Ll Liquor, Inc. v. State of Montana

Citation: 912 F.3d 533Docket: 17-35405

Court: Court of Appeals for the Ninth Circuit; December 27, 2018; Federal Appellate Court

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The United States Court of Appeals for the Ninth Circuit affirmed the district court's summary judgment in favor of the State of Montana regarding LL Liquor's claim that Senate Bill 193, which restructured the pricing formula for liquor purchased from the state by agency franchise stores, violated the Contracts Clause by impairing LL Liquor's contract with the Montana Department of Revenue (DOR). The court determined that Montana did not impair its contractual obligations, as the changes did not eliminate LL Liquor’s remedy for breach of contract. LL Liquor operates as one of the state's agency franchise stores, which are heavily regulated and required to purchase liquor exclusively from the DOR. Prior to 2016, pricing for liquor was based on individually negotiated discount rates in each store’s franchise agreement, but the state later implemented a uniform commission structure affecting all franchise stores. The court held that this legislative change did not constitute a valid Contracts Clause claim. The franchise agreement included provisions for renewal that acknowledged potential changes in law affecting contract terms.

Section 16-2-101(5)(a) of the Montana Code, as of 2013, mandated that agency franchise agreements be renewed at the existing commission rate for additional 10-year periods. It allowed for commission rate reviews every three years, as indicated in section 16-2-101(6), which stipulated that adjustments could occur only with the franchise store's concurrence. Section 5 detailed Lolo Liquor's commission rate of 16.144%, derived from three components: an 11.400% commission percentage discount rate (negotiable), a 3.869% weighted average discount percentage rate, and a 0.875% volume of sales discount rate, with the latter two set by statute. This section stated that Lolo Liquor's commission rate could be reviewed under Montana law, being the sole financial term in the agreement.

Section 11 permitted the Department of Revenue (DOR) to amend the agreement in accordance with changes in state or federal law and included a merger clause requiring written modifications signed by all parties, except for those necessitated by law changes, which would take effect immediately. 

In 2014, Lolo Liquor was acquired by Josh and Leigh Paffhausen, who claimed assurances from the DOR that their commission rate would remain unchanged. Following the acquisition, Lolo Liquor expanded significantly in the wholesale market, increasing purchases from the DOR substantially. The Paffhausens credited their growth to innovation and customer service, while competitors attributed it to their favorable commission rate.

Concurrently, the Liquor Store Owners Association of Montana proposed changes to the commission structure, leading to Senate Bill 193, passed in 2015. This legislation altered the commission rate calculation method, shifting from negotiation-based rates to a preset schedule determined by each store's total liquor purchases from the DOR in the preceding year, where lower purchases correlated with higher commission rates.

The commission rates for liquor sold by the Department of Revenue (DOR) were adjusted based on individual store sales, resulting in lower sales stores receiving higher commission rates. This change was phased in over two years starting in February 2016, with most franchise stores experiencing a modest increase in commission rates, except Lolo Liquor, which faced a reduction. The Paffhausens, owners of Lolo Liquor, rejected an addendum detailing the new commission structure. In response, the DOR implemented the changes unilaterally in February 2016. Lolo Liquor subsequently filed a lawsuit alleging breach of contract and violations of the Contracts Clause of the U.S. Constitution, claiming that their agreement guaranteed a stable commission rate for ten years without consent for changes. The case was moved to federal court, where Lolo Liquor sought a preliminary injunction against the state’s actions, arguing that Montana's change constituted a breach. Montana countered that the franchise agreement allowed immediate changes in compliance with state law, leading the district court to deny the injunction. Montana later sought summary judgment, which was granted by the court. The Contracts Clause, which prohibits states from impairing contractual obligations, requires a determination of whether a law substantially impairs a contractual relationship, involving an assessment of the existence of a contract, the nature of the law's impact, and the degree of impairment. This case acknowledges the franchise agreement as a valid contract under the Contracts Clause and proceeds to evaluate whether Montana's actions constituted an impairment.

The Supreme Court has consistently ruled that mere interpretive disagreements over a contract, including those involving municipalities, do not alone invoke the Contracts Clause. The Court clarified that a situation where a municipality asserts it is not liable under a contract, while the other party claims it is, does not automatically constitute a constitutional impairment of contractual obligations. This principle was established in St. Paul Gaslight Co. v. City of St. Paul, which emphasized that not every controversy regarding governmental contracts falls under federal jurisdiction.

The distinction between "impairing" a contract and merely breaching it is crucial. In Pure Wafer Inc. v. City of Prescott, it was noted that if a state action allows both parties to seek court remedies for non-performance, it does not impair contractual obligations under the Contracts Clause. Conversely, if a state's action effectively eliminates any remedy for a party, it implicates the Contracts Clause.

For instance, in Cayetano, a law that delayed state employee payments, despite an existing contract, impaired the obligation as it left no viable legal remedy for the employees. In contrast, Pure Wafer ruled that a city ordinance limiting pollutant discharge did not impair a pre-existing contract, as the city did not claim the ordinance discharged its contractual duties, but rather argued compliance was part of the agreement. Thus, the city did not impair the contract’s obligations.

The analysis centers on whether the Contracts Clause is relevant following the enactment of SB 153, particularly concerning Lolo Liquor's potential remedies against Montana for an alleged breach of contract. If state law offers a remedy for the breach, Montana's alteration of the commission structure is not considered an "impairment" under the Contracts Clause. Lolo Liquor claims that the agency franchise agreement guaranteed a stable commission rate for ten years unless it consented to changes, and it asserts that Montana breached this by lowering the rate according to SB 193. 

Montana argues against Lolo Liquor's claim by asserting two points. First, it contends that section 11 of the agreement allows for modifications by state law, implying that the commission adjustment was permissible under the contract's terms. Second, Montana claims that as a sovereign, it retains the right to unilaterally alter terms in a franchise agreement. The response to Montana’s first argument is that it addresses a contractual issue rather than a constitutional one, indicating that if the parties agreed to a fixed rate, the change constitutes a breach. The dispute ultimately reflects differing interpretations of the contract rather than a legal attempt to make rights unenforceable, which does not invoke Contracts Clause scrutiny. The precedent from Southern California Gas Co. v. City of Santa Monica is cited to illustrate that claims of alteration must demonstrate substantial impairment to trigger such scrutiny, which is not established in this case.

The city contended that by agreeing to operate under the ordinance, the company acknowledged that its contractual rights could be modified by future police power ordinances. This argument was rejected, emphasizing that the city could not bypass Contract Clause scrutiny merely by asserting the ordinance was a legitimate exercise of police power. The court declined to interpret the contract in a manner that would allow the city to unilaterally change its terms.

In the case of Southern California Gas, the gas company did not pursue a breach-of-contract claim, leading to uncertainty about whether such a claim could have been made since the asserted "contract" was another city ordinance. It was noted that the parties agreed the Gas Company's claim should be evaluated under the Contract Clause rather than as a standard breach of contract, highlighting that conflicting interpretations of contracts typically lead to breach-of-contract claims, not Contracts Clause claims.

The decision in Seven Up Pete Venture v. State supported the court's reasoning, where a mining company challenged a statute banning a specific mining technique as an impairment of its state-issued mining lease. The court found that the lease's requirement to comply with laws did not anticipate a ban on the mining method considered by the parties, thus determining that the statute substantially impaired the contract. Seven Up Pete confirmed that the mining company lacked a contractual right to use the prohibited technique, aligning with the conclusion that a Contracts Clause claim could be appropriately raised.

Furthermore, the argument that the state has unilateral authority to modify contract terms raises Contracts Clause concerns, as such authority contradicts the prohibition against states unilaterally abandoning their financial obligations. The overarching principle is that no such unilateral authority exists under the Contracts Clause.

Montana retains its sovereign power even when entering contracts, and this does not negate its financial liability if future actions breach those contracts. It is standard for states and municipalities to promise regulatory stability while accepting the risk of law changes that may hinder contract performance, agreeing to pay damages for any resulting financial harm. If Montana promised to maintain Lolo Liquor’s commission rate irrespective of future legal changes, it still kept the right to alter the law. Lolo Liquor can seek damages for Montana's breach, but this does not exempt Montana from its contractual obligations. Consequently, Montana's passage of SB 153 did not violate the Contracts Clause, as it did not impede Lolo Liquor's ability to recover for breach. Thus, the court affirmed the district court's summary judgment in favor of Montana regarding Lolo Liquor’s Contracts Clause claim, indicating that Lolo Liquor's rights under state law remain enforceable. The breach-of-contract claim is addressed separately in a concurrent memorandum disposition.