principle that may protect retailers who are legally prohibited from obtaining direct shipping permits from states such as Illinois, as well as the wineries that ship wine purchased by their winery visitors to the buyers home without direct shipping permits (which is the case with many very small wineries throughout the US).  That is, if the seller doesn’t (or is not permitted to) register with the state, and the seller requires the purchaser to be the party legally sending the wine to the address desired by the purchaser, then the receiving state doesn’t have an adequate “nexus” (connection) with the out of state seller to assert liability for taxes. This also presumptively applies to other forms of liability (such as criminal or civil liability against the seller for assisting the state resident buyer’s violation of the relevant direct shipping protocol).  This would certainly validate the common seller (retailers and wineries alike) practice of paying sales taxes on sales in their home state and putting the onus on the buyer to be responsible for taxes in the state of the buyer. This makes the common invoice admonition “title passes to the buyer at the winery (or the store)” a potentially very powerful legal protection.

However, this compounds the uncertainly that is currently playing out in states such as New York over initiatives to hold retailers (such as Empire wine in Albany) responsible for violating the laws of other states by permitting (or assisting) customers buying in New York to ship to themselves in other states. Did the Illinois court really find that Illinois has no jurisdiction over New York (or California, or other states) retailers or producers with customers from Illinois if the goods are actually imported by the buyer as a technical contractual matter? A strong argument can be made that this is exactly what happened on May 23rd (which, if true, may soon be known as direct shipping freedom day in Illinois).

The stakes continue to rise across the US as retailers, international producers and small wineries without direct shipping permits continue to accommodate consumer demand for their products by allowing consumers to ship wine to themselves regardless of where they live. Stay tuned because this Illinois battle is not yet over.  There is too much money in it for Diamond who, rumor has it, is very well connected politically in the Illinois capital.

The Day the Music Almost Died: The Story of the BottleRock ABC Accusations, the ABC Appeals Board and a Victory for a Common Sense Interpretation of the Tied House Laws

In a huge victory for common sense interpretation of the law and a reaffirmation of reasonableness by the California ABC Appeals Board, several decisions in favor of wineries (Hinman & Carmichael LLP clients) who participated in the 2013 BottleRock festival have clarified the muddy waters of tied-house issues in California.  The ABC Appeals Board’s opinions reversing findings of violations of ABC statutes relating to indirect ownership of retail licenses and sponsorships of festivals, and the exchange of goods for promotional consideration, pave the way for a more rational ABC approach to the tied-house laws in the future. 

The 2013 Festival and the ABC – the Backstory

In 2013 a group of promoters in Napa invented the music festival known as BottleRock. BottleRock Festivals LLC (BRF) signed up wineries from Napa and Sonoma (as well as a major brewer) as sponsors. The festival featured three days of music and wineries presenting their wines to festival attendees in tents at the Napa Valley Fairgrounds. Before the festival the BRF promoters met with the ABC and showed ABC the sponsorship contracts (which provided for venues for after-parties, including the Uptown Theatre; wine being contributed to the artist’s gift bags for promotional purposes; wine being contributed for charitable auction donations in connection with the event; as well as generous ticket packages and hospitality tents for the sponsors). BRF booked the acts, publicized the festival and worked with a caterer to have wine poured in the hospitality tents under a permit issued by the ABC, which the sponsoring wineries considered to be ABC approval of the event.

Almost immediately after the 2013 festival concluded, BRF had financial problems and declared bankruptcy. About that time an ABC investigator trolling the internet came across a story that connected the BRF principals to the Uptown Theatre through a real estate investment trust that owned a minority (21%) interest in the LLC that owned the Uptown (this is called an indirect ownership interest). None of the wineries knew any details about the interest of the promoters in the Uptown, and the chain of indirect ownership could not have been discovered had someone using the ABC public records looked up the Uptown’s ownership. That is because only direct ownership interests show up on the ABC public databases.

“Gotcha” declared the investigator!  This, he concluded, was all the ABC needed to bring a case against ALL of the producer-licensed sponsors.  He theorized that, because the “after-parties” were at the Uptown (a licensed venue) and BRF revenue (which may or may not have come from sponsorship funds from the wineries; no one could prove this one way or another) was used to pay for those parties, the wineries had indirectly provided a “thing of value” to the Uptown in violation of the tied house laws. The ABC filed the accusations on that theory. 

The ABC Accusations, the Hearings and the Appeal Dismissing the Accusation

Of the approximately two dozen wineries and other suppliers indicted by the ABC in 2014, most settled for a fine, a license suspension for 10 to 15 days or probation for a year.  However, many wineries felt they had done nothing wrong and were determined to defend themselves. These wineries went to hearings at which the allegations in the accusations were challenged. There was no substantive dispute over the facts; the real dispute was over the legal standards to apply to the facts. The result after the hearing (the ABC Director was the decision maker) was a conviction based on the ABC’s legal theory that neither knowledge of a tied relationship, nor intent to violate the law via that relationship, was necessary to finding a violation.

Our clients appealed to the ABC Appeals Board, which has jurisdiction over the ABC and the power to reverse ABC decisions. The reversals by the Appeals Board sent a clear message to the ABC.

The most important result from these cases is the publication of a refined standard of conduct that will now be required for the ABC to find a licensee guilty of a tied house violation related to a thing of value.

The lessons from these cases will benefit every licensee in this state.

Just as important (and perhaps more important from a day to day operational perspective), the Appeals Board specifically found that alcoholic beverages bartered for promotional consideration (specifically, the wine provided for the artists in their gift bags) do not violate the Section 25600 prohibition on “premiums, gifts or free goods.”  This provides enormous relief to those wineries who use wine for trade, provide wine to wine writers and who provide wine to events in return for promotional consideration.  The board found that “promotional consideration” was in fact “consideration” and nothing had been given away for free. 

While this application of the California Civil Code definition of “consideration” to the ABC Act prohibitions is heartening, licensees are cautioned that use of this privilege requires careful adherence to proper invoicing and bookkeeping procedures. 

The BottleRock festival (under different promoters) proceeded in 2014 and 2015 (and will soon happen again in 2016) under the aegis of special legislation applying to the festival itself and to the Napa Fairgrounds.  Unfortunately that legislation does not apply to other music festivals in other places in the state.  However, because ABC Appeals Board decisions do apply throughout the state we can safely say that the music now lives!

Why the Accusations were dismissed

The Appeals Board, after performing a statutory analysis of the claimed ABC theory of criminality, essentially said “nonsense.” The Appeals Board said that the “directly or indirectly” standard (at least in the context of the Section 25500(a)(2) “thing of value” section) does not apply to the “ownership” of the retail venue but rather to the “inducement” (or “thing of value”) actually provided by the supplier to the retail account for the purpose of inducing the retail account’s purchase of the supplier’s product. While legalistic, this is a critical distinction for guidance of future conduct. Basically this means that the important factor is the nature and purpose of the inducement, not the nature of the ownership or investment interests.

In the context of these cases the lesson was clear – you can’t have a “thing of value” violation based solely on indirect ownership connections.

There must be a connection between the inducement and the supplier

In the BottleRock cases there was no intent on the part of the defendant wineries to program their brands into the Uptown, the purportedly “tied” retail account. In fact, most of them didn’t even sell wine to the Uptown, and none of them attended the after-parties there. This was consistent with the finding of the Schiefflin case where the supplier was found guilty because it paid money to a promotional company that underwrote retailer expenses to curry favor with the retailer. That was an example of inducing the retailer to purchase the supplier’s products because the retailer received a thing of value from a third party.

The result is that any “thing of value” charge against a winery (or a retailer, both are liable) from now on must include a clear connection between the supplier, the thing of value and the retailer as well as a benefit to the retailer connected to the suppliers brand being promoted in the retail account. The government must also show some evidence of a corrupt intent.  Put more positively, the Appeals Board will not countenance “Gotcha” prosecutions based upon facts that were unknown to, and unknowable by, the licensee.  This negates any intent to violate the statute. While licensees no longer need to fear prosecutions based on unknowable facts, it is nonetheless always prudent to do a due diligence on those with whom the licensee does business.

This conclusion comports with the corruption-based cases currently rocking the industry. In Massachusetts the Craft Brewer’s Guild just paid $2.6 million to avoid a 90 day shutdown for bribing on-premises accounts to get tap handles.  And in Ohio the Kroger’s/Southern initiative requiring suppliers who wanted to get their wines into Kroger’s to pay 3% of total sales to a marketing company furnishing services to Kroger’s was recently determined by Ohio to be a violation of its tied house laws.  In both of those instances the intent of the suppliers is to benefit a retail account for the direct purpose of inducing the retailer to carry their brands.  Intent to induce is now clearly required for a violation to be found in California.  That comports with federal law, and the law of most other states.

The First Amendment Defense: What the Board Said by Not Going There

Perhaps the most interesting facet of the decisions was the way the Appeals Board dealt with the First Amendment defense.  The defendants asserted a First Amendment defense because participation in the BottleRock festival was indisputably commercial speech protected by the First Amendment, as we have explained in previous posts [Commercial Speech & Alcoholic Beverages – Part I, Part II, Part III and The Grapes Escaped – Why The First Amendment Matters].  The courts have been applying increasingly rigorous standards to curb governmental restrictions on commercial speech, the most recent being the January 2016 Retail Digital Network (RDN) case.  The Appeals Board noted that, because it found for the defendants on the basis of the ABC’s failure to meet the statutory requirements for liability (as discussed above), it did not need to address the First Amendment issues. The Board nonetheless went on to devote over a page to RDN.  RDN is still an active case with potential appeals or a remand for a district court trial on the merits looming.  We will report on these developments as they occur.

In RDN the 9th Circuit overruled the 1986 9th Circuit Actmedia case, which prohibited a supplier from paying a retailer to advertise in retail premises. Up to now, Actmedia has been the standard used to gauge tied house liability for paying retailers for advertising.  RDN placed screens in retail accounts carrying basic content as well as supplier advertising, and paid the retailers to put up the screens up.  The ABC considered this to be a basic tied house violation (indirect payment of money to a retail account by a beverage supplier).  The 9th Circuit found that this was commercial free speech and the ABC had to meet a “heightened” standard of scrutiny under recent Supreme Court precedent in order to punish this conduct.

This quote from the Retail Digital Network case was cited by the Appeals Board in their discussion of the decision.  Judge for yourself what this says about how the Appeals Board thinks tied house policy in the real world should be evaluated:

“While California has a legitimate interest in preventing the ills associated with tied-house arrangements, statements in the Retail Digital Network opinion denote skepticism about the Department's apparent "all-or-nothing" application and enforcement of the tied-house statutes and invite legislative reexamination of the tied- house laws: ‘While we 'hesitate to disagree with the accumulated, common-sense judgments of [the] lawmakers' who enacted [the tied-house statutes], we cannot say on the record before us that the State's Prohibition-era concern about advertising payments leading to vertical and horizontal integration, and thus leading to other social ills, remains an actual problem in need of solving.’” (Retail Digital Network, 9th Cir. 2016, 810 F.3d 638). 

There are many Lessons in these cases – Here are a few. 

• Lesson 1: Do your homework. Before engaging in activities involving sponsorship requests find out exactly who is involved, who the money is going to and what it is paying for. Always follow the money.
• Lesson 2: Have a good sponsorship agreement with clear terms. This is critical because the agreement should specify who the money is going to, what it is being used for and contain representations and warranties related to the promoters as well as any retailers also involved in the event.
• Lesson 3: Question the promoters. Find out how much experience they have and make sure that you are comfortable with their plans for the event and their use of the sponsorship funds.
• Lesson 4: Use invoices for promotional trades of wine. Keep your books properly because the value of the wine that is being used for promotion is part of the cost of that promotion.
• Lesson 5: Don’t deliver wine to a caterer on a Sunday. (This 1935 law was cited in one of the accusations, really!). Wine can be picked up by a caterer on a Sunday but not delivered.

The cases were tried by John Hinman and Rebecca Stamey-White.  John, Rebecca and John Edwards worked on the briefs.  Rebecca argued all of the cases before the ABC Appeals Board.

The Arsenic in Wine Class Action Dismissal – what it means

On March 23, 2016, the Superior Court for Los Angeles County entered an order dismissing Charles, et al. v. The Wine Group, et al., the last remaining class action lawsuit based upon the presence of minute quantities of arsenic in wine.  (For a discussion of arsenic in wine, see our earlier blog post “A Layperson Looks At Arsenic in Wine”).  Several other class actions in other states had earlier been dismissed voluntarily by the plaintiffs. 

The dismissal was at the pleading stage of the case, which means that there was no discovery and no trial.  The Court essentially said that even if everything the plaintiff’s claimed was true they didn’t have a case. That is what the appeal (already announced by the plaintiffs) is going to be all about. This case will be important to establishing the parameters of the safe harbor that compliance with Proposition 65 is supposed to provide to the wine industry.*

The Charles plaintiff’s claimed that the defendant wineries violated Proposition 65.  That is, of course, the law that gave rise to the proliferation of signs at every cash register at every store in the state stating: “This product contains [or---This facility uses] chemicals known to the State of California to cause cancer and birth defects or other reproductive harm.”   Plaintiffs claimed that Prop 65 required the defendant wineries to disclose specifically that their wines contain small quantities of arsenic.

Those claims were rejected because plaintiffs did not allege any physical injury resulting from arsenic. Further, the plaintiffs conceded that “the danger of arsenic varies with the level of concentration (as it does with every toxin) and that arsenic can be present in safe drinking water, so long as the concentration level is low.”  In other words, these lawyer-driven claims didn’t show that any real harm existed from the low levels of arsenic that exist in almost all wines.

The court then said that Proposition 65 doesn’t require disclosure of the specific chemicals that give rise to the duty to post the general warning.  This is important because there are over 800 compounds “known to the State of California” to be potential carcinogens or teratogens, and the list is available on-line.  Can you imagine what a label listing 800 chemical compounds would look like?

Turning to specifics, the Judge noted that the list “includes, for instance ‘Aloe Vera, non-decolorized whole leaf extract,” “Aspirin,” “Oral Contraceptives, sequential,” ‘Salted fish, Chinese-style,” “Unleaded gasoline (wholly vaporized),’ ‘and “Wood dust.’”  The point the Judge made was that California law requires only the general warning.  At that point the consumer is the one responsible or obtaining information about minute (and here the parts per billion is truly minute) specific compounds “from the party responsible for the exposure after the warning, rather than through the warning.” 

The Judge then made the obvious point that requiring disclosure of specific compounds would make the warnings “too congested and cumbersome to read and understand.”  That was an understated observation by the Judge.

Wine does not include the “known to the State of California” warning.  Instead, all bottles carry the warning prescribed by both federal and California law:

WARNING: Drinking Distilled Spirits, Beer, Coolers, Wine and Other Alcoholic Beverages May Increase Cancer Risk, and, During Pregnancy, Can Cause Birth Defects.

The Court then held that the warning given is “a designated safe harbor provision that specifically applies to ‘wine’” and is sufficient by itself.  This is important to every producer in the wine industry because it is a guide to lawful conduct. Everyone wants to know how they can be complaint. The Judge here answered that question: make sure that the Proposition 65 warning requirements are observed.

For those reasons the Judge dismissed the complaint and told the plaintiff’s that there was no way they could amend it to actually prove a case.  That order can be appealed (and the plaintiff’s said that they will appeal it), but, in our view, the dismissal should be affirmed. Keep in mind that an appeal that results in the Judge’s order being affirmed would not be a bad thing because then the decision would have a broader precedential effect. The message to the plaintiff’s here is be careful what you ask for.

The bottom line is that the decision both terminates a meritless claim and provides an important precedent for the industry.  There are undoubtedly traces of some of the 800-plus compounds on the “known to California” list, other than arsenic, in many products, including wine.  Putting the prescribed warning on the bottle protects producers from having to disclose specific compounds and from future frivolous lawsuits. So make sure your labels are compliant!

Finally, when you raise your next glass, please remember to toast the Superior Court and this Judge for a sound, well-reasoned rejection of what is hopefully the last lawsuit based upon the presence of minute quantities of arsenic (or anything else) in wine.  Salut!

*n.b. Hinman & Carmichael LLP represented defendants in the arsenic cases, and served as regulatory counsel to the joint defense committee

Counterfeit or Artisanal Mexican Spirits? Pick your Poison, or your lime wedge

New proposed regulations in Mexico threaten the ability of small producers of artisanal agave spirits to market what makes them artisanal

Much like how the farm-to-table movement in restaurants has placed the source of the food on your plate front and center, the Mexican agave artisanal spirits movement is highlighting each element that goes into a glass, from the cultivation of the plant and the methods for harvesting and cooking the piña to the distillation process and ultimate bottling. Long gone are the days of tequila or mezcal with its worms, relegated to shots and frozen margaritas.

“New” Mexican agave spirits are making inroads in the American bar scene precisely because they can be marketed as artisanal and small-batch, with a focus on the specific types of varietal used in the distillation and the specific regions in which they are produced—a transparency that’s particularly attractive to American bartenders and imbibers alike. However, a new regulation proposed in Mexico may severely limit what information will appear on bottles of Mexican spirits in the future.   

traditional mezcal production source: flickr.com

In a proposed regulation first published in November 2015, the Mexican government plans to create new classifications and requirements for labeling and marketing of agave spirits, which it claims will combat the issue of counterfeiting and better protect brands.

The introduction to this new regulation, PROYECTO DE NORMA OFICIAL MEXICANA PROY-NOM-199-SCFI-2015, “BEBIDAS ALCOHÓLICAS – DENOMINACIÓN, ESPECIFICACIONES FISICOQUÍMICAS, INFORMACIÓN COMERCIAL Y MÉTODOS DE PRUEBA,” or “NOM-199,” states that its purpose is to protect consumers from deceptive marketing by setting standards for the naming, production, and testing of agave spirits produced in Mexico. 

In spite of the positive intention behind the new regulation, these same classifications and regulations may ultimately create consumer confusion and threaten the ability of legitimate small producers to advertise the special qualities of their authentic spirits that are driving the increased demand in the marketplace. Outrage is being voiced on industry-specific blogs, with fears that the proposed regulations will hamstring small producers from standing out in an increasingly-crowded field of competitors, both licit and illicit.  

NOM-199 will change how many Mexican spirits are named and categorized. The biggest change under the new regulation is the creation of a new umbrella spirit called “komil.” Under NOM-199, any agave distillate spirit that is 51% or more agave and is produced outside of certain defined Denomination of Origin regions in Mexico must be labeled komil, a word not defined in the regulation nor known by most consumers, but which appears to originate from the Nahuatl word for “alcoholic beverage.”

In the new world of Mexican spirits there would be no distinction between a small-production 100% agave spirit made using traditional methods, and a 51% agave / 49% filler mixture, including industrial spirits made on a mass scale in commercial facilities. No reference can be made to what agave varietals are used; in fact, the word “agave” itself cannot be used in any labeling. As a result, small producers would be unable to distinguish their products based on agave varietal, location, or production method and consumers would have no clue what they were imbibing under the komil name.  (To further complicate matters, Wild Agave Imports, LLC of Texas filed a USPTO intent to use trademark application in January for the word mark “Komil.”)

It is not yet certain that this regulation will, in fact, be enacted. A similar regulation was defeated in 2012 after a concerted effort by independent producers and retailers. There are already a number of petitions opposing NOM-199 that have are gaining support, and it may very well be that the public outcry will be enough to change the course of this regulation. On March 17, David Suro, president of the Tequila Interchange Project, a non-profit advocating on behalf of the agave distilled spirits industry, and one of the leading voices of Mezcal promotion in the United States, and others filed their comment in opposition of NOM-199 with Mexico’s Regulatory Commission.

Retailers and consumers of agave spirits here in America should watch with interest as NOM-199 goes through its comment and enactment process. Depending on what happens, we should all keep our eye on the Mexican spirits that end up behind bars and on shelves in the near future.  

Warning - CA ABC enforcement teams are on the prowl this weekend!

Yesterday morning (March 10th) the CA ABC quietly issued a notice informing the public that on Saturday, March 12 it will be conducting, in conjunction with “as many as 100 local Police and Sheriff’s Departments” a statewide “shoulder tap decoy operation.” 

In shoulder tap operations, minors under the supervision of law enforcement officers will stand outside stores that sell wine, beer and spirits (potentially including urban winery, brewery and craft distiller tasting rooms) and attempt to solicit adults to purchase alcohol for them.  If an adult agrees to purchase alcohol for the minor decoy, the adult will be arrested and cited for furnishing alcohol to a minor.  “The penalty for furnishing alcohol to a minor is a minimum $1000 fine and 24 hours of community service.”

If the merchant knows or should have known that the adult was purchasing for a minor the merchant would also be liable for the crime, and its license would be at risk. An example of this would be when a licensee employee sees the minor hanging out in front of the location, and doesn’t take steps to tell the minor to move on.

While the goal of a shoulder tap operation is to curtail the purchasing of alcohol for underage individuals by adults, the increased law enforcement presence has in the past, and will undoubtedly in this operation, lead to additional arrests and citations for other, alcoholic beverage law related offenses.  Hundreds of law enforcement agents focusing on licensee alcohol sales protocols means that all aspects of the licensees operation (including compliance with conditions) will be examined and, if the licensee is found wanting, will result in accusations.

The ABC press release states that during a similar operation last year, citations were issued for “open containers, false identification and other violations.” We are assuming that no one wants to be part of a sale to a minor.  It’s the “other violations” that give us (and should give every licensee out there) heartburn. Retailers should be extra vigilant this weekend to ensure they are fully compliant with all laws and regulations – the police are out in force! 

The timing of the operation and the notice will allow the ABC to claim that they gave notice of the operation, which could result in aggravated discipline.

If you would like a refresher on compliance, Hinman & Carmichael has 30+ years of experience in the arena.