Authorities alleging “of value” violations over pricing discounts still need to show discount threatens retailer independence and risks “tied-house” integration

You may want to think twice before just accepting a regulator’s assertion that a pricing program violates an “of-value” statute. Consider, for instance, the Illinois Supreme Court case of Sharpenter v. Illinois Liquor Control Commission, 119 Ill.2d 169 518 N.E.2d 128 (1987).

In Sharpenter, a beer distributor brought suit challenging an Illinois Liquor Control Commission finding that the practice of offering different discounts to retailers depending on the type of sales they made (on-premise or off-premise sales) and not uniformly based on volume purchased, violated the “of value” statutory provisions of the Illinois LIquor Control Act.

The preferential discount system the distributor applied gave off-premise retailers larger and more frequent pricing discounts than on-premise retailers. The off-premise retailers only received the discounts if they agreed to both purchase a minimum quantity of beer and engage in “good faith” promotional efforts (newspaper advertising, in-store advertising, generally emphasizing the discounted items).

Off-premise retailers received the greater discounts because they passed them on to consumers as they compete in a price-sensitive market and as such, discounts from the manufacturer result in greater sales. So the distributor sees a substantial increase in sales volumes by offering the discounts to off-premise retailers.

But where grocery stores and liquor stores that sell beer to go pass those discounts through to purchasers, bars and restaurants and other on-premise accounts rarely pass them along to patrons as their sales and business are not as price-sensitive. The on-premise account’s failure to reduce the price or promote the discount means an attendant increase in sales volumes does not occur.

Some of the on-premise retailers brought a claim with the Commission and the Illinois Liquor Control Commission charged that the provision of these discounts at different levels to differently situated sales accounts offended Section 6-5 of the Act prohibition on manufacturers or distributors offering things “of value” to retailers:

Except as provided below, it is unlawful for any manufacturer or distributor or importing distributor to give or lend money or anything of value, or otherwise loan or extend credit (except such merchandising credit) directly or indirectly to any retail licensee or to the manager, representative, agent, officer or director of such licensee.

235 ILCS 5/6-5

The Illinois Supreme Court disagreed.

In holding the Commission’s ruling was incorrect, the Court looked to the purpose of the “of value” statute. Finding that “Section 6-5 was intended to remedy a competitive abuse in the beer industry referred to as the ‘tied house.’ By the granting of gifts and loaning of money to retailers, distributors could effectively ‘tie’ themselves to retailers to the point of excluding all competitors. This form of vertical integration between beer distributing and retailing allowed the distributor to exercise almost complete control over the retailers. ‘The interest of a particular brewery in promoting its product in a given area went to the point of determining location, asserting control over the licensee, and, through the power of credit and the use of equipment, it was, in fact, in the practical retail sale of beer.’ ( Weisberg v. Taylor (1951), 409 Ill. 384, 390.) Tied houses became associated with such evils as political corruption, intemperance and the irresponsible ownership of taverns … and the legislature therefore sought to prohibit the gifts and loans which made them possible. ‘The evils of the ‘tied house’ have long been recognized and most, if not all, of the States, including our own, have prohibited the furnishing by manufacturers or distributors of buildings, bars, equipment, or loans of money to a retailer.’ Id.”

The Court went on to note that the statute did not prohibit price discrimination. “While price discrimination in this context may not necessarily be desirable, section 6-5 simply does not proscribe it.” The Court also noted that the Commission and the aggrieved retailers certainly were not arguing that volume discounts should be proscribed “even though such discounts are discriminatory in the sense that they disfavor retailers unable to purchase in large quantity.”

The Court also cited a federal case, National Distributing Co. v. United States Treasury Dept., 626 F.2d 997 (D.C. Cir. 1980) that came to a similar conclusion and which, like Sharpenter, has been cited by various other cases for a similar proposition. In “National, a wine distributor, had sold wine at below its own cost to retail outlets throughout a particular county. The Bureau of Alcohol, Tobacco and Firearms argued  that below-cost sales, without justification, constituted the furnishing of a “thing of value” as the difference between what the distributor paid and the price it was sold to the retailer. After thoroughly reviewing the legislative history, the court concluded that the “giving …[of] other thing [sic] of value, 27 U.S.C. § 205(b)(3), when read in the context of the statute as a whole, does not prohibit below-cost pricing….The court reasoned that “[i]n  the absence of any indication that National’s price cut had the purpose or effect of gaining control over retail outlets in Leon County, we doubt whether the Act can have any application.” 626 F.2d 997, 1004. … [T]he court was … referring to price discriminations and conditions which were instituted for the purpose of, or had the effect of, obtaining control over retail outlets. The court stated that ‘[p]rice cuts are prohibited by the Act only when they are coupled with an agreement or understanding that a retailer will buy other products of the wholesaler or producer to the exclusion of competitors, or when they lead to domination and control of a retail outlet by the wholesaler or producer.’ As such, National cannot be read as authority for the proposition that preferential discount policies which are enacted, as here, solely in order to increase sales, constitute the giving of a thing of value.”

As more proof that a rule of analysis about the end effect of the activity guides the “of value” analysis, the Illinois Supreme Court declined to make a bright line rule about pricing practices out of this case.  The Court went so far as to say that there may be pricing practices (those in which the distributor offers a preferential discount “to gain control over the avantaged retailers”, or one in which a distributor granted discounts to impermissibly influence a retailer, or one where the pricing arrangement was subterfuge in disguising a grant of financial assistance) that would merit finding a pricing discount program amounted to an “of value” violation.

The Takeaway: Challenging an asserted “of value” violation as failing to threaten retailer independence may be worth the effort as many regulations declaring certain practices “of value” violations were adopted in the same fashion that most statutes were… back when people just assumed their cultural “understandings” or “just so stories” about the resulting evils of an activity would lead to a certain result. These assumptions and conclusions were drawn without evidence and without economic study or proof. Those looking to hire experts to show that the underlying conclusions and foundations are mistaken may find that they have winning cases against blanket prohibitions laid down by regulators decades ago and still enforced by them today.