Untapped Potential — Challenging the Distributor Monopoly in Brewing

In recent years, the microbrew industry in North Carolina has come into conflict with state regulations artificially limiting the growth of an otherwise booming business model. Specifically, North Carolina law mandates that a microbrewery may only distribute and sell its own beer if it sells less than 25,000 barrels of its own product per year. This cap on production by microbreweries serves as a boon to large-scale malt beverage producers and distributors. In this article, I ask three questions. First, how did our legal system develop to where a statutory framework that blatantly favors one class of businesses over another is constitutionally permissible? Second, what does North Carolina’s system of microbrewery regulations look like, and why does it look that way? And third, do microbrewery operators have any possible avenues through which to challenge the current regulatory system as unconstitutional?

The Historical Context

It is 1934. The State of New York has established the “New York Milk Control Board,” which is empowered to regulate the price of milk. Pursuant to its legislative grant of power, the Board has issued a decree that, if a storekeeper buys milk from a “milk dealer,” i.e. a milk distributor, the storekeeper must pay higher prices and resell at lower prices than the dealer is permitted to pay or charge.

The law, obviously, works to the advantage of distributors and to the disadvantage of their competitors. And, predictably, distributors have quickly seen their profit margins grow, while storekeepers and consumers have taken a financial hit. The State’s rationale is that farmers are not making enough money, and they therefore need support from the State in the form of price controls, even if this effectively robs storekeepers of a portion of their profits.

One of these storekeepers, Leo Nebbia, has had enough. In defiance of the law, he sells two quarts of milk and a 5-cent loaf of bread for 18 cents. The State prosecutes him for a violation of the price regulation, and he is convicted. All lower courts uphold his conviction, and eventually Mr. Nebbia ends up before the United States Supreme Court.

The case – Nebbia v. New York – presents the Court with the question of whether the price regulation, and therefore Nebbia’s conviction, is constitutional. Can the state effectively take from one group and give to another via economic regulations, so long as it justifies such action as important for the public welfare?

In 1934, this question is contentious indeed. In a long line of cases, of which Lochner v. New York is the most well known, the Supreme Court has repeatedly held that the government has no place interfering in the economic relationships between buyers, sellers, and producers. Such interferences have repeatedly been declared unconstitutional under the due process clause of the Fourteenth Amendment. It is not the job of government, the thinking goes, to take from one group and give to another, no matter how altruistic the government’s motives might be. The state’s role is one of neutral arbiter, not balancer of scales.

But progressives have been consistently pressuring the Court to change this mindset. Their hope is to pass a wide range of economic regulation aimed at leveling the playing field and keeping certain groups from taking advantage of others through commerce, but to do so they need the Supreme Court to scale back its robust judicial review of economic regulation. And in 1934, these progressives win a major victory when Justice Owen Roberts changes his vote in Nebbia, making it a 5-4 decision in favor of the state.

“So far as the requirement of due process is concerned,” Roberts writes for the majority, “a state is free to adopt whatever economic policy may reasonably be deemed to promote public welfare, and to enforce that policy by legislation adapted to its purpose … If the laws passed are seen to have a reasonable relation to a proper legislative purpose, and are neither arbitrary nor discriminatory, the requirements of due process are satisfied.”

In Nebbia, the progressives had won their battle to regulate the economy for their chosen ends. The far more famous case of West Coast Hotel v. Parrish confirmed the Left’s victory three years later. Regulators were now free to interfere in the economy as they saw fit, so long as some rational motive could be offered. The most important takeaway is that if the Court could find any ostensibly rational reason for a regulation, then it had to uphold the law. Deference to the legislature had become the name of the constitutional game.

Not all were happy with this result. In his dissenting opinion, Justice James Clark McReynolds had a warning for his fellow justices:

The Legislature cannot lawfully destroy guaranteed rights of one man with the prime purpose of enriching another, even if for the moment, this may seem advantageous to the public. And the adoption of any ‘concept of jurisprudence’ which permits facile disregard of the Constitution as long interpreted and respected will inevitably lead to its destruction. Then, all rights will be subject to the caprice of the hour; government by stable laws will pass.

Fast-forward 80 years. Federal and state governments, free from the shackles of the early 20th century’s laissez-faire jurisprudence, regulate nearly every aspect of our economy. North Carolina alone has dozens of licensing boards that regulate trades from “animal breeder” to “cement finishing contractor” to “skin care specialist.” Despite consistent arguments by libertarians and conservatives that such economic regulation often produces few benefits for society while explicitly benefitting certain businesses over others, the courts have been effectively neutered in the realm of economic regulation. Challenging such laws as unconstitutional has become nearly impossible, notwithstanding rare outliers such as a line of cases striking down bans of unlicensed funeral casket production and another vindicating the economic rights of hair braiders.

And yet, it may be that the 21st Century has provided proponents of economic liberty in North Carolina with a new tool to make their case – the microbrew boom. Over the last ten years, North Carolina has seen a massive growth in microbreweries. Red Oak Brewery, Olde Mecklenburg Brewery, NoDa Brewing Company, and countless others have seemingly come out of nowhere to revolutionize the state of beer in the Old North State. The North Carolina microbrew movement has in fact grown to the point that it has come up against a new barrier – a state law that benefits distributors and large-scale producers at the expense of their competitors and consumers, under the guise of protecting the public welfare.

Sound familiar?

North Carolina’s Brewery Regulatory Scheme

N.C. Gen. Stat. § 18B-1104 authorizes the issuance of brewery permits in North Carolina. Holders of brewery permits must meet several conditions, the most controversial of which is found in subdivision (8), which provides:

“The holder of a brewery permit may … obtain a malt beverage wholesaler permit to sell, deliver, and ship at wholesale only malt beverages manufactured by the brewery. The authorization of this subdivision applies to a brewery that sells … fewer than 25,000 barrels … of malt beverages produced by it per year.”

Layman’s translation: Microbreweries may ship and sell their own beer only if they produce fewer than 25,000 barrels annually. At 25,000 barrels, microbreweries must sign a portion of their business away to licensed distributors.

Why might the state enact such a law? The General Assembly has spelled out its ostensible reasoning in N.C. Gen. Stat. § 18B-1300:

“Pursuant to the authority of the State under the Twenty-First Amendment to the United States Constitution, the General Assembly finds that regulation of the business relations between malt beverage manufacturers and importers and the wholesalers of such products is necessary to:

  • Maintain stability and healthy competition in the malt beverage industry in this State.
  • Promote and maintain a sound, stable and viable three-tier system of distributions of malt beverages to the public.
  • Promote the compelling interest of the public in fair business relations between malt beverage suppliers and wholesalers, and in the continuation of beer franchise agreements on a fair basis.
  • Maintain a uniform system of control over the sale, purchase and distribution of malt beverages in the State.”

Microbrew proponents who are familiar with how distributors benefit at the expense of small-scale breweries might call foul, alleging that the law’s true effect is not to accomplish any of the above-stated goals but rather to line the pockets of large-scale breweries and distributors. But remember – in the post-Nebbia world, it does not matter whether the reasons or intentions of the legislature in any way reflect reality. It only matters that the legislature has spelled out ostensibly rational and legitimate reasons for requiring microbreweries to sign their profits away to distributors.

Never mind that some businesses, i.e. incumbent distributors and large-scale breweries, are explicitly benefitting from a law that is damaging the ability of another group, i.e. up and coming microbreweries, to grow their profits. Never mind that a statutory scheme shielding mass producers like Anheuser-Busch and MillerCoors from new market entrants does anything but “maintain … healthy competition.” Never mind that when several legislators sought to raise the barrel limit for microbreweries to 100,000 barrels, it was the N.C. Beer and Wine Wholesalers Association — not Mothers Against Drunk Driving — that mobilized its lobbying arm to ensure that such deregulation never even received discussion in committee, thus protecting their state-supported business model.

All that matters, in a world of Progressive Era economic regulation, is that the legislature has proclaimed ostensibly legitimate policy ends. Business interests are free to advocate for laws that line their pockets at the expense of others, so long as some legitimate policy goal can be imagined. In other words, lobbying and economic protectionism are features, not kinks, of the progressive constitutional system in which the legislature reigns supreme. In the 21st Century world of watered-down judicial review, North Carolina’s microbreweries are left with no recourse from the courts. Or are they?

Hope for Brewers?

Since the days of Nebbia and West Coast Hotel, challenges to economic regulation have almost universally failed. Particularly in the realm of alcohol, where the State historically plays a role in regulating the distribution and consumption of an intoxicating product, it would be difficult to challenge any type of regulation as unconstitutionally “arbitrary” or “discriminatory.” Add to this the fact that state regulation of alcohol is explicitly authorized in the 21st Amendment, and it becomes clear that a challenge under the federal Constitution would fall flat.

But there is another fundamental document that North Carolinians often forget – our state Constitution. Originally authored in 1776 and then reorganized in 1868 and 1971, the state Constitution provides North Carolinians with many protections that are non-existent in federal law. And while the U.S. Constitution provides a rights “floor,” state courts are free to interpret their state constitutions as providing more protections than are conferred by federal law.

For example, take Article 1 Section 1: “We hold it to be self-evident that all persons are created equal; that they are endowed by their Creator with certain inalienable rights; that among these are life, liberty, the enjoyment of the fruits of their own labor, and the pursuit of happiness.” This provision was intended to echo the United States Declaration of Independence. While it does not create a constitutionally protected interest in any particular job, the “fruits of their labor” clause mandates that state regulation of business must be rationally related to a substantial government purpose – a higher standard than exists under federal law.

Article 1 Section 19 provides that “no person shall be…in any manner deprived of his life, liberty, or property, but by the law of the land” and that “no person shall be denied equal protection of the laws.” These are state guarantees of due process and equal protection. While decisions of the United States Supreme Court construing the federal due process clause are persuasive, they are not binding upon the North Carolina Supreme Court in interpreting the state Constitution’s “law of the land” clause. So, while North Carolina courts have historically interpreted the due process provisions of the state and federal constitutions in the same way, they are not required to do so. The equal protection clause is also interpretted in the same way as its federal counterpart.

Article I Section 34 declares that “Perpetuities and monopolies are contrary to the genius of a free state and shall not be allowed.” In interpreting this provision, our state courts have conceded that the legislature has the power to “enact laws, within constitutional limits, to protect or promote health, morals, order, safety, and general welfare of society.” State v. Balance, 229 N.C. 764, 769 (1949). However, when it is clear that “the Legislature has exceeded limitations upon its powers … Courts will interpose to declare an act void or nullify manifest purpose of legislative will.” Freeman v. Bd. of Comm’rs of Madison Cty., 217 N.C. 209 (1940). This provision seeks to prevent “horizontal restraints” which “impede competition and lead inexorably to increased prices.” Am. Motors Sales Corp. v. Peters, 311 N.C. 311, 318 (1984).

And finally, there is the capstone to our state Constitution’s Declaration of Rights — Article I Section 35. This provision states: “A frequent recurrence to fundamental principles is absolutely necessary to preserve the blessings of liberty.” Far from being mere fluff language, these words have been interpreted to have meaning and significance of their own. They require other constitutional provisions to “receive a liberal interpretation in favor of a citizen, especially with respect to those provisions which are designed to safeguard the liberty and security of the citizen in regard to both person and property.” Corum v. Univ. of N. Carolina Through Bd. of Governors, 330 N.C. 761, 783 (1992). The section further requires that “the meaning of the Constitution … be found in its spirit, not letter thereof, which gives way to promote equity of the spirit.” Under this section and others, “the right to earn a living is an inalienable right.” State v. Harris, 216, N.C. 746 (1940).

Does any of this mean that, as of right now, the state’s regulation of microbreweries is unconstitutional? No. But it does provide potential for microbreweries to make a principled, constitutionally-rooted argument that the state’s current three-tier system favors distributors and large-scale producers in such a way as to violate the rights of microbreweries and their operators. What might such an argument look like?

It would begin with the propositions that North Carolinians have an “inalienable right to earn a living,” as well as rights to equal protection and due process of law. Any regulations implicating these rights must pass constitutional muster. On this basis, microbrewery operators might offer three primary arguments, and a fourth reinforcing the other three:

  1. The 25,000-barrel cap is a regulation on a microbrewery owner’s “inalienable right to earn a living” that is not “rationally related to a substantial governmental purpose,” and therefore violates Article 1 Section 1 of the North Carolina Constitution.
  2. The 25,000-barrel cap artificially transfers wealth from microbrewery operators to distributors and larger-scale competitors in such a away as to violate the “law of the land” and equal protection clauses of Article 1 Section 19 of the North Carolina Constitution.
  3. The state’s malt beverage regulatory scheme favors distributors and large-scale breweries to such an extent that it creates an impermissible monopoly in favor of entrenched interests, and therefore violates Article 1 Section 34 of the North Carolina Constitution.
  4. The aforementioned constitutional provisions are all intended to “safeguard the liberty and security of the citizen in regard to both person and property,” and therefore must all “receive a liberal interpretation in favor of” citizens and against the State.

Despite the potential for such arguments, a betting man would still expect such a lawsuit to fail. That is because economic regulations, and particularly those of traditionally dangerous substances like alcohol, have historically been upheld. Further, North Carolina courts have followed their federal and state counterparts in allowing almost any economic regulation to survive rational-basis review.

That being said, more can be learned from the Nebbia and West Coast Hotel sagas than simply that courts have scaled back their power of judicial review. That episode also demonstrates that American courts are open to change. Perhaps, if microbreweries advance a legitimate argument under the North Carolina Constitution that they are being deprived of their rights, courts will listen, and develop a legal test that maintains deferrence to the legislature while increasing protections for economic liberties. After all, constitutions exist to protect our most fundamental freedoms from our own government. When entrenched business interests with the capacity to lobby are using the law to protect their profits at the expense of emerging small businesses, it would seem that there must be a constitutional remedy. Perhaps in the future our state courts will have the opportunity to decide whether, and how, our state’s constitution can protect a flourishing new industry from the influence of economic incumbents in Raleigh.

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