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THE THREE-TIER DISTRIBUTION SYSTEM

The United States Constitution, the U.S. Three-Tier Distribution System and Southern Wine and Spirits of America's Government-Affairs Activities

Southern Wine and Spirits of America, Inc. is the country's single largest wine and spirits distributor-with operations in 35 states. As such, the Company naturally has had a longstanding commitment to and interest in the nation's set of alcoholic beverage laws and regulations at both the state and federal levels.
American historians have described the nation's regulatory framework for the production, distribution and retail sales of wine, spirits and beer as a three-tier distribution system. This means that a wine, distilled spirits or beer product moves in a legally sanctioned series of transactions from the producer to a designated distributor at the state level and then on to a legally licensed retail, restaurant or bar. Under this highly regulated chain, distillers, vintners and brewers are collectively known as the first tier; wholesalers and distributors are recognized as the second tier; and individual and/or chain retail, bar and restaurants are characterized together as the so-called third tier.

The American three-tier distribution system is governed by the 21st Amendment of the United States Constitution. When the U.S. Congress first passed this law in 1933, this historic Constitutional Amendment overturned the infamous 18th Amendment to the U.S. Constitution, passed 14 years before in 1919. The 18th Amendment totally outlawed the manufacture, distribution and sales of all types of alcoholic beverages (with only a few exceptions regarding medicinal or religious uses) within the United States. This period of time was known as Prohibition, an era when extreme social, religious and political forces were unleashed to an extent never before seen (or experienced) in American history.

Not surprisingly, this 14-year experiment in faulty social engineering turned out to be a miserable failure. Historians have documented that actual consumption of beer, wine and spirits increased during this period instead of "drying up," as was the fervent, yet unrealistic hope of religious and political proponents of Prohibition. But America's "dry" period had the unintended consequence of forcing heretofore civic-minded, law-abiding Americans to begin breaking the law on a regular, if not daily basis. Americans may have passed a law banning alcohol in 1919, but its government could not do away with thousands of years of ingrained habits of shared hospitality and the country's abiding, adult taste for these types of previously legal beverages.

When Democrat Franklin Delano Roosevelt entered the Presidential contest in 1932 against the incumbent Republican Herbert Hoover, a key plank in the Democratic Party's campaign platform was a call for the end of the 18th Amendment. This campaign to return to the nation's previously "wet" traditions was almost universally supported under the banner of "Repeal of Prohibition." Roosevelt won that Presidential election, and in his first 100 days of furious legislative activity, the 21st Amendment was introduced and quickly passed in Congress. Shortly thereafter, the new Amendment was ratified by a necessary two-thirds of all the states in the Union, a process in which each state had to vote up or down the proposed Amendment.

The 21st Amendment ended Prohibition and returned to the states all power over the sale and distribution of beer, wine and spirits. Its passage allowed federal as well as state authorities to tax wine, spirits and beer, which generate billions of tax dollars annually for local, state and federal authorities. In another of its most important consequences, its passage prompted U.S. federal authorities to issue regulations outlawing the pre-1919 phenomenon of the tied-house, a regime under which a brewer, vintner or distiller typically owned one or more retail establishments, excluding in the process, all other competition. Enshrined in the Federal Alcohol Act passed in 1933, these so-called "tied-house," anti-competitive arrangements are explicitly forbidden within the nation's three-tier distribution system.

At the state level, two legal approaches emerged in the wake of the 21st Amendment's passage: a competitive model and a so-called control model. Today, 33 states permit the private sector to distribute and sell alcoholic beverages, including such states as California, New York and Florida, among others. Elsewhere, 17 states have decided to adopt a so-called control model, under which the state is involved in one or more tiers of the traditional three-tier distribution system noted earlier. Control state markets like Pennsylvania and New Hampshire not only manage the distribution tier (and related tax revenue collections), but also the retail tier as well, while other control states like Michigan, North Carolina and Vermont all take slightly different approaches.

Indeed, this complicated patchwork of approaches, evident in each and every one of the country's 50 states, is a living expression of the important constitutional concept known as "State's rights," or those specific powers exercised by the state over its own destiny. These powers are expressly protected under the U.S. Constitution. It is worthwhile to note that in the 80 years since the 21st Amendment became the law of the land, only one state (Washington, from control- to open-state status in spirits in 2012) has changed the model its legislators originally mandated regarding the sale and distribution of wine, distilled spirits and beer.

With reference to these two approaches at the state level, Southern Wine & Spirits of America, Inc. operates in 18 competitive-model (known as “open states” or “license states”) markets, including Alaska, Arizona, California, Colorado, Delaware, the District of Columbia, Florida, Kentucky, Hawaii, Illinois, Indiana, Maryland, Minnesota, Nevada, New Mexico, New York, South Carolina and Washington. Southern also holds operating licenses and permits in Nebraska and Texas. Southern is operates in 17 control state jurisdictions, including Alabama, Iowa, Idaho, Maine, Michigan, Mississippi, Montana, New Hampshire, North Carolina, Ohio, Oregon, Pennsylvania, Utah, Vermont, Virginia, West Virginia and Wyoming.

While all three tiers of the alcoholic beverage industry actively support programs to combat and reduce alcohol abuse and underage drinking, it is the special responsibility of the third tier, because of its face-to-face contact with customers, to prevent sales to minors. One of the most important benefits of the three-tier system is that it makes a specific licensed party - in this case the retailer, restaurateur or bar-owner- responsible for preventing sales to minors. The three-tier system also makes sure the licensed party - in this case the distributor - is responsible for the remittance of excise taxes on alcoholic beverages to the state.

From the standpoint of government relations, Southern Wine and Spirits of America is involved at both the federal and state levels, advocating (as well as educating) government and elected officials about the three-tier distribution system and precisely why it is so critical to the U.S. beverage industry's overall performance. Company officials take a pro-active stance in educating and informing state and federal legislators about the industry's three-tier distribution system, the 18th and 21st Amendments and other pertinent topics affecting the drinks industry.

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