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Hempling@ari.net

Herbert Olson, Legislative Counsel

From: Scott Hempling

David Lapp

Dina Sarbanes

Date: October 12, 1999

OVERVIEW AND SUMMARY *

This memorandum seeks to present to the Committee the legal principles necessary to fashion and evaluate methods of regulating the price of pharmaceuticals in Vermont. The memorandum integrates legal material presented to the Committee in past meetings with additional research.

The document has two main Parts:

Part One explains each relevant constitutional provision and discusses how it might apply to various generic types of state regulation of the prescription drug industry. Part Two then applies the legal principles described in Part Two to more specific proposals under consideration in Vermont. Because Part One presents the legal principle in detail, Part Two serves more as a summary applying our legal analysis to the main generic types of proposals.

An alternative way to understand the relationship of Part One to Part Two is as follows: Part One is organized according the main clauses of the Constitution; Part Two is organized by type of proposal. Because the detailed analysis appears in Part One as part of the exposition of constitutional law, we do not repeat it in Part Two, but instead apply the principles to the specifics of each generic type of proposal. To assist readers, in Part Two we refer to the applicable analysis in Part One.

State regulation of any multistate industry must take into account various limitations imposed by the U.S. Constitution. The limitations relevant to the present inquiry come from five clauses:

• Commerce Clause
• Supremacy Clause
• Contract Clause
• Takings Clause
• Due Process Clause

The Commerce Clause of the United States Constitution provides that Congress may "regulate Commerce with foreign Nations, and among the several States." Article I, ' 8, cl. 3. Since 1849, the Supreme Court has interpreted the Commerce Clause as including two features: a grant of power to Congress, and limitation on the power of states. The first feature defines the power of Congress to pass laws concerning goods or services that are in or that affect interstate commerce. Conversely, this same grant of power precludes the U.S. Congress from regulating matters that are entirely intrastate in character.

The Commerce Clause's second feature is its limitation on the power of the States to regulate interstate commerce. This feature is sometimes referred to as the "negative" or the "dormant" Commerce Clause. This document's discussion of the Commerce Clause is concerned with its negative implications.

The primary concern of the dormant Commerce Clause is to ensure that buyers and sellers have access to a national market in which they are able to transact business with out-of-state buyers and sellers free from undue interference by the states. The negative Commerce Clause protects this national market against state statutes that protect a state's own economy from out-of-state competition and inconsistent state statutes that create obstacles to national competition.

As a general rule, state regulation therefore must involve a matter not requiring uniformity among the states, and it must not unduly burden interstate commerce. When states encroach on matters requiring federal uniformity or pass laws unduly burdening interstate commerce, courts will step in and invalidate those laws. While courts generally invalidate protectionist state legislation, the courts also are mindful of the states' inherent police powers to enact legislation to promote the health and safety of their citizens.

State laws can violate the Commerce Clause in two ways.

The boundary between these two types of violation is not always clear. Courts acknowledge this fact. In evaluating a state statute, therefore, they focus on its practical effect, rather than its express terms. Moreover, the courts consider the consequences that will result if several states adopted laws similar to the law being challenged. As one court explained,

Cotto Waxo v. Williams, 46 F.3d 790, 794 (8th Cir. 1995).

The remainder of this overview provides more detail on the two methods of analysis that courts apply: the "heightened scrutiny" method and the "balancing" method. It then summarizes the requirements a state law must meet in order to tax goods or services in interstate commerce and concludes by noting the effect of federal authorization of state regulation which, absent such federal authorization, would violate the Commerce Clause.

State laws which are designed to protect in-state competitors from out-of-state competitors, or which have such an effect, are "virtually per se invalid." These laws are "virtually per se invalid" because the courts assess their validity under a "strict" or "rigorous" scrutiny test. For a state or local law to pass the rigorous scrutiny test, the law must promote a legitimate local purpose and there must be no nondiscriminatory means of furthering that purpose.

One of the leading cases involving a state statute protecting local business interests is Baldwin v. G.A.F. Seelig, 294 U.S. 511 (1935). In Baldwin, the Supreme Court invalidated New York's enactment of a law setting minimum wholesale prices for milk for the purpose of protecting local milk producers. The statute was challenged by a local milk dealer who had been denied a license to sell milk purchased from a Vermont dealer at a price lower than the minimum price set by the New York law. Thirty percent of the milk sold in New York came from out of state.

More recent cases reinforce the view that states may not act to protect local businesses. The Supreme Court invalidated an Ohio law making its statute of limitations inapplicable to claims against out-of-state corporations. Bendix Autolite Corp. v. Midwesco Enterprises, Inc., 486 U.S. 888 (1988). The statute forced foreign corporations to either register with the state and be subject to its general jurisdiction or be subject to suit forever. Another example of a local law held per se invalid is found in C & A Carbone, Inc. v. Town of Clarkstown, 511 U.S. 383 (1994).

Carbone involved a New York town's ordinance requiring all local waste to be processed through the local facility where haulers had to pay an above-market tipping fee. The ordinance was intended to offset the costs of building a local waste transfer facility constructed in part to comply with state environmental laws. See also Barringer v. Griffes, 1 F.3d 1331 (2nd Cir. 1993) (holding Vermont use tax on automobiles invalid because it "create[s] a bias towards in-state purchases" as a result of its failure to provide a credit for cars purchased out of state).

Just as a state law many not protect in-state businesses from out-of-state competition, a state may not regulate in a way that "hoards" a scarce in-state resource for local use. For example, the Supreme Court invalidated an Alabama law imposing a hazardous waste disposal fee on hazardous waste generated out-of-state, but not on hazardous waste generated in-state. Chemical Waste Management, Inc. v. Hunt, 504 U.S. 334 (1992). The Court observed that the state could have addressed its environmental concerns through nondiscriminatory means. See also New England Power Co. v. New Hampshire, 455 U.S. 331 (1982) (invalidating a New Hampshire law prohibiting a private power company from exporting out-of-state hydroelectric power that was generated in-state).

The leading example of a state law withstanding the rigorous scrutiny test is Maine's complete ban on importation of live bait fish; the Court found the ban was necessary to protect local fish from parasites. Maine v. Taylor, 477 U.S. 131 (1986). The state made a strong factual showing that no other means were available for protecting local fish. Maine v. Taylor may be contrasted with Dean Milk Co. v. City of Madison, 340 U.S. 349 (1951). In that case the Court concluded that the city could not enact, in the name of food safety, an ordinance requiring that milk sold within its limits be pasteurized at a local processing plant. The Court concluded there were other "reasonable nondiscriminatory alternatives, adequate to conserve legitimate local interests."

Finally, courts are skeptical of health and safety arguments when they are tied to matters relating to pricing and competition. For example, in Baldwin, the Supreme Court responded to New York's contention that its minimum price laws were necessary to protect the adequacy of a wholesome supply of milk as follows:

Baldwin, 294 U.S. at 523.

A neutral but burdensome law is valid if the burden on interstate commerce is not disproportionate relative to the local interest the law seeks to achieve. Courts frequently quote from the Supreme Court's description of the balancing test in Pike v. Bruce Church, Inc. 397 U.S. 137, 142 (1970):

In applying the balancing test, a state will have more leeway to burden interstate commerce if the purpose is to promote local health and safety. Courts will consider, however, whether means less burdensome to interstate commerce are available to promote the health or safety interest.

An example of a law upheld because the benefits of the state law involved health and safety is Sligh v. Kirkwood, 237 U.S. 52 (1915). In that case the Court upheld a Florida statute banning the sale of fruit that was immature and unfit for human consumption. The Court declared: "The power of the State to prescribe regulations which shall prevent the production within its borders of impure foods, unfit for use, and such articles as would spread disease and pestilence, is well established." 237 U.S. at 60.

On the other hand, in Pike v. Bruce Church, supra, the Court applied the balancing test to invalidate a facially nondiscriminatory statute. The Court held the negative Commerce Clause prohibited an Arizona law calling for all cantaloupes grown in the state to be packaged in the state. The law would have required the processor challenging the statute to build a $200,000 processing plant in Arizona. The state's purpose -- enhancing the reputation of its cantaloupes by prohibiting deceptive advertising on the packaging -- was insufficient to justify this burden.

Recently, in General Motors Corp. v. Tracy, 519 U.S. 278 (1997), the Court reaffirmed the notion that a state may burden interstate commerce when promoting the health and safety of its citizens. Ohio had imposed general sales and use taxes on natural gas purchases from all sellers, except regulated public utilities that met the state's statutory definition of a "natural gas company." The law was challenged by an out-of-state competitor of the public utilities. The Court declared (519 U.S. at 306 (footnotes and internal quotes omitted)):

In considering the burden a state law places on interstate commerce, the Court will consider the burden created by one state's law with respect to the laws of other states. In Bibb v. Navajo Freight Lines, 359 U.S. 520 (1959), the Court addressed an Illinois truck safety law requiring "contour" mud guards for trucks operating on its roads. The law conflicted with the laws of 45 other states permitting "straight" mud guards, and it conflicted directly with an Arkansas statute which banned contour mud flaps. The Court held the Illinois statute invalid.

That the effects of a facially neutral state law fall disproportionately on out-of-state businesses does not make the law invalid:

The inner political check: A useful analytical tool in assessing the potential vulnerability to a Commerce Clause challenge of nondiscriminatory state legislation is the concept of "inner political check." If the burdens of a state regulation fall primarily out-of-state, the state's political processes provide fewer restraints on the regulatory activity, the regulation will be subject to greater judicial scrutiny. If, however, the state law is largely subject to the state's political processes, it may be more likely to withstand a court challenge. See Rotunda & Nowak, Treatise on Constitutional Law (3d Ed. 1999) ' 11.11.

Because state taxation has elements in common with state price regulation, and because many cases address the constitutionality of state taxes, a discussion of major tax cases here is useful.

Courts apply a four-part test to determine whether the validity of a state tax affecting interstate commerce. Courts consider whether the tax (1) has a substantial nexus to the state (some physical presence required); (2) is fairly apportioned according to the share of activity or property that is attributable to the state; (3) discriminates against interstate commerce; and (4) is fairly related to the benefits or services provided by the state. Complete Auto Transit v. Brady, 430 U.S. 274, 279 (1977).

The Court applied the Complete Auto test to invalidate a state tax in Quill v. North Dakota, 504 U.S. 298 (1992). The Court held that a national mail order catalog business, with no significant physical presence in the taxing state, did not have a substantial nexus with the state by virtue of its flyers, catalogues, advertisements in national magazines and phone solicitations. Even though the contacts between the business and the state were sufficient to satisfy the Due Process Clause, they were insufficient to satisfy the negative Commerce Clause.

Because the Commerce Clause provides the U.S. Congress with the power to regulate interstate commerce, Congress may sanction state and local laws that would otherwise violate the Commerce Clause. In ascertaining whether Congress has authorized state lawmakers to burden interstate commerce, courts ask whether federal law clearly authorizes the state action. See, e.g., South-Central Timber Dev., Inc. v. Wunnicke, 467 U.S. 82 (1984) (plurality opinion) (holding that federal natural resources law did not clearly authorize the state to require persons buying timber from the state to process the timber in-state before exporting it).

This effect of constitutional law has a solid policy foundation: When a state acts alone, unrepresented, out-of-state interests are at risk of bearing the brunt of the regulations imposed by the state; but when Congress acts, all segments of the country are represented in its decision.

Having provided this overview, we turn now to the Commerce Clause principles implicated by five general types of state regulation now under discussion in Vermont:

• Price Regulation
• State and Local Laws that Exclude Competitors
• The "State-as-Market-Participant" Exception to the Commerce Clause
• State Regulation Incorporating Reference Prices
• Price Disclosure

The Commerce Clause implications of price regulation depend on what kinds of transactions are being regulated -- out-of-state sales or in-state sales. Each type of price regulation is discussed next.

A state cannot constitutionally regulate a sale which occurs outside its boundaries. A court will find a statute per se unconstitutional, without further inquiry, if it determines that the statute dictates how buyers and sellers do business outside of the state. Courts often refer to such statutes as having an "extraterritorial reach."

For example, a state law requiring a producer to sell at a particular price to wholesalers which in turn sell into the regulating state would constitute an unconstitutional exertion of control over out-of-state transactions.

Two separate lines of caselaw support this conclusion: cases that directly address state pricing laws, and cases analyzing a state's jurisdiction to tax particular transactions for goods or services. These are discussed next.

In Baldwin v. G.A.F. Seelig, Inc., supra, the Court invalidated New York's denial of a license to sell milk to a business that purchased milk from an out-of-state producer at a lower price than the minimum price established by New York law. In a later case, the Supreme Court described the New York law it invalidated as being one that "said in effect to farmers in Vermont: your milk cannot be sold by dealers to whom you ship it in New York unless you sell it to them in Vermont at a price determined here." Henneford v. Silas Mason Co., 300 U.S. 577, 585 (1937). The Henneford Court's description of the Baldwin holding stands for the clear proposition that one state cannot set prices for transactions occurring in another state.

Tying in-state sales to out-of-state prices: The Supreme Court more recently has held invalid statutes that tie in-state sales to out-of-state prices, where the statute has the effect of determining prices in other states. In Brown-Forman Distillers Corp. v. New York State Liquor Auth., 476 U.S. 573 (1986), the Court invalidated a New York law requiring liquor producers to affirm that, during a given month, they would not sell to any customer out of New York at a lower price than the price they charged New York wholesalers. Once the producer made the affirmation, it could not lower out-of-state prices during that month without violating the New York law. The effect of this rule, said the Court, was to set a price floor in other states for the month following the producer's affirmation.

In the case of Healy v. The Beer Institute, 491 U.S. 324 (1989)(applying Brown-Forman to hold a similar law invalid), the Supreme Court provided guidance for assessing whether a statute has a per se unconstitutional extraterritorial reach or effect:

Federal Express Corp. v. California Pub. Util. Comm'n, 723 F. Supp. 1379, 1382-3 (D. Cal. 1989) (upholding California transportation regulations that did not apply to or control out-of-state commerce and did not conflict with regulations in other states) (emphasis added).

Given these judicial interpretations of the Commerce Clause, it is apparent that regulation of the prices of transactions occurring out-of-state would constitute an unconstitutional extraterritorial reach of state power. An attempt to regulate prices of out-of-state transactions would not withstand the 3-part test articulated by the Supreme Court in Healy: price regulation of out-of-state sales would apply to commerce wholly outside the state's borders, it would have the "practical effect" of controlling conduct beyond the borders, and it may conflict with valid regulations of the state in which the transaction does occur.

Note that Brown-Forman expands this prohibition to state laws that regulate in a manner that preclude a business from altering its prices in other states.

A close analogy to price regulation is state taxation. Price regulation constitutes a more burdensome variation of taxation, since its effects are more difficult to pass on to others in the stream of commerce.

The Supreme Court has explained on a number of occasions that where transfer of possession from seller to buyer occurs outside the state, a state tax on the sale may be invalid under both the Due Process and the Commerce Clauses. Two early examples include McGoldrick v. Berwind-White Coal Mining Co., 309 U.S. 33 (1940), and McLeod v. J.E. Dilworth Co., 322 U.S. 327 (1944).

In McGoldrick, the Court upheld a tax on coal sales. The Court observed that the "transfer of possession to the purchaser within the state ... is the taxable event regardless of the time and place of passing title...." 309 U.S. at 49.

McLeod presents the contrasting case. There the taxpayer sold mill supplies and machinery and was headquartered in Tennessee. Its traveling salesmen obtained orders from Arkansas customers and submitted those orders to the Tennessee home office for approval. The seller transferred title and possession to the Arkansas buyer on delivery to the carrier in Tennessee. The Tennessee office made the collections. When Arkansas attempted to apply its sales tax to these sales, the Court invalidated the tax: "[For] Arkansas to impose a tax on such transactions would be to project its powers beyond its boundaries and to tax an interstate transaction." 322 U.S. at 330. See also R. Rotunda and J. Nowak, Constitutional Law Treatise ' 13.6 at 431 and n.5 (3^rd Ed. 1999)("To permit a state to tax a sale consummated outside the state would violate both due process and the commerce clause.").

More recently, the Supreme Court applied Commerce Clause analysis to the more complicated situation of a sales tax assessed on mail order catalog sales. The Court determined that where a company's only contact with a state is sales by mail order, the Commerce Clause prohibits the state from imposing any tax obligation on the company. Quill Corp. v. North Dakota, 504 U.S. 298 (1992). Quill involved a North Dakota tax on a retailer of office supplies and equipment, which had no outlets and no sales representatives in North Dakota and owned no significant tangible property within the state. The retailer solicited business through catalogs and flyers, advertisements in national periodicals, and telephone calls. It delivered all of its merchandise by mail or common carrier from out-of-state locations.

As explained above, the Court in Quill found that the retailer's continuous and widespread solicitation of business within North Dakota were sufficient for the state to exercise its jurisdiction over the company without violating the Due Process Clause. However, the Court found that the state's specific requirement that the company collect a use tax from its customers violated the Commerce Clause because mail orders provided an insufficient nexus for purposes of the Commerce Clause. The Court emphasized that the retailer had no physical presence in the state. The Court left open the possibility that if the company's contacts with a state included more than mere mail order sales, the state could impose the tax obligation without violating the Commerce Clause.

Quill and the Supreme Court's earlier cases on state power to tax underscore the Commerce Clause's prohibition on state regulation of transactions occurring in other states. While McGoldrick makes clear that a state may tax a transaction where transfer of possession occurs in that state, McLeod makes clear that if title and transfer of possession occur out-of-state the state may not tax that transaction. Finally, in Quill, it appears that the transfer of possession of the goods that North Dakota sought to tax actually occurred within North Dakota, but the Supreme Court nevertheless held that the state had no jurisdiction to require Quill to collect the tax.

1. Price Regulation of In-State Sales

In contrast to price regulation of transactions occuring out-of-state, states have jurisdiction to regulate transactions occuring within the state. Quill, described immediately above, indicates that entities that have a sufficient physical presence in a state are subject to regulation by that state. Outside of the public utility context (which is special for reasons discussed in Part One: I.C.3 below), however, there are few cases addressing state power to set prices. Nevertheless, state price regulation of in-state transactions is comparable to state taxation in that both influence the price of the commodity. (Price regulation may raise other constitutional considerations, however. See Parts One: III.B, IV.D and V.C.) As a result, if a state has jurisdiction to tax, a court will likely conclude it has jurisdiction to regulate prices.

While courts are likely to find that states have jurisdiction to regulate transactions taking place within their borders, "state regulation of retail sales is not, as a constitutional matter, immune from our ordinary Commerce Clause jurisprudence." General Motors Corp., 519 U.S. at 291 n.8. So long as out-of-state competitors and in-state competitors are treated equally and have equal access to other buyers and sellers in the state, state regulation of in-state transactions may avoid analysis under the rigorous standard of review normally applied to instances of discrimination.

Nondiscriminatory price regulation of in-state sales still may be analyzed under the balancing test of Pike v. Bruce Church, Inc. See Part One: I.A.3. A reviewing court would weigh the burden price regulation has on interstate commerce against its anticipated benefits.

An example of an application of the balancing test being applied to state regulation of pharmaceutical wholesalers is Ferndale Laboratories, Inc. v. Cavendish, 79 F.3d 488 (6th Cir. 1996). Ferndale involved a Michigan pharmaceutical manufacturer's challenge to an Ohio statute requiring wholesale distributors to register with Ohio and pay a license fee. The requirement applied evenhandedly to all in-state and out-of-state wholesale distributors. The court concluded that the statute "effectuates a very strong local public interest by providing information concerning the types and sources of prescription drugs entering Ohio" and that the $100 fee and two-page registration form imposed little, if any, burden on interstate commerce.

Cotto Waxo Company v. Williams, 46 F.3d 790 (8th Cir. 1995), provides another recent, albeit contrasting, example of an application of the balancing test. At issue was a Minnesota law prohibiting the sale in the state of petroleum-based sweeping compounds. The court found that the law minimally burdened interstate commerce. The Court found no evidence, however, that the statute contributed to the state's legitimate objective of preventing contamination or promoting conservation and therefore held that a trial was necessary to determine if the state's interest in the statute was sufficiently legitimate.

The different outcomes in Ferndale and Cotto Waxo underscore the difficulty in predicting how a court may apply the balancing test to price regulation. Given the lack of precedent for state price regulation outside of the public utility context, it is difficult to predict the result of an application of the Commerce Clause balancing test to price regulation in the prescription drug area. A court would have to see a clear state policy that could not be addressed by less burdensome means.

This section examines whether a state may, consistent with the Commerce Clause, bar in-state sales except those passing through one retail or wholesale entity. The assumption is a state law involving the use of a wholesale or retail entity -- a state program or a privately run or state-run business -- through which each retail sale must pass. All sellers, whether located in-state or out-of-state, would be limited to accessing in-state consumers except through the state regulatory regime.

States have a long history of granting exclusive franchises in the utility context, such as for electricity, gas, telephone, cable, and water. Few cases challenge the existence of these utility franchises. Outside the utility area, there is little precedent with the exception of state and local regulation of solid waste. The remainder of this section considers applicable precedent in the non-utility area and then the public utility context.

There are few cases, outside the utility context, directly addressing a state's attempt to establish or provide entities with the exclusive right to control the flow of products into the state. This section first considers how such a state regime fits within the broader context of Commerce Clause case law, as set forth in the Commerce Clause Overview, Part One: I.A. It then considers the one area in which courts have addressed an analogous situation, restrictions on the flow of waste.

The establishment of a franchise, wholesale (or retail) through which all in-state sales must pass would serve as a barrier preventing out-of-state businesses from reaching local consumers. This barrier feature would likely subject the regime to the "rigorous" scrutiny standard of Commerce Clause review and make it "virtually per se" invalid.

Baldwin v. G.A.F. Seelig addressed a New York law regulating milk prices through a regulatory regime requiring all in-state dealers to be licensed by the state. The license requirement facilitated a pricing system that protected in-state milk producers. Specifically, the program barred out-of-state businesses from access to local consumers unless the out-of-state businesses were willing to meet the state's condition of charging the higher price that protected the higher prices of in-state milk producers. The license system was challenged by a local milk dealer who had been denied a license to sell milk purchased from a Vermont dealer at a price lower than the minimum price set by the New York law. The Supreme Court said that New York could not set minimum wholesale prices for milk transferred in out-of-state transactions in order to protect local milk producers:

Baldwin, 294 U.S. at 521.

Aside from Baldwin, other Supreme Court decisions also have invalidated state statutes barring competitors from access to local markets. For example:

• In Buck v. Kuykendall, 267 U.S. 307 (1925), the Court addressed a state law prohibiting common carriers from using state highways over certain routes without a certificate of public convenience. The Court said the law's "primary purpose is not regulation with a view to safety or to conservation of the highways, but the prohibition of competition. It determines not the manner of use, but the persons by whom the highways may be used. It prohibits such use to some persons while permitting it to others for the same purpose and in the same manner." Id. at 315-316.
• H. P. Hood & Sons v. Du Mond, 336 U.S. 525 (1949), involved a challenge to a New York law requiring businesses distributing milk in the state to obtain a license from the Commissioner of Agriculture and Markets. The Commissioner was authorized to withhold the license unless satisfied "that the issuance of the license will not tend to a destructive competition in a market already adequately served, and that the issuance of the license will be in the public interest." A Massachusetts distributor of milk who had two receiving stations sought a license for a third station but was denied. The Court held that a state may not refuse to license an additional receiving station for milk to be shipped to a distributor from another state. It rejected the state's arguments that the law was needed to prevent milk shortages and that by reducing the amount of milk received at plants of competitors within the area their cost of handling milk would be increased.
• In Pennsylvania v. West Virginia, 262 U.S. 553 (1923), the Court invalidated a West Virginia law regulating pipe-line companies designed to keep all state-produced natural gas in the state that would be required for local needs. The Court held that the State could not accord to its own consumers a preferred right of purchase over consumers in other states. The Court observed that

Would Baldwin apply to a state law requiring all sellers to deal only with a single state-appointed purchaser? It is possible, although the specific issue has not arisen. There are similarities and differences. Both the milk price licensing regime in Baldwin and a state-granted exclusive franchise operate to limit the access of out-of-state businesses to local consumers by channeling all imports through a single state system. In Baldwin, the system involved a licensing process requiring that the importer affirm its compliance with the New York minimum price laws for its out-of-state transactions; the establishment of an exclusive regulatory regime for sale of all of a commodity would similarly impact all importers of the commodity by precluding their market entry. In fact, one could argue that whereas Baldwin at least allowed outside sellers to enter, albeit only if they complied with the price floor, a regulatory regime requiring all of a commodity to go through a single wholesaler allows no one to enter.

More recently, in C & A Carbone, Inc. v. Town of Clarkstown, supra, the Supreme Court directly addressed a law granting an exclusive franchise to an in-state business for waste processing.

Carbone arose as a result of the town of Clarkstown, New York's effort to build a waste transfer station. The station was built by a private contractor which agreed to build the waste transfer station and operate it for five years, and then sell it to the town for $1. To assure the station's commercial viability, the town assured the station's market: the town passed an ordinance requiring all nonhazardous waste generated or brought into the town to be processed at the transfer station, guaranteeing a minimum amount of waste would go through the station, despite its above-market fees. All recyclers, such as Carbone, had to bring nonrecycled waste to the transfer station and pay an above-market tipping fee on the waste. Carbone, a waste hauler, challenged the Clarkstown ordinance.

The Court held that the law deprived out-of-state businesses of access to a local market and was therefore virtually per se invalid under the Commerce Clause. The Court rejected the argument that the statute applies evenhandedly to all solid waste processed within the Town, regardless of point of origin. The Court said:

Id. at 389 (emphasis added).

The Court rejected the Town's contention that the ordinance was nondiscriminatory because it also covered in-state and in-town waste processors. The Court noted that the ordinance allowed only the favored facility to process waste located within the limits of the town. The Court found this "no less discriminatory because in-state or in-town processors are also covered by the prohibition." Id. at 1682.

To support its holding, the Carbone Court cited a long string of cases invalidating protectionist state laws because they restricted the movement of articles through interstate commerce, including: Dean Milk Co. v. Madison, 340 U.S. 349 (1951)(striking down a city ordinance that required all milk sold in the city to be pasteurized within five miles of the city lines); Minnesota v. Barber, 136 U.S. 313 (1890) (striking down a Minnesota statute that required any meat sold within the state, whether originating within or without the State, to be examined by an inspector within the State); Toomer v. Witsell, 334 U.S. 385 (1948) (striking down a South Carolina law that required shrimp fishermen to unload, pack, and stamp their catch before shipping it to another State).

Then the Court directly addressed the exclusivity aspect of the Clarkstown ordinance:

Id. at 392 (emphasis added).

After Carbone, federal courts have applied rigorous scrutiny analysis to invalidate similar waste flow control laws which established entities through which certain waste had to flow. One court described New Jersey's laws as follows:

Atlantic Coast Demolition & Recycling, Inc. v. Board of Chosen Freeholders of Atlantic Cty., 48 F.3d 701, 710-11 (3d Cir. 1995) (emphasis added).

A state law requiring all transactions for a particular commodity to pass through a state program or single wholesaler or retailer, whose price would be set by government regulation, could be viewed as analogous to the Clarkstown ordinance requiring that all waste be processed through the local facility. Both regimes establish a barrier to the local market for out-of-state businesses, direct all business through a local entity, and regulate the price for business passing through the exclusive entity.

Even though a state regulatory regime calling for exclusivity could be drafted to be textually non-discriminatory, it would still involve regulation favoring an in-state program, retailer or wholesaler, just as Clarkstown favored a single local waste processing facility. As a result, a court may similarly deem a state law establishing an exclusive means by which commodities may be sold in the state as "more acutely" protectionist than other laws that have been found to discriminate against interstate commerce and were invalidated by the Court.

It is true that the Clarkstown law appeared to keep processing prices above market, whereas the intent of a Vermont effort to establish an exclusive wholesaler would be to bring prices down. This difference would not insulate a Vermont statute from attack, because the Carbone opinion focused primarily on the exclusive effect of the ordinance, not on the goal of above-market prices.

The existence of public utility exclusive franchises suggests that at least under certain circumstances states are free to establish exclusive entities through which commodities must be channeled before they are sold at retail.

The longstanding existence of exclusive utility franchises does not provide a clear path for an exclusive statute in Vermont. At least two features may distinguish utilities from other commodities that are typically freely sold in interstate commerce. These factors include:

This section first reviews some of the Supreme Court decisions applying Commerce Clause analysis to state laws affecting public utilities. It then describes a recent Supreme Court decision that may provide some insight into how the Court may distinguish the public utility context from other state regulation restricting competitors.

There is no general exemption from the Commerce Clause for state regulation of public utilities. In Arkansas Electric Cooperative Corp. v. Arkansas Public Service Commission, 461 U.S. 375, 391 (1983), the Court noted that "[o]ur constitutional review of state utility regulation in related contexts has not treated it as a special province insulated from our general Commerce Clause jurisprudence." Thus in New England Power Co. v. New Hampshire, 455 U.S. 331, 334-36 (1982), the Supreme Court invalidated an order of the New Hampshire Public Utility Commission that required the New England Power Company to reserve for New Hampshire residents a particular amount of low-cost power generated within the state. In Wyoming v. Oklahoma, 502 U.S. 437 (1992), the Supreme Court invalidated a state statute that required that all coal-fired electricity plants located within the state of Oklahoma burn at least ten percent Oklahoma-mined coal. The Court noted that the question of which level of scrutiny to apply to the protectionist measure was "not a close call." Id. at 800 n.12.

None of these cases addresses the constitutionality of the state's grant of an exclusive. Indeed, one federal court has stated that only one Supreme Court case has involved "a Commerce Clause challenge ... [to] the exclusionary effects of a monopoly created by a state public utility regulatory scheme." Atlantic Coast Demolition & Recycling, Inc. v. Board of Chosen Freeholders of Atlantic County, 48 F.3d 701 (3rd Cir. 1995).

That Supreme Court case was decided in 1951. Panhandle Eastern Pipe Line Co. v. Michigan Public Service Commission, 341 U.S. 329 (1951). In Panhandle Eastern, the Court upheld a state utility commission's refusal to allow an out-of-state natural gas supplier to sell natural gas to industrial consumers in an area where a Michigan public utility had been granted an exclusive certificate of public convenience and necessity. The decision was based largely on the distinction between wholesale and retail sales of natural gas, a distinction the Court had relied upon in earlier cases.

Since 1951, however, the Commerce Clause law has developed considerably and the Court no longer applies the retail/wholesale distinction in utility cases, see Arkansas Electric Cooperative, supra. These changes raise doubts as to whether the Supreme Court would address a challenge similar to Panhandle Eastern the same way today.

We were able to locate only one recent discussion of how the Commerce Clause may apply to a challenge to a state utility's exclusive franchise. In Atlantic Coast Demolition & Recycling, supra, the court addressed a waste flow control statute similar to the Clarkstown ordinance at issue in Carbone. New Jersey attempted to distinguish the ordinance in Carbone, arguing that Clarkstown's transfer station was not a regulated public utility, while New Jersey's designated waste facilities constituted regulated public utilities. Due to this distinction, New Jersey argued, the court should subject its program to the balancing test of Pike v. Bruce Church, rather than the strict scrutiny test applied in Carbone.

The court rejected this argument, concluding that rigorous scrutiny would be applied to a Commerce Clause challenge to the exclusive service territories of public utilities:

Id. at 714-15. The Court then went on to apply heightened scrutiny and invalidate the New Jersey waste regulations.

According to the court's discussion in Atlantic Coast, while a court may apply heightened Commerce Clause scrutiny to a public utility's exclusive franchise, there may be unique features that would sustain the burden on interstate commerce, namely that exclusivity "may be the only economically feasible alternative." In the context of waste processing, that court determined that exclusivity was not the only feasible alternative.

In the recent case of General Motors Corp. v. Tracy, supra, the Supreme Court addressed a challenge to an Ohio tax which discriminated in favor of Ohio natural gas public utilities. The case may shed some light on how the Supreme Court would respond to a challenge to an exclusive utility franchise.

The Ohio law at issue in General Motors exempted from general sales and use taxes natural gas sales by state-regulated gas utilities. The taxes applied to sales of natural gas by other in-state and out-of-state sellers, who challenged the tax under the Commerce Clause. Ultimately, the Court treated the Commerce Clause challenge as a threshold question of whether the out-of-state sellers and the state-regulated gas utilities are "similarly situated for constitutional purposes." Id. at 299. The Court upheld the tax on the grounds that it was not discriminatory because the history of state regulation of the natural gas industry distinguished the franchisees from independent marketers to the point that the enterprises should not be considered similarly situated so as to make the tax facially discriminatory.

The Court's thorough review of the natural gas industry and its regulation, which underpinned its decision to uphold the law, may indicate how a court would view public utility franchises as distinguishable from a state's effort to establish a franchise for a commodity -- prescription drugs -- that otherwise has been freely bought and sold in interstate commerce. The Court reviewed the history and current conditions of the natural gas industry, discussing, inter alia, the industry's natural monopoly characteristics, the establishment of federal regulation and Congress's own recognition of state utility regulations, as well as the state's interest in protecting captive customers and in the health and safety of its citizens. It also noted the universal recognition of the need for regulated gas utilities, citing the relevant statutes from all 50 states.

The General Motors decision initially discussed how economic factors brought about the need for comprehensive state regulation:

***

Id. at 289-95 (citations and footnotes omitted; emphasis added).

Ultimately, the Court concluded that the history and economics combined with the various obligations the states imposed on public utilities distinguished them from the out-of-state sellers for purposes of Commerce Clause analysis:

Id. at 297-98 (citations omitted).

The Supreme Court's decision General Motors suggests that a combination of special factors would be considered in a Commerce Clause challenge to a state public utility franchise. Many, if not most, of these features are distinguishable from commodities that otherwise have been freely exchanged in interstate commerce, including pharmaceuticals. Perhaps most significantly, there is no long-running federal recognition of the need for and benefits of state regulation of exclusive franchises.

Outside the utility context, state attempts to limit out-of-state businesses' access to local consumers have been invalidated by judicial application of the "rigorous" scrutiny standard of Commerce Clause review. In the public utility context, research has uncovered few cases challenging a state's right to close off access to local consumers by establishing exclusive retail franchises. When other aspects of public utility law have been challenged, the Supreme Court has applied normal Commerce Clause analysis, including the per se rule to invalidate discriminatory laws and the balancing test to non-discriminatory laws. Case law does indicate, however, that a challenge to a public utility's exclusive franchise could be distinguished from a similar challenge to an exclusive state regulatory regime for non-utility commodities. Public utilities are largely distinct creatures of law, economics, engineering and history, generally not comparable to other goods and services traded in interstate commerce.

States may favor local economic interests when they act as market participants. Reeves, Inc. v. Stake, 447 U.S. 429 (1980) (sustaining a restriction on the sale of state government-produced cement to state residents). This "market participant" exception to the negative Commerce Clause applies when the state acts as a market participant and not as a market regulator. As a market participant, the state-controlled wholesaler may favor in-state residents and businesses in making purchases and sales. Below we (a) explain variations of the market participant doctrine, (b) explore the distinction between market participant and market regulator and (c) address the relationship between states-as-market-participants and private contractors they hire.

The Supreme Court has recognized two variations of the market participant doctrine. The first variation is when the government itself enters the market as a producer, buyer, or seller. The most obvious example is when the state procures the various items necessary for administering government, e.g., computers and pencils. The Commerce Clause does not bar the state from making a policy decision to purchase those items from in-state sellers.

The Supreme Court, in Reeves, Inc. v. Stake, supra, applied similar reasoning to the converse situation of when the state becomes seller instead of buyer. In Reeves, South Dakota had entered the market as a cement processor because no private company was processing cement in the state. For years, an out-of-state buyer purchased cement from the state plant, but when the state decided that it would no longer sell cement for out-of-state users, the buyer brought suit, alleging the state's decision to refuse to sell out-of-state violated the Commerce Clause. The Court upheld the law, applying the market participant exception.

The Court distinguished Reeves in South Central Timber Development v. Wunnicke, supra. In South Central, an Alaska statute provided that all contracts for the sale of state-owned timber include provisions requiring that the timber be processed within the state. The Court declared the statute invalid because it imposed "downstream restrictions" on the market after the state had already sold the timber product.

Another variation on the market participant theme is when the state enters the market by using its general revenues to provide what the Supreme Court has called a "bounty." The leading example is Hughes v. Alexandria Scrap Corp., 426 U.S. 794 (1976). Alexandria Scrap concerned a Maryland program designed to remove abandoned automobiles from the state's roadways and junkyards. To encourage recycling of junk cars, a "bounty" was offered for every Maryland-titled junk car converted into scrap. Processors located both in and outside Maryland were eligible to collect these subsidies. However, the law imposed more exacting documentation requirements on out-of-state than in-state processors and made it less profitable for suppliers to transfer vehicles outside Maryland. The law caused a decline in the number of bounty-eligible hulks supplied to a Virginia plant (owned by the party challenging the Maryland program) from Maryland sources. 426 U.S. at 801.

When the law was challenged by out-of-state processors as unfairly favoring in-state processors, the Court responded:

Id. at 806-08 (emphasis added).

Relatedly, the case law is clear in holding that state legislation may promote local economic interests if the costs of promotion are paid by in-state residents. For example, a state may give local industries direct subsidies or tax relief, although a state may not shift the cost of supporting local economic interests to out-of-state residents. In other words, while a state may subsidize local business, it may not create a nondiscriminatory tax against all producers, but then channel the proceeds directly back to in-state producers. For example, a state cannot tax all milk sold by producers to in-state retailers and then distribute the tax to in-state farmers. See West Lynn Creamery, Inc. v. Healy, 512 U.S. 186 (1994).

The market participant doctrine applies only to actions taken by a state entity acting in a similar capacity as a private business. As described by the Supreme Court, the market participant doctrine "differentiates between a State's acting in its distinctive governmental capacity, and a State's acting in the more general capacity of a market participant." New Energy Co. of Indiana v. Limbach, 486 U.S. 269, 277 (1988). In other words, a state-run business may act just as a private business in deciding to purchase only local goods or sell to local citizens.

Language in C & A Carbone, supra, supports this distinction between the creation of a market participant and the simultaneous enactment of regulation protecting the market participant through methods that discriminate against interstate commerce:

511 U.S. at 394 (citation omitted).

The ordinance challenged in Carbone repeatedly refers to the solid waste transfer facility as a "town operated" facility, see appendix to the Court's decision, and the Supreme Court simply refers to the entity operating the facility as a "private contractor." Also, Justice Souter's dissent in Carbone stated:

511 U.S. at 417 (Souter, J., dissenting). Despite the Court's recognition of the town's pervasive role in the waste transfer facility, there was no discussion in the case of whether the market participant doctrine applied. It would appear that the market participant doctrine was never raised in Carbone because target of the challenge was the ordinance's regulatory aspect, not its proprietary aspect.

On the other hand, in New Energy Co. of Indiana v. Limbach, supra, Ohio expressly offered the market participant doctrine as a defense to the charge of discrimination. Ohio's statute gave a sales tax credit to fuel dealers for each gallon of ethanol sold for motor vehicles. The credit was made unavailable to ethanol coming from a state which did not grant tax advantages to Ohio-produced ethanol and was limited, for ethanol coming from a state which did allow credit for Ohio-produced ethanol, to an amount equivalent to that which such state allowed. The Court rejected Ohio's market participant defense, concluding that the state action ultimately at issue -- the assessment and computation of taxes -- is a governmental activity and "cannot plausibly be analogized to the activity of a private purchaser." 486 U.S. at 278.

The state of New Jersey, in Atlantic Coast Demolition & Recycling, described supra, also attempted to defend its exclusive waste flow program with the market participant. The state argued that its waste disposal program incorporating Carbone-type flow control provisions entitled it to the market participant exception because under state law New Jersey either participates (or directs local government entities to participate) in the waste disposal market as sellers and purchasers of waste disposal services and disposal capacity. Individual districts, the state argued, "sell" waste disposal services through the designated disposal facilities, and where a district has opted not to own or operate the designated facilities directly, it "purchases" services for "resale" by contracting with private facilities for the provision of waste disposal services. Therefore, the state contended, "the waste flow regulations simply represent a means by which the state manages the districts' market participation and the regulations are therefore protected from Commerce Clause scrutiny under the market participant doctrine." Atlantic Coast 48 F.3d at 716-17.

The court agreed with the state's characterization of the districts' activities under the statute as involving purchases and sales of disposal service and capacity, i.e., that at least for some purposes, the state laws created market participants. However, that the districts operated as market participants did not immunize the regulatory aspects of flow control ordinances:

***

Id. at 717.

We have found no reason why a state would be prohibited from hiring a private entity to perform services for an entity that qualifies as a market participant. We have identified no cases in which the market participant exception was denied because a state contracted out its services instead of using state employees.

A version of price regulation is the use of reference prices. These raise special issues under the Commerce Clause. We discuss three possibilities here: a requirement of "best price," a prohibition against discrimination, and regulations that tie state prices to a federal benchmark.

A state might consider using benchmarks based on private transactions, within the state or outside the state. A state statute limiting in-state prices to those charged in out-of-state sales would be invalid. "No state may require sellers to charge the same price within its borders as they charge elsewhere." K-S Pharmacies v. American Home Corp., 962 F.2d 728, 730 (7th Cir. 1992) (citing Healy and Brown-Forman).

Consequently, a state may not require that a seller extend to all buyers within the state the best price offered by that seller in some other state:

Id. (citations to Healy and Brown-Forman omitted).

On the other hand, a state may require that the seller extend to all buyers within the state the best price offered by that seller in the same state.

Finally, a state statute does not control commerce outside the state where (a) the statute prohibits price discrimination within the state and (b) federal law dictates that a supplier must sell to purchasers in another state at the same price. See Exxon Corp. v. Governor of Maryland, 437 U.S. 117 (1978) (dismissing Commerce Clause claim where extraterritorial effect arose from requirements of Robinson-Patman Act and not the Maryland statute prohibiting price discrimination).

As an alternative to basing the reference price on private transactions, a state might wish to base it on the Federal Supply Schedule (FSS). This type of reference raises questions similar to those discussed in the context of private reference prices. Because of the complex and unique features of the FSS, we explore it here in detail.

A court may strike a state price regulation statute because it (a) forces sellers to take the state-regulated price into account in setting prices in transactions outside the state for other purchasers, or (b) deprives non-state purchasers of competitive advantages that they otherwise would use to obtain lower prices. Courts will always focus on the statute's "practical effect."

This section analyzes how these Commerce Clause principles might apply to state legislation establishing a prescription pricing or rebate program that effectively limits state prices to the price that the U.S. government pays for pharmaceuticals under the Federal Supply Schedule (FSS). It concludes that manufacturers could make a plausible challenge to the FSS pricing scheme on the basis that it controls commerce that takes place wholly outside the state. Specifically, challengers could argue that a state-level FSS reference is likely to cause manufacturers to increase the FSS price to the federal government.

In order to help avoid the Commerce Clause problems associated with the FSS benchmark, an alternative benchmark, such as the average manufacturer price might be possible. Such a benchmark would allow a manufacturer to set prices for customers in other states without automatically setting the price for the entire Vermont market.

This section first explains why tying prices (or rebates) to the FSS schedule will have a practical effect on out-of-state commerce. It then explains that a court either may (1) find that the FSS benchmark regulation is invalid per se or (2) if it does not find that the regulation is invalid per se, analyze the regulation's benefits and burdens to determine its validity under the Commerce Clause. The section then turns to a discussion of the implications of using a potential alternative to the FSS. The section concludes by discussing whether a reference price based on the average manufacturer price would improve the statute's chance of validity.

The Federal Supply Schedule (FSS) for pharmaceuticals is a catalog of drug prices from which the federal government spends more than $1 billion annually. The bulk of the purchases are made by the Veteran's Administration, which has been delegated administration of the FSS by the General Services Administration.

The process of establishing the FSS for pharmaceutical drugs is a complex one. The following aspects of the pricing process are relevant to the Commerce Clause analysis:

• Term. As we understand it, manufacturers enter into agreements with the federal government setting the prices for pharmaceuticals for a one-year period.
• Price. The price charged to certain protected agencies must be less than 76% of the non-federal average price (this is known as the "Federal Ceiling Price" or "FCP"). 38 U.S.C. ' 8126. The federal government may negotiate a lower price. The government often avoids protracted price negotiations by basing the FSS on prices that the manufacturer charges to its "most-favored customer." As a result of these negotiations, prices for those drugs covered by the Veterans Health Care Act are "on average, about 28 percent below the FCP." U.S. General Accounting Office, "Effects of Opening the Pharmaceutical Schedule are Uncertain" at 6 (July 10, 1997) (hereinafter cited as "GAO Testimony") (commenting on federal proposal to open FSS pricing to state governments).
• Manufacturer Considerations. In negotiating the FSS, manufacturers take into account that the federal government's FSS schedule is a limited program. Among the factors that manufacturers cite include the benefits that will result from the use of their products by physicians training at VA hospitals. GAO Testimony, p. 3.

A state's adoption of the FSS benchmark may have the effect of impeding the federal government's ability to use its competitive advantages to obtain low prices for pharmaceuticals. In negotiating the FSS price with the federal government, the manufacturer's calculations would change. To determine the effect on its profits of agreeing to a particular price, the manufacturer would have to take into account not only federal purchasers of the product, but all those segments of the market for which the benchmark is applicable. This consideration would likely drive the FSS price higher. As the GAO has explained: "The larger the market, the greater the economic incentive would be for a manufacturer to raise schedule prices to limit the impact of giving low prices to more purchasers." GAO Testimony, p. 2.

Moreover, if more than one state adopted the FSS as a benchmark, there would be even greater upward pressure on the FSS:

GAO Testimony, p. 7.

Just as a state's tying pharmaceutical prices (or rebates) to the FSS may affect federal transactions, it may affect prices to customers in other states. If state regulations tying prices to the FSS cause manufacturers to increase the FSS, that increase could occur in various ways.

For example, manufacturers' FSS agreements with the federal government often tie the FSS price to the price the manufacturer sells to its "most-favored customer." Manufacturers might therefore raise prices to favored private customers in order to boost the FSS prices that are based on most-favored customer prices. Manufacturers might abandon most-favored customer prices altogether and negotiate higher FSS prices with the federal government. By depriving out-of-customers of competitive advantages they would otherwise enjoy relative to Vermont customers, a state's use of the FSS could raise Commerce Clause problems, as discussed in more detail below.

A state's use of an FSS Benchmark is unlikely to result in conflict with other state statutes. The Healy case, discussed in Part One: I.B.1.b, supra, dictates that "the practical effect of ... a statute must be evaluated . .. by considering how the challenged statute may interact with the legitimate regulatory regimes of other states and what effect would arise if not one, but many or every, state adopted similar legislation." 491 U.S. at 336.

The Healy Court found that existing and potential states' affirmation and beer pricing statutes would "create just the kind of competing and interlocking local economic regulation that the Commerce Clause was meant to preclude." 491 U.S. at 337. This effect would occur because each state would impose a cap on the others based upon the prices charged in the preceding month, resulting in a "price gridlock" and a "short-circuiting of normal pricing decisions based on local conditions" on a scale reserved by the Commerce Clause to the Federal Government. Healy, 491 U.S. at 340.

A state law tying pharmaceutical prices to a benchmark established by the federal government, as opposed to one based on pricing decisions in other states, probably reduces the risk of conflicting statutes. If all states adopted the same FSS benchmark, compliance would not be a problem for manufacturers. Nor would the statutes "interlock" because they would not make reference to other states' statutes. However, as described in the preceding section, the impact on prices to other customers would be greater the more states followed Vermont's lead. It is possible that specific terms of various state statutes adopting the FSS might lead to conflicts, but there is no basis for predicting such an outcome at this time.

Setting a schedule of prices for sales outside of the state could be viewed as constituting an exercise of control over out-of-state transactions, in violation of the rules announced by the Supreme Court in Healy and Brown-Forman. See discussion in Part One: I.B.1.b. Brown-Forman held invalid a law requiring liquor producers to affirm that they would not sell to any customer out of New York at a lower price than the price it charged New York wholesalers. Once the affirmation was made, the producers could not lower out-of-state prices without violating New York law.

In Healy, the Court invalidated a Connecticut beer price affirmation statute that required beer producers to post prices for the month and guarantee that the prices were no higher than prices charged in bordering states at the time of posting. This statute differed from the Brown-Forman statute, which applied prospectively, in that sellers could change out-of-state prices without Connecticut's approval. The Court found that this "contemporaneous" affirmation statute still had the practical effect of controlling commercial activity outside of Connecticut because a producer would have to take the Connecticut statute into account in negotiating prices with out-of-state customers:

Healy, 491 U.S. at 338. Similarly, because New York required promotional discounts to remain in effect for 180 days and the Connecticut regulation considered promotional discounts as price reductions, the manufacturer offering promotional discounts in New York would have to lock in Connecticut prices for 180 days at the discounted price. The statute also discouraged volume discounts in other states.

A state law that restricts the ability of a seller to set out-of-state prices based upon local competitive factors, by requiring the seller to consider the effect on prices in the regulating state, may constitute forbidden control of prices in other states. The Court in Healy observed that the Connecticut law would deprive producers and out-of-state customers of competitive advantages that would result in lower prices:

491 U.S. at 338, citing 849 F. 2d at 759.

The Brown-Forman Court expressed similar concerns about statutes that require out-of-state entities to surrender "whatever competitive advantages they may possess." Brown-Forman, 476 U.S. at 580. As one commentator has observed:

Greenberg, Ward A., "Liquor Price Affirmation Statutes and the Dormant Commerce Clause," 86 Mich. L. Rev. 186, 203 (1987).

The concerns of the Court in the Brown-Forman and Healy opinions may apply to a state's tying of pharmaceutical prices to a federal benchmark. As explained above, the FSS benchmark law could affect competitive advantages enjoyed by the federal government and most-favored customers in other states. In negotiating the FSS (or the price to a "most-favored customer" that determines the FSS), manufacturers would have to be prepared to offer the same price to customers in the states adopting the FSS benchmark. Moreover, assuming that the FSS agreement is in effect for a period of a year or more, the manufacturer negotiating the FSS prices would have to consider the prices it planned to charge in all such regulating states for a corresponding period.

Assuming that a court would not view a state law's reference to FSS prices as per se discriminatory, the law could still be challenged as being excessively burdensome on interstate commerce relative to its benefits.

It is difficult to predict how a court would balance benefits and burdens, and no cases specifically address this issue. The court would assess the economic effects of the state's incorporation of FSS prices, and ask whether the state had equally effective alternatives. Finally, if the Court accepts that the statute would likely result in increased FSS prices, it may conclude that the statute would be ineffective in achieving the state's drug price reduction goal.

Using an objective benchmark that is not tied to a manufacturer's competitive pricing decisions could avoid particular Commerce Clause problems. If the state adopts the average wholesale price, the statute will not affect directly the competitive position of buyers and sellers in other markets. Manufacturers would be able to set prices elsewhere without at the same time setting prices for the entire state of Vermont. Such a provision would be an attempt to obtain the benefits of national competition for Vermont citizens, but the effect on manufacturer sales elsewhere would be far less direct.

The use of the average wholesale price benchmark requires further analysis. While we think that this may be a more viable option than the FSS benchmark, there may be other legal and practical concerns raised by such an approach. Some of these are addressed in Part One: II.C.4.a, which discusses possible preemption problems with such an approach.

If price disclosure obligations are enacted as part of a voluntary program, for example, a program which qualified under the market participant doctrine, the Commerce Clause should not pose any problems. Manufacturers and wholesalers would participate in the program on a voluntary basis, and they would be able to take into account the disclosure requirements in their decision to participate in the state program.

The question of mandatory price disclosure requirements outside of a statewide program may raise Commerce Clause issues, however. As Part One: I.B.1 explains, a state may not regulate an out-of-state company's transactions occurring in another state. The constitutional principles that would preclude a state from regulating or taxing transactions occurring in another state would likely preclude the state from requiring an out-of-state company to disclose information about transactions occurring in another state. Price disclosure requirements in federal and other state programs, for example, are required only for those participating in the relevant federal or state program. In other words, the analysis that precludes price regulation of out-of state transactions may apply to a price disclosure requirement, thus precluding a state from requiring an out-of-state company to provide price information from transactions occurring out the state.

A different analysis would apply if the disclosure requirement is placed only on in-state transactions. Since such disclosure requirements would apply only to transactions occurring within the state, they should not pose a significant barrier to manufacturers and wholesalers wishing to import into the state. Again, as with in-state price regulation, such legislation would likely be subject to the Commerce Clause balancing test. See Part One: I.B.2.

The U.S. Constitution provides that federal laws shall be "the supreme law of the land." Article VI, cl. 2. This provision, known as the "Supremacy Clause," means that federal law can nullify a state law. In other words, state laws can be "preempted" by federal laws. Because there is a large body of federal law that may relate to the legislative options the Committee is considering -- for example, pharmaceutical products and labeling, market regulation, health care, and pharmaceutical procurement -- it is important to be aware of potential preemption issues.

After an overview of the preemption doctrine, the potential preemptive effects of specific areas of federal law are considered. As seen below, with certain limitations, Congress has appeared to leave some room for state action. A number of the laws examined are noted in only abbreviated form because they are unlikely to raise any preemption issues. The statutes are divided into two sections according to the potential risk of preemption.

When the Committee is closer to drafting of an actual bill, potential bill language should be analyzed in order to assess the potential for preemption under the statutes cited here, and perhaps under additional federal law, should it be implicated.

Whether a federal law preempts state law depends on congressional intent. Congress may signal its intent to preempt by passing laws directly, or by delegating its preemption authority to a federal agency. Courts hesitate to find preemption, except where "the nature of the regulated subject matter permits no other conclusion, or [where] Congress has unmistakably so ordained." N.Y. State Dep't of Social Services v. Dublino, 413 U.S. 405, 413 (1973). The party asserting preemption carries the burden of proving congressional intent to preempt. The Supreme Court has summarized preemption doctrine as follows:

Pacific Gas & Electric v. State Energy Resources Conservation & Dev. Comm'n, 461 U.S. 190, 203-04 (1983)(internal quotations and citations omitted).

To summarize the Court's preemption analysis in Pacific Gas & Electric, congressional intent to preempt may be (a) clearly expressed in a federal statute or (b) implied. Courts have found implied Congressional intent to preempt state law in three general categories of situations: (1) where there is a need for uniform national standards; (2) where Congress has legislated in an area comprehensively, occupying the entire field of regulation, and leaving no room for state supplementation; or (3) where the state law actually conflicts with federal law and compliance with both state and federal law is physically impossible.

Illustrations of the each of the type of preemption include the following:

• Uniform national standards not required: California set standards measuring the maturity of avocados. The standards were higher than federal standards and served to bar some Florida avocados from California markets. Congress did not intend uniform standards; and compliance with minimum federal standards did not conflict with California's standards since Florida growers could comply with both standards. Florida Lime & Avocado Growers, Inc. v. Paul, 373 U.S. 132 (1963).
• Federal scheme does not "occupy the field": California moratorium on the construction of new nuclear plants, until a high-level nuclear waste disposal facility is approved by the federal government, was not preempted by the Atomic Energy Act. The state law was passed for purposes of economics, while the federal law was geared to safety. Pacific Gas & Electric, supra.
• Conflicting laws: State law established food labeling requirements, but did not allow for "reasonable weight variations." Federal law, designed to allow for value comparisons, allowed for reasonable variations to account for moisture loss during shipping. Jones v. Rath Packing Co., 430 U.S. 519 (1977).
• Conflict between state and federal -- partial preemption: Federal law providing that "no statement relating to smoking and health shall be required in the advertising of any cigarettes" other than the federally mandated warnings did not preclude state product liability claims, but did preclude state from mandating particular warnings. Later amendment to the federal law prohibiting states from enacting requirements "with respect to the advertising or promotion of any cigarettes the packages of which are labeled [in compliance with federal law]" preempted certain state law remedies relying on failure to warn in excess of federally mandated warnings. Cipollone v. Liggett Group, Inc., 505 U.S. 504 (1992).
• Conflict between state and federal law -- no preemption: A federally licensed nuclear facility, appealing the award of $10 million in punitive damages related to a worker's exposure to plutonium, argued that federal nuclear safety regulations preempted the state law claim. Despite its Pacific Gas & Electric decision (see above), the Supreme Court held that the nuclear facility had not met its burden of showing that Congress intended to preclude state-law remedies, including punitive damage awards. Punitive awards are not inconsistent with Nuclear Regulatory Commission civil penalties and do not "frustrate any purpose of the federal remedial scheme." Silkwood v. Kerr-McGee Corp., 464 U.S. 238, 257 (1984).

Some of legislative options relating to prescription drugs considered could implicate insurance and prescription benefit programs administered by employers. As a result, there is a risk that the legislation, or certain provisions of it, could be preempted by the federal Employee Retirement Income Security Act of 1974 (ERISA).

ERISA's express preemption language states:

29 U.S.C. ' 1144(a)(emphasis added). An employee benefit plan is defined as any plan maintained:

' 1003(a).

ERISA includes a "savings clause," which declares that states may regulate insurance by providing that "nothing in this subchapter shall be construed to exempt or relieve any person from any law of any State which regulates insurance . . . ." 29 U.S.C. ' 1144(b)(2)(A).

The statute also includes a "deemer clause" which prohibits the treatment of employee benefit plans as being the business of providing insurance. It states that

29 U.S.C. ' 1144(b)(2)(B).

In enacting ERISA, Congress intended to facilitate the administration of employee benefit plans by creating a uniform body of employee pension and benefit laws, thereby ensuring that plan administrators need only comply with only one set of regulations and not with conflicting state and local regulations. Among other provisions, ERISA imposes reporting and disclosure obligations, schedules for the vesting and funding of pension plans, standards of care and loyalty for plan administrators, and various other specific obligations for benefits plans and their administrators.

At the most general level, preemption of state law under ERISA occurs when a state law will influence the course of action taken by administrators of employee benefit plans. The scope of ERISA preemption is perhaps the broadest of any federal