Hb 2040 Analysis

HB 2040/SB 6027: AN ALTERNATIVE VIEW I.

Introduction

The bill as signed by the governor on May 15, 2006 changes the Washington liquor code in three areas: (1) Trade practices by suppliers, such as point-of-sale merchandising. (2) Prices charged by suppliers. (3) Interests an industry member in a supplier tier of distribution may hold in a retail tier business, and vice versa. Although the bill has been touted as liberalizing tied house law, its actual effect on tied house is to tighten the trade practice restrictions while offering a mostly illusory relaxation of the inter-tier interest provisions. With respect to pricing, the bill deletes the 10% minimum wholesaler markup and minimally conforms statutes to the Costco decision’s elimination of the 30-day post-and-hold system, which the Washington State Liquor Control Board (LCB) had already abandoned. The bill’s limitation of competition in price, promotional activities, and services represents an historical objective of the wholesaler lobby, whose members appear to be the primary beneficiaries. Publicity about the bill correctly reports that it was supported by Costco Wholesale Company, trade associations representing retailers, winery trade associations, and others. Indeed, the impetus came from a broadly based “three-tier task force“ convened by the LCB, which issued its report in late 2006 with relatively liberal recommendations and was followed by a select joint legislative committee that received input from various sources, including wineries. Once put in the form of a bill before the legislature, however, the measure exhibited the typical characteristics of wholesaler-written legislation. Observers differ on how broadly the resulting law is supported, or is even understood, by other industry groups, but it is difficult to deny that the wholesalers –perennially the strongest lobbying organization I n the industry– blocked attempts to address its contradictions and appear to have effectively controlled the drafting process. II.

Trade Practices

Trade practice restrictions of the bill start with revision of the core concept. Present RCW 66.28.010(1)(a): “Except as provided in subsection (3) of this section, no manufacturer,

importer, distributor, or authorized representative shall advance1 moneys or moneys’ worth to a licensed person under an arrangement, nor shall such licensed person receive, under an arrangement, an advance of moneys or moneys’ worth.” Bill § 6:                                                              1 The bill makes no change in use of the term “advance,” rather than a more general term, such as “furnish.” Thus, both current and proposed tied house laws stop short of applying to all transfers of things or services of value. Because there is no exception for ordinary trade, either in § 7 of the bill or in current law, if the basic prohibition applied to all transfers of value, it would be illegal for a supplier to deliver wine to a retailer (thereby furnishing “money’s worth”), even if paid for. The only obvious basis on which an ordinary delivery is lawful is that “advance” does not include transactions generally regarded as equal exchanges. Later statutes and LCB regulations do not, however, consistently apply that understanding of the term.  2008‐2009 HB 2040 ANALYSIS V4.DOCX 

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“Except as provided in section 7 of this act, no industry member shall

advance and no retailer3 shall receive moneys or moneys’ worth under . . . any . . . agreement[,] . . . business practice or arrangement.” The above change abandons the present limitation of the law to advances “under an arrangement” and expands the reach of the law to any business practice. Although there is no judicial definition of “under an arrangement,” the law of statutory construction requires that it be given some effect. The most likely meaning is to include only direct transfers of monetary value, excluding those with indirect effects that do not involve any express or implied arrangement between the paying and receiving parties –e.g., the business practice of a winery’s advertising the brand in local media, which is worth money to the retailer, but involves an arrangement only with the advertising medium. Thus, a wide range of marketing activities that are probably not forbidden under current law because there is no arrangement with the retailer are likely prohibited under the bill because they are, of course, business practices. The bill also removes an important tied house exception, now found in RCW 66.28.010(3)(a): “. . . . Nothing in this section shall prohibit a retail licensee, or any

person financially interested, directly or indirectly, in such a retail licensee from having a financial interest, direct or indirect, in a business which provides, for a compensation commensurate in value to the services provided, . . . services to a manufacturer, so long as the retail licensee or person interested therein has no direct financial interest in or control of said manufacturer.” The § 7 exceptions referred to in § 6 of the bill do not parallel the subsection 3 exceptions of the current code, which the bill repeals. Any marketing plan involving payments to a retailer in exchange for services –e.g., buying a listing or ad in a retailer-affiliated publication– currently permitted as a subsection 3 exception will be forbidden when the bill becomes law, unless specifically described in § 7 or regarded as something other than an “advance” (a term the LCB has never defined).

                                                             2 “Industry member” is defined in § 2(3) of the bill as a manufacturer, importer, wholesaler or similar supplier and its affiliates, subsidiaries, officers, directors, partners, employees and representatives. The list does not include shareholders or LLC members, and it is unclear whether an investor or parent company is an affiliate. 3

The bill retains the current one-way perspective of regulating only benefits running from supplier tier members to retailers and does not prohibit benefits retailers may confer on suppliers. However, by regulation the LCB maintains a reverse restriction on suppliers’ receipt of benefits from retailers, WAC 314-12-140(3), whose validity is an open question under current law. Under the bill the issue is more complicated, as “retailer,” defined in § 2(5), includes agents, officers, directors, partners, shareholders and employees. Thus, a winery parent of, or investor in, a retailer is explicitly a retailer, but a retailer parent of a winery would be an industry member only if parents are considered “affiliates” of their subsidiaries. 2008‐2009 HB 2040 ANALYSIS V4.DOCX 

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Exception-listing not only perpetuates, but reinforces, the concept that everything beneficial to a retailer not expressly permitted is forbidden. An expressexceptions-only approach, when the basic tied house prohibition has been extended to any “business practice,” creates many new implied prohibitions. In net effect, the bill compels an administrative policy against allowing any program that is not described in some detail by statute, tempered only by the LCB’s willingness to allow common-sense contravention of the statute. The list of permitted activities at § 7 is extremely limited. Proponents of the bill have claimed that it expands permissible winery marketing practices to include (1) providing brand-identified items of “nominal value,” such as T-shirts, cigarette lighters, and pens, to preferred retailers and (2) pouring wine and otherwise participating in events at private clubs and premises with temporary special event permits. Even those modest claims are difficult to sustain. All the items and activities mentioned are made illegal by the bill (but not by current law) if the LCB finds giving them is likely to influence the buying or selling decisions of the retailer. Ordinarily, the entire purpose of branded novelty items or presenting a wine tasting (like almost any marketing effort) is to have a favorable influence on purchase decisions. With respect to branded advertising novelties, the bill impliedly allows furnishing such items without charge, as compared to current law, which requires a winery to charge the retailer at least cost for them. The bill introduces the restriction that the retailer may not sell or give any of the items to its customers. It is unclear whether the sale option will still exist and, if so, will remain free of the prohibition on, for example, a patron’s taking a brand-identified coaster home. Businesses can only guess at what constitutes “nominal value,” which is an independent requirement, not necessarily met by the examples of items in the statute. Items are not deemed to be of nominal value by virtue of their appearance on the list. Rather, furnishing listed items is permissible (assuming it meets other § 7 requirements) only if it the items are in fact of nominal value in the aggregate. Listing shirts, for example, suggests that there are some shirts that individually would qualify as of nominal value, thereby providing a clue to what is meant by “nominal” for a single item (presumably not less than the value of the cheapest imprinted T-shirt, or around $7.50). There is, however, not even a clue as to how many such shirts could be furnished without going over aggregate nominal value. With respect to presenting wines at private club and special event premises, current law, RCW 66.28.155, permits those activities at “the licensed premises of a retailer.” It is well within the LCB’s administrative authority to include the locations of private club licenses (RCW 66.24.440-.452) and special occasion licensees (RCW 66.24.380) in the category already allowed by statute. III.

Pricing

Section 10 of the bill removes formal posting of prices, the requirement that they be unchanged for thirty days, and the minimum wholesale markup.

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The problematic uniform pricing requirement remains in RCW 66.28.170, which will not be repealed, and in § 10(2)(d) of the bill. The bill also retains prohibition of quantity discounts and sales below acquisition cost, § 10(1)(d). The bill is ambiguous regarding the effect of “close-out” status of prices under § 10(1)(e), which probably creates an exception to the acquisition cost pricing floor. The bill in § 10(2)(a) requires wineries to maintain price lists at their licensed premises, for the purpose of auditing sales to enforce uniform prices, but doesn’t say the price lists cannot be in electronic form changeable by cell phone from the field or specify how frequently they can be modified. How much pricing flexibility will result from the Costco changes depends on policies and procedures yet to be adopted by the LCB. Deleting the 10% minimum wholesale markup will not affect traditional fullservice three-tier distribution, whose economics involve a substantially larger margin, but could have beneficial effects on innovative variations, such as nofrills “guerilla” distribution and, provided the LCB remains flexible on physical delivery of goods that skips one or more stops in the path of purchase and resale, paper-only three-tier distribution with efficient “drop shipment” delivery. IV.

Inter-Tier Interests

With narrow “custom” exceptions created to allow specific transactions, under current law parties licensed as suppliers (primarily manufacturers, importers, and wholesalers) and their investors and officers are forbidden to hold financial interests, such as stock, LLC membership, promissory notes, or outright ownership, in a licensed retail business. Present RCW 66.28.010(1)(a): “No manufacturer, importer, distributor, or authorized representative,

or person financially interested, directly or indirectly, in such business; whether resident or nonresident, shall have any financial interest, direct or indirect, in any licensed retail business . . . .” Oddly enough (and contrary to assertions by some regulators), there is currently no direct prohibition of a winery’s obtaining financing from, or even being owned by, a retailer.4 The bill permits some supplier interests in retailers that are currently forbidden, but only if operation of the enterprise meets certain conditions, and extends the tied house restriction to retailer interests in suppliers. The conditions for legality are drawn (whether by design or oversight) so as to render impractical operation of, for example, a wineryowned wine bar or a restaurateur-owned winery. Moreover, receiving or advancing any payment of a dividend, investment or other monetary transfer between those entities would seem to require an exception to bill § 6, but is not found in the § 7 list.                                                              4 In one view, a person financially interested in a retailer would necessarily have an indirect interest in a business in which the retailer holds a direct interest. If that makes the investor a “person financially interested” in the winery, then the person may not hold the interest in the retailer. Under that interpretation, the bill permits an inter-tier interest that would otherwise be forbidden. The same argument does not apply to the current absence of a prohibition of a retailer’s advancing moneys’ worth to wineries, but the interlocking definitions in the bill may introduce a new tied house prohibition of “upstream” financial assistance. 2008‐2009 HB 2040 ANALYSIS V4.DOCX 

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The bill will repeal current RCW 66.28.010, which prohibits such interests with specific limited exceptions, leaving the code with no explicit prohibition of intertier interests. However, taking together the “unless” clause of § 3(1), the preamble’s vague favorable reference to a three-tier distribution system in § 1, and the possibility of adverse action by the LCB in § 5, such an interest is in effect declared illegal if one entity directly or indirectly influences the buying or selling decisions of the other or if the LCB finds the interest has at any time resulted, or is likely to result, in: a. Any of the disqualifying conditions listed in § 2(6), or b. Making alcohol significantly more attractive5 or available to minors, or c. Overconsumption, or d. Any consumption by minors, or e. Any other harmful or abusive form of consumption. As industry members are in the business of buying and selling, and the whole point of owning or holding an interest in another business is usually to consolidate business decision-making, the circumstances under which the bill’s dispensation could be of practical benefit are extremely limited. Part of the problem for inter-tier integration and capitalization is the interlocked nature of § 2 definitions. A winery subsidiary of a retailer is also a retailer under the statute, and the retailer parent, if it is considered an “affiliate” of its subsidiary, is deemed a supplier. Thus, provisions that seem aimed at protecting retailer independence may apply in reverse, with anomalous effects. Anyone, whether or not involved in the industry and whether or not harmed or threatened to be harmed, at any time before or after creation of an inter-tier financial interest, can require the LCB to determine whether any of the disqualifying conditions exists. The following are non-exclusive examples of conditions that would normally exist in an affiliated supplier-retailer relationship, but could trigger a divestiture order under §§ 2(6) and 5, in the hypothetical case of a winery selling wine to a retail licensee that owns shares of the winery’s stock, even in the absence of any effect on buying or selling decisions: a. The retailer orders a specific number of cases of any product, § 2(6)(d). b. A commitment exists between the winery and the retailer to continue doing business with one another, § 2(6)(h). The LCB must upon complaint investigate “as it deems appropriate” to ascertain whether influence over buying or selling decisions, or other influence defined as “undue,” or an influence on public health and safety defined as “adverse,” has occurred any time or is more likely than not to occur. If so, the LCB, must begin administrative violation proceedings and/or deny any pending license application                                                              5 Presumably, any vertical integration of distribution or inter-tier capitalization that brings a substantially cheaper wine to market would make “alcohol” more attractive to persons under 18 (“minors”) along with everyone else, even if no underage purchases occur. The bill, like much of the liquor code, depends on willingness of regulators to apply common sense rather than literal meaning. 2008‐2009 HB 2040 ANALYSIS V4.DOCX 

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by a party to the interest and, if the interest already exists, may require the parties to “undo” the transaction. Risk of forced divestiture will render inter-tier investment highly problematic. Managers with responsibilities to shareholders would be well advised to steer clear of acquisitions or investments that could be ruinously reversed under unpredictable circumstances. Thus, the tied house “liberalization” claimed for the bill does not seem likely to encourage economic development. V.

Conclusion

HB 2040 is another measure to tighten tied house trade practice rules. Its effect is to increase the wholesalers’ means of resisting supplier pressure to engage in inter-brand competition in merchandising services and other non-price competition, by declaring a broader range of practices illegal. The façade of financial interest dispensation does not seem likely to compensate the public for reduction of competition in distribution of licensed beverages. #

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