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Costco Loses Long Fight to Reform Wine Distribution Laws

Wine prices will remain higher for consumers in Washington, as a federal judge upheld the state laws that reduce competition at the wholesale level

Eric Arnold
Posted: February 4, 2008

Costco Wholesale Corp. has lost its long battle to overhaul wine-distribution laws in its home state of Washington. Costco first sued the state in 2004, arguing that Washington's system violated federal antitrust laws. But last week, an appellate court knocked down all but one of Costco's claims, leaving Washington's distribution system largely intact—and Costco with little chance of pressing its cause further in the courts.

The decision of the Ninth Circuit appellate court comes as a surprise if only because, to this point, Costco had largely scored wins as its case traveled through the court system. In April 2006, a judge declared several regulations in Washington's distribution system to be in violation of antitrust laws, siding with Costco. This gave momentum to the belief that the three-tier system of alcohol distribution in the United States could be on the way to serious reform—and that wine prices for consumers could ultimately drop. But that momentum ran out in the Ninth Circuit.

"They got a dose of old-time religion from the judge," said Corbin Houchins, a Seattle attorney who specializes in alcoholic-beverage law. He explained that the judge looked at each element of the state's distribution system separately, rather than considering them as a whole, which is what led to an upholding of the state's system for alcohol distribution.

For most of the products Costco sells, it buys in bulk directly from producers and is therefore able to offer lower prices on most goods. But Costco can't do that with wine in its home state of Washington, where the state Liquor Control Board (LCB) requires both distributors and retailers to mark up prices at least 10 percent; prevents volume discounts; prevents retailers from buying beer and wine on credit; prevents retailers from storing wine or beer at a central warehouse; and requires wholesalers to post wine and beer prices with the state and hold them for 30 days. Costco argued that these provisions violate the Sherman Act, which seeks to prevent hurdles unfair to businesses. But the Ninth Circuit only agreed that the price-posting requirement is unlawful and that, when considered separately, the other elements of the system are not anticompetitive.

"The federal judge went as far as you can go at looking at each thing in a separate box," Houchins explained. "The fact that a related law is invalid doesn't make all the other pieces invalid. So, he says, what you can't do is have a post-and-hold law that puts your prices up ... but you can keep in place the other laws."

The judge never said in his 40-plus-page opinion, however, that the other laws are particularly good laws since they do in fact result in higher prices for consumers, just that they don't facilitate collusion when viewed separately. As Houchins explained, it's as if everyone on the highway is obeying the speed limit, but the motorists haven't all gotten together ahead of time and agreed that's what they're going to do. Similarly, the state's liquor wholesalers haven't all gotten together in a smoky room and agreed on higher prices, they're just following each individual law.

But that's what's so troubling to Costco. The company pointed out that the state presented its case by packaging the state's distribution laws—created to keep prices high—all together. So the company feels the judge erred by considering the laws separately.

"The state actually went to trial and said, 'We intended to have these anticompetitive laws that raise prices so everyone will drink less, and everyone who abuses alcohol will drink less as well. That is our game plan," said John Sullivan, Costco's legal officer. "The former chair of the LCB even said that you can't look at any component by itself, you have to look at the whole system."

The bright side for Costco, however, is that the ruling doesn't mean Washington's distribution laws are now etched in stone. The LCB itself found its own requirements too anticompetitive through a task force it set up in 2006 to examine Washington's distribution laws. The task force ultimately recommended the elimination of price posting, the mandatory mark-up, the ban on volume discounts and the ban on paying in credit. Action on any of the recommendations was deferred pending the outcome of the litigation, but Costco can at least rest easy knowing that the organization on the other side of the courtroom was, all this time, well aware of the problems with its own system.

"The task force was looking at [the laws] to ask, 'Do these laws make sense?' And largely they said they do not make sense," said Sullivan. Just because the circuit court didn't strike down the laws, "that in our view should in no way reduce the validity of the task force," he added. "Essentially, these things are a product of decades-old practice to address concerns that are no longer present in the 21st century."

While a spokesperson for the LCB said that it is still considering what action to take next, if any, the available legal options for Costco, at this point, are somewhat limited. The next court to appeal to would be the United States Supreme Court, which Houchins said isn't likely to accept the case because there isn't a record of disagreement at the circuit-court level. Costco could begin to lobby the state legislature for reform, but it only meets for about two months every two years, and does not convene again until a year from now. So in the meantime, it's just business as usual for Costco—and hoping that its efforts thus far aren't forgotten.

"We're very hopeful that the consciousness that's been raised around these issues by our litigation, including the task force, will lead to serious consideration of reforms by the LCB and the legislature," said Sullivan.

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