Beer Law Mashing

What’s All the Fuss about North Carolina’s Beer Distribution Laws? Part II—The Three-Tier System

Introduction

North Carolina regulates beer distribution under a so-called “three-tier system.” If you’re familiar with the craft beer industry, then you’ve probably heard the three-tier system is a carryover of old, Prohibition-era laws designed to promote temperance and eliminate abusive industry practices prevalent in the years leading up to Prohibition. That’s the story I knew anyway. And while it may be that simple in some places, the history of the three-tier system in North Carolina is more elusive.

This Part II of my series on North Carolina’s beer distribution laws focuses on the history of North Carolina’s three-tier system, with an emphasis on understanding its purpose. For context, I’m also including some historical facts about North Carolina’s brewing industry. As the debate continues over North Carolina’s three-tier system, including its 25,000-barrel small brewery exception,[1] it makes sense to consider the arguments with a clearer understanding of the system’s place in North Carolina history.

The Controversy

If you’re not familiar with the three-tier system, it’s a regulatory scheme that requires industry participants to distribute beer through three separate and distinct tiers—breweries, wholesalers, and retailers. That is, breweries may sell only to wholesalers, wholesalers may sell only to retailers, and retailers may sell only to consumers. North Carolina’s three-tier system is “modified” because it includes exceptions for smaller breweries that sell fewer than 25,000 barrels of beer per year.

The three-tier system is a fairly rigid regulatory scheme because it mandates an industry’s structure, which arguably limits the freedom of its participants to innovate and adapt to changing market conditions. For example, if a craft brewery believes self-distribution is a key element of its success (e.g., for delivering a unique product that requires special attention, adapting to the size or particularities of its market, or other strategic concerns), the three-tier system forces it to choose between (1) giving up that important element of its business model (i.e., self-distribution) or (2) artificially suppressing its annual production and future growth to fewer than 25,000 barrels of beer per year.[2] Whenever a regulatory scheme restricts free market activity in this way, it should be narrowly designed to serve an important public purpose.[3] It should also be monitored and revised appropriately as our society and markets inevitably change over time.

Whenever a regulatory scheme restricts free market activity in this way, it should be narrowly designed to serve an important public purpose. It should also be monitored and revised appropriately as our society and markets inevitably change over time.

Some argue that inserting wholesalers as a barrier between breweries and retailers, which is what the three-tier system does, is important because it promotes temperance, consumer choice, brewer access to retailers, product safety, quality control, and timely tax collection.[4] They contend the three-tier system has been serving North Carolina well for many years, evidenced by the recent success of craft breweries. Others argue the three-tier system is a carryover of old, outdated laws from the Prohibition era that have outlived their intended purposes and are holding back craft breweries.[5] For them, the three-tier system is “economic protectionism” for wholesalers through an undue restraint of free trade.[6]

Irrespective of the arguments, I believe the debate should focus on whether North Carolina’s three-tier system serves an important public purpose that (1) justifies the free market restrictions it imposes and (2) cannot be achieved sufficiently through less restrictive alternatives. In other words, “We don’t need a sledgehammer to crack a nut.” With this framework in mind, this post considers the history and purpose of the three-tier system with the hope of adding context to the debate.[7]

Overview of North Carolina’s Three-Tier System

North Carolina’s modified three-tier system is codified in Chapter 18B of the North Carolina General Statutes and related administrative regulations.[8]

As modified, the three-tier system permits breweries to sell beer only to licensed wholesalers, subject to limited exceptions for small breweries.[9] Wholesalers may then sell beer only to licensed retailers and other licensed wholesalers.[10] This establishes the three separate tiers of distribution—breweries, wholesalers, and retailers.

Under the small brewery exceptions, a brewery may generally (1) sell its beer as a retailer on its premises (the “brewpub exception”) or (2) obtain a wholesaler’s permit to sell, deliver, and ship its beer as a wholesaler (the “self-distribution exception”), provided it sells “fewer than 25,000 barrels” of beer “produced by it per year.”[11] Once a brewery reaches the 25,000-barrel limit, however, it must discontinue any self-distribution and hire a third-party wholesaler to distribute all of its future beer production.[12]

Any distribution relationship between a brewery and a wholesaler is governed by North Carolina’s “beer franchise laws,”[13] which mandate certain contractual relationships between the brewery and wholesaler.

A brewery is generally prohibited from:

  • requiring a retailer to purchase the brewery’s beer at the exclusion of any other alcoholic beverages.
  • having a direct or indirect financial interest in the business or premises of a retailer; or
  • lending or giving to a retailer money, services, equipment, furniture, fixtures, or anything of value.[14]

I refer to these as “tied house” laws. If a brewery qualifies for the small brewery exceptions, the “tied house” laws precluding a brewery from having a financial interest in, or lending or giving things of value to, a retailer do not apply to a retail establishment on the brewery’s premises (e.g., a taproom or brewpub).[15] A brewery is also prohibited from, among other things, imposing sales quotas on retailers.[16]

History of North Carolina’s Three-Tier System

As noted above, the generally accepted history of the three-tier system suggests it’s a carryover of Prohibition-era laws designed to promote temperance and eliminate abusive industry practices prevalent in the years leading up to Prohibition. Based on my research, however, the actual history of the three-tier system in North Carolina is a little more complicated, particularly in regard to beer regulation.

For years following Prohibition, the manufacture, distribution, and sale of beer were only lightly regulated in North Carolina, with most of those regulations focused on taxation. The more rigid three-tier system was not contemplated or enacted in North Carolina until decades after Prohibition, around the same time as North Carolina’s “beer franchise laws.” In fact, North Carolina did not even adopt a mandatory “two-tier” beer distribution system until 1953, when it first prohibited breweries and wholesalers from having financial interests in retailers.

For years following Prohibition, the manufacture, distribution, and sale of beer were only lightly regulated in North Carolina, with most of those regulations focused on taxation.

To be clear, the three tiers of beer distribution have existed in North Carolina since the repeal of Prohibition, presumably because that structure made good business sense for large out-of-state breweries and others wanting to focus solely on brewing. But the system was voluntary, not mandatory. I have not found any evidence suggesting the three-tier system was mandated in North Carolina before sometime around the 1980’s. The exact timing is unclear.

In any event, let’s start at the beginning with Prohibition.

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What’s All the Fuss about North Carolina’s Beer Distribution Laws? Part I – The Controversy

It’s no secret. The craft beer industry is booming in North Carolina. A new brewery seems to be opening every week, and even the smallest breweries appear to be thriving.

Since 2010, the number of craft breweries in North Carolina has increased from forty-five to more than two hundred, with an estimated annual economic impact of $1.2 billion for the State.[1] This includes significant tax dollars, more than 10,000 jobs, and over $300 million in annual wages.[2]

It also includes benefits that aren’t easily quantifiable. It’s apparent from my own neighborhood—Charlotte’s NoDa—and experience, that craft breweries are helping to revitalize urban industrial districts and small towns around the State.[3] The industry is also driving tourism, as cities in North Carolina become popular “beercation” destinations within the national “beer tourism” scene.[4]

But is all this success sustainable?

Inevitably, the growth and novelty of North Carolina’s craft beer industry will regulate over time. There is only so much space on grocery store shelves and consumers are fickle, constantly chasing the next “cool” thing. But beer drinkers aren’t going away, and there doesn’t seem to be any reason why our craft beer industry shouldn’t enjoy steady growth and success for years to come.

Or is there?

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Beer Regulation and Change

I was doing some research this morning on the history and original intent of North Carolina’s beer distribution laws, and several quotes jumped out at me. They relate to the interplay between statutory law, regulation, and change in society—a topic I’ve always enjoyed. And I thought it might be fun to share a few of them, along with some random thoughts.

The quotes aren’t famous or fancy. Both are from Toward Liquor Control, an influential study commissioned in the 1930s by John D. Rockefeller, Jr. The study recommended best practices for state alcohol regulation following the failure and repeal of Prohibition in 1933. [1]

Here are the quotes:

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