Michigan: Canary in the DtC Coal Mine?

A note from John Hinman: The following is a guest blog post by Jeff Carroll. Formerly VP of Compliance at ShipCompliant and a wine industry veteran, Jeff is an astute observer of wine industry trends and continues to stay on top of industry developments while blogging at Obsequium. On breaks from chasing two young kids around, you can find him on the slopes of Colorado or on the tennis court.

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The Michigan Timeline: a great case study of how DtC marketing and sales are evolving in a key state:

• 2005: Wineries prevail at the Supreme Court in Granholm v Heald in their case against the states of Michigan and New York, which had prohibited direct shipping.
• 2005: HB 4959 is signed into law, allowing out-of-state wineries to ship to consumers.
• 2008: Retailers successfully sue Michigan in Siesta Village Market LLC v Granholm, forcing Michigan to allow out-of-state sales by retailers.
• 2008: Michigan immediately passes SB 6644, leveling down on DtC shipping by retailers, but with an exception for delivery with a retailer’s own trucks.
• 2014:MB&WWA issues an RFP for a private investigator to conduct investigation in collaboration with law enforcement
• 2015: The Wine & Spirits Wholesalers of America (WSWA) invests in Drizly.
• 2015: MLCC begins sending out warnings and fines for DtC shipping violations.
• 2015: MB&WWA issues Michigan “Wine Direct Shipping research and Analysis" report
• 2017: SB 1088 is signed into law permitting local delivery but prohibiting out of state retailer shipping into Michigan.
• 2017: Retailers sue Michigan on Commerce Clause grounds.

Over the last several years, direct-to-consumer (DtC) wine shipping grew at a blistering pace. According to the recent report issued by ShipCompliant and Wines & Vines, the value of wine shipped by US wineries reached $2.33 billion, representing 75% growth since 2011. No longer a niche channel for high-end wineries, DtC shipping is moving towards maturity.

So, now that 93% of the US population has legal access to direct shipments by wineries, what should we expect in the next phase for the DtC channel?

The Michigan experience is a roadmap. The recent flurry of legislative activity that has resulted in a third important lawsuit against the State of Michigan related to DtC shipping legislation provides both clarity and a better understanding of the motivations of each of the tiers of the wine industry in every state.

Wineries are mostly in clean-up mode

With the passing of DtC legislation in Massachusetts and Pennsylvania over the last few years, wineries can now legally ship wines ordered off-site to 43 states (plus Washington D.C.) representing 93% of the US population. Only Alabama, Delaware, Kentucky, Mississippi, Oklahoma, Rhode Island, and Utah prohibit off-site shipments. Although these states will eventually pass DtC laws (the pressure is on from the winery associations, as well as from consumers), it may take another five or ten years to fully play out in the more conservative legislatures.

Meanwhile, winery advocates are working to tweak some of the more problematic provisions in the states that allow DtC shipments. Michigan’s new legislation (SB 1088) is one such example of a "clean-up" initiative. Going back to the 2005 DtC legislation, the original Michigan statute required wineries to print their direct shipping license number as well as the order number on the shipping label. The MLCC also required the product registration number to appear on invoices. SB 1088 removes the unique requirements for the outside of the box, and also clarifies that registration numbers are required but need not appear on the label or on invoices. Both will greatly simplify compliance for licensees. Cleaning up mostly useless requirements is a positive.

Retailers need a Granholm moment

While wineries have seen tremendous success with DtC legislation since the watershed Granholm ruling, wine retailers have actually moved backwards and today can legally ship to only 14 states, representing only 24% of the US population. This lack of traction and ineffectiveness can be attributed to tremendous pushback and legislative clout from both wine wholesaler and local package store associations.  The issue for both is competition.

In Michigan, for example, while the Michigan Beer & Wine Wholesalers Association (MB&WWA) maintains neutrality when it comes to DtC shipping by wineries, the group opposes DtC shipping by out-of-state retailers. This is reflected in SB 1088, which also creates a new license to allow in-state retailers to ship to consumers but prohibits out-of-state retailers from doing the same. According to Spencer Nevins, President of MB&WWA, there are “only a limited number of wineries in the United States. In contrast, there are hundreds of thousands of wine retailers in the United States."

The prohibition against out-of-state retailers creates at least three challenges for Michigan consumers. First, foreign wines can only be purchased through the inventory available at Michigan retailers. National wine clubs and alternative distribution models like Wine.com will also have a hard time reaching Michigan consumers now without owning a bricks and mortar retailer in Michigan. Finally, out-of-state shipments will be limited to wines from a single winery at a time (no mixed shipments).

Retailers jumped on the discriminatory nature of SB 1088 and filed suit against the Governor, Attorney General, and Chairman of the MLCC in US District Court. Similar to lawsuits filed in Illinois and Missouri, an out-of-state retailer plaintiff seeks a judgement on Commerce Clause and Granholm grounds. Lebamoff Enterprises Inc. v Snyder is the third major court case brought against Michigan regarding the direct shipment of wine following Granholm and Siesta Village Market.

The National Association of Wine Retailers (NAWR) would like nothing more than to replicate the momentum and success that wineries had following the Granholm ruling of 2005 and are hopeful that the three current suits in Michigan, Illinois and Missouri will move them closer to the Supreme Court and a possible landmark ruling to clarify the scope of Granholm. “The Lebamoff case is identical to the Siesta Village Market case Michigan lost in 2008. Once again, wine wholesalers have put their own interests ahead of those of Michigan consumers with this facially discriminatory bill,” said Tom Wark, Executive Director of NAWR.

Wholesalers want more enforcement (plus a piece of the pie)

Prior to 2015, wholesaler groups primarily opposed DtC shipping in general without offering much in terms of alternatives. Now, as evidenced by Michigan, they are mostly conceding the battle to wineries but remain adamantly opposed to out-of-state retailer shipping.

But does the 2015 investment in Drizly by the Wine & Spirits Wholesalers of America (WSWA) signal a shift in philosophy?

Allowing (and encouraging) in-state retailers to ship to consumers appears to be part of a new wholesaler strategy to participate in the growing and important DtC channel. Spencer Nevins expanded on the motivation behind the SB 1088 legislation when he cited a "desire to expand access to wines for Michigan consumers in a manner that can be realistically and effectively regulated by the MLCC and by a desire to embrace the recent development of third-party facilitators such as Liquor Limo and Drizly.” SB 1088 also creates a “Third Party Facilitator” license to enable services that create third party apps and websites to advertise wines available, but only through in-state retailers.

At the same time, wholesalers are working with state liquor control agencies in multiple states, including Michigan and Illinois, to seek better enforcement of DtC laws and regulations. In Michigan, the MB&WWA issued an Request for Proposal (RFP) for a private investigator to “research the scope of direct shipping of alcoholic beverages in Michigan” through controlled buys with law enforcement. The RFP identified several companies to target specifically, including the Wall St. Journal Wine Club and Amazon Wine. The resulting report, prepared by The Hill Group, found very low compliance rates, although the selection methodology for the 18 vendors used for controlled buys in the report is fuzzy.

A central component of this effort to crack down on illegal shipments is to adopt new bills like SB 1088 in Michigan and HF 791 in Minnesota that create licenses for common carriers (FedEx and UPS) and requires the carriers to submit detailed periodic reports of all shipments (what, from who, to who, etc.) containing alcohol coming into the state. While this allows liquor control agencies to better monitor, quantify, and enforce tax payments for DtC shipments, it also creates a means to identify shipments from industry members that are legally barred from obtaining permits and paying state taxes.

New battle lines are drawn

We are in a new era of direct wine shipping where laws allow consumers in most states to purchase wines from domestic wineries but not from importers or out-of-state retailers. At the same time, agencies, who now have the tools to do more active monitoring, continue to step up enforcement. With the addition of laws such as SB 2989 in Illinois, the penalties for failure to comply with the requirements include a felony and potential jail time; high stakes indeed. Additionally, the new carrier reporting laws will force FedEx and UPS to create much stricter controls for wine shipments. In turn, wine businesses operating in the “gray” areas of the law will be exposed while wineries and in-state retailers that are legally able to operate compliantly will benefit.

Retailers are gearing for a fight while wholesalers dig in and begin to embrace the DtC trend. The three retailer shipping cases will either provide a boost for retailers or will affirm the status quo. In order for significant change to come about, consumers and rare wine collectors will have to become a significant part of the conversation. Retailers are hopeful they'll demand a broader selection of imported wines, mixed shipments, and innovative business models.

We’ll be watching these trends closely over the next few years, and as the industry turns this interesting corner we see in Michigan the proverbial canary in the coal mine.

California ABC and Federal Credit Laws – Active Enforcement and Lots of Questions!

This edition of Booze Rules is published in conjunction with the launch of our new video web series, the Booze Bulletin.  This post on credit laws digs into the specifics of some of the issues discussed in our video Booze Bulletin. 

The important news is that the California ABC, with an invigorated trade enforcement unit, is actively enforcing the California 30-day credit law. Accusations charging credit law violations were filed in the fourth quarter of 2016.

A violation of the 30 day rule (or shorter period in many states) is a federal and state crime for the provider of credit (the supplier) and a state crime for the receiver of credit (the retailer).

The CA state level penalties for failure to comply typically include a license suspension or a $10,000 fine for the supplier (with escalating fines for successive violations), and license suspensions or a $3,000 fine for the retailer for a first violation, with escalating fines for successive violations. The federal penalties for the supplier are just as serious but the fine level may be far greater depending on the assessment of culpability by the TTB.

Intentional violations are treated much more seriously than negligent violations by both agencies.

The Reason for the Credit Laws

Providing credit in excess of the permitted period is considered to be a “thing of value” and the prohibition on excessive credit goes back to the dawn of trade practice enforcement following the repeal of Prohibition. 

The regulatory concern with the provision of credit from alcohol suppliers to alcohol retailers has it genesis in the pre-prohibition American saloon.  In the early part of the last century brewers and distillers used credit and consignment sale techniques to induce saloon owners to carry their brands of beer and spirits over competing brands.  Preventing abuse of credit was a core concern of alcohol regulators from the early 1930’s onward because the technique had been so widely used by pre-prohibition distillers and brewers.

By offering long credit terms the suppliers locked in the retailers and increased consumer consumption of their specific alcohol brands to intemperate levels.  This theory of intemperate consumption underlies almost all of the tied house laws as they were enacted in the original Federal Alcohol Administration Act at the time of Repeal.

Over the intervening years, and even today, restrictions on credit have been adopted in some form in every state and are codified in the regulations implementing the Federal Alcohol Administration Act.

State and Federal Law

Federal law, applicable throughout the US, provides for a maximum of 30 days credit from a supplier to a retailer.  Federal law, however, only governs suppliers. (See 27 CFR 6.65 to 6.67)

Every state has regulated credit between suppliers and retailers, most mirroring the federal law, but some states prohibit credit altogether.  There are many cash states where no credit at all is permitted and all purchases must be on a COD or CBD basis (certainly a vendor’s dream – legally required in-cash purchases). 

In California the legislature (in 1963) enacted complex (and often difficult to decipher) credit restrictions intended to interpret and enforce the California 30-day credit law.  The calculations surrounding the 30-day credit law are found in the ABC Act at Business and Professions Section 25509.

Excerpts from Business and Professions Code § 25509. “Additional charge against retailer not making payment”

(a) A [supplier] who sold and delivered beer, wine, or distilled spirits to a retailer and who did not receive payment for such beer, wine, or distilled spirits by the expiration of the 42nd day from date of delivery shall charge the retailer 1 percent of the unpaid balance for such beer, wine, and distilled spirits on the 43rd day from date of delivery and an additional 1 percent for each 30 days thereafter. . .

(b) A [supplier] who sold and delivered beer, wine, or distilled spirits to a retailer and who did not receive payment in full by the expiration of the 30th day from date of delivery or who has not received payment of the 1 percent charge at the expiration of the 30th day from the day the charge became due shall thereafter sell beer, wine, or distilled spirits to said retailer either for cash or by receiving payment in advance of delivery until such time as all payments are received for the beer, wine, or distilled spirits sold and delivered to the said retailer more than 30 days previously. . .

(c) The 42-day period and the 30-day period provided for in this section shall commence with the day immediately following the date of invoice and shall include all successive days including Sundays and holidays to and including the 42nd or 30th day as the case may be. When the 42nd day from date of invoice or the expiration of each additional 30-day period falls on Saturday, Sunday, or legal holiday, the next business day shall be deemed to be the expiration day. . .

(d) All moneys received from a retailer in payment for any beer, wine, or distilled spirits sold and delivered to him or her shall be first applied to the payment of the oldest balance on beer, wine, or distilled spirits. . .

The California credit law requires that suppliers charge specific yet varying amounts of interest to their customers based on how late their customers are with their payments, and enforce cash on or before delivery terms to any customers who have past due accounts.  The federal law just requires COD or CBD terms to retail accounts in arrears.

In California, it is not easy to calculate when exactly an account is in arrears. The calculation is not made on a discrete invoice by invoice basis (as most purchase transactions are considered today in order to monitor and track specific product deliveries), but rather on a total amount of debt outstanding between the supplier and the retailer at any time basis as determined by the suppliers records.  If any debt owed by a retailer goes over 30 days from the date of delivery of any specific purchase (regardless of the reason, including claimed non-receipt of the product), all subsequent transactions between that supplier and that retailer must be cash before or cash on delivery until the account is brought current.  In addition, in another trap for the unwary, if any retailer debt goes over 42 days based on the same calculation, there is a mandatory 1% surcharge that must be collected before the COD requirement can be lifted, as well as another 1% payment for every additional 30 days.

The California accounting calculation provisions go back to the days (1963 specifically) when retailers and suppliers primarily operated on ledger cards showing deliveries and payments on an entire account basis rather than on individual invoices.   The result is that the accounting methods that are applied to ABC transactions by the statute are different than those that apply to most modern non-alcohol purchase and sale transactions.  This creates enormous accounting reconciliation problems for both retailers and suppliers when the delivery invoice is checked upon arrival and what is actually delivered doesn't match what was supposed to be delivered.    For this reason many retailers just pay invoices rather than question the delivery, which can and does result in a windfall to the supplier making a short delivery in the event that the delivery mistake never gets straightened out. 

In one case dating back several years a retail chain (one that has since been acquired by another chain) with central purchasing was threatened with having to send over 100 stores COD following an ABC audit investigation that showed central purchasing was over 30 days out to a specific supplier (because of unposted credit memos) until the accounting could be straightened out, and then had to face an accusation for the receipt of unlawful credit (the supplier involved, a major wholesaler, was also charged and paid the fine).    In another case a large California retailer audited their own records against actual deliveries and discovered literally millions of dollars of annual DSD (direct store delivery) overcharges from certain wholesalers, who insisted on invoices being paid regardless of what was actually delivered.

The wholesaler trade organizations have maintained (since the early 1990’s) that the assessment of accounting charges relating to researching non-conforming invoices (where receipts don’t match up to deliveries, and whoever made the mistake is responsible for research costs) are prohibited “things of value,” a position that makes the cost-effectiveness of internal auditing of massive numbers of invoices where the delivery records are disputed very difficult. This is not an issue limited to California; alcohol vendors throughout the US benefit from these restrictions, and from the application of strict credit laws to the resolution of otherwise normal delivery disputes.

The issue of when the clock for a violation starts ticking is critical.  The statute uses the term "date of delivery." This obviously requires all parties to keep track of actual delivery dates regardless of the date on the invoice (which may be earlier, or occasionally later) than the delivery date).  While the ABC does allow 15 days after delivery to return products in excess of those ordered, after 15 days permission has to be sought from the ABC to make returns.  This is a procedure that is seldom used, and there is no legal procedure for managing short deliveries.

Because of these confusing requirements, every accounting department of every winery, brewery and retailer should regularly review the credit restrictions and should structure their accounting and collection protocols to comport with the federal and state credit laws.    The penalties are substantial and the odds of getting caught if there is an investigation (usually triggered by complaints from competitors) are very high because the records that are kept by both the supplier and the retailer are easily available for audit upon request of the agency as a matter of law.

Our message? Train your salespeople and accounting department and track your invoices which, by the way, are legally required to be maintained for three years.

Big Bottles For The Holidays - The Highest Calling Of The Winemaker's Art

To kick off the holiday season this year, Hinman & Carmichael LLP celebrated the 30th annual Big Bottle Party on December 1st at the University Club in San Francisco, overlooking the City on a beautiful starlit night.

The purpose of the event was to honor the winemakers of California and throughout the world, whose large formats are generously offered as lots at wine industry charity auctions. These special wines are the highest calling of the winemaker’s art and we consider it our duty to share the large format lots we buy at the charity auctions with our friends and colleagues, and with the winemakers themselves; many of whom were in attendance.

This year a wonderful time was had by all, and the large formats – Jeroboams, Rehoboams, Imperials, Salmanzars, Balthazars, Nebuchanezzar and Melchoirs – were perfect for the evening. Those assembled enjoyed Champagne, Pinot Noir, Rose, Zinfandel, Chardonnay, Cabernet, Syrah, Viognier and many blends, as well as the great food available from the University Club.

The large format wines that were served were all sourced from wine industry charitable auctions (including Sonoma County Vintners, ZAP, Rhone Rangers, Lodi Vintners, Reggae and Rhone, Winesong as well as other events). We urge everyone who has Big Bottles in their cellars to share them generously with their friends and family this holiday season.  Ask the winemakers – that’s why they made the wines!

Please enjoy the video from the H&C 30th Annual Big Bottle Party.  

Cheers and Happy Holidays!

Hinman & Carmichael LLP

FINAL COMMENTS TO TTB NOTICE 160 DUE ON WEDNESDAY DECEMBER 7TH – WE ARE ASKING THE TTB TO EXTEND THE COMMENT PERIOD AGAIN TO ALLOW FOR INDUSTRY NEGOTIATION AND ALIGNMENT OF INTERESTS

As the TTB’s 90-day extension to submit comments on the proposed rule changes governing the use of label exemptions for wine sold intra-state comes to a close, there is only one thing that has been settled.  TTB Notice 160 is very controversial.

The original proposal responded to the concerns of wineries in various AVA regions that when grapes from those regions are being sold to wineries outside of the state the resulting wine could then be labeled under the current “in-state sale only” exemption with AVA identifying information; contrary to non-exempt federal AVA labeling requirements mandating that the wine bearing an AVA be produced almost entirely within the AVA. 

The bottom line is that under Notice 160, the exemption would be no longer available and the out of state wineries that buy the grapes from AVA areas would not be permitted to identify on their labels where the wine grapes used in their wine came from.  This would both depress the price and desirability of wine grapes sourced from growers in areas that carry an AVA designation, and result in non-California wineries using out of state grapes from AVA designated areas being unable to tell consumers where their grapes originated.

We extensively summarized the various points of view in our August 15, 2016 blog post before the last extension of the TTB comment period.  The current extension for comments period expires on December 7, 2016 and we are sending this blog to the TTB as a comment. 

What we are asking for is another extension to allow time for the industry to attempt to arrive at a negotiated consensus.  If you agree with us, please copy the blog and email it to the TTB as an endorsed comment.  Here is the Notice as published in the Federal Register with filing instructions.

The purpose in asking for another extension is to permit the different affected participants (wineries and growers) time to arrive at a compromise that both permits the sale of the fruit, and satisfies the consumers right to know where the grapes in their wine came from. Without a compromise one possible outcome is First Amendment litigation that could undermine the entire AVA system.  Another outcome could be widespread scoffing at the AVA system through moving the identifying information that should be on the label on-line.

Is a compromise possible?  The Napa Valley Vintners have been circulating a white paper laying out a possible compromise through a mechanism they called “Grape Source Information” on the back label of a wine. The grape source information could not use the AVA of the area from which the grapes emanated but could use the address of the vineyard from which the fruit came. It is yet to be seen whether or not NVV will file this proposal with the TTB, as their first comment filed in August simply calls for the proposed changes to be approved.  Regardless, this is a very promising approach. However, in its current form (with identification limited to counties) it doesn’t completely accomplish the goal because (among other address related identification issues) viticultural areas (such as Lodi) are often located in different counties or in counties that are not that well known to consumers. 

However it is a framework for compromise and, as such, we believe that the discussions should be continued.

We urge the TTB to keep the comment period open for at least another 90 days.

SONOMA COUNTY WINERY USE PERMITS, EVENT RESTICTIONS AND DTC

BOOZE RULES GUEST BLOG

There have been hundreds of articles and reports in recent months detailing winery marketing event restrictions in Napa, Sonoma and throughout California.  Local authorities from Santa Barbara to Napa to Sonoma have been grappling with the winery and hospitality business need to market their wines to visiting customers against the desire of local residents (many of them new to the wine country) to experience a quiet agricultural countryside. This conflict is not going away and is reflected in applications for new wineries being protested and in applications for use and event permits for existing wineries being denied.  The DTC model is essential to the survival of the small to medium size winery, and entertaining visitors is essential to the DTC model. We and our colleagues at Carle, Mackie, Power & Ross, LLP, (a law firm on the ground in Sonoma County) are tracking Sonoma developments as they occur so that our winery clients and friends can input in the process. Kim Corcoran, an experienced wine business and litigation attorney at CMPR, attends the County Board of Supervisors meetings on these issues.  This is her report.

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Latest Developments on Winery Use Permits and Visitor Restrictions

Kim Corcoran, Attorney

Sonoma County wineries have been under attack in the last few years by groups in opposition to winery events, new wineries, and even the direct-to-consumer business model itself.  The vast majority of Sonoma County wineries are good neighbors and work to ensure that their impacts on nearby residents are lessened.  Most of the neighbors understand that they are living on land zoned for agriculture (which includes wineries), but opposition groups are advocating for more residential-oriented rights on ag land.  The wineries have pushed back, stating that without a high value crop such as wine, the land is worth more for housing tracts than it is for agriculture.  To help bring the parties to some resolution, the Board of Supervisors convened a Winery Working Group panel.  After many months of meetings, however the animosity seemed to grow stronger.  The issues were placed back in the hands of the Board of Supervisors.  

Meeting 10/11/16, Sonoma County Board of Supervisors

The Sonoma County Board of Supervisors agreed this week to move forward with zoning code amendments to facilitate clarity for the wine business in the County.  The Board adopted a limited resolution asking County staff to develop specific code amendments as well as standards and siting criteria for areas of local concentration to be adopted either as guidelines or code amendments.

Perhaps the most remarkable thing about this week’s action is that it was on the Board’s “consent” calendar.  This means that there was none of the public comment (read “rancor and discord”) that has attended other public hearings on this subject.  Of course, it takes a lot of work on everyone’s part to get an “easy” result - hats off to all for getting to this point.

Indeed, it is a sign of the times that direction from the Board simply to craft some code amendments is seen as a major milestone.  Opposition groups have pushed hard for an immediate moratorium on any new winery use permits and for an immediate determination of (and prohibitions within) “areas of over-concentration.”  Leaving aside the redundancy of their term, anyone with knowledge of the areas in issue knows that it will not be easy to define areas of the County that may fall into such a category.  Moreover, opposition groups appear to seek County regulation for the express purpose of interfering with the direct-to-consumer marketing model that has made Sonoma County wineries vibrant and prosperous. 

Each of the Supervisors expressed their appreciation for a more deliberative process, one Supervisor referring to the process as “deliberative by design.”  Another Supervisor, with nods of approval from others, reminded the audience that direct-to-consumer sales is an old business model from the time before grapes were even a major crop.  Such a sales model can greatly assist in keeping much of the County’s current land in agriculture. 

The winery supporters have been advocating for the adoption of clear definitions and this week the Supervisors instructed County staff to develop such definitions.   Under the current ordinances, the County is asked to regulate winery “special events” when there is no definition for the term.  The wineries are seeking definitions for “events” and “activities.”  An activity is a normal business activity within the winery’s usual, site-specific capacity (such as a special tasting, a distributor meeting or a winemaker lunch) that would not be counted as a “special event.”  Under the wineries’ proposed set of definitions, new wineries would be limited in the number and scope of special events, but not activities. 

Several of the Supervisors discussed the need for additional enforcement mechanisms with one of them specifically complimenting the wine industry for their proposals in this regard.  The wineries have proposed outside funding for a position that would be available on nights and weekends to assist neighbors and wineries alike, and to coordinate larger winery events with other neighborhood pressures such as marathons and bicycle races. 

While we will need to wait for County’s staff’s recommendation on each of the issues before we’ll know what’s in front of us, the meeting this week was a step forward in that process. 

Please do not hesitate to contact Kim Corcoran at kcorcoran@cmprlaw.com or (707) 526-4200 if you have questions or concerns regarding this article.