December 8, 2006
By: Daniel Duffy, Principal Analyst
You asked what strategies other states have adopted to enforce their bans on selling cigarettes below cost.
Connecticut prohibits cigarette distributors and dealers from selling below cost. Absent proof otherwise, the law presumes that their cost includes a percentage mark-up that depends on the type of seller and transaction.
Violators are subject to three different enforcement mechanisms. One, the Department of Revenue Services, which licenses cigarette distributors and dealers, may impose license suspensions, license revocations and fines up to $50,000, depending on the type of seller and the number of violations. Two, there are criminal fines as high as $10,000. Three, anyone who is hurt by a violation of the law may sue for damages and to stop the violation.
The states we identified with laws prohibiting below-cost cigarette sales had similar enforcement mechanisms. We found two variations. Some states, like Arkansas, allow cost surveys to be used as evidence in court. Washington makes selling cigarettes below cost a violation of its unfair trade practices law. This has the effect of changing the state agency that administers the law.
The law generally prohibits cigarette distributors and dealers from buying or selling cigarettes below cost if the intent is to injure competitors or to destroy or substantially lessen competition. It presumes that “cost” includes a mark-up based on the types of businesses selling and buying the cigarettes (CGS § 12-326b).
The law establishes three classes of cigarette distributors. “Stamping agents” are distributors, other than buying pools, who (1) buy cigarettes wholesale to sell to licensed dealers, (2) maintain an established place of business with a stock of cigarettes, and (3) sell 75% of their cigarettes to retailers. “Subjobbers” are distributors who buy stamped cigarettes wholesale to sell to dealers. “Chain stores” are distributors who operate five or more retail stores or 25 or more cigarette vending machines, and who buy cigarettes wholesale from another distributor, or from the manufacturer, to sell exclusively in the retail stores or vending machines.
For a stamping agent the mark-up is presumed to be (1) 0.875% of basic cost when selling to subjobbers and chain stores and (2) 5.75% of basic cost when selling to dealers. For a subjobber, it is presumed to be 4.875% of basic cost when selling to dealers. If a stamping agent or subjobber delivers, he may add 0.75% of basic cost. “Basic cost” is defined as the invoice or replacement cost, plus the face value of the stamps if not included in the invoice cost, minus any trade discounts (CGS § 12-326a).
For a dealer, cost is presumed to be 8% of invoice cost and the cost of doing business, which is defined to include labor, rent, equipment, insurance, and other items. Distributors and dealers are authorized by the act to submit evidence of greater or lesser cost to the revenue services commissioner.
Violators are subject to administrative and criminal penalties and to civil suit.
Distributors. A distributor who violates the law is subject to the following administrative penalties imposed by the revenue services commissioner:
1. for a first offense, a license suspension of at least seven days and a fine of up to $10,000;
2. for a second offense within five years, a license suspension of at least 30 days and a fine of up to $25,000; and
3. for a third offense within five years, license revocation and a fine of up to $50,000 (CGS § 12-295).
A distributor is also subject to a criminal penalty of a fine of up to $1,000 for a first offense, up to $5,000 for a second offense, and up to $10,000 for subsequent offenses (CGS § 12-326g (a)).
Dealers. A dealer is subject to the following administrative penalties:
1. for a first offense, a license suspension of at least seven days and a fine of at least $1,000; and
2. for a second or subsequent offense within five years, a license suspension of at least 30 days and a fine of at least $5,000.
A dealer is also subject to a criminal penalty of up to $250 for a first offense and up to $500 for subsequent offenses (CGS § 12-326g (b)).
The law authorizes anyone injured by a violation or threatened violation of the law and the attorney general at the request of the revenue services commissioner to seek restraining orders. It provides that it is not necessary to allege or prove actual damages, but entitles the successful plaintiff to damages if he does so in addition to legal costs, including attorney's fees (CGS § 12-326h).
The law specifies that it is prima facie evidence of intent and likelihood to injure and to destroy or substantially lessen competition, if there is (1) evidence that a distributor or dealer has advertised an offer to sell or has sold cigarettes at less than his cost; (2) evidence of an offer or of giving a price rebate or an offer or giving of a concession of any kind in connection with the sale of cigarettes; or (3) inducement, attempt to induce, procurement, or attempt to procure the purchase of cigarettes at a price less than the distributors' or dealers' cost (CGS § 12-326h)
Connecticut's law prohibiting below-cost cigarette sales establishes criminal and administrative penalties and authorizes civil suit. We found the same pattern in other states with laws prohibiting cigarette sales below cost. But some states, like Arkansas, explicitly allow certain cost surveys to be used as evidence in court. And Washington makes a violation an unfair trade practice.
Arkansas requires courts to consider evidence (1) tending to show that a defendant purchased cigarettes at a fictitious price or on terms or in such a way as to conceal the true cost and (2) of the normal, customary, and prevailing terms and discounts in the trade. If a cost survey conducted according to recognized statistical and cost accounting practices has been made in the trading area to determine the basis of actual lowest cost to wholesalers, the law requires courts to deem it competent evidence. It also allows the other party to offer evidence to prove the inaccuracy of the cost survey (Ark. Stat. Ann. § 4-75-11). Arkansas, like Connecticut, prohibits cigarette sales below cost and requires a certain mark-up, absent proof of a different cost of doing business.
Washington makes selling cigarettes below cost a violation of its unfair trade practices act. This takes responsibility for administrative enforcement away from its revenue collecting agency while still allowing injured private parties to sue for damages. In Connecticut, this approach would give enforcement responsibility to the Department of Consumer Protection rather than the Department of Revenue Services. In part, the statement of legislative intent in the Washington legislation said:
It is the policy of the legislature to encourage competition by reducing the government's role in price setting. It is the legislature's intent to leave price setting mainly to the forces of the marketplace. In the field of cigarette sales, the legislature finds that the goal of open competition should be balanced against the public policy disallowing use of cigarette sales as loss leaders. To balance these public policies, it is the intent of the legislature to repeal the unfair cigarette sales below cost act and to declare the use of cigarettes as loss leaders as an unfair practice under the consumer protection act (RCW § 82.24.500 and Ch. 19.86).