Why States should keep winning the physical-presence cases, Part I: using the extraterritoriality doctrine on defense

Guest Column:  John Neiman, Shareholder,  Maynard Cooper & Gale in Birmingham, Alabama and former Supreme Court (and 4^th Circuit) law clerk and former Alabama State Solicitor General

On June 1st the Fourth Circuit upheld, against a dormant Commerce Clause challenge, a North Carolina law requiring retailers who sell alcohol in the State to have a physical presence there. It’s the third federal court of appeals to have upheld laws of this kind against claims that they unconstitutionally discriminate against interstate commerce: the Sixth and Eighth Circuits previously did so in cases out of Michigan and Missouri, and a similar case out of Indiana is now pending in the Seventh Circuit. These laws are common and, in my view, easily defensible. There’s a reason every judge who previously had weighed in had little trouble rejecting the plaintiffs’ claims.

But much to my chagrin, in the Fourth Circuit case—in which I filed an amicus brief for the Center for Alcohol Policy and the NC Association of ABC Boards supporting North Carolina—Judge J. Harvie Wilkinson wrote a dissent in which he became the first jurist to go the other way. Judge Wilkinson is one of the most respected judges on the bench, but his dissent missed a couple of important points I want to highlight in this post and another in the future.

The first is the role the extraterritoriality doctrine—the constitutional principle barring States from regulating activity occurring outside their borders—should play in this analysis. States are generally wary of this doctrine, and with good reason; they see it used against them all the time. (The Supreme Court recently granted cert in a case in which the plaintiffs argue that California pork laws are unconstitutionally regulating conduct in other States.) But in this context the doctrine turns out to be a really good defense for States—and I think the doctrine even requires States to have physical-presence laws if they want to regulate alcohol in accordance with what the framers of the Twenty-first Amendment had in mind.

That’s because the extraterritoriality doctrine, as a practical matter, precludes a State from creating a three-tier distribution system—and from providing the necessary separation between producers and retailers the Twenty-first Amendment’s framers envisioned—unless wholesalers and retailers have physical presences there. It’s an uncontroversial proposition that section 2 of the Twenty-first Amendment was meant, among other things, to free up States to separate the producer and retailer tiers—and to thus end the “tied house” that was seen as the source of pre-Prohibition excesses. States have used the three-tier model—which requires retailers to obtain their alcohol from separately owned wholesalers, who must in turn obtain their alcohol from producers who are separate from both the retailer and wholesaler tiers—to achieve this result. So, if a State can’t mandate separation of the producer and retail tiers without a particular kind of law in place, then you can be pretty sure that Section 2 of the Twenty-first Amendment makes that law constitutional.

Judge Wilkinson didn’t deny this. He just argued that in-state physical-presence requirements weren’t among the laws needed to keep the tiers separate in this way. If a State like North Carolina wants to make sure out-of-state retailers retain sufficient separation from producers, he said, “[n]othing” would “stop” it from requiring out-of-state retailers to purchase their alcohol “from a wholesaler.” A State can thus “maintain three strictly regulated, separately owned tiers,” he claimed, “without also requiring retailers to be physically present.”

But that’s wrong, and the extraterritoriality doctrine is why. The doctrine’s central tenet is that a State’s laws can’t apply, as the Supreme Court put it in Healy v. Beer Institute, 491 U.S. 324 (1989), “to commerce that takes place wholly outside of the State’s borders, whether or not the commerce has effects within the State.” The Court in Healy invalidated a state law that had the practical effect of regulating beer prices in other States, reasoning that a State can’t “control[] commercial activity occurring wholly outside the boundary of the State.” As the Sixth Circuit suggested in its own decision upholding Michigan’s physical-presence requirements for alcohol retailers, the same principles preclude the States from passing laws dictating the terms on which out-of-state retailers obtain their alcohol. A State can mandate that a retailer buy all its alcohol from an independent wholesaler only as to retailers and wholesalers that are physically present in that State.

Someone might respond that this doesn’t currently matter, practically speaking, because every State has a three-tier system of some kind, and any out-of-state retailer will therefore have purchased its alcohol from a wholesaler in any event. But physical-presence requirements still are essential because the States have chosen different ways to separate the tiers—and the extraterritoriality doctrine would preclude them from imposing their three-tier regulations on entities outside their borders. Some States, for example, have specific limits on the amount of equity a company in one tier may own of a company in another. Others don’t. Some States preclude wholesalers from making sales to retailers on credit. Others don’t. Some States make it illegal for retailers to negotiate volume discounts with wholesalers. Others don’t. These differences in state laws are natural incidents of federalism, and they are 100% consistent with the original understanding that the Twenty-first Amendment allowed each State to develop its own solution to the alcohol problem. So, it’s constitutional for States to impose their own tier-separating requirements on in-state businesses, but the extraterritoriality doctrine would preclude that State from making out-of-state retailers and wholesalers follow those rules.

The upshot is that, because the Twenty-first Amendment gives States power to adopt their own unique laws to separate the alcohol-distribution tiers, the extraterritoriality doctrine means that the States must also have the power to adopt these physical-presence requirements, so that they can subject the participants in the alcohol market to these requirements. That logic alone ought to be enough to make these laws constitutional, so I found it a little surprising that neither the Fourth Circuit majority nor the Wilkinson dissent made any mention of the extraterritoriality doctrine’s implications in this context.

Another part of Judge Wilkinson’s dissent, however, was at least implicitly responsive on the point: he also argued that States like North Carolina, because they now allow wineries to ship their product directly to customers, have abandoned the three-tier system for wine in any event. That’s a big, novel argument, and as it turns out I respectfully disagree with it as well. But that needs to be a topic for another day.

The author can be reached at jneiman@maynardcooper.com