E-Commerce Protectionism and US Appellate Courts

One of the areas that is increasingly becoming of concern to online retailers is a state’s power to regulate e-commerce through enforcing that particular state’s regulation of certain offline business activities. A recent case in point is Powers v. Harris, where the U.S. Court of Appeals for the 10th Circuit upheld the constitutionality of an Oklahoma statute regulating casket sales.

As the statute required that, in most situations, one must be a licensed funeral director operating out of a funeral establishment to sell caskets, it had the effect of preventing online casket sales into Oklahoma by out-of-state e-tailers. Two individuals, Kim Powers and Dennis Bridges, who own a company called Memorial Concepts Online, which sells funeral merchandise over the Internet, challenged the constitutionality of the protectionist statute.

The Court of Appeals affirmed the District Court’s decision upholding the constitutionality of the law. In particular, and among other constitutional matters, the Court of Appeals addressed the plaintiffs’ argument that the statute violated the due process and equal protection clauses of the Fourteenth Amendment of the U.S. Constitution by stating that the due process and equal protection clauses protect distinctly different interests.

Protection Against Interference

The substantive component of the due process clause provides heightened protection against government interference with certain fundamental rights and liberties, even when the challenged regulation affects all persons equally. The essence of the equal protection clause is that the state must treat all those similarly situated equally and, therefore, only applies when the state treats two individuals or groups differently.

In its equal protection analysis, the Court of Appeals used the “rational basis” test, stating that the statute needed only to be rationally related to a legitimate government interest.

However, the Court used a lower standard of the test, disagreeing with the decision in Craigmiles v. Giles, which struck a nearly identical Tennessee statute because it violated the equal protection and due process clauses. In particular, the court disagreed with the holding in Craigmiles that protecting a discrete interest group from economic competition is not a legitimate government purpose.

Rather, the court concluded that intrastate economic protectionism is a legitimate state interest and that the Oklahoma statute is rationally related to this legitimate end. Although the Court acknowledged that the statute “may exact a needless, wasteful requirement in many cases,” it deferred to the legislature, stating that it is not the position of the courts to balance the statute’s advantages and disadvantages.

Following on the Heels of Other Decisions

The above decision comes on the heels of several other recent relevant decisions dealing with the sale of alcohol online. In Swedenburg v. Kelly, the 2nd U.S. Circuit Court of Appeals upheld a state law barring out-of-state wineries from shipping wine directly to New York consumers, overturning a lower court decision that found the ban unconstitutional as interfering with interstate commerce.

Specifically, the Court of Appeals reaffirmed New York’s constitutional right to ensure that out-of-state alcohol providers comply with the state’s alcohol regulatory system, a right conferred upon the state by the Twenty-First Amendment. The Court was not persuaded by evidence that the Internet and increased travel have created an easier access for an “increasingly sophisticated national market of wine connoisseurs” and held that “changes in marketing techniques or national consumer demand for a product do not alter the meaning of a constitutional amendment.”

New York, like most states, requires that all sales of alcohol in the state, whether by producers or importers, wholesalers or retailers, be made to or by state-licensed entities. For out-of-state companies to be able to ship to New York customers, they need to establish a “physical presence” in the state.

The issue of the online sale of alcohol has national implications as similar cases have been filed in at least eleven other states, and there have been several decisions from appeal courts across the country. For example, on June 26, 2003, the 5th Circuit Court of Appeals in Dickerson v. Bailey decided that a state-legislated ban on the direct-to-consumer sale of wine to Texan consumers, which applied only to out-of-state producers, was unconstitutional.

Specifically, the Court ruled that the ban “facially” violated the judicial doctrine of the “dormant commerce clause.” The Court also found that the ban was of discriminatory intent and effect, blatantly promoting the economic interests of Texas wine producers over those of other state wine producers.

Lastly, the Court held that the ban was not saved by Section 2 of the Twenty-First Amendment (state powers to regulate alcohol), because the discriminatory effect of the ban was not “incidental” and the legislation did not have a “legitimate local purpose.”

Discriminatory Sales Bans

Other courts have issued similar opinions on the unconstitutionality of discriminatory bans on direct-to-consumer sales by out-of-state wineries. For example, the 4th Circuit Court of Appeals in Beskind v. Easley (April 8, 2003) came to the same conclusion in respect of a similar ban in North Carolina.

It is worth noting, however, that U.S. courts have upheld bans on direct-to-consumer sales of wine, if such bans are applicable to both in-state and out-of-state wineries equally, and therefore are nondiscriminatory in nature.

One such decision is the judgment of the 6th Circuit Court of Appeals in Heald v. Engler, which struck down as unconstitutional a Michigan state law regulating the sale and distribution of wine, the provisions of which law differentiated between in-state and out-of-state wineries.

Overall, the discrepancies of the above decisions between the different appellate courts leave e-businesses with uncertainty and exposed to excessive state protectionist laws, with the only solution being either federal legislation or some guidance from the U.S. Supreme Court.