A call for analyzing the 3-tiered system? NJ Court says alcohol regulations need to be revisited in light of changing conditions

There’s an quote from Justice Holmes’ The Path of the Law that goes “[i]t is revolting to have no better reason for a rule of law than that so it was laid down in the time of Henry IV. It is still more revolting if the grounds upon which it was laid down have vanished long since, and the rule simply persists from blind imitation of the past.”

We often deal with a version of such a contemptible state of affairs every time someone argues or asserts “tied houses” or the “lawlessness of prohibition and pre-prohibition times” as a justification for the three-tiered-system.  These are vestiges of the past that can be remedied with simple prohibitive laws against such behavior and don’t require entire state-sanctioned distribution schemes for a remedy.

Recently, a superior court in New Jersey upheld an administrative decision from the New Jersey Division of Alcoholic Beverage Control that removed a grandfather exclusion that allowed some select employees of distributors to “service” the accounts of retailers that the employees were related to, thereby receiving kickbacks in the form of sales incentive commissions from their employer for sales the employer-distributor made to that retailer.

The practice had been prohibited by a 1999 regulation and amendment to New Jersey’s Administrative Code stating that no solicitor (distributor’s salesperson) could solicit or order from a retail establishment in which an immediate family member of the solicitor a direct or indirect financial interest.  The reason for the change was a particular situation amongst distributors that had arisen and looked like a scheme that violated the competitive intent of New Jersey’s liquor laws.

In brief, the Court described the scheme as:

[W]holesalers were illegally rebating or “kicking back” a percentage of solicitors’ commissions to retailers who regularly purchased from them. This practice was most prevalent with high volume retailers and the result was that the retailers’ incomes were subsidized by these illegal rebates or “kickbacks.” Complaints by industry members further evidenced a trend whereby some of the large-volume retailers would request that a wholesaler hire the retailer’s relative as the solicitor to that retailer’s accounts [thereby creating the possibility that the relative-solicitor’s commissions were indirectly subsidizing the retailer].

Because the latter practice gave retailers and distributors an advantage where they employed or had a family relationship between employees, the practice was prohibited, but a number of people were grandfathered in if they were already solicitors as of 1999.  The thought behind the grandfather exception was that over time, those people would retire and the practices that the prohibition sought to end would gradually phase out.  That didn’t happen.  A subsequent investigation of the industry in 2007 uncovered new and continued abuses:

“This investigation established that certain solicitors, who were permitted to service retail accounts held by a member of the solicitor’s immediate family pursuant to the grandfather clause … performed no services for their relative’s retail accounts but were paid commissions for sales made to those accounts… [m]any large-volume retailers do not even need or want a solicitor assigned to their accounts because they have sophisticated ordering systems in place. Paying commissions to a solicitor when no services are rendered is a violation of the law making … the commissions paid … no more than rebates or “kickbacks” to the large volume retailers.

“This activity created a competitive advantage for the wholesalers employing those relatives because it ensured the retailers would purchase from them. The retailers whose relatives were employed as solicitors also gained a competitive advantage because the commissions could subsidize their household incomes and allow them to lower their prices. As a result, other wholesalers and retailers sought out ways to compete with these subsidies. In sum, the Division’s recent investigation demonstrated that further restrictions are necessary to continue to prevent illegal rebates, maintain trade stability and foster a competitive three-tier system of distribution in the liquor industry.”

So the code was amended and the grandfather clause removed, unsurprisingly, the retailers benefitting from the scheme sued claiming they had been wronged and appealed when the administrative hearing didn’t go their way.  In upholding the regulation and the decision in the administrative hearing, the Court sided with the Justice Holmes approach stating:

“New Jersey’s liquor control laws and regulations must be administered in the light of changing conditions. Prior measures of enforcement may have failed their mark. Recurrent instances of particular violations must be dealt with accordingly.”

The case strengthens the argument that a vigilant regulatory system can uncover and prohibit the practices that people claim the three-tiered system was meant to forestall.  It’s further proof that some day, we may need to have an honest conversation about the basis for the system and the portions of the system that work and the ones that don’t.