The TTB Crusade Against Small Producers and the “Consignment Sale” Business Model

By John Hinman and Gillian Garrett, Hinman & Carmichael LLP, and Richard Wender, Wender Law Group

Small Producer Market Access

By now most of the industry knows about the TTB’s crusade against small wineries in California, Oregon and elsewhere that use extended payment terms to provide wine to wholesalers in out-of-state markets, such as to Angels’ Share Wine – a wholesaler in New York.  

Extended terms, i.e., offering wholesalers a longer window in which to pay for their purchases, can be fluid because there are no state or federal laws requiring any sort of credit terms between producers or importers on the one hand and wholesalers on the other. The purpose of extended terms is often to allow a producer to make wine available to wholesalers, for use in prospecting calls, sales to retailers or simply working with the product, without the wholesaler bearing the risk of immediate payment.  Typically, as with Angels’ Share, wholesalers sell the wine in the remote marketplace within a relatively short time.  And, as with Angels’ Share, all the wine is sold.

The Definition of Consignment Sales - Practical Reality and the Fedway[1] decision

The TTB characterizes the business model described above as “consignment sales” between producers and wholesalers in violation of 27 CFR Part 11.  

The first problem with applying the defined term “consignment” to these extended sales terms is that the wholesalers own the wine until they sell it; and must eventually pay for the wine.  The wholesalers have no right to return the wine if a sale never materializes.  The wholesalers own, store, pay taxes, pay for shipment and sell all wines they purchase. This is NOT consignment as the term is generally used in commerce.  Rather, it is sale on extended terms, which still requires the wholesaler to pay for the wine but gives them more time to find a market for new products. 

The second problem with labeling extended term transactions as prohibited “consignment” sales is that these cases do not involve domination by one “tier” of the industry over another; or the inducement of a trade buyer (in this case a wholesaler is defined as a trade buyer) to buy the supplier’s product to the exclusion of a competitor’s product. 

The legislative history of the consignment sales statute shows that Congress was concerned that large and economically powerful buyers could use their purchasing power to compel sellers to sell inventory on consignment or force the seller to take back product – essentially controlling or dominating another tier. The statute was designed to protect the business independence of each of the three tiers. 

This overriding purpose and goal of the trade practice provisions was articulated by then Circuit-Court Justice Ginsburg in Fedway.  Justice Ginsburg focused on the use of market power by suppliers to induce retailers to buy products from one supplier to the exclusion of products from other suppliers.  The “inducement and exclusion” and market power tests for liability she articulated in Fedway underly the trade practice regulations adopted after the decision was published.

While Fedway did not specifically mention consignment sales, because the distributor (selling to a retailer) in that investigation and proceeding was not charged with consignment sales, the principles of inducement, exclusion and market power equally apply to the charges made in these cases.

Further, the absence of the express exclusion element for consignment sales in the regulations does not negate the court's clear articulation of Congress' purpose to prevent domination and control by one tier over another as the pervasive goal of the statute.  Various court decisions, legislative history, and past bureau practice all support this conclusion.   

Ultimately it will be this issue – the failure of the TTB to allege or prove there was any prohibited domination of one tier over another - that will go to the federal courts when the TTB finishes with its crusade; assuming the TTB does not rule in favor of Angels’ Share at the administrative level (where these cases are right now).

This analysis also is supported by the legislative reality that extended terms (over 30 days) are specifically prohibited between suppliers and retailers but permitted (with no specific time limit in the regulations) between the importing, producing and wholesaling tiers of the industry. This case alleges violative conduct between producers and importers on one hand and wholesalers on the other. The fact that supplier/retailer transactions are subject to state and federal credit laws, and producer/wholesaler transactions are subject to no federal credit laws, will figure heavily in the ultimate determination of these cases.

Late Payments or Consignment Sales – which is it?

TTB relies on Section 11.22 of the Code of Federal Regulations in arguing that the actions by the various wineries and importers here constituted consignment sales, even without the right of return and even without any showing of restraint of trade.  Section 11.22 defines consignment sales as “arrangements wherein the trade buyer is under no obligation to pay for distilled spirits, wine, or malt beverages until they are sold by the trade buyer.”  TTB’s reliance on this provision in these cases is problematic and misplaced for two reasons.

First, as noted above, the failure to require a showing of exclusion and restraint on trade for a consignment sale violation is simply inconsistent with the purposes of the trade practice provisions in general and does not achieve the goals of those statutes.

Second, this provision directly conflicts with the fact that there are no required credit terms between supplier and wholesalers at either the federal or state level.  Under federal law, a supplier is free to give a wholesaler an unlimited amount of time to pay for the wine, beer or spirits it has purchased.   If a supplier gives a wholesaler 60 days to pay its invoices, but the wholesaler does not pay until after the wholesaler has sold the products, is the supplier then guilty of engaging in consignment sales where such late payment was not a result of any agreement or arrangement between the supplier and the wholesaler? If a supplier does not give the wholesaler any term for payment of the invoice (which is it legally permitted to do), and the wholesaler simply does not pay until after it has sold the wines, is the supplier then guilty of engaging in consignment sales where such payment was not a result of any agreement or arrangement between the supplier and the wholesaler? That is what the TTB seems to be saying here and that is simply incorrect.  Late or delayed payments to suppliers by wholesalers, or payments made after an extended period of time, are common in the industry and are simply not consignment sales under federal law, even if payments are made after the products have sold.

In fact, many industry members have built their business model on extremely long terms that mirror the Angels’ Share terms, although some do include ultimate end dates for their terms (years out sometimes).  If this is the model that the TTB believes is lawful, the result is absurd and TTB is elevating form over substance to the detriment of competition and in derogation of the intent of the legislation. 

The “Successful” TTB Prosecutions – Against Who and at What Cost?

TTB’s misunderstanding of consignment sales has resulted in significant costs to small wineries who had no intention of exerting influence over other tiers of the industry and complied with federal law under Fedway.

We estimate the TTB’s cost in investigating and prosecuting these small family-run wineries is running into the hundreds of thousands of dollars for each case.  These “successful” prosecutions, according to the TTB, are ample justification for their previous additional $5 million trade enforcement budget, and for their budgetary ask for the coming year. 

The TTB has published regular press releases reporting on their “success” in obtaining more than a dozen stipulated permit suspensions against small wineries who attempted to build their New York and other remote states market presence through Angels’ Share.  A real success would be to define what is, and is not, a permissible consignment sale, and what payment terms are lawful.   This would not only level the playing field, but free up TTB to focus on truly anticompetitive trade practices and keeping products in our market safe for consumers.   

Instead, these investigations stifle the growth of the small wineries to the benefit of the large wine producing conglomerates and the multi-state wholesalers who have neither the time or the inclination to buy wine from small producers without an established market presence. This is the opposite of what Congress intended when it passed the consignment provision.

Targeting the Small Wineries

The TTB exclusively targeted small businesses without in-house legal staff who must rely on expensive outside counsel arrangements to defend themselves.  Most of the small producers and importers have incurred significant legal fees.  All have diverted financial resources away from developing their businesses and paying employees. 

These stipulated permit suspensions do not affect the on-going production of the wineries and only require that tasting room sales be postponed for one day. Most targets preferred to settle the TTB’s claims rather than continue to suffer the disruptions in their day-to-day business operations occasioned by the constant invasion of TTB investigators, and the growing legal costs of fighting the TTB’s threats of more severe penalties.  

Many targets with inadequate legal defense budgets reasoned that a one-day suspension on a convenient Friday (such as the day after Thanksgiving Day) was the best business decision; even though having a record as a violator that must be disclosed in detail in every future state license and permit application was a consequence. The common penalty for deliberate failure to disclose the details of the violation (the forms are under penalty of perjury) is revocation of the license or permit being applied for or renewed. The settling wineries are marked forever.

No one argues that the TTB’s job is not important – it is, and the TTB personnel are dedicated professionals – but the priorities should be investigating the real abuses in the national alcohol market; not building a string of successes at the expense of small wineries using a legitimate tool – extended terms – to build their brands.

TTB Scorched Earth Prosecution and Denial of Consolidation

The attorneys for Angels’ Share asked the TTB to consolidate the cases against the small wineries and to file their case against Angels’ Share because the issues and evidence were substantially identical in all the cases – only the parties were different.  This would have allowed all the producers and Angels’ Share to pool their resources in a full and fair hearing on the fundamental legal issue– whether extended terms between producers, importers and wholesalers are prohibited by the consignment sales provisions of the FAA Act. 

But the TTB has refused to bring the cases together, has opposed the wineries’ requests for consolidation and has instead launched expensive discovery and deposition proceedings before multiple (and TTB-paid) independent administrative law judges (such as those from the Federal Bureau of Mines) engaged solely for each case.   Educating multiple administrative law judges with no experience in the alcohol industry (but lots of experience with mine safety) in how this industry works is an expensive and time-consuming proposition.

The TTB insisted that each small producer litigate its case independently, knowing full well that the producers – most of whom produce only a few hundred cases of wine per year -- lacked the resources to do so.  Thus, the TTB could “score” an easy win, not on the merits, but merely to improve its scorecard and justify its trade enforcement budget. The TTB has no incentive to economize with its $5 million budget.

More Stipulated Permit Suspensions – and Angels Share wants its day in court

This week four more wineries, Grable Vineyards, Albini Family Vineyards, Five Vintners and Carabella Vineyard & Winery, and a small importer of Greek wines, Cava Spiliadis, along with other wineries, are being forced to agree to a settlement with the TTB on these terms.  All would continue the litigation if they could afford to do so but they can’t – so they are leaving the defense of the business model to Angels’ Share – which has asked the TTB to file its case and proceed to hearing expeditiously.  Angels’ Share wants its day in court.

All the settling producers will testify they thought the model was lawful and that they have been bullied by the TTB into agreeing to take a permit suspension they do not deserve.  This is not a secret and the TTB already knows this from statements made in depositions.  All believe that the business model is legal and effective in helping them get to market in today’s growth-inhibiting environment of massive wholesaler consolidation, and all want to use the model.

This is the operative term from the settlement agreement with the TTB:

  • “[Industry Member] continues to deny the allegations.  [Industry Member] asserts that it did not knowingly violate any laws and is withdrawing its hearing request due to the mounting cost of defending the case, which it is unable to afford.”  

The TTB has told Angels’ Share’s attorneys it will not bring its case against Angels’ Share until all the cases involving the producers have been completed.  Why?  Because the TTB knows that Angels’ Share intends to defend its position on its legal merits and if it wins, it would bar the cases against the producers that the TTB is now racking up on its scorecard.  This is unfair to the small wineries that will now continue to have an enforcement record even if Angels’ Share, as expected, ultimately prevails.

The Bottom Line – How are the Enforcement Dollars Being Spent?

When you look at the bottom line, what is the TTB doing with a significant portion of its new enforcement budget?  It is spending taxpayers’ money to bring a multitude of cases against small producers who make up a tiny percentage of the market on a questionable legal theory.  The cases do not affect real abuses in the marketplace and only stifle competition.  The TTB has lost its way.  Instead of using its resources to police the real marketplace abuses (especially those attributable to the current wave of massive retailer, wholesaler and producer consolidation), its purpose has morphed into justifying its own budget, at whatever cost to the small producer industry – which has been the historic backbone of the wine, beer and spirits industry in the US. 

This topic was explored in greater detail in the series of blog posts by our colleague Rob Tobiassen, the former Chief Counsel of the TTB, here, here, here and here.

Regardless, we cannot emphasize enough the importance of the real and enduring purpose of the TTB and the dedicated compliance and enforcement professionals that work there every day throughout the country – which is to manage international, national and interstate commerce in alcoholic beverages to the benefit of every citizen and business in the United States.  These professionals deserve our respect and admiration.

Conclusion

This case is about the viability of the Angels’ Share business model of using extended terms of sale to permit small producers to build a presence in remote markets.  This business model enables the small producer segment of the alcoholic beverage market (wine, spirits and beer) to use their inventory to expand into remote markets they otherwise could not reach because true power in the modern alcohol marketplace is held by the large retailers and increasingly consolidated wholesalers, not the small suppliers.  Defending this business model, and small producer market access, is a worthy cause and one which we, as industry lawyers, believe in and for which we are working.


[1] Fedway Associates, Inc., et al. v. United States Treasury, Bureau of Alcohol, Tobacco and Firearms, 976 F.2d 1416 (D.C. Cir. 1992)

 

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