Federal Judges Use Dormant Commerce Clause to Revamp Traditionally-Regulated Industries

Traditionally, state governments played a large role in regulating the transportation and sale of certain substances such as alcohol and cannabis. Recent federal court decisions suggest that a state’s ability to control such conduct may be eroding. Historically, the alcohol industry, and, more recently, the cannabis industry, was built on state-level licensing regulations that generally favor in-state residents. This is a considerable barrier to entry for many aspiring participants in these industries. Recently, federal courts have confronted many of these state-residency requirements in the cannabis license and liquor license context and found them to be unconstitutional, or at least constitutionally questionable, under the Dormant Commerce Clause of the United States Constitution.

The United States Supreme Court most recently addressed state residency requirements in the liquor licensing context in 2019. In that matter, the Court held that Section 2 of the 21st Amendment did not shield liquor-licensing regulations from Dormant Commerce Clause challenges and that such residency requirements violate the Dormant Commerce Clause because various state interests could be achieved through less restrictive means. Tenn. Wine & Spirits Retailers Ass’n v. Thomas, 139 S. Ct. 2449, 2467 (2019). Likewise, state attorneys general have concluded that both durational and non-durational residency requirements found in state liquor licensing regulations are unconstitutional.

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In contrast, courts have found three-tiered regulatory systems in the liquor licensing context constitutional under the Dormant Commerce Clause. Unlike the blanket residency requirements, courts have found states’ discriminatory treatment of out-of-state residents in these systems essential because the alternative would provide out-of-state retailers with a competitive pricing advantage, which the Dormant Commerce Clause does not mandate.

Using the United States Supreme Court’s reasoning and analysis, federal courts have similarly found state residency requirements in cannabis licensure regulations to also be unconstitutional under the Dormant Commerce Clause. These decisions serve to shake up the regulated substances industry and provide for greater opportunities for potential licensees looking to participate from out-of-state.

The Dormant Commerce Clause of the United States Constitution

Courts have inferred the Dormant Commerce Clause from the United States Constitution’s Commerce Clause, which grants broad authority to Congress “to regulate Commerce . . . among the several States.” The Dormant Commerce Clause prohibits state governments from regulating commerce in other states. Courts analyze state laws under the Dormant Commerce Clause when such a law discriminates against out-of-state goods or nonresident economic actors. If the court determines the state law is discriminatory, then it will only uphold the law if it “advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives.” Toigo v. Dep’t of Health & Senior Servs., No. 2:20-cv-04243, 2021 U.S. Dist. LEXIS 228062, at *8 (W.D. Mo. June 21, 2021).

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Courts Find State Residency Requirements in Liquor Industry Unconstitutional 

Relying on the United States Supreme Court’s decision in Tennessee Wine, the United States District Court for the Southern District of Indiana enjoined enforcement of Indiana’s liquor licensing statute because the statute contained a durational residency requirement for eligibility to receive an alcoholic beverage retailer’s or dealer’s permit of any type. Chi. Wine Co. v. Holcomb, No. 1:19-cv-02785, 2021 U.S. Dist. LEXIS 60171, at *15 (S.D. Ind. Mar. 30, 2021). Applying Tennessee Wine, the court granted summary judgment for the wine connoisseur, retailer, and collector plaintiffs and enjoined the statute.

State Attorneys General Reached the Same Conclusion

In a May 4, 2021 opinion, the Maryland attorney general concluded that the non-durational residency requirements for alcoholic beverages licenses issued in multiple Maryland counties likely violate the Dormant Commerce Clause. The attorney general noted the Thomas court did not distinguish between durational and non-durational residency requirements and it was unlikely that any distinctions between the durational and non-durational residency requirements were sufficient to produce a different result.

Similarly, the attorneys general of Kansas and Oklahoma specifically noted that blanket residency and durational residency requirements found in their state liquor licensing statutes are likely unconstitutional under the Dormant Commerce Clause. Responding to Tennessee Wine, the Oklahoma attorney general deemed the Oklahoma Constitution’s liquor license residency requirement likely unenforceable due to the requirement that the sole proprietor applicant be a resident of Oklahoma for at least five years.

Similarly, the Kansas attorney general determined that Kansas’s liquor licensing statutes containing residency and durational residency requirements, respectively, were likely unconstitutional under the Dormant Commerce Clause. The attorney general determined the durational residency requirement in the Kansas liquor licensing statute to be indistinguishable from the statute in Tennessee Wine. Further, turning to the second statute, the attorney general stated that a constitutional challenge to the Kansas licensing statute containing a “non-durational” residency requirement would also likely be successful.

Courts Treat Three-Tiered Regulatory Systems Differently

Federal courts have recognized that three-tiered state regulatory systems are distinct from blanket residency requirements in licensing schemes and have found these three-tiered systems constitutional under the Dormant Commerce Clause. A three-tiered system generally requires producers or distillers of alcoholic beverages to sell only to licensed in-state wholesalers, who in turn then sell to in-state retailers, who sell to consumers. See, e.g., Granholm v. Heald, 544 U.S. 460, 468 (2005) (stating Michigan’s three-tier system required producers of alcoholic beverages to sell only to in-state wholesalers, who sell to only in-state retailers); Brooks v. Vassar, 462 F.3d 341, 345 (4th Cir. 2006) (noting Virginia’s three-tier structure allows producers and sellers of alcoholic beverages to sell in Virginia only to Virginia-licensed wholesalers, who sell only to Virginia-licensed retailers).

In July 2021, the United States District Court for the Western District of North Carolina upheld North Carolina’s three-tier regulatory framework prohibiting out-of-state wine retailers from shipping wine directly to consumers residing in North Carolina and prohibiting retailers from obtaining a North Carolina Alcoholic Beverage Control Commission permit unless certain conditions are met. Such permits are only issued to North Carolina residents unless the permit applicant falls within a defined exception. The court found North Carolina’s discriminatory treatment of out-of-state wine retailers was essential to its three-tier system and thus permissible under § 2 of the Twenty-First Amendment. B-21 Wines, Inc. v. Stein, No. 3:20-CV-00099, 2021 U.S. Dist. LEXIS 127909, at *16 (W.D.N.C. July 9, 2021).

Citing Tennessee Wine, the court recognized a distinction between discrimination of out-of-state products and producers, which § 2 of the 21st Amendment prohibits, and out-of-state retailers. As the court summarized, “[a]llowing producers to circumvent the three-tier system does not undermine the system in the same way allowing retailers to circumvent the system would.” Id. at *15.

Similarly, the United States Court of Appeals for the Eighth Circuit held Florida’s three-tiered alcohol regulatory scheme constitutional under the Dormant Commerce Clause. The court held that a Florida-based wine retailer, its owner-operator, and two Missouri residents seeking direct delivery of wines not sold in Missouri, failed to state a viable Dormant Commerce Clause claim because Florida’s challenged restrictions, prohibiting out-of-state retailers from shipping wine directly to Missouri consumers and Missouri’s residency and physical presence licensing requirements, are part of a three-tiered system that has been consistently upheld as “unquestionably legitimate.” Sarasota Wine Mkt., LLC v. Schmitt, 987 F.3d 1171, 1182 (8th Cir. 2021).

The court noted the distinction between the plaintiffs in this case, who were challenging Missouri’s requirements that licensed liquor retailers be residents of Missouri, have a physical presence in the state, and purchase liquor sold in the state from licensed in-state wholesalers, and applicants for an in-state Missouri liquor license challenging a durational residency requirement. Agreeing with the United States Court of Appeals for the Sixth Circuit, the court concluded that “[t]he purpose of the [three-tiered] system, for better or worse, is to make it harder to sell alcohol by requiring it to pass through regulated in-state wholesalers . . . [This] seems far afield from the tied-saloon system that the three-tier system was designed to replace . . . But the Twenty-first Amendment leaves these considerations to the people[,] . . . not to federal judges.” Sarasota Wine, 987 F.3d at 1183 (quoting Lebamoff Enters. Inc. v. Whitmer, 956 F.3d 863, 876 (6th Cir. 2020), cert. denied, 141 S. Ct. 1049 (2021)).

The Supreme Court of the United States declined to hear this case. Sarasota Wine, 987 F.3d at 1183, cert denied, No. 20-1767, 2021 U.S. Dist. LEXIS 5097, at *1 (2021).

Federal Courts Strike Down State Residency Requirements in Cannabis Industry

In 2021, federal judges turned from alcohol to state cannabis licensure regulations that required potential licensees to reside in-state. Beginning in June 2021, a federal judge for the Eastern District of Michigan enjoined enforcement of the City of Detroit’s recreational marijuana licensing ordinance process, containing a durational residency requirement, because it was “unfair, irrational and likely unconstitutional.” Lowe v. City of Detroit, No. 21-CV-10709, 2021 U.S. Dist. LEXIS 113444, at *1 (E.D. Mich. June 17, 2021). The court found the requirement “more protectionist than it is equitable” as the challenged provisions of the Detroit Ordinance did “not appear to be rationally related to the stated purpose of rectifying the harm to City residents by the War on Drugs.” Id. at *21-22.

Four days later, a federal judge found Missouri’s regulation requiring that medical cannabis facilities be majority-owned by state residents who had resided in the state for at least one year likely unconstitutional under the Dormant Commerce Clause. Toigo, 2021 U.S. Dist. LEXIS 228062, at *22. The judge issued a preliminary injunction prohibiting enforcement of the Missouri Department of Health and Senior Service’s regulation because there were several non-discriminatory means available to further the legitimate interests advanced by the regulation. These non-discriminatory means included conducting background checks on potential cannabis licensees to further the interest of enforcing drug laws. Id. at *11.

Seven weeks later, the United States District Court for the District of Maine rendered a final judgment and held that Maine’s dispensary residency requirement, providing that all officers or directors of a medical marijuana dispensary must be residents of Maine, violated the Dormant Commerce Clause because this was the type of law that furthered “the sort of economic protectionism that the Supreme Court has long prohibited.” Northeast Patients Grp. v. Me. Dep’t of Admin. & Fin. Servs., No. 1:20-cv-00468, 2021 U.S. Dist. LEXIS 151027, at *12 (D. Me. Aug. 11, 2021).

The Defendants, Kirsten Figueroa, the Commissioner of Maine’s Department of Administrative and Financial Services, and United Cannabis Patients and Caregivers of Maine, an in-state trade group that intervened in the case, are asking the United States Court of Appeals for the First Circuit to reverse this ruling.

The Future of The Alcohol and Cannabis Industry

The litigation concerning state regulations in the cannabis and liquor industries serves to alter traditional roles within these trades. Historically, states played a large role in the regulation of the sale of these substances and often preferred in-state residents to participate in the industries. Recent successful challenges to state liquor and cannabis licensing schemes containing a durational or non-durational residency requirement pave the way for future litigation concerning state regulations with similar requirements and likely will open up the markets for out-of-state residents to be participants. National manufacturers and distributors of alcohol and cannabis should closely monitor these developments as their ability to be present in, and serve, new markets may multiple as preferential restrictions are loosened or eliminated.