August 22 2002
Internet Legislation and Pre-emption
The Dormant Commerce Clause
Statutes that Directly Regulate Internet Activities
General Regulations Affecting Commercial Uses of the Internet
Regulation of Internet Liquor Sales
State-by-state regulation of the Internet is incongruous, given the Internet's virtually limitless accessibility and the lack of a meaningful territorial nexus for most of what goes on there. Regulation by particular states almost inevitably has a significant impact on out-of-state activities and interstate commerce. Accordingly, courts have already invalidated a number of state laws restricting internet-related activities under the federal Constitution’s so-called 'dormant commerce clause'. However, courts have also recognized that not all regulatory schemes will “fall before the mighty altar of the Internet”.(1) For example, courts have generally upheld individual state laws regulating the internet transmission of unsolicited commercial email ('spam'), but rejected state laws designed to restrain in-state access to child pornography available on the World Wide Web.
Perhaps the most significant development regarding the Internet and federal pre-emption concerns taxes. In legislation sponsored by Congressman Christopher Cox and others, Congress extended its earlier law banning states from adopting any and all new, special or discriminatory internet taxes until November 1 2003. President Bush signed the Internet Tax Non-discrimination Act on November 28 2001. In introducing the legislation, Cox recognized the Internet’s global nature, and the need to protect the national economy from a “tyranny” of exactions from different jurisdictions.
These same considerations are now playing out in the national and state debates over new legislation governing privacy. Numerous representatives of business have argued that national standards for privacy are necessary in order to avoid the Babel of differing laws all regulating the same personal information – information which can and must pass freely across state lines if market efficiencies are to continue.
Internet Legislation and Pre-emption
As noted, the Internet Tax Non-discrimination Act pre-empts state laws that would impose new, special or discriminatory taxation on the Internet.(2)
The Electronic Signatures in Global and National Commerce Act(3) was signed into law on June 30 2000. It provides a legal framework to facilitate electronic commerce. The act has two principal prongs: (i) provisions governing electronic records and signatures generally, and (ii) specific provisions relating to consumer transactions. The act provides that electronic records are, in general, considered 'writings' for most legal purposes. For electronic records to be effective in the consumer context, however, the consumer must consent to the use of such electronic records. Such consent must meet certain detailed requirements, which are discussed below. To satisfy document retention requirements, an electronic record must be accurate, accessible and capable of being reproduced. The law also authorizes federal agencies to interpret and issue rulemakings to modify some of the law’s requirements. Finally, the act is avowedly 'neutral' in refusing to prefer any form of technology used in connection with electronic signatures or records.
While vaguely drafted, the law generally pre-empts state law. There are two scenarios under which a state statute, regulation or other law may modify, limit or supersede the act’s electronic contract provisions. The first is where the state law constitutes an enactment or adoption of the Uniform Electronic Transactions Act. However, any exceptions to the scope of the act are pre-empted to the extent they are inconsistent with the federal law, or if they are not technology-neutral (ie, if they prefer some form(s) of technology for creating or authenticating electronic signatures or records over others).
The second is where the state law is enacted after the Electronic Signatures Act, makes specific reference to the act, and specifies alternative procedures or requirements for use and/or acceptance of electronic records or signatures that are consistent with the federal law and are technology-neutral.
The Gramm-Leach-Bliley Act(4) establishes extensive new obligations and rights with respect to consumer financial privacy. In general, the act:
The act provides that state laws are pre-empted only to the extent that such laws are inconsistent with the federal law, but state laws will not be considered inconsistent to the extent they provide consumers with greater protection than federal law. Thus, state laws that require that a consumer consent to information-sharing programmes, that require additional disclosures or that impose other consumer protections on financial institutions are not likely to be pre-empted by the act.
Under the Health Insurance Portability and Accountability Act 1996(5) the Department of Health and Human Services has issued detailed rules governing the privacy of patient medical records.(6) Section 1178 (a)(2)(B) of this act specifically pre-empts state laws related to the privacy of individually identifiable health information unless the state law is more stringent. Accordingly, the Health and Human Services regulation only pre-empts state laws where there is a direct conflict between state laws and the regulation, and where the federal regulation provides more stringent privacy protection than state law. In its federalism analysis under Executive Order 12612, the Health and Human Services stated the following:
“[W]e have interpreted state and local laws and regulations that would impose less stringent requirements for protection of individually identifiable health information as undermining the agency's goal of ensuring that all patients who receive medical services are assured a minimum level of personal privacy. Particularly where the absence of privacy protection undermines an individual’s access to health care services, both the personal and public interest is served by establishing federal rules.”
Case law generally supports Cox’s policy objective to save the Internet from drowning in "a sea of red tape". In American Libraries Association v Pataki the court identified the Internet as a “national preserve” in which only the federal government may legislate.(7) (However, even the federal government’s attempts to regulate within this preserve have been rebuked on constitutional grounds.(8)) In any event, it will not be exceedingly difficult for would-be state regulators of the Internet to impose local regulatory solutions that are not deemed "unworkable" and “uneconomic” by courts judging the impact on those seeking to conduct legitimate business online.(9)
Article 1(8) of the US Constitution states that “Congress shall have power...to regulate commerce...among the several states”.(10) For at least 175 years, this affirmative grant of power to Congress has been understood to carry with it a negative, or 'dormant', command upon the states that they may not enact laws that interfere with the flow of interstate commerce.(11) In the years since, numerous cases have developed this concept into a line of jurisprudence know as 'dormant commerce clause' analysis.(12)
Primarily, the dormant commerce clause doctrine prohibits states from engaging in three activities. First, the doctrine prohibits state laws that directly discriminate against interstate commerce.(13) Second, states are precluded from enacting laws that, although facially non-discriminatory, place an excessive burden on interstate commerce.(14) Third, states may not enact laws regarding certain aspects of commerce which, by their nature, require uniform national treatment.(15)
While the dormant commerce clause and 'pre-emption' do not present identical issues or analysis, the fact that so much state regulation of the Internet falls foul of the Constitution’s commerce clause indicates that this is an area where the propriety of congressional pre-emption cannot easily be dismissed.
American Libraries Association(16) involved a challenge to a New York state statute criminalizing the intentional use of "any computer communication system...to initiate or engage in” communication depicting certain sexual conduct with “a person who is a minor”.(17) This statute was held to violate the dormant commerce clause for three reasons. First, it violates the extraterritoriality principle by projecting “New York law into conduct that occurs wholly outside New York”.(18) Second, it failed the Pike balancing test, because the “burdens on interstate commerce resulting from the act clearly exceed any local benefit derived from it”.(19) Third, it violated the' inconsistent regulations' prong of dormant commerce clause analysis because, in the view of the trial judge:
“the Internet is one of those areas of commerce that must be marked off as a national preserve to protect users from inconsistent regulations that...could paralyze development of the Internet altogether."(20)Specifically, the court found that “no aspect of the Internet can feasibly be closed off to users from another state”.(21) Further, the court found that the fact that in the ordinary course of internet activity, information transmitted over the Internet will likely pass through computers located in many different states, without either the intent or knowledge of the person transmitting that information, means that “the New York act...cannot effectively be limited to pure intrastate communications over the Internet because no such communications exist".(22)
Justice Preska found that exercising criminal jurisdiction over out-of-state parties who allegedly violate the act is “beset with practical difficulties”, and that the cost of compliance with the act and the act’s chilling effect on internet activity outweighed whatever meagre benefits accrued to New York as a result of the act.(23) Preska also found that the Internet, “like the rail and highway traffic...requires a cohesive national scheme of regulation so that users are reasonably able to determine their obligations”.(24) Without such uniformity, internet users would be “lost in a welter of inconsistent laws, imposed by different states with different priorities”.(25)
State of Washington v Heckel(26) upheld the constitutionality of a state anti-spam statute. Heckel, decided by the Washington Supreme Court in June 2001, involved Washington state’s attempt to enforce its commercial electronic mail act(27) against a resident of Oregon. Washington’s anti-spam law makes it unlawful for anyone “sending a commercial email message from a computer located in Washington or to an email address held by a Washington resident” to use “a third party’s domain name without permission, misrepresent or disguise in any other way the message’s point of origin or transmission path, or use a misleading subject line”.(28) The court first determined that the act did not “openly discriminate against interstate commerce in favour of intrastate economic interests”, but rather was “facially neutral, applying impartially to in-state and out-of-state businesses”.(29) As such, the court held that the Pike balancing test applied to determine the constitutionality of the provision.(30)
Applying the balancing test, the court concluded that the local benefits of the act “surpassed any alleged burden on interstate commerce”.(31) The court found that the act served to protect the interests of three distinct groups: internet service providers, the actual owners of forged domain names and email users.(32) As the court noted, unsolicited commercial email messages impose a significant cost on these three groups by diverting their valuable resources and thereby increasing operational costs.(33) The effect of this is to shift the advertising costs of the individuals and entities employing these unsolicited commercial emails onto the consumers who receive them. The court, resting on federal precedent, held that “the act serves the ‘legitimate local purpose’ of banning the cost-shifting inherent in the sending of deceptive spam”.(34)
Addressing two other prongs of dormant commerce clause analysis, the Heckel court likewise held that the act did not violate either the inconsistent regulations prong or the extraterritoriality principle.(35) With respect to the former prong, no violation was found because “the truthfulness requirements of the act do not conflict with any of the requirements in the other state’s statutes”.(36) Again drawing on federal precedent, the court stated that the proper inquiry under the inconsistent regulations inquiry was not whether a state statute created “additional obligations”, but whether the statute creates “irreconcilable obligations".(37)
On January 2 2002 a California appellate court upheld California's regulation of the transmission of unsolicited advertising materials.(38) The suit originated with a complaint filed by a California resident against Friendfinders, Inc, a California business. The plaintiff alleged that Friendfinders had violated Section 17538.4 of the California Business and Professional Code by sending deceptive and misleading email advertisements.
This section provides that persons or entities conducting business in California who transmit unsolicited commercial emails must:
The provision applies to unsolicited emails delivered to California residents via the service or equipment of a service provider located in California. The lower court had held that Section 17538.4 violated the dormant commerce clause of the US Constitution because the provision subjects interstate use of the Internet to inconsistent state regulations.
The California Court of Appeal reversed the lower court's decision, finding that Section 17538.4 does not violate the dormant commerce clause because the provision does not directly regulate commerce that occurs entirely outside the state of California. Rather, the provision applies only when unsolicited advertisements are transmitted to California residents through the equipment of a service provider located in California. The court rejected the defendant's argument that the provision's geographical limitations are ineffective because the Internet transcends geographical boundaries. According to the court, the provision does not regulate the Internet or internet use in itself. Instead, the law imposes valid restrictions on individuals and entities who do business in California, use equipment located in California and send unsolicited advertisements to California residents. The possible inconvenience to senders occasioned by the need to determine the geographical residence of recipients for the purpose of complying with applicable laws does not amount to a violation of the commerce clause.
In addition to holding that Section 17538.4 does not discriminate against or directly regulate interstate commerce, the court found that California has a legitimate public interest in protecting its citizens from the harmful consequences of deceptive unsolicited advertisements, and that any burdens Section 17538.4 imposes on interstate commerce are minimal and do not outweigh the provision's benefits.(39)
General Regulations Affecting Commercial Uses of the
The same district court and judge that decided American Libraries Association ruled on another dormant commerce clause challenge to a New York statute. Santa Fe Natural Tobacco Co v Spitzer(40) permanently enjoined the enforcement of a state statute prohibiting both direct sales of cigarettes to New York consumers and common carriers from delivering cigarettes directly to New York residents under the force of a dormant commerce clause argument.(41) This prohibition included those entities selling cigarettes online. In the court’s opinion, this law effectively limited retail sales of cigarettes in New York to face-to-face transactions at in-state retail locations, a legislative act that discriminates against interstate commerce by banning interstate retail cigarette sales in New York and shielding New York retailers from out-of-state competitors.(42) Consequently, the court ruled that the statute fails under both strict scrutiny and the Pike balancing test.(43)
Evidence at trial showed that New York had not provided any technological reasons why age-verification checks could not be done on the Internet.(44) The court also found that New York had not attempted to use existing federal or state mechanisms for collecting taxes on cigarettes sold by out-of-state direct retailers to New York consumers via the Internet or any other direct sales channels.(45) Moreover, the court pointed to programmes used by other states to collect unpaid taxes on cigarettes flowing into their state through interstate commerce which have proven effective and significantly less burdensome than New York’s outright ban on direct sales.(46)
In Ford Motor Company v Texas Department of Transportation(47) Ford Motor Company sought an injunction preventing Texas’s enforcement of certain statutory provisions prohibiting, among other things, automobile manufacturers from “directly or indirectly owning an interest in a dealer or dealership, operating or controlling a dealer or dealership, or acting in the capacity of a dealer".(48) Ford brought suit in response to an administrative complaint filed by the Texas Motor Vehicle Board alleging that Ford had been in violation of these provisions by “selling pre-owned vehicles directly or indirectly to consumers through the Internet without a licence”.(49) At the time, Ford had been operating a website, known as the Showroom, wherein prospective consumers could view pre-owned vehicles for sale or lease.(50) Internet users who found a specific vehicle that they were interested in could, after paying a refundable deposit to Ford, have the vehicle transported to a specific independent dealership where the prospective purchaser could view and test drive the vehicle.(51) The prices for the vehicles displayed on the Showroom website were set by Ford and described as no-haggle prices that could not be lowered.(52) If the prospective purchaser were to decide to buy the vehicle, he or she would enter into a sales agreement with the dealership, which would also negotiate the terms of any vehicle trade-in.(53) However, under the terms of the voluntary agreement between Ford and the dealerships that chose to participate in the Showroom programme, the dealership was precluded from showing another vehicle to the prospective purchaser until he or she “clearly rejected the vehicle chosen from the Showroom”.(54) It was Ford’s operation of the Showroom programme that prompted Texas’s complaint against it.
The Ford Motor Company court rejected Ford’s dormant commerce claim on the grounds that the statutes at issue regulated evenhandedly and the local benefits of the regulation did not unduly burden interstate commerce.(55) The court found that:
“based on valid legislative findings, the Texas legislature has enacted a statutory scheme that attempts to equalize the market power between manufacturers and dealers, and further the public interest of the citizens of Texas."(56)Further, the court specifically rejected Ford’s argument that “an activity which is appropriately regulated when accomplished through any other medium becomes sacrosanct when accomplished through the Internet”.(57) The court continued that accepting Ford’s internet argument would mean that “all state regulatory schemes would fall before the mighty altar of the Internet”.(58)
The Ford Motor Company court distinguished American Libraries Association on the grounds that the statute at issue in that case specifically targeted the Internet for regulation.(59) By contrast, the court noted that Texas Revised Civil Statute Article 4413(36) Section 5.02C(c) is a law of general applicability regardless of the medium through which an automobile manufacturer seeks to sell automobiles directly to consumers.(60) This difference may have been dispositive of the issue, as the court concluded that “the fact that a law of general applicability affects Ford’s use of the Internet does not mean that Texas is attempting to directly regulate the Internet”.(61) Had Texas attempted directly to regulate the Internet, Ford’s challenge may have been upheld.
The Fifth Circuit upheld this decision against the commerce cause challenge.(62) The court rejected Ford’s invocation of Pataki’s holding that the Internet is a type of commerce “demand[ing] consistent treatment and...therefore susceptible to regulation only on a national level”.(63) The Fifth Circuit drew a distinction between laws that directly and indirectly regulate the Internet:
“When considering laws that directly regulate internet activities, this alleged need for uniformity may well prevail. However, application of this principle in circumstances like the instant case would lead to absurd results. It would allow corporations or individuals to circumvent otherwise constitutional state laws and regulations simply by connecting the transaction to the Internet.”
In Arizona, another federal district court weighed in on an issue closely related to that in Ford Motor Company. In Alliance of Auto Manufacturers v Hull(64) the court refused to grant a preliminary injunction preventing enforcement of an Arizona law prohibiting automobile manufacturers from directly or indirectly competing with or unfairly discriminating between their dealers.(65) With respect to the alliance’s claim that the ban on selling automobile accessories and financing in any respect, including through its websites, violated the dormant Commerce Clause, the court responded simply that it “fails to find a distinction between the sale of vehicles and the sale of aftermarket parts and services related to those vehicles”.(66) As such, the court held that the ban on such services burdened interstate commerce no more than the ban on direct sales of automobiles, and served to curtail the disparity of bargaining power between manufacturers and dealers in furtherance of the public interest.(67)
Regulation of Internet Liquor Sales
Several cases have tested the validity of state laws purporting to ban the direct sale of wine over the Internet. Initially, in the district courts, these laws were struck down against dormant commerce clause analysis. Swedenburg v Kelly(68) is illustrative. In this case a New York law prohibiting advertisement, sales and shipment of alcoholic beverages except by persons licensed by New York state to do so was challenged by several small out-of-state wineries and several New York wine consumers.(69) This, the plaintiffs alleged, discriminated against out-of-state wineries that wished to sell their wines on the Internet to consumers in New York state.(70) The Swedenburg court denied New York state’s motion to dismiss and allowed the suit to proceed on the merits.(71)
A few days after New York’s argument in Swedenburg was rejected, the Seventh Circuit Court of Appeals issued an opinion that may ultimately prove to have changed the course of future litigation in this area. In Bridenbaugh v Freeman-Wilson(72) the Seventh Circuit Court of Appeals reversed the district court’s ruling that Indiana Code Section 7.1-5-11-1.5(a), prohibiting direct sales and shipments of alcoholic beverages to Indiana residents by “persons in the business of selling alcoholic beverages in another state or country”, unconstitutionally violates the dormant commerce clause.(73) In the opinion of the Seventh Circuit panel, this section has only one effect on out-of-state sellers of wine, that being to channel “their sales through Indiana permit-holders, enabling Indiana to collect its excise tax equally from in-state and out-of-state sellers...this is precisely what Section 2 [of the 21st Amendment] is for”.(74)
As indicated above, the Bridenbaugh panel grounded its decision on the text and history of the 21st Amendment. Justice Easterbrook began his analysis by stating: “This case pits the 21st Amendment, which appears in the Constitution, against the ‘dormant commerce clause’, which does not.”(75) After noting that if the statute regulated the importation of cheese it would surely fail scrutiny under dormant commerce clause analysis, he further noted that “Section 2 of the 21st Amendment empowers Indiana to control alcohol in ways that it cannot control cheese”.(76) Further, Easterbrook debunked the notion that the extent of state powers under the 21st Amendment is controlled by an exploration of the “core purposes” of Section 2;(77) rather, “our guide is the text and history of the Constitution, not the 'purposes' or 'concerns' that may or may not have animated its drafters”.(78)
In October 2000 Congress acted to restrain internet liquor sales by adopting the 21st Amendment Enforcement Act.(79) This act empowers state law enforcement officials to seek federal court injunctions to stop direct shipments of alcohol to consumers where state law prohibits such interstate commerce.
For further information on this topic please contact Alan Raul at Sidley Austin Brown & Wood LLP by telephone (+1 202 736 8477) or by fax (+1 202 736 8711) or by email (email@example.com). The Sidley Austin Brown & Wood website can be accessed at www.sidley.com and the firm's CyberLaw website is located at www.sidley.com/cyberlaw.
(1) Ford Motor Co v Texas Dep’t of Trans, 106 F Supp 2d 905 (WD Texas, 2000), affirmed, __ F 3d __ (2001) (http://laws.lp.findlaw.com/5th/050750cv0.html).
(8) See Reno v American Civil Liberties Union, 521 US 844 (1997) (holding that federal statute aimed at restricting obscenity on the Internet violated the First Amendment); see also American Civil Liberties Union v Reno, 217 F 3d 162 (3rd Cir 2000).
(12) See Bowman v Chicago & Northwestern Ry, 125 US 465 (1888); Di Santo v Pennsylvania, 273 US 34 (1927); Parker v Brown, 317 US 341 (1943); Pike v Bruce Church, Inc, 397 US 137 (1970); Hughes v Oklahoma, 441 US 322 (1979); Maine v Taylor, 477 US 131 (1986); C & A Carbone v Town of Clarkstown, NY, 511 US 383 (1994); General Motors Corp v Tracy, 519 US 278 (1997).
(13) See, for example, Hunt v Washington State Apple Advertising Comm'n, 432 US 333 (1977); Hughes v Oklahoma, 441 US 322 (1979); Philadelphia v New Jersey, 437 US 617 (1978); Wyoming v Oklahoma, 502 US 437 (1992); C & A Carbone, Inc v Town of Clarkstown, 511 US 383 (1994).
(14) See, for example, Huron Portland Cement Co v City of Detroit, 362 US 440 (1960); Pike v Bruce Church, Inc, 397 US 137 (1970); Raymond Motor Trans, Inc v Rice, 434 US 429 (1978); Kassel v Consolidated Freightways Corp of Del, 450 US 662 (1981); Northwest Central Pipeline Corp v State Corp Comm’n of Kansas, 489 US 493.
(39) Id at *8-9 (discussing the financial costs of deceptive email, as well as the harms caused by emails that facilitate fraudulent business schemes or contain offensive subject matter or computer viruses), and at *9-10.
(41) NY Pub Health Law Section 1399-ll (West 2001). Specifically, Section 1399-ll prohibits persons engaged in the business of selling cigarettes from shipping or causing to be shipped any cigarettes to any person in New York state who is not:
Section 2 forbids any common or contract carrier knowingly to transport cigarettes to any person in New York state, other than those who are exempted in Section 1. Important in the court’s analysis of the statute is the final sentence of Section 2, which provides for an exception as follows:
“Nothing in this subdivision shall be construed to prohibit a person other than a common or contract carrier from transporting not more than 800 cigarettes at any one time to any person in this state.” NY Pub Health Law Section 1399-ll.(42) Santa Fe Natural Tobacco Co, 2001 WL 636441 at *13.
(45) Id. Among these mechanisms is the Jenkins Act, a federal act requiring persons who sell cigarettes in interstate commerce and ship them into a state that taxes cigarettes to file a monthly report with the state tax administrator specifying the details of the transaction. See 28 USC Section 375 et seq. Also, states do have recourse within their own state courts with which to collect taxes owed to them from the interstate sale of cigarettes into their state.
(48) Id at 908 (quoting Tex Rev Civ Stat Article 4413(36) Section 5.02C(c)). The other challenged provisions prohibited anyone from engaging in the business of, or acting in the capacity of, or as, a dealer of automobiles without obtaining a licence to do so. Tex Rev Civ Stat Article 4413(36) Section 4.01(a).
(62) http://laws.lp.findlaw.com/5th/050750cv0.html (August 27 2001).
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