Costco Wholesale Corp v. Hoen and Federal Antitrust Law

The SCOTUS Granholm decision of 2005 is far-reaching with respect to subsequent issues entailing the three-tier distribution system. Many states allowed wineries to self-distribute their wines directly to retailers and bypass the wholesaler intermediary. This was the issue in Costco Wholesale Corp. v. Hoen, a case decided by the United States Court of Appeals for the Ninth Circuit. Costco Wholesale Corp. v. Hoen, 522 F.3d 874 (9th. Cir. 2008). In Costco, under Washington law, the privilege of self-distribution awarded to in-state wineries was not granted to wineries from out-of-state. Costco, the largest wine retailer in the United States, brought claims against the Washington State Liquor Control Board and certain state officials, challenging the constitutionality of the Washington law that allowed retailers to purchase wine directly from in-state producers but not from out-of-state wineries. The wine retailer argued that the Washington laws violated the commerce clause and the Sherman Act and were not protected by the 21st Amendment. The federal district court ruled that the Washington state law was discriminatory on its face and invalidated the law. Although this particular issue was not touched by the Supreme Court, the Washington state court’s ruling is applicable to ensuing issues entailing the three-tier distribution model. This entry serves as an overview to the background and the ruling of the court in Costco.

Costco Wholesale Corporation is a national chain based in Washington state that provides annual memberships to its discount buying club in the United States and Canada. As a member, an affiliate benefits from Costco’s business model, which entails offering low prices on a limited selection of products in a broad collection of merchandise. The retailer purchases its inventory in bulk, mostly through direct sales from producers of the product and thus eliminating the use of a distribution chain and middleman sales. Costco’s key is to generate quick inventory turnover and elevated sales numbers through operating efficiencies, large volume purchases, streamlined distribution, and self-service product selection. Through this process, Costco severely cuts costs that its members are able to procure at its store locations.

Generally, Costco’s business model is practical for its merchandise. In the world of wine purchasing and the three-tier distribution model, however, its business model has proven less than savvy at times. Costco’s business model does not rely on distributors with respect to wine shipment; in many cases, Costco buys directly from the wine producer, which allows the retailer to offer a wide variety of wine at a low price. This model proved faulty in the state of Washington because the Washington Liquor Control Board created certain restrictions and liquor sales for distributors and retailers that resulted in higher static prices in wines sold in Washington state.

In addition, the Washington law enforced a variety of regulatory requirements on liquor sales: “it required both distributors and retailers to mark up prices at least 10 percent; it outlawed volume discounts; it prohibited retailers from buying beer or wine on credit and prevented them from storing wine or beer at their central warehouse; and it required wholesalers to post wine and beer prices with the state LCB and to hold them in place for 30 days (post-and-hold requirement).” (See Carol Robertson, The Little Red Book of Wine Law, 123 (American Bar Association) (citing Washington Administrative Code (WAC) 314-20-100(2), (5); WAC 314-24-190 (2), (5)). When Costco filed the original suit, it argued in the district court that these restrictions violated the Sherman Antitrust Act because such restrictions were anticompetitive; additionally, Costco argued that such laws violated the Commerce Clause because they discriminated against out-of-state wineries. The district court ruled in favor of Costco with respect to both the antitrust and Commerce Clause issues. The court reasoned that the state’s “posting, holding, minimum markup, delivered pricing, uniform pricing, ban on volume discounts, and ban on credit sale requirements conflicted with federal antitrust laws.” (Id.) Washington state did not appeal with respect to the Commerce Clause issue, but did appeal to the Ninth Circuit with respect to the antitrust issue.

On appeal, the Ninth Circuit overturned the majority of the district court’s holding and upheld Washington’s law, with the exception of the post-and-hold requirements. When determining the outcome of the case, the district court analyzed the restrictions collectively and determined the full impact of Washington’s law. This full impact analysis allowed the court to recognize an antitrust violation. The Ninth Circuit, however, considered the substance of each individual law on an independent basis and determined none of the laws, with the exception of the post-and-hold requirement, to be in violation of the federal Sherman Antitrust Act. The Ninth Circuit reasoned that, although the post-and-hold requirement violated federal antitrust laws, the remaining requirements were reasonably within state power under Section 2 of the Twenty-First Amendment. Section 2 of the Twenty-First Amendment reads as follows:

The transportation or importation into any State, Territory, or possession of the United States for delivery or use therein of intoxicating liquors, in violation of the laws thereof, is hereby prohibited. U.S. Const. amend. XXI, § 2.

Whereas the result of this decision was seen as a victory for alcoholic beverage distributers and small retailers, the overall outcome prompted Costco to pursue the case and issues further. In February of 2008, Costco filed a petition for a rehearing in the Ninth Circuit among the same panel of judges. Costco’s petition additionally asked for an  en banc review of the case. However, in April of 2008, the Ninth Circuit denied Costco’s request for a rehearing and refused the en banc review of the case. The court simultaneously requested that the Washington Liquor Control Board replace the post-and-hold law that the court found to violate the antitrust laws within several days of its ruling. Finally, in June of 2008, Costco declared it would not appeal the Ninth Circuit’s decision to the U.S. Supreme Court.

(Image property of Made In Italy.)

For more information on wine or alcohol law, direct shipping, or three-tier distribution, please contact Lindsey Zahn.

DISCLAIMER: This blog post is for general information purposes only, is not intended to constitute legal advice, and no attorney-client relationship results. Please consult your own attorney for legal advice.