Loosening the rules for California distillers

"The growth in California, I think, is due to the fact that we grow so much here. Between the beer industry and the wine industry, that creative momentum just grew into distilling." - Cris Stellar, California Artisanal Distillers Guild

On Oct. 8, 2015, Gov. Jerry Brown signed into law the California Craft Distillers Act of 2015, Assembly Bill 1295. Effective Jan. 1, 2016, AB 1295 is intended to provide equity between craft distillers - those producing less than 100,000 gallons per fiscal year - and their small-label, "craft" counterparts in the beer and wine industries.

A Quick History Lesson

Contrary to popular belief, while the 21st Amendment to the U.S. Constitution repealed Prohibition under the 18th Amendment, it did not legalize the production and consumption of alcohol. Rather, ratification of the 21st Amendment gave the individual states the ability to determine if, when and how alcoholic beverages could be produced, sold and consumed within its borders. Indeed, many states remained "dry" long after the end of Prohibition, with Mississippi remaining dry until 1966.

Following Prohibition's repeal, many states implemented so-called "three-tier systems" - a method of regulating distribution channels for alcohol. Under typical three-tier systems, states organized the alcohol industry into three separate groups: producers, distributors and retailers. In order to stave the commonplace monopolization in the industry prior to Prohibition, no single entity could own an interest in all three tiers, and no single entity could participate in more than one tier. Although this three-tier system improved diversity in the marketplace by limiting the vertical integration envisioned by the titans of industry at the turn of the last century (think Andrew Carnegie's steel industry and John D. Rockefeller's oil industry), and implemented in the whiskey industry by pioneers like Joseph B. Greenhut through his Whiskey Trust, it may be of limited utility today and a hindrance to the ability of small producers to compete in the increasingly busy craft market.

Where once the three-tier system was intended to provide order, rehabilitate the alcohol industry's image, and assuage the concerns of the still-lingering temperance movement, today the place of alcohol as a part of the fabric of American culture is cemented. Where once the three-tier system was essential to legitimizing the sales practices of the alcohol industry (which prior to and during Prohibition were unscrupulous at best), today alcohol producers adopt industry-wide responsible best practices. Where once the three-tier system was critical to generating tax revenue at three separate levels for a Depression-era government, today it unnecessarily raises prices and involves unnecessary middlemen. Where once the three-tier system was meant to encourage competition and thwart monopolies, the reinstatement of antitrust laws in the mid-1930s virtually ensures a place for small and emerging brands in the alcohol marketplace.

Today, the three-tier system affects the ability of small alcohol producers to compete in a modern marketplace. For example, absent nationwide distribution networks, a small distilled spirits brand produced in, say, California, could be difficult to purchase in New York, and vice versa. Even within a single state, if a local distributor does not carry the small brand you are looking for, and you can't find it at a local retailer, then you as the consumer are essentially out of luck. Since the separate tiers aren't allowed to bypass one another except in limited circumstances (think brewpubs), your local retailer cannot purchase the brand you are looking for directly from the producer; the retailer must purchase the bottle from the distributor, and because of convoluted relationships with competing labels, it's possible you may never get your hands on that bottle you've heard so much about. Even worse - as the consumer, you could not go to your favorite craft distiller and purchase a bottle yourself. In California, these limitations are somewhat addressed by the recently passed Craft Distiller's Act of 2015.

How AB 1295 (Sort of) Collapses the Three-Tier System

Much of the separation between producer, distributor and retailer continues to exist under the California Craft Distillers Act of 2015. In fact, AB 1295 explicitly aims to "uphold and support the three-tier system as the appropriate mechanism for regulating and licensing the sale of distilled spirits in California." However, there can be no question that AB 1295's provisions include several important changes for California's craft distillers that chip away at, for the first time since the repeal of Prohibition, the three-tier system as it applies to the production and sale of distilled spirits by craft producers.

Here are the highlights:

AB 1295 creates a new craft distiller's license. This license is applicable to individual distillers producing less than 100,000 gallons of distilled spirits per fiscal year (including distilled spirits the distillery has manufactured for them), exclusive of brandy. To obtain it, distillers must apply for and purchase a new "Craft Distiller's License," which the Department of Alcohol Beverage Control has designated a Type-74 License.

It allows direct to consumer Sales. Craft distillers may now sell directly to consumers who participated in a distilled spirits tasting up to 2.25 liters of distilled spirits in any combination of prepackaged containers per day/per consumer, provided the spirits tasting took place on the craft distiller's licensed premises.

It permits restaurant ownership. Licensed craft distillers may now own an interest in up to three on-sale licenses of "bona fide eating places" (read: restaurant) provided that: one of the restaurants is located on the licensed distilling premises, the other on-sale retail premises offer competing alcoholic beverage brands in addition to the craft distiller's brand, and alcoholic beverages not manufactured or produced by the licensee are purchased from a licensed wholesaler. Importantly, a distiller may continue to operate up to three restaurants even after it no longer qualifies as a craft distiller as long as the interest in the restaurants "was first obtained at a time when the licensee did hold a craft distiller's license."

It allows the sale of other brands at on-premises private events. Craft distillers who host private events on their licensed distilling premises can now sell alcoholic beverages other than those manufactured by the craft distiller, as long as alcoholic beverages not produced by the craft distiller are purchased from a licensed wholesaler.

It permits 1.5 ounce samplings. AB 1295 permits distillers to serve one full 1.5 ounce serving per day/per consumer as opposed to the prior restriction of up to six, one-quarter ounce tastings per day/per consumer. Additionally, distillers now have the option of serving their tasting samples with a non-alcoholic mixer, solving the problem of the taster who does not like his or her liquor neat.

While many of these benefits have been enjoyed by the wine and beer industries for years, allowing wineries and breweries across the state to flourish in number and economic success, this is the first time in over 80 years that tied-house restrictions have been loosened as applied to producers of distilled spirits in California.

Molly Jones is an associate in the San Francisco office of Gordon and Rees.