Note from John Hinman: This is the second in a series of blog articles from Rob [read the first blog here]. As the retired Chief Counsel of the TTB, Rob is the most sophisticated analyst of regulatory enforcement policies in the US today. The articles highlight unfair, and often unconstitutional, enforcement policies and tactics being engaged in by the TTB as a regulatory agency. Today’s article concerns the TTB’s extortion of penalties when the holder of a basic permit changes (by death or corporate operation of law) and the change is unreported for over 30 days. Future articles will include analysis of unfair or inconsistent state agency policies from our firm. The overall purpose of the series is to further industry member understanding of the regulatory climate in which they operate, and to drive industry debate over regulatory reform. None of us should live in fear that the people who regulate our industry will act against licenses and permits based on arbitrary or capricious policies or legal interpretations.
“No free government can survive that is not based on the supremacy of the law. Where law ends tyranny begins. Law alone can give us freedom.” — John Locke Quotation on Department of Justice HQ, Washington, DC
Death and Taxes – the American Reality.
American history teaches us that death and taxes are the only certain things in this world.[1] Only second to hearing TTB talk about the Whiskey Rebellion in the late 1700’s as its heritage, we frequently are reminded that TTB is the third largest revenue source for the Federal Government following the Internal Revenue Service (IRS) and the Customs and Border Protection Bureau (CPB).[2]
Not to overlook the certainty of taxes, in its recent trade practice investigations TTB has learned to use death as an enforcement tool. Let me explain.
How Basic Permits and the Change in Control Provisions work.
Wholesalers, importers, and certain producers or bottlers must obtain a basic permit before engaging in the business.[3] A basic permit remains in effect until voluntarily surrendered, revoked, suspended, annulled, or terminated by law because of a change in the actual or legal control of the basic permit holder.[4]
If there is a change in actual or legal control of the basic permit holder, then the basic permit terminates unless a new application is filed within 30 days. So long as the new application is filed in a timely manner (within 30 days of the event that must be reported), the existing basic permit continues in place pending final action on the new application. Reporting corporate changes is critical to federally licensed businesses.
The statutory provisions state: “if actual or legal control of the permittee is acquired, directly or indirectly, whether by stock-ownership or in any other manner, by any person, then such permit shall be automatically terminated at the expiration of thirty days thereafter.”
The statute is concerned about whether a “person” has acquired sufficient ownership to have obtained actual or legal control of the entity holding the basic permit. The FAA Act carefully defines a “person” as:
“The term ‘person’ means individual, partnership, joint stock company, business trust, association, corporation, or other form of business enterprise, including a receiver, trustee, or liquidating agent and including an officer or employee of any agency of a State or political subdivision thereof;”
Little guidance is available on what constitutes a change in actual or legal control. For wholesalers or importers, the TTB website contains one page of general information on changes in proprietorships and changes in control.[5] TTB explains:
“A change in control can either be a change in legal control or in actual control. A change in legal control occurs when there has been a change in the person or entity that owns or controls the majority of voting stock in a corporation or the majority membership interest in an LLC. A change in actual control occurs when there is a change in the person or entity who exercises managerial control over the operations of the business.”
The regulations in 27 CFR Part 1, contain no examples.[6] A few older Revenue Rulings by the IRS in the 1950s contain some examples,[7] and there is minimal case law under the FAA Act on this portion of section 204(g). Finally, the legislative history is uninformative of examples other than one referring to stock ownership.[8]
What’s more important – the change in control or the failure to report changes in ownership?
Most significantly, however, is the legal distinction between a change in actual or legal control arising from a change in stock owner AND failing to give notice to TTB of a change in stock ownership. The regulations require timely notices of stock ownership changes.[9] However, everyone agrees that not every stock ownership change results in a change in actual or legal control. A basic permit holder may have failed to meet a reporting change of stock ownership reporting requirement but the industry assumes that the basic permit itself remains in place – that is not necessarily the case.
The subjective character of what constitutes a change in actual or legal control is the heart of the matter here.
“O Death, where is thy sting?” – Look No Further than Changes in Control from the Death of Permit Holders holding stock interests
In recent trade practice investigations, the provision of a change in control arising from the stock interest transferring from a person in family run wholesaler businesses has taken on new importance if a death has taken place within the family. This arises in two scenarios. First, a parent (or other immediate family member) died several years ago and his/her stock transferred to a spouse, sibling, and/or an offspring. In the family’s mind, there has not been a change in control. The family owned and managed the company before, during, and after this death. The same family is making the decisions. Often, these family members are already on an approved basic permit and have, therefore, been reviewed before by TTB on their background and suitability under the FAA Act standards.
A second scenario arises where the death is recent, and the estate of the decedent remains open pending final probate.
Death is Eternal and Not Subject to Judicial Review – But must be Reported within 30 days upon pain of an Automatic Permit Revocation
In several recent trade practice investigations, TTB has raised as a collateral violation that the industry member had an unreported change in stock ownership that occurred from five to 10 or more years ago.
Any change in ownership must be reported to TTB but not every change in stock ownership is automatically a change in actual or legal control that triggers the termination of the permit by operation of law. TTB treats unreported changes in ownership in every case I know as a change in actual or legal control whereby the basic permit terminated years ago.
Because the 30-day period for applying for a new basic permit has long passed since the purported change in actual or legal control occurred, the continuing of business operations is not available. The industry member must file for a new basic permit and cease operations pending that processing time. In any State where the distributor, for example, has a franchise or distribution agreement or the requirement of a federal permit as a condition of the validity of its state licenses, this cessation of operations is the “kiss of death.”
Death as a Device to extort Trade Practice Penalties – the current case law.
TTB has used the death and reporting scenarios to extort offers in compromise for alleged trade practice violations. TTB will not bifurcate different alleged violations and will only sign a global settlement offer in compromise covering both the alleged basic permit violation and the alleged trade practice violation. There is no legal reason these two alleged violations cannot be bi-furcated and resolved separately. TTB does bifurcate the dollar amounts because it seeks around $250,000 for the alleged basic permit violation and then pyramids on an amount for the alleged trade practice violations. Regardless of how much merit the industry member believes its defense to the alleged trade practice violation may be, the risk of TTB telling their supplier or local state agency they do not hold a basic permit would end their business. So, the forced settlement is the only viable option.
There is a lack of due process of law under the Fifth Amendment to the United States Constitution implicit in this scenario. TTB claims there is no right to an administrative review or hearing where the basic permit holder disputes the TTB notice that its basic permit terminated by operation of law due to a decade old alleged change in actual or legal control. Because of the judicial disaster suffered by ATF in the Black Death USA vodka label matter, TTB should have seen this on the horizon.[10] This is discussed more below.
TTB cites two recent judicial decisions for the proposition there is no administrative or judicial review available where TTB advises an industry member that, in the view of the bureau, its basic permit terminated by law.[11] One of these recent cases involved a transfer of stock because of the death of the recipient’s spouse. Both cases involved tobacco importer permits under the Internal Revenue Code of 1986 and importer and wholesaler basic permits under the FAA Act; my comments only go to the basic permits.
Essentially, both judicial decisions hold that the FAA Act only allows for administrative and judicial review for suspensions, revocation, or annulments of basic permit and not for a notice from TTB it believes the basic permit of an industry member terminated as a matter of law.
Further, the Administrative Procedures Act does not provide an independent ground for judicial review because Congress provided an alternative remedy in the case of an automatic termination through applying for a new basic permit within 30 days and continuing to operate under the former basic permit pending final action on the new application.
Neither court discusses the scenario where over 30 days has passed and TTB then issues the notice. Each decision has its own interesting twist. In Gulf Coast Maritime Supply, the panel opines that the notice might be a final agency action subject to judicial review but in this case the plaintiff pled the complaint as a revocation and must live with that characterization. In Marine Wholesaler & Warehouse the District Court holds likewise there is no basis for judicial review of the notice advising of the automatic termination of the basic permit because the alternative remedy of applying for a new basic permit and continuing operations (if done within the 30 days) is the exclusive remedy by Congress as it enacted the FAA Act in 1935.
However, the District Court then discusses the case in a manner showing it believes that a change in actual or legal control did take place after saying it did not have jurisdiction to hear the challenge.
Death is Not Final and Deserves Due Process – the 5th and 14th Amendments
Somewhere in this process, TTB Counsel, the Justice Department, and the judges’ clerks forgot about due process for property interests under the Fifth Amendment. No one can dispute that the basic permit constitutes a property interest under the Fifth Amendment. Starting in the late 1960s, the Supreme Court articulated the due process that must be afforded under both the Fifth and Fourteenth Amendments. Where a property (or liberty) interest lies, the Government may only take it away from the person after allowing that person to be heard.[12] . This is America. A wrong has a remedy.
Smart Law and the TTB
As TTB Chief Counsel, one challenge was assessing how to apply a 1935 law to a present world with First Amendment “commercial speech” rights from the 1970s, due process of law for property interests from the 1960s, and statutory procedures that pre-date the enactment of the Administrative Procedure Act in 1946.
How to practice “smart law” is to keep your laws functional in the time and place you find your agency through the authority of reasonable and fair administrative discretion. One example of how this was done involved the FAA Act labeling prohibition on “disparaging” statements by one industry member of another industry member’s products. We only applied that provision in the First Amendment “commercial speech” world when we could show the disparaging statement was a misleading statement and thus not protected by the First Amendment.
The automatic termination by operation of law provision of the FAA Act is likely unconstitutional without the opportunity for the holder of a basic permit to challenge it when TTB issues a notice advising that basic permit holder that its basic permit had terminated over 30 days earlier, and even more so where TTB is saying five or 10 years. The two recent decisions cite in passing judicial decisions from the 1950s but, again, aspects of those decisions predate the more recent judicial decisions on basic constitutional rights so the continued legal relevance of the earlier decisions is questionable.
I opened with the plaque from the Department of Justice Building because of the writing of the late Professional Kenneth Culp Davis, the “father” of administrative law in a book entitled “Discretionary Justice, A Preliminary Inquiry.”[13] Prof. Davis cites the John Locke quote and then writes:
“I think that in our system of government, where law ends tyranny need not begin. Where law ends, discretion beings, and the exercise of discretion may mean either beneficence or tyranny, either justice or injustice, either reasonableness or arbitrariness……
“The central inquiry of this essay is what can be done to assure that where law ends tyranny will not begin. More precisely, the central inquiry is what can be done that is not now done to minimize injustice from the exercise of discretionary power….”
Returning to what due process is required to save the automatic termination by operation of law provision in the FAA Act from a Fifth Amendment defect, TTB could promulgate a regulatory review process that allows the basic permit holder to present its case as to why a specific change in stock ownership did not result in a change in the legal or actual control of the basic permit holder.
This was the smart lawyering approach that promulgated the regulations in 27 CFR Part 13, Labeling Proceedings on the denial and revocation of certificates of label approvals, etc. These regulations were crafted after the Cabo Distributing Co. court decision ruled there was no law or regulation allowing for such action. Due process was met by promulgating procedural regulations that afforded due process notice and opportunity to be heard and have a review.[14]
Lack of Guidance on Procedures in Death Scenarios Continues
Several of the recent trade practice cases noted above involved facts where TTB is now citing as the factual basis for the change in legal or actual control a death that took place many years ago. A second scenario is where the death is recent, and the estate of the decedent remains open pending final probate.
In these situations, TTB asserts that the act of death immediately results in a change in actual or legal control of the basic permit holder.
That the stock remains held in the decedent’s name, all income from the stock is paid to the decedent’s estate which is filing tax returns, and the executor owes the fiduciary duty to the decedent’s estate are irrelevant. These are family situations where the family views it as controlling the entity before, during, and after the death of the family member. Once the estate is settled it can be sorted out whether any legal or actual change in control has occurred.
Unlike the Internal Revenue Code of 1986[15] (as did the Internal Revenue Code of 1939,[16] closer in time to the FAA Act enactment) which includes an “estate” in the definition of “person”, the FAA Act definition of “person” does not include the term “estate.”[17] This distinction is important because the FAA Act is looking at whether a “person” has acquired sufficient ownership to have obtained actual or legal control of the entity holding the basic permit. The TTB position is of questionable legality and, at most, relies on form over substance. Nothing in Gulf Coast Maritime Supply supports this interpretation.
Even TTB has not sorted the implications of its position. For example, it has yet to clarify when the actual date starts running for the 30-day new application rule.
Is it the date of death, is it the date the will is located and the identity of the executor is known, is it the date that the appointment of the executor is approved by the probate court? These questions have been pending for months with TTB and no responses forthcoming. Even to this date, you will find nothing on the TTB website relating to these death scenarios.
And yet, alas, like in other alleged trade practice violations, this strict (and judicially unreviewable determination) by TTB is being used to extort large offers in compromise as global settlements with refusals to bifurcate the two alleged violations.
Life After Death – The Blog Series
This blog journey started for me shortly after Congress enacted the $5 million budget allocation for TTB’s unfair trade practice enforcement program.[18] I was excited by the future. A later Presidential budget proposal (that continues in the current President’s budget) on transferring alcohol and tobacco functions remaining in ATF to TTB gave me pause;[19] a pause that has only increased after seeing the aggressive nature of the current trade practice enforcement initiative.
John Hinman and I consulted on his blog on the consignment sales investigations that his firm is ably handling.[20] My last blog before this one mused about public policy concerns that the “subterfuge” overflow by TTB is stifling innovation in a way not intended by Congress, nor in the interests of consumers and small and medium sized businesses.[21] My next blog will examine the human side of this trade practice enforcement initiative.
I always reminded my attorneys at the TTB there is a person affected by what you do with an industry member…someone may lose his or her job so we had better be right. Similarly, you have been given great power over the public lives as a Federal employee but “to whom much has been given, much is expected” so remember that you represent the face of the Government of the United States of America.
The job now is to translate the mission of the TTB to serve the industry members it regulates rather than to serve itself by scoring penalties and assessments that are not justified and not subject to judicial review.
_______________________________
[1] Benjamin Franklin, who wrote in a 1789 letter that “Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.”
[2] TTB Annual Report, Fiscal Year 2018, page 2, at https://www.ttb.gov/foia/pdf/ttbar2018.pdf This is opening information in all of the TTB Annual Reports.
Only last week at the kick-off TTB Trade Practice Seminar in New York City were we again reminded of the bureau’s “proud past” represented by the Whiskey Rebellion. This reflects the TTB motto of “A proud past, a focused future.
[3] §203. Unlawful businesses without permit; application to State agency
In order effectively to regulate interstate and foreign commerce in distilled spirits, wine, and malt beverages, to enforce the twenty-first amendment, and to protect the revenue and enforce the postal laws with respect to distilled spirits, wine, and malt beverages:
(a) It shall be unlawful, except pursuant to a basic permit issued under this subchapter by the Secretary of the Treasury—
(1) to engage in the business of importing into the United States distilled spirits, wine, or malt beverages; or
(2) for any person so engaged to sell, offer or deliver for sale, contract to sell, or ship, in interstate or foreign commerce, directly or indirectly or through an affiliate, distilled spirits, wine, or malt beverages so imported.
(b) It shall be unlawful, except pursuant to a basic permit issued under this subchapter by the Secretary of the Treasury—
(1) to engage in the business of distilling distilled spirits, producing wine, rectifying or blending distilled spirits or wine, or bottling, or warehousing and bottling, distilled spirits; or
(2) for any person so engaged to sell, offer or deliver for sale, contract to sell, or ship, in interstate or foreign commerce, directly or indirectly or through an affiliate, distilled spirits or wine so distilled, produced, rectified, blended, or bottled, or warehoused and bottled.
(c) It shall be unlawful, except pursuant to a basic permit issued under this subchapter by the Secretary of the Treasury—
(1) to engage in the business of purchasing for resale at wholesale distilled spirits, wine, or malt beverages; or
(2) for any person so engaged to receive or to sell, offer or deliver for sale, contract to sell, or ship, in interstate or foreign commerce, directly or indirectly or through an affiliate, distilled spirits, wine, or malt beverages so purchased.
This subsection shall take effect July 1, 1936.
This section shall not apply to any agency of a State or political subdivision thereof or any officer or employee of any such agency, and no such agency or officer or employee shall be required to obtain a basic permit under this subchapter.
[4] Section 204(g):
A basic permit shall continue in effect until suspended, revoked, or annulled as provided herein, or voluntarily surrendered; except that (1) if leased, sold, or otherwise voluntarily transferred, the permit shall be automatically terminated thereupon, and (2) if transferred by operation of law or if actual or legal control of the permittee is acquired, directly or indirectly, whether by stock-ownership or in any other manner, by any person, then such permit shall be automatically terminated at the expiration of thirty days thereafter: Provided, That if within such thirty-day period application for a new basic permit is made by the transferee or permittee, respectively, then the outstanding basic permit shall continue in effect until such application is finally acted on by the Secretary of the Treasury. (Emphasis added.)
[5] https://www.ttb.gov/importers/makechanges.shtml Similar pages appear for Beer, Tobacco, etc.
[6] Title 27, Code of Federal Regulations (CFR), Part 1 - BASIC PERMIT REQUIREMENTS UNDER THE FEDERAL ALCOHOL ADMINISTRATION ACT, NONINDUSTRIAL USE OF DISTILLED SPIRITS AND WINE, BULK SALES AND BOTTLING OF DISTILLED SPIRITS, at https://www.ecfr.gov/cgi-bin/text-idx?c=ecfr&sid=33fc0c0194b58b6fe95208945b5c637a&rgn=div5&view=text&node=27:1.0.1.1.1&idno=27
[7] Revenue Ruling 54-527 at https://ttb.gov/rulings/54-527.htm. Revenue Ruling 55-164 at https://ttb.gov/rulings/55-164.htm . Revenue Ruling 56-690 at https://ttb.gov/rulings/56-690.htm
[8] Legislative History of the FAA Act, pages 46-47, at https://archive.org/details/legislativehisto00unit/page/8
[9] 27 CFR section 1.42.
[10] Cabo Distributing Co., Inc. v. Brady, 821 F. Supp 601 (N.D. Cal. 1992).
[11] Gulf Coast Maritime Supply, Inc v. United States, 867 F.3d 123 (D.C. Cir. 2017) and Marine Wholesaler & Warehouse Co. v. United States, Civil Action No. 17-1300, 2018 WL 2223663.
[12] Goldberg v. Kelly, 397 U.S. 254 (1970).
[13] University of Illinois Press 1971, Copyright 1979 by the Louisiana State University Press.
[14] Treasury Decision ATF-406, at https://ttb.gov/rrd/fr_td406.htm This is America. A wrong must have a remedy.
[15] 26 USC section 7701(a)(1).
[16] 26 USC section 3797(a)(1) repealed.
[17] 27 USC section 211(a)(3).
[18] https://www.beveragelaw.com/booze-rules/2018/1/29/the-renaissance-of-federal-unfair-trade-practices-current-issues-and-strategies
[19] https://www.beveragelaw.com/booze-rules/2018/3/14/atf-and-ttb-is-another-divorce-on-the-horizon-whats-going-on-with-the-agency
[20] https://www.beveragelaw.com/booze-rules/2019/3/12/ttb-consignment-sales-investigations-what-is-behind-the-curtain-of-the-ttb-press-releases
[21] https://www.beveragelaw.com/booze-rules/2019/3/12/ttb-stifling-innovation