Arizona's Direct to Consumer Shipping Rules - An Exercise in Complexity

Many wineries that ship direct to consumer (DTC) in Arizona have received compliance notices from the AZ Dept. of Liquor Licenses and Control (DLLC), seeking to audit how much wine they produce to assure compliance under Arizona’s byzantine DTC laws. 

What’s going on in Arizona?

People are wondering, what’s going on in Arizona? According to the DLLC the step-up in enforcement is due to a recently-implemented new reporting mechanism developed with input from the industry to make it easier for wineries to do their reporting (which is not a new requirement), and for the state to track that reporting.  To streamline the process, reporting is now done online (via this page).

Arizona has the dubious distinction of having some of the most complicated direct shipping rules in the country.  We thought it might be helpful if we broke them down and made them a little easier to understand for non-Arizona wineries (and tiny distillers – you too can ship direct!):

The Production Requirements – What are they?

The bottom line is that the amount of alcohol produced per calendar year by the licensee with the permit is the basis for the Arizona direct shipping rules.  It’s best to be a very small winery, and the requirement to be licensed is measured on a facility by facility basis. Each individual winery (regardless of common ownership by a parent company) counts as one permittee.  If the winery produces between 200 gallons/year and 20,000 gallons/year and obtains an Out of State Farm Winery license from the DLLC, the winery will be allowed to ship any amount of wine that the winery produces or manufactures to an Arizona individual, regardless of whether they purchased the wine in person at the winery, or over the Internet, phone or other method.  Wineries in this category are also allowed to sell direct to trade (i.e. to Arizona retailers, both on- and off-premise). 

Craft Distillers are included in the DTC program

Small craft distillers may take advantage of this privilege:  A craft distiller producing no more than 1,189 gallons/year (and obtaining an Out of State Craft Distillery license), may ship any amount of their products directly to AZ residents who order it via Internet or any other method, as well as directly to AZ retailers. This is an important privilege.

What about the larger wineries?  Now it gets confusing. The 8,333 to 16,600 case winery restrictions

It a winery produces between 20,000 and 40,000 gallons (16,666 9L cases of wine) per year, it is still eligible for a Farm Winery permit, but the winery can only ship its wine to an Arizona resident who had at some point visited and made an in-person purchase at the winery with the permit, and the winery is limited to shipping 2 cases per individual per year.  The winery must keep records that can back up the in-person visit, such as a signature and ID-verification in a logbook, etc., as Arizona requires such records to be kept for two years.   This is where the audit comes into play, as the state audits the production limits, the visit requirement and 2 cases per year requirement.

How about the big wineries, can they do anything?

Yes. Although wineries that produce over 40,000 gallons/year are not eligible for the Farm Winery Permit, if they hold any other license in Arizona (such as an Out of State Producer license for shipping to Arizona wholesalers), they don’t need any additional license in order to ship DTC, though they still must follow the in-person purchase rule and the 2-case per person per year rule.

This is important: The DLLC interprets the in-person purchase requirement to mean that the person must visit the winery, at some point (and the winery must have records to back this up), but does not require that person to place each subsequent order in-person at the winery. The winery is required to keep records for two years, but in order to keep shipping directly to a person beyond the two-year period, the winery would need to have a record of that person's on-site purchase (which may reach back more than two years). Again, this is subject to audit.    

General Requirements

For all of the direct shipment methods described above, age verification at time of purchase is required.  Additionally, products cannot be shipped to a licensed premises but only to an individual for personal use; the delivery person must be at least 21; and the packaging must contain language identifying the contents as alcohol and that an adult signature is required.  And last but not least, shipment reports are required from both the shipping winery and the carrier that shipped the product.

Finally, the Arizona Direct Shipment Permit

And finally, there is what’s called a Direct Shipment permit in Arizona – but it’s not at all what it sounds like, and is a last resort.  It is for any winery that holds no other licenses in Arizona and wishes to ship DTC to consumers who have not visited the winery in person. It allows an out of state winery to take orders via Internet or any other method from and ship to a consumer, but the shipment must go through an Arizona wholesaler and retailer, and the retailer must be the one who makes the delivery to the consumer.  Cumbersome? Yes.  Does anyone do this?  Probably not many large wineries take advantage of this dubious solution.

What’s next?

There are rumblings that the confusing DTC situation in Arizona may be cleared up with legislation next year, so stay tuned.  However if you get an audit letter, read this blog post (and the requirements in the audit letter) carefully and make sure that you are eligible for the shipping method that you are using.  Failure to properly comply carries potentially serious consequences.

The Biggest Retailer in the World vs. the TABC

Wal-Mart sells spirits in 25 states, and it would very much like to sell spirits in Texas.  However, Wal-Mart can’t sell spirits in any of its 543 Texas stores because of several bizarre legal restrictions on package store ownership in Texas.  So last month Wal-Mart filed a suit in federal district court in Texas against the Texas Alcoholic Beverage Commission challenging those statutes on constitutional equal protection, commerce clause and general “these crazy statutes don’t make any sense at all” grounds.

Wal-Mart does not qualify to sell spirits in Texas because (a) Wal-Mart is a publicly traded company, and (b) Wal-Mart does not operate hotels (publicly traded hotels may have package stores inside their hotels).  Texas’ ban on publicly traded corporations holding package store licenses goes back to 1995.  Before 1995, Texas prohibited any out of state company from owning a package store license in Texas, but this was struck down by the Fifth Circuit, as the court found the state couldn’t offer a justification substantial enough to authorize such discrimination against non-Texans. 

Immediately after the Fifth Circuit put the kibosh on barring non-Texans from holding package store permits, the Texas legislature passed the bill that prohibits public corporations from doing so, though it made an exception for publicly traded hotel corporations.   The Texas Package Store Association was the principal supporter of the bill, not surprisingly.  The fact that Walmart would be the largest private employer in Texas apparently held no sway in the legislature that year.

Walmart stores and Sam’s Clubs now hold 543 beer and wine off-premise permits in Texas, which are called “Q” permits, but if Wal-Mart got even one package store permit (ignoring the fact that they can’t, as a public corporation), they would have to give up all 543 of those permits.  So Wal-Mart is challenging that restriction as well.

Then there's the five package store limit.  Even if Wal-Mart were able to qualify for a package store license (ignoring for the moment that it would have to give up its 543 beer and wine store permits to do so), it would be limited to five package stores in the entire state.  There are similar restrictions in other states - MA comes to mind - but Texas has a Texas-sized loophole in its law. If you are a Texan and own five package stores, and your Texan parents own five, and your Texan sister and brother both own five, the law allows you to consolidate all twenty of those stores into one entity.  Not only that, but you can sell your business and transfer all of those licenses to another entity who doesn't have to be related to you. That's how Spec's and Twin Liquors own so many package store in Texas; 160 and 76, respectively.

Wal-Mart isn’t challenging the three-tier system in Texas in any way. Its claims revolve solely around the discriminatory laws that Texas imposes on package store licensure, and it does a good job of arguing that those laws should not stand up under the Equal Protection Clause and the Commerce Clause of the U.S. Constitution. It's true that Wal-Mart can be seen as a Goliath in a lot of ways, but everyone should be cheering for them this time. 

DC Weighs in Strongly on Third Party Marketer Delivery Services

On August 13th the District of Columbia ABC Board issued an Advisory Opinion directed at third party marketers who develop websites and apps that allow consumers to purchase alcoholic beverages from brick and mortar retailers and have them delivered.  The DC Advisory is not directed at any particular company, but there are a number of such third party providers (“TPPs”) opening up in various cities throughout the U.S. this year and the service they are providing is a fairly new one.  No state regulators have weighed in on this particular model, other than the New York State Liquor Authority in its declaratory ruling last fall on Drizly.

The DC ABC Board does allow TPPs to “connect customers through the internet to a licensed off-premise retailer, as long as the transaction to purchase alcoholic beverages occurs between the consumer and the licensed retailer.”   The retailer must retain control over the transaction funds, and must be the one who makes the decision whether to fill the order or not; the retailer also must be the one who stores, packages, fills, and ships the orders.

The DC Advisory cites three other jurisdictions that have issued advisories on TPPs in general – California, New York, and Texas – but ends up going beyond them all in restricting the permissible activities of TPPs.  The following guidelines illustrate this narrow scope:

• The TPP cannot charge consumers’ credits cards or directly or indirectly collect or receive funds from the consumer.  The Advisory explicitly says it disagrees with the portion of the CA Advisory that allows TPPs to charge the credit card (and pass the full amount of funds to the retailer).
• The delivery person must be either the retailer, an employee of the retailer, or a “contractor of” the retailer.
• The sales transaction must occur directly between the consumer and retailer “through a separate written agreement.”
• The TPP fee cannot “stem from the transaction between the consumer and licensee” – that is, it must either be a flat fee, or else bear no relation to the transactions. It cannot be based on a percentage of the sale price.

The DC ABC Board appears to consider noncompliance with any of the foregoing to constitute (a) a violation by the retailer of the terms of its license (i.e. acting as an agent for a third party who is not a licensee); and (b) a violation by the TPP of DC’s statute prohibiting alcohol sales without a license.

One variation of the TPP delivery models that appears to comply with the DC guidelines is the Drizly model, which received a positive declaratory ruling from the NY SLA last fall.  Drizly is a TPP that markets retailers’ products on its app, and provides the technology necessary for the interface between retailer and consumer via the app, but the consumer’s funds are received directly by the retailer; the retailer or its employees deliver the products; and Drizly’s fees are flat fees rather than a percentage of the sales.

Though not mentioned in the DC Advisory, there is a 1995 Florida regulation that allows certain delivery service providers to act as agents of the consumer and may be helpful to today’s high tech service providers. The California and Texas advisories were directed at TPP models in general, not specifically to smartphone app delivery models, but they provide good guidance for all TPP providers who plan to operate in those markets.  For those looking to service the DC market, the safe harbor just got significantly narrower.

New Marketing Model for New York – Lot 18 and the NYSLA

On April 23, the New York State Liquor Authority held a hearing on Lot 18’s request for declaratory ruling on (as worded in the request for ruling), the “validity of using nationally recognized marketing companies to market wine clubs in New York State, which are offered for sale by a New York State licensed package store.”  The hearing was interesting and informative for anyone in the business of marketing wine to NY consumers. Lot 18 told the NYSLA in the hearing that it has secured a NY retail package store license (and location) and plans to provide product and fulfill orders for third party marketers, including the Forbes wine club.    As a licensed retailer, Lot 18 will be doing most of the work in connection with the Forbes Wine Club orders (accepting the orders, taking the consumer’s payment, customer service, and making the delivery arrangements).  Lot 18 will be purchasing the inventory for the Forbes Wine Club in advance of taking customer orders.

Based on the comments and questions by the SLA Board members at the meeting (most questions were friendly and the approach was approving), it appears likely that the SLA will approve Lot 18’s model as presented.

During the meeting representatives of other NY package stores spoke, or rather, aired their grievances regarding the Lot 18 model.  Most of the remarks addressed the concern that if third party marketing entities were allowed to utilize the services of a NY retailer,  the perceived result would be the lack of a “level playing field” for regular retailers (regular retailers being, in this case, those who do not affiliate themselves with third party marketing entities).  The NY retailers also voiced concern that they wouldn’t have access to the same products that were being sold by Lot 18 for the Forbes club. Lot 18 responded that about 40% of their products are true private labels (owned by Lot 18), which can be lawfully restricted to Lot 18.  The other 60% would be available to other retailers through the NY wholesale system.

In response to the accusations that Lot 18 is not a bona fide retailer since its store is only 800 square feet and only open 30 hours a week, Chairman Rosen observed that the SLA had held two public hearings on Lot 18’s license application, and that after investigation, the SLA does in fact consider Lot 18 to be a bona fide retailer.  Chairman Rosen also noted that the SLA has no policy against just in time inventory models.

Chairman Rosen mentioned that the SLA has been receiving complaints that the agency is not  offering more guidance regarding the subject of Internet marketing, unlike – for example – the CA ABC, with its 2011 Advisory.  Chairman Rosen pointed out that the SLA’s declaratory ruling on ShipCompliant was lengthy, offered good guidance, and that rather than having strict parameters, using the “rule of reason” is a better method by which to evaluate Internet marketing programs.  This observation comported with H&C’s blog post following the ShipCompliant hearing making the same point.

The next event will be the Wine Cellar’s hearing on its similar request for declaratory ruling, which has been rescheduled for June 4.