September 30, 2003, 12:00 AM

Wine’s online future may be settled by an appeals court

A three-judge panel last month heard arguments in New York state`s bid to overturn a lower court`s ruling last October that found New York`s ban on Internet sales of wine unconstitutional.

Ambitious vineyards have long sought ways of expanding their markets. Many are too small to afford the effort to get the wines into liquor distributors, and so they did what they could: most opened wine tasting rooms, listed their operations on wine country tours and many adopted mail order operations. When the Internet came along, many thought they had found their outlet.

Then state law got in the way. State liquor-control laws are a complex web of regulations designed to keep liquor out of the hands of minors and to collect the taxes that states are increasingly relying on.

But two California wine industry groups, Family Winemakers of California and The Coalition for Free Trade, consider state regulation to be an un-navigable web of Byzantine laws and so have gone to court to crack open new markets. Their federal suit to force New York to open its liquor distribution market has made it to the appeals level, and a three-judge panel last month heard arguments in New York state’s bid to overturn a lower court’s ruling last October that found New York’s ban on Internet sales of wine unconstitutional. New York, second only to California in wine sales, could set a precedent for Internet wine sales if the lower court’s ruling is upheld. Similar legal actions have recently overturned bans in Texas and Michigan. Participants expect a ruling by the end of the year.

The winemakers, represented by former Clinton prosecutor Kenneth W. Starr, contend that established distribution networks to retail liquor stores are largely closed to thousands of small wine sellers, forcing them to turn to the web as a direct-to-consumer channel. “For these winemakers, it’s Internet or die,” Starr says.

Starr contends that thousands of small wineries across the U.S. are being shut out of traditional wine distribution networks that favor only the largest and most popular wine labels. He estimates that there are about 6,000 wineries nationwide, including some in each of the 50 states, and that they lose hundreds of thousands of dollars per month in sales by being shut out of direct-to-consumer sales by state laws. “For many of these wineries, it’s the tasting room, their catalog and the Internet as their only options for selling,” he says, adding that most see the web as the best way to reach the largest number of customers.

New York state officials contend that the battle is over states’ rights, and that they oppose the federal government’s taking action to usurp New York state law. Without the ban, the state will have no way of regulating direct-to-consumer wine sales for payment of sales tax and for preventing sales to minors, adds Randy Mastro, a partner with law firm Gibson, Dunne & Crutcher in New York City, representing several wholesalers and the New York City-based Metropolitan Retail Association. “There are wineries that will ship directly to minors and that won’t collect sales tax,” he says.

Moreover, he adds, there are more than 200 wine wholesalers in New York state and 90% of the wine sold in the state is from out-of-state winemakers. “This is not a free trade issue,” Mastro says. “My clients have invited out-of-state wineries to talk about distribution.”

But Starr, a partner with Washington, D.C.-based law firm Kirkland & Ellis, contends there are too many wineries for existing wholesalers to handle. Further, he notes, there are software systems that handle multi-state sales tax collection for web sales. And wine groups have worked with shipping companies, including FedEx and UPS, to establish procedures that require an adult to sign for deliveries of wine in direct-to-consumer orders.

Kirkland & Ellis argued in the case that the market opportunities for many wineries have sharply declined over the past several decades. Since the mid-1960s, it notes, the number of wine wholesalers has decreased to about 3,000 from 11,000, while the number of wineries has increased. At the same time, most wholesalers insist on selling a limited number of the most popular wine labels, restricting the market access of many wineries.

“There now are often only two or three major wholesalers per market,” the suit contends. “Moreover, those wholesalers focus almost exclusively on well-known, high-volume wines at the expense of smaller, lesser-known brands. As a result, small- and medium-sized wineries cannot depend upon wholesalers to develop or maintain an out-of-state customer base for their wines.”

Starr adds that Internet sales would be good for the overall wine industry by promoting new varieties. “The innovation in this industry is coming from these small, family-owned wineries,” he says.

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