Home Wine Business Editorial DTC The State of DTC: A Year-End Conversation with Sovos ShipCompliant’s Alex Koral

The State of DTC: A Year-End Conversation with Sovos ShipCompliant’s Alex Koral

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DTC Expert Alex Koral reviews 2022 developments in the arena
and looks to the future of wine shipping.

 

Wine Industry Advisor is lucky to count Alex Koral among its regular contributors. Koral, a regulatory general counsel for Sovos ShipCompliant since 2015, actively researches beverage alcohol regulations and market developments to inform development of Sovos’ ShipCompliant product and help educate the industry on compliance issues. 

As 2022 winds down, we asked him about where DtC regulations stand now — including proposed legislation, outside industry meddling and related services (such as for spirits and beer) — and where they’re headed. Assuringly (after the past few years of pandemic-related upheaval), Koral sees calmer seas ahead.  

 

Q: What does Louisiana’s move on fulfillment houses suggest about where states might be headed in terms of regulating fulfillment houses and their role in DtC alcohol shipping in the months and years ahead?

Background: In August 2022, the state of Louisiana Administrative Code was updated to define “fulfillment house” as an entity that makes DTC wine (and other alcohol beverages) shipments into Louisiana on behalf of a direct shipper permittee. Under the new rules, fulfillment houses “shall consent to the jurisdiction of the Office of Alcohol and Tobacco Control and the State, and shall file quarterly reports detailing each shipment due.” The law allows a civil penalty of up to $25,000 for unlicensed shipments. (Source: Sovos ShipCompliant Oct. 20, 2022)

ALEX KORAL: The recent action by the Louisiana Office of Alcohol and Tobacco Control (ATC) to establish regulations around fulfillment houses involved in DtC shipping of alcohol largely reflects a broad trend among states, but is not a major change or advancement in itself. We saw several states — Alabama, Kansas, Tennessee — add fulfillment house regulations in 2021, and each of them implemented more onerous policies than Louisiana. Indeed, Louisiana tried to restrict the use of fulfillment houses in 2021, taking a maximalist stand that they could not be used at all. That policy was, thankfully, reversed almost immediately. But it was clear that the ATC wanted some way to monitor the activities of fulfillment houses. What they ended up instituting is more in line with the rules for using fulfillment houses in Illinois, placing the registration responsibility on the shippers while also requiring the fulfillment houses to file their own reports. 

This signals that there is still clear concern among regulators about who is shipping into their states and how, which will almost certainly result in further efforts in other states to adopt their own fulfillment house regulations. The question, then, is what shape those regulations will take? 

Some kind of enrollment of active fulfillment houses and reporting by such third-party logistics services seems to be the developing pattern. That the rules enacted by the ATC more closely resemble those in Illinois rather than those in, say, Tennessee (the main difference being whether the fulfillment house needs only to be listed by their shippers or if they need to apply for their own separate license), might indicate the development of divergent tracks of regulation that other states could take. That’s not inherently a problem, though the prospect of different rules in different states for ultimately the same action creates the risk of confusion.

 

Q: The ULC’s Alcohol Direct-Shipping Compliance Act created quite a stir in the industry earlier this year. Has it driven any noticeable changes yet? And are industry watchers anticipating any actions in the states as a result of this model legislation being put forth?

Background: In July 2022, the Uniform Law Commission (ULC; an attorney committee otherwise best known for promulgating the Uniform Commercial Code, required reading for every first-year law student and MBA candidate) sent shock waves through the wine business. The bipartisan commission released two draft proposals that require licensing for fulfillment houses and focus on increased access to information about DtC shipments. Analysts, lawyers and pundits quickly predicted that, if adopted, the model direct shipping law offered by the ULC would torpedo 16 years of legal direct shipping. (Source: Wine Industry Advisor July 25, 2022)

ALEX KORAL: First, the ULC is merely an advisory organization and has no legislative authority of its own, so what they issued was guidance that states might follow, but not a valid law in itself.

There has been no action in any state in response to the ULC’s proposed model shipping bill. Frankly, it seems unlikely that it will be acted on by any state, at least in its current form. The biggest sign for that prediction is that essentially everyone was upset with the results, including distributors and other detractors of the DtC shipping market. That does not mean it won’t be picked up, but there is no obvious sponsor in any state to adopt the ULC’s proposed model bill, so it’s unclear what its path forward would be.

It’s also helpful to remind ourselves what was in the ULC’s proposed bill. While it started years ago as a proposal to create a model spirits DtC shipping bill, and then morphed into “solving” the current “problems” within the wine DtC shipping market, it ended up proposing only two general policy positions that states could adopt: 1) regulation of fulfillment houses, and 2) enforcement powers for states to go after local businesses that violate the laws of other states. 

As we’ve seen, regulation of fulfillment houses has been happening anyway without any input from the ULC, which leaves the expanded enforcement provision as really the only novel element. However, state regulators are extremely loathe to enforce the laws of other states, so even if such a provision were adopted into law, it’s very uncertain if it would ever be acted on. As such, the ULC efforts are likely to end up more as sound and fury, but result in little actual change.

 

Q: There was a decline in DtC legislative changes in 2022 as compared to 2020 and 2021. What areas of DtC regulation do you suspect will be the focus of industry associations, lobbyists and lawmakers in 2023 legislative sessions?

ALEX KORAL: 2022 did actually see significant legislative changes when it comes to the beverage alcohol industry, it’s just that most of it was related to local concerns — namely, expanding local retail delivery options. That said, Alaska saw a major overhaul of its alcohol laws, including on DtC shipping, and Vermont notably expanded DtC shipping to include (limited) spirits products. 

That said, it’s true there were few stand-out headlines when it came to DtC legislation in 2022. Part of that reflects the past success by proponents of wine DtC shipping; there are only three more states for them to open up, so there is less availability for major changes. DtC wine shipping proponents are now acting more to prevent any retrenchment of their permissions or the adoption of archaic restrictions designed to limit their market. This is different from proponents of beer and spirits shipping, which did see some high profile attempts to change state laws, though they largely failed to pass. 

It seems likely 2023 will end up generally following the patterns set in 2022: efforts to expand DtC shipping for spirits producers and, to a lesser degree, beer producers, contrasted with efforts to restrict/impede existing DtC shipping permissions, such as extending regulation of fulfillment houses. It’s likely that each side — proponents and detractors — will take lessons from 2022 as they continue to push their agendas, so it’s possible we will see more big headlines as bills do pass that previously failed in 2022. But many will still fail, and it’s likely that what will pass will be a smattering of both expansions (there will certainly be a lot of focus on passing a spirits shipping bill in California) and restrictions (see fulfillment houses). 

At the same time, it’s likely that state regulators will continue to look for ways to enable greater enforcement of their laws and prevent improper sales, such as those going to minors, though much of that may easily end up being more talk than action.

 

Q: You’ve previously discussed the numerous gray areas in the world of bev/alc distribution. What do you think are the most concerning/potentially dangerous areas for producers to engage with at this time? Do you expect any of those to become more well-regulated this year, and/or potentially the target of stronger enforcement?

ALEX KORAL: Underlying the debate around fulfillment houses is the fear among state regulators around third-party services involved in the DtC shipping model. While it seems like regulators are missing the point — as fulfillment houses are logistics companies and are not marketplaces nor do they purport to sell alcohol at all — it’s clear that regulators are expressing valid concerns around the swaths of unlicensed parties shipping alcohol within the U.S. As such, any producer availing themselves of a third-party DtC shipping service should be aware of what those third-party services are doing and what the producer’s remaining liability should be. 

Again, logistics services (or compliance services) should not be a major concern for producers, as long as they make sure their fulfillment houses are abiding by any license and reporting requirements adopted by a state. But if the producer is using a third-party marketplace, or any service that offers the use of their licenses to facilitate DtC shipping, that should demand a second — and even a third and fourth — look. State regulators say they’re very concerned about third-party marketplaces for alcohol, and while they’ve largely not done anything about them (Ohio’s past enforcement action against wine.com being the exception), it feels like it’s only a matter of time before that shoe drops and producers that have their bottles for sale on those sites may end up having to answer some difficult questions.

Within the wholesale distribution market, there’s been notable expansion of offerings to enable “direct” sales within the three-tier system. How these programs are described is that a producer would establish its own online marketplace where it could advertise and sell its products to consumers across the country; the orders would then be passed along to a local partner retailer to fulfill and deliver to the consumer. While on its face this has the imprimatur of operating in the “indisputably” valid three-tier system (and is fully supported by distributors), this is an extremely new and untested sales model that could result in unanticipated concerns for an alcohol attorney and the producers they represent. 

Namely, this seems to violate state and federal trade practice laws against exclusive outlets, along with possibly implicating consignment sales and other collusion prohibitions. If nothing else, this type of sale would still require the producer to be active in the three-tier system in every state, which brings a host of compliance burdens and the risk of being trapped by franchise laws. While, again, these sales have the approval of distributors (and so will not have to deal with their opposition), they are unvetted and so are risky for producers to sign up for blithely.

 

Q: Looking in your crystal ball, what do you think the biggest DtC trend or change will be in the coming year?

ALEX KORAL: Barring the unforeseeable, it seems like 2023 will largely be an extension of 2022, with efforts to expand shipping for beer and spirits gaining some ground (but not an overwhelming sea change), and other efforts to curtail existing DtC shipping permissions being suggested but also largely failing to get real traction. If a high-profile state like California were to pass a bill expanding DtC for spirits (which will be on the docket in 2023), that would certainly be a big story, but it’s unlikely many other states will immediately follow suit. And it will still take quite a while for it to come into effect and really change the market.

In terms of the DtC market itself, again, things will likely stay the course in 2023. There are no obvious major new consumer markets (certainly, as much as DtC shipping surged in 2020, we don’t want a return to the conditions that led to that surge), so we will likely see the continuation of 2022 trends. This will mean increased premiumization of the products shipped DtC, with shippers acting to maximize their share of the existing ranks of active DtC consumers.

Of course, I stand ready to be corrected by future events. If California adopts spirits shipping, that could spark a trend that other states will follow in future years. Or if, say, Texas were to go after and shut down a major third-party online marketplace, that could have a chilling effect. 

Crystal balls are always foggy, so it’s hard to say anything more than there are possibilities for big change. As such, past trends are always the best predictor of future action.

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