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Costco Court Victory Sends Washington's Wine Laws Back to the Drawing Board

If judge's decision holds, consumers could see lower prices on wine in the future

Eric Arnold
Posted: April 24, 2006

In the most closely watched wine-related litigation since last year's Supreme Court decision on direct shipments, federal courts have struck another blow to the three-tier system of distributing and selling wine in the United States. On April 21, a judge declared several regulations in the state of Washington's distribution system to be in violation of antitrust laws. For consumers in Washington--and the rest of the country--the ruling could eventually mean a drop in wine prices.

The plaintiff in the case, Costco Wholesale Corp., a national chain of discount warehouse clubs, is the largest wine retailer in the United States. The secret to Costco's success with all the other products it sells has been its ability to buy in bulk directly from producers, allowing it to charge consumers much lower prices. In 2004, the company filed a lawsuit against the Washington Liquor Control Board, arguing that the state's liquor regulations prevented Costco from applying its business model to wine sales.

Under dispute were Washington laws that required both distributors and retailers to mark up prices at least 10 percent; prevented volume discounts; prevented retailers from buying beer and wine on credit; required posting of prices with the state; and prevented retailers from storing wine or beer at a central warehouse. Costco argued that these provisions violated the Sherman Act, which seeks to prevent hurdles unfair to businesses.

The state liquor control board, backed by the Washington Beer & Wine Wholesalers Association, argued that the laws were acceptable under the 21st Amendment, which ended Prohibition but gave the states the power to control the sales of alcoholic beverages. The defense team also said that the system of helping keep prices high in turn keeps consumption moderate.

But U.S. District Judge Marsha Pechman disagreed and struck down all but one of the regulations (which prevents retailers from selling wine to each other). "Washington does not seek to promote 'temperance' by promoting abstention or by reducing overall consumption of beer and wine. Indeed, the state actively promotes its domestic beer and wine industries and seeks to serve overall lawful demand for beer and wine," Pechman wrote in her decision.

Pechman stayed her decision for 30 days to allow the state to appeal. If there is no appeal and the state legislature modifies its laws according to the judge's decision, Costco and other Washington retailers would be able to buy wine directly from producers and sell it to consumers at a modest markup. Wholesalers, forced to operate in this competitive market, would in theory have to bring their prices down as well.

"We think this is a great result," said Joel Benoliel, senior vice president and chief legal officer for Costco. He was quick to point out, however, that the judge's decision does not enjoin the state from enforcing its laws. "She does make it very clear that she does not intend to reshape the regulatory policy. She's just saying the way you've got it now doesn't work." The defendants have yet to announce plans for an appeal, and the legislature does not meet again until early 2007, so it may take some time before new laws go into effect.

"[The judge] pointed out that if what they wanted to do was raise prices to reduce overall consumption, they could do that effectively by increasing the excise tax. We don't have to violate the Sherman Act," explained R. Corbin Houchins, an attorney specializing in alcoholic-beverage law with the Seattle law firm Graham & Dunn. "And since they say revenue is one of their objectives, giving the extra money to the wholesalers rather than taking it in a tax didn't seem logical to the court."

Wholesalers nationwide have long enjoyed legislatively mandated existence and protection from competition, insomuch as most states passed laws after Prohibition that effectively set up a three-tier system. Producers sell alcohol to a wholesaler/distributor, who then sells it to retailers. Many states took things a step or two further. Washington, for example, allowed in-state wineries to sell directly to retailers and restaurants, but out-of-state wineries could not. Before Costco's case even went to trial, late last year, Pechman struck down this law in a pretrial ruling, and the legislature quickly passed a new law allowing all wineries to sell their products directly to retailers and restaurants in Washington. Pechman decided that Costco's other complaints needed to be heard at trial, which began in early March.

Despite the case's twin blows to wholesalers, Benoliel claims that the lawsuit was not anti-distributor. "We think they perform a very valuable function and will continue to do so," he said. What Costco objected to, he said, was the state rule that allowed for anticompetitive pricing. With the change, "just because the normal market forces are at work, you see distributors keeping most of the business, but you also see prices starting to come down."

He pointed to several other states in which Costco does business, free from Washington-like regulation. "The big one is California," he said. "We have over 100 of our locations there. When you look at California, you see that market forces are brought to bear. Distributors figure out a way to keep most of the business because they definitely perform a service to the industry. And they will continue to have most of the business, but pricing will come down."

The decision could affect several other states, because Pechman ruled that all of the liquor board practices, except one, are anticompetitive individually as well as collectively. Explained Houchins, "To say that they're individually invalid extends antitrust law considerably … and could have very far-reaching implications, the most obvious of which is that there are states that have no price-posting laws, but do have impediments to central warehousing or to quantity discounts, or to credit, or other things that are swept away by this decision." In other words, if the decision holds up, other states will likely have to pass legislation removing similar regulations, lest they too be sued.

If the case does not spend the next couple of years in appeals, just how much prices will change--at Costco or small wine shops--remains to be seen. The same goes for which other states look at changing their own regulations on distribution, though the argument for greater regulation is becoming weaker with each court decision.

"There's no question that alcoholic beverages can have a social cost, and some regulation of the way they're sold and consumed is appropriate," said Houchins. "But doing these things that are clearly beneficial to a single sector of the economy and that distort market forces that are generally favorable to the consumer is beginning to become passé."

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