Legato Vapors, LLC v. David Cook

In the

United States Court of Appeals

For the Seventh Circuit

____________________

No. 16-3071

LEGATO VAPORS, LLC, et al.,

Plaintiffs-Appellants,

and

RIGHT TO BE SMOKE-FREE COALITION, INC.,

Intervenor-Appellant,

v.

DAVID COOK, et al.,

Defendants-Appellees.

____________________

Appeal from the United States District Court for the

Southern District of Indiana, Indianapolis Division.

No. 1:15-cv-00761-SEB/TAB — Sarah Evans Barker, Judge.

____________________

ARGUED DECEMBER 8, 2016 — DECIDED JANUARY 30, 2017

____________________

Before MANION, KANNE, and HAMILTON, Circuit Judges.

HAMILTON, Circuit Judge. In 2015 the State of Indiana en-

acted the Vapor Pens and E-Liquid Act to regulate the manu-

facture and distribution of vapor pens and the liquids used in

2 No. 16-3071

so-called e-cigarettes. 2015 Ind. Acts 1870, Ind. Code §§ 7.1-7-

1-1 et seq. The Act is written so as to have extraterritorial reach

that is unprecedented, imposing detailed requirements of In-

diana law on out-of-state manufacturing operations. The Act

regulates the design and operation of out-of-state production

facilities, including requirements for sinks, cleaning products,

and even the details of contracts with outside security firms

and the qualifications of those firms’ personnel. Imposing

these Indiana laws on out-of-state manufacturers violates the

dormant Commerce Clause of the United States Constitution.

The federal Constitution leaves Indiana ample authority

to regulate in-state commerce in vapor pens, e-liquids, and e-

cigarettes to protect the health and safety of its residents. For

example, the Act’s prohibitions on sales to minors, its require-

ments for child-proof packaging, ingredient labeling, and pu-

rity, and requirements for in-state production facilities pose

no inherent constitutional problems. Indiana may not, how-

ever, try to achieve those health and safety goals by directly

regulating out-of-state factories and commercial transactions.

As applied to out-of-state manufacturers, the challenged pro-

visions of the Act violate the dormant Commerce Clause pro-

hibition against extraterritorial legislation.

We reverse the judgment of the district court dismissing

this case and remand with instructions to enjoin enforcement

of the challenged provisions against the plaintiffs and to de-

clare the challenged provisions unenforceable against out-of-

state manufacturers. To explain our reasons, we first review

the statutory provisions and procedural history of the case.

Then we apply the Commerce Clause analysis to three cate-

gories of challenged provisions: security terms, clean room

specifications, and audit requirements.

No. 16-3071 3

I. Factual and Procedural Background

In 2015, the Indiana legislature passed the Vapor Pens and

E-Liquid Act, regulating the production and sale of e-liquid

solutions. E-liquid solutions—generally consisting of a mix-

ture of propylene glycol, vegetable glycerin, flavorings, water,

and a range of nicotine concentrations—are ingested by the

consumer using an e-vapor device. E-vapor devices are often

shaped like cigarettes. They use a battery and atomizer to turn

an e-liquid solution into an aerosol that can be inhaled

through a mouthpiece, simulating the act of smoking a ciga-

rette. The popularity of “vaping” has increased dramatically

since its introduction to the United States market in 2007. Cur-

rently, there are an estimated 138 brick-and-mortar “vape”

shops in Indiana, and products are also available online to In-

diana consumers. Total annual sales of vape devices and e-

liquids in the state are more than $77 million.

In some ways, the Act is unremarkable and uncontrover-

sial. It regulates in-state sales of e-liquids with requirements

for tamper-evident and child-proof packaging, as well as la-

bels designating active ingredients, nicotine content, and ex-

piration dates. Ind. Code § 7.1-7-4-6(b)(1)–(7). The Act prohib-

its sales to minors. § 7.1-7-6-2(a)(1). The Act itself explains that

its purpose is to protect public health and safety in the use of

these products “in the absence of federal regulations,” § 7.1-

7-1-2, since the federal government has not adopted compa-

rable regulations for safety and purity of e-cigarette products.

What is remarkable, however, is the Act’s extensive regu-

lation beyond the manufacture and sale of e-liquid solutions

in Indiana. The statute requires not just that in-state and out-

of-state manufacturers meet stringent security standards, but

it also goes so far as to require the manufacturer to contract

4 No. 16-3071

with an independent security firm rather than provide the se-

curity services in-house. It requires the manufacturer to enter

a service agreement with a security firm that is valid for five

years after the date of permit application. Ind. Code §§ 7.1-7-

4-1(d)(2)(B), (d)(3). The security firm must meet stringent cer-

tification standards and provide 24-hour video monitoring

and high-security key systems. § 7.1-7-4-6(b)(12)–(13). The Act

also dictates details for the construction, design, and opera-

tion of the manufacturing facility, including requiring a “clean

room” for mixing and bottling that adheres to requirements

of the Indiana Commercial Kitchen Code. §§ 7.1-7-4-1(d)(1),

7.1-7-2-4(3).

The Act imposes each of these substantive requirements

governing manufacturing processes and facilities as a condi-

tion of obtaining and keeping a permit. If a manufacturer’s

products are sold in Indiana, the manufacturer must obtain a

permit from the Indiana Alcohol and Tobacco Commission.

§ 7.1-7-4-1(a). To obtain a permit, the substantial requirements

for security and clean room facilities must be met, and audit

provisions apply to ensure compliance after the permit is

granted. See, e.g., § 7.1-7-4-6(b)(17). A permitted manufac-

turer “must submit to random audits,” § 7.1-7-4-6(b)(16), de-

fined as procedures “performed by the commission, includ-

ing inspection of manufacturing facilities and preparation ar-

eas, review of required records, compliance checks, and au-

diting of samples of e-liquid,” § 7.1-7-2-3. The Act defines a

“manufacturer” as “a person or cooperative, located inside or

outside Indiana, that is engaged in manufacturing e-liquid.”

§ 7.1-7-2-15 (emphasis added).

The plaintiffs are three out-of-state manufacturers of reg-

ulated products: Legato Vapors, Rocky Mountain E Cigs, and

No. 16-3071 5

Derb E Cigs. They filed suit in the district court for injunctive

and declaratory relief against members of the Indiana Alcohol

and Tobacco Commission on several state and federal

grounds. The parties filed cross-motions for summary judg-

ment on stipulated facts. The district court granted summary

judgment for the defendants. Legato Vapors LLC v. Cook, — F.

Supp. 3d —, 2016 WL 3548658 at *18 (S.D. Ind. June 30, 2016).

Where the district court has decided cross-motions for

summary judgment on stipulated facts, our review on appeal

is de novo, without deference to the legal analysis of the district

court. On appeal, plaintiffs have narrowed both their theory

and the scope of their challenge. They have narrowed their

legal theory to the argument that the Act, as applied to out-

of-state manufacturers, violates the dormant Commerce

Clause prohibition on extraterritorial state regulation of com-

merce. Plaintiffs have narrowed their challenges to the Act’s

direct regulations applicable to manufacturing facilities, in-

cluding those regulating the physical manufacturing facility,

security and cleaning arrangements, and facility audits.

II. The Dormant Commerce Clause

The Commerce Clause gives Congress the power to regu-

late commerce “among the several States.” U.S. Const. art. I,

§ 8, cl. 3; see Gibbons v. Ogden, 22 U.S. 1 (1824); Wilson v. Black-

Bird Creek Marsh Co., 27 U.S. 245 (1829). While the clause ex-

pressly grants power to Congress, since before the Civil War

it has been settled that it also has an implicit or “dormant”

dimension: “Although the Clause thus speaks in terms of

powers bestowed upon Congress, the Court long has recog-

nized that it also limits the power of the States to erect barriers

against interstate trade.” Lewis v. BT Investment Managers, Inc.,

447 U.S. 27, 35 (1980); see also, e.g., CTS Corp. v. Dynamics

6 No. 16-3071

Corp. of America, 481 U.S. 69, 87 (1987), citing Cooley v. Board of

Wardens, 53 U.S. 299 (1851).

For many years, dormant Commerce Clause jurispru-

dence drew a distinction between States’ direct and indirect

regulation of interstate commerce. Direct interference with in-

terstate commerce was invalid as a violation of the dormant

Commerce Clause, but legislation having indirect effects re-

mained permissible. See, e.g., Di Santo v. Pennsylvania, 273

U.S. 34, 36–37 (1927) (state law seeking to prevent fraud by

requiring state license to sell steamship tickets was invalid as

direct regulation of foreign and interstate commerce).

The distinction between direct and indirect regulation

proved to be less a bright line and more a matter of degree.

The Supreme Court then began to rely more on a balancing

test that weighs the regulating state’s interests against the bur-

dens on interstate commerce (at least when the state does not

actually discriminate against interstate commerce). See South-

ern Pacific Co. v. Arizona, 325 U.S. 761, 770–71, 783–84 (1945)

(applying balancing test to hold that state law restricting

length of interstate trains was invalid burden on interstate

commerce); California v. Thompson, 313 U.S. 109, 116 (1941)

(overruling Di Santo); South Carolina State Highway Dep’t v.

Barnwell Bros., 303 U.S. 177, 196 (1938) (upholding state limits

on size and weight of trucks on state highways).

Despite the fading reliance on the direct-indirect distinc-

tion and the further development of balancing tests for non-

discriminatory state laws, the Supreme Court has never held

that a state may impose truly direct and burdensome state

regulation of commerce beyond the state’s boundaries. See,

e.g., Brown-Forman Distillers Corp. v. New York State Liquor Au-

No. 16-3071 7

thority, 476 U.S. 573, 584 (1986) (invalidating state’s price-affir-

mation law that directly regulated “interstate commerce”);

Edgar v. MITE Corp., 457 U.S. 624, 642 (1982) (plurality opin-

ion) (“[A] state statute which by its necessary operation di-

rectly interferes with or burdens [interstate] commerce is a

prohibited regulation and invalid, regardless of the purpose

with which it was enacted.”), quoting Shafer v. Farmers Grain

Co., 268 U.S. 189, 199 (1925). The dormant Commerce Clause

continues to prohibit “the application of a state statute to com-

merce that takes places wholly outside of the State’s borders,

whether or not the commerce has effects within the State.”

Healy v. Beer Institute, Inc., 491 U.S. 324, 336 (1989), quoting

Edgar, 457 U.S. at 642–43. When a state directly regulates in-

terstate commerce, it “exceeds the inherent limits of the enact-

ing State’s authority and is invalid regardless of whether the

statute’s extraterritorial reach was intended by the legisla-

ture.” Id.

Generally, courts will strike down a statute that “directly

regulates or discriminates against interstate commerce, or

when its effect is to favor in-state economic interests over out-

of-state interests,” without engaging in the more permissive

balancing tests applied to non-discriminatory legislation.

Brown-Forman Distillers, 476 U.S. at 578–79; Edgar, 457 U.S. at

640, 643. See, e.g., Pike v. Bruce Church, Inc., 397 U.S. 137 (1970).

Laws that discriminate directly against interstate commerce

are subject to what amounts to strict scrutiny. Maine v. Taylor,

477 U.S. 131, 138 (1986). “[O]nce a state law is shown to dis-

criminate against interstate commerce either on its face or in

practical effect, the burden falls on the State to demonstrate

both that the statute serves a legitimate local purpose, and

8 No. 16-3071

that this purpose could not be served as well by available non-

discriminatory means.” Id. (internal quotation marks and ci-

tations omitted).

In this case, plaintiffs do not contend that the Indiana Act

discriminates against interstate commerce. They argue that

the law violates the Commerce Clause by directly regulating

commercial activity outside Indiana. Where the issue is the

extraterritorial effect of a law, the focus is on its “practical ef-

fect.” Healy, 491 U.S. at 336. The practical effect is assessed by

considering both the consequences of the law itself and how

the law may interact with the legitimate regulatory regimes

of other states—potential inconsistent legislation. Id.

Here, plaintiffs argue that the Indiana Act violates the

Commerce Clause as extraterritorial regulation because it dic-

tates how out-of-state manufacturers must build and secure

their facilities, operate assembly lines, clean their equipment,

and contract with security providers, if any of their products

are sold in Indiana. Plaintiffs also argue that the Act puts out-

of-state manufacturers at risk of inconsistent regulations im-

posed by other states. The defendant state officials argue that

the transactions regulated by the Act are not wholly outside

Indiana and that the Act is facially neutral, without discrimi-

nating against interstate commerce. The Act applies equally

to in-state and out-of-state manufacturers.

We assess only whether particular provisions of the Indi-

ana Act, as applied to out-of-state manufacturers, are invalid

as direct extraterritorial regulation. To figure out which pro-

visions plaintiffs challenge, we note their general claim that

“the security, clean room, and audit requirements” violate the

Commerce Clause, their list of twenty-two challenged provi-

No. 16-3071 9

sions in the first amended complaint, and the imprecise dis-

claimer that plaintiffs are not challenging, or at least are no

longer challenging, “local sales rules” in Ind. Code § 7.1-7-4-

6. The result, as we see it, is that plaintiffs continue to chal-

lenge the following sixteen provisions: Ind. Code §§ 7.1-7-4-

1(d)(1)–(3), (6), (8)–(10); 7.1-7-4-6(b)(8), (10)–(16), and (19). See

Legato Vapors, 2016 WL 3548658, at *1 n.1 (district court’s ob-

servation that exact provisions plaintiffs challenged were not

clear in the filings).

With almost two hundred years of precedents to consider,

our review of prior dormant Commerce Clause decisions has

not revealed a single appellate case permitting any direct reg-

ulation of out-of-state manufacturing processes and facilities

comparable to the Indiana Act. The Supreme Court has issued

a number of decisions in closer cases, such as challenges to

price-affirmation laws and laws regulating in-state segments

of interstate transportation. At first glance, both types of laws

seem to regulate only in-state commerce. Those lines of cases

reveal two facets of the basic rule prohibiting extraterritorial

legislation. Price-affirmation laws can violate the Commerce

Clause because they have ripple effects in other states, effec-

tively setting the price for a commodity in transactions out-

side the regulating state. See, e.g., Healy, 491 U.S. 324; Brown-

Forman Distillers, 476 U.S. 573. State regulation of in-state seg-

ments of interstate railroad and highway traffic can violate

the Commerce Clause because national uniformity is “practi-

cally indispensable to the operation of an efficient and eco-

nomical national railway system,” Southern Pacific, 325 U.S. at

771, and the effect of one state’s regulation can place a “sub-

stantial burden on the interstate movement of goods,” Ray-

mond Motor Transp., Inc. v. Rice, 434 U.S. 429, 445 (1978). Im-

plicit in both lines of cases is the more general principle that a

10 No. 16-3071

state may not impose its laws on commerce in and between

other states.

This court has struck down as extraterritorial state laws

much less intrusive than the Indiana Act. For example, we in-

validated a state law that attempted to regulate loan transac-

tions entered into entirely out-of-state. In Midwest Title Loans,

Inc. v. Mills, the plaintiff challenged an Indiana law that

deemed a loan transaction to take place in Indiana and thus

subject to Indiana law if the out-of-state lender advertised in

Indiana, even if an Indiana resident entered into the transac-

tion entirely in Illinois. 593 F.3d 660, at 661–62, 669 (7th Cir.

2010). Indiana’s attempt to regulate loan transactions occur-

ring wholly outside the state constituted impermissible extra-

territorial regulation. Id. at 669. Similarly, in Dean Foods Co. v.

Brancel, a Wisconsin law prohibited payment of volume pre-

miums for bulk purchases of milk produced in Wisconsin. 187

F.3d 609 (7th Cir. 1999). We held that Wisconsin could not ap-

ply its law to regulate the price of sales of milk produced in

Wisconsin but where the sales took place outside the state, af-

ter the producers had transported the milk beyond the state

boundary. Id. at 620.

In National Solid Wastes Management Association v. Meyer, a

Wisconsin statute prohibited both in-state and out-of-state

generators of solid waste from dumping certain materials in

Wisconsin landfills unless they resided in a community that

had adopted an “effective recycling program.” 63 F.3d 652,

653–54 (7th Cir. 1995). We held that the law violated the Com-

merce Clause as extraterritorial regulation. Id. at 661–62. The

law controlled the conduct of those engaging in commerce oc-

curring wholly outside the state when it conditioned the “use

of Wisconsin landfills by non-Wisconsin waste generators on

No. 16-3071 11

their home communities’ adoption and enforcement of Wis-

consin recycling standards,” such that all persons in those

communities outside Wisconsin had to “adhere to the Wis-

consin standards whether or not they dump[ed] their waste

in Wisconsin.” Id. at 658. That Wisconsin law also directly reg-

ulated out-of-state commerce and was invalid. Id. at 661.

It is useful to compare these cases on extraterritorial legis-

lation to decisions dealing with state laws imposing product

labeling requirements for in-state sales, even when the prod-

uct is produced out-of-state. The Second Circuit upheld a Ver-

mont law requiring special labels for light bulbs containing

mercury in National Electrical Manufacturers Association v. Sor-

rell, 272 F.3d 104 (2d Cir. 2001). The court found that the law

was not extraterritorial in scope. Although the law may have

required out-of-state manufacturers to “modify their produc-

tion and distribution systems to differentiate” between light

bulbs bound for Vermont and those bound elsewhere, the law

was not invalid. Id. at 110. Nor did it matter that the law might

compel manufacturers to withdraw from the Vermont mar-

ket, or alternatively, to sell light bulbs with labeling conform-

ing to Vermont’s requirements in other states. Id. at 110–11.

The Second Circuit found that no conflict with other state reg-

ulatory schemes had been shown, so that the labeling law did

not pose a risk of inconsistent regulation. Id. at 112.

The Sixth Circuit took a similar approach to uphold a

state-specific labeling requirement in International Dairy Foods

Association v. Boggs, 622 F.3d 628, 647–49 (6th Cir. 2010). An

Ohio law said that labels on milk sold in the state could not

carry certain claims about the absence of artificial hormones

and had to include a disclaimer for claims about the absence

of artificial hormones in production processes. Id. at 632–34.

12 No. 16-3071

The Sixth Circuit held that the law was not invalid as extrater-

ritorial despite out-of-state producers’ claims that it would

burden interstate commerce. Id. at 649–50. The Sixth Circuit

reasoned that the law had only indirect effects on out-of-state

manufacturers, who may have needed to adjust their labels,

and did not impede the flow of milk across state lines. Id. at

647–48.

The contrast between the labeling laws and the extraterri-

torial laws we have struck down helps to mark the extent of

the dormant Commerce Clause prohibition. When we com-

pare the challenged provisions of the Indiana Act here, it be-

comes clear that they cannot be applied to out-of-state manu-

facturers of vaping products.

A. Security Provisions

We first consider the requirements for security contracts,

beginning with Indiana Code § 7.1-7-4-1(d), which governs

initial applications for e-liquid manufacturing permits. Para-

graph 7.1.-7-4-1(d)(1) requires the permit application to in-

clude plans “for the construction and operation of the manu-

facturing facility that demonstrate that the facility design is …

capable of meeting … the security requirements.” Paragraphs

(d)(2) and (d)(3) make explicit the requirements referenced in

(d)(1): the applicant-manufacturer must have entered into a

service agreement that is valid for five years after the date of

application, renewable for the entire duration the applicant

holds a permit, and with a security firm that can certify that it

meets the requirements of § 7.1-7-4-6(b)(10)–(15).

The provisions of § 7.1-7-4-6(b)(10)–(15) in turn require the

manufacturer to “take reasonable steps to ensure that all in-

gredients used in the production of e-liquid are stored in a

No. 16-3071 13

secure area accessible only by authorized personnel,” and

“that only authorized personnel have access to secured ar-

eas;” to have “a remotely monitored security system” and “an

exclusive high security key system;” to record 24-hour video

surveillance; and to maintain samples from each production

batch for not less than three years in areas with “recorded

video surveillance.”

In remarkably specific provisions, § 7.1-7-4-1(d)(3) re-

quires an applicant for a manufacturing permit to provide

“verified documents” demonstrating that the “security firm

has continuously employed” for not less than one year at least

one employee certified by the Door and Hardware Institute

and at least one employee certified as a Rolling Steel Fire Door

Technician. The security firm must also have at least one year

of commercial experience with “video surveillance system de-

sign and installation with remote viewing capability from a

secure facility,” owning and operating a security monitoring

system with redundant offsite backup, and operating “a facil-

ity that modifies commercial hollow metal doors, frames, and

borrowed lights with authorization to apply the Underwriters

Laboratories label.” § 7.1-7-4-1(d)(3).

From the perspective of the dormant Commerce Clause,

these are extraordinary provisions, at least as applied to out-

of-state manufacturers. At the most basic level, one might

wonder why Indiana cares whether an out-of-state manufac-

turer provides for security at its facilities through a contract

with an independent company rather than through its own

employees. The specific provisions for the forms of security,

including the types of systems and the use of on-site or off-

site monitoring, raise more questions. The astoundingly spe-

cific provisions for the qualifications of the security firm that

14 No. 16-3071

the manufacturer must commit to hire for at least five years

raise still more questions that go well beyond the Commerce

Clause.

Another district court decision in Indiana recently found

that only one company in the entire United States, located not

so coincidentally in Indiana, satisfied the criteria of the Indi-

ana Act and has the approval of the Indiana Alcohol and To-

bacco Commission. GoodCat, LLC v. Cook, — F. Supp. 3d —,

2016 WL 4734588 at *5–6 (S.D. Ind. Aug. 19, 2016). In fact, prior

to an amendment to the bill that became the Act, not even that

favored company would have met the Act’s requirements. Id.

at *5. That lone company was neither required nor had the ca-

pacity to accept all contract applications. The result has been

that the one security company serves six companies who

sought security contracts with it. Id. at *5–6. Only those six

companies may lawfully sell their vaping products in Indiana.

Before the Act went into effect, ninety percent of e-liquid rev-

enue in Indiana came from e-liquids manufactured out-of-

state. Now, only six manufacturers—compared to the more

than one hundred selling in Indiana before the Act—supply

e-liquids to Indiana retailers. Four of those six are in-state

companies. Id. at *15.

These circumstances raise obvious concerns about protec-

tionist purposes and what looks very much like a legislative

grant of a monopoly to one favored in-state company in the

security business. We can decide this case without pursuing

all of those questions, however. As applied to out-of-state

manufacturers, the security provisions of the Indiana Act vi-

olate the Commerce Clause for a more basic reason. They op-

erate as extraterritorial legislation, governing the services and

commercial relationships between out-of-state manufacturers

No. 16-3071 15

and their employees and contractors. With two hundred years

of Commerce Clause precedents to draw from, the defendant

state officials have offered no authority supporting such ex-

traterritorial legislation.

We understand the State’s arguments that good security

for manufacturing facilities is vital to protect vaping products

from contamination. The Commerce Clause does not prohibit

Indiana from imposing reasonable and even-handed purity

requirements on vaping products sold in Indiana. It may not

try to achieve that goal by direct extraterritorial regulation of

the manufacturing processes and facilities of out-of-state

manufacturers. 1

Consideration of potential inconsistent regulation only re-

inforces our conclusion that, as applied to out-of-state manu-

facturers, the challenged provisions violate the Commerce

Clause. Plaintiffs argue that now, ten years after the launch of

the e-liquid market, states have had the opportunity to adopt

their own distinct regulatory regimes for e-liquids. Plaintiffs

point us to less stringent e-liquid laws in Arkansas and Utah,

for example, but the threat of inconsistent regulation, not in-

consistent regulation in fact, is enough to show why Indiana

1 The Supreme Court has said that extraterritorial laws, like laws that

discriminate against interstate commerce, are “virtually per se invalid” un-

der the Commerce Clause. Brown-Forman Distillers, 476 U.S. at 579; see also

International Dairy Foods, 622 F.3d at 644–45. We understand the qualifier

“virtually” to refer to unusual circumstances where the state law serves

an important purpose and the state can show that no less restrictive or

intrusive measures could serve that purpose, so that the law survives strict

scrutiny, as in Taylor, 477 U.S. at 138 (upholding discriminatory state law

under strict scrutiny). Indiana has not tried to satisfy that standard here.

16 No. 16-3071

cannot impose these security requirements on out-of-state

manufacturers. See Dean Foods, 187 F.3d at 615.

The potential for conflicts in the remarkably specific secu-

rity requirements is obvious. Suppose another state chose to

enact a similarly specific security provision tailored to one of

its own in-state security firms. Or suppose another state

simply required manufacturers to provide adequate security

through their own employees, without trying to contract out

the service. Indiana responds that the e-liquid market is new

and states are just beginning to regulate it, making the possi-

bility of inconsistent regulation slight. We reject this argu-

ment. The very youth of the market and of state health and

safety regulations cuts the other way. In the absence of

preemptive federal laws, we can expect more states to enact

their own laws (and to treat existing laws in other states, like

Indiana, as models). In any event, the obvious risk of incon-

sistent regulation is enough here. See Healy, 491 U.S. at 336.

Taken together and individually, the security provisions

amount to direct and unconstitutional extraterritorial regula-

tion of out-of-state e-liquid manufacturers’ production facili-

ties and their purchases of services in their home states. These

requirements are not like the labeling cases, where an out-of-

state producer may comply by making minor adjustments to

its production processes so that labeling will conform to the

governing state’s requirements. The direct regulation of out-

of-state facilities and services has effects that are not compa-

rable to mere incidental effects of a facially neutral law regu-

lating labels, such as those on light bulbs or milk. Compare

National Electrical Manufacturers Ass’n, 272 F.3d 104, and Inter-

national Dairy Foods Ass’n, 622 F.3d 628, with Ind. Code § 7.1-

No. 16-3071 17

7-4-6(b). More than just posing a significant threat of incon-

sistent regulation, the Indiana Act directly regulates specific

elements of any security contract made by out-of-state manu-

facturers. These provisions control conduct “beyond the

boundaries of the state” and tell out-of-state companies how

to operate their businesses. See Edgar, 457 U.S. at 643 (citation

omitted).

The defendant state officials have not tried to show that

they can satisfy the “strictest scrutiny” that would be needed

to uphold a discriminatory or extraterritorial law. See Taylor,

477 U.S. at 144 (citation omitted). The defendants simply as-

sert without support that “for a product such as e-liquids

there is no practical way to regulate the quality of it without

regulating the manufacturing process.” The asserted purpose

of the statute—protecting the health and safety of Hoosiers

who consume e-liquids—is of course legitimate. But the de-

fendants have failed to offer any evidence that less intrusive

alternatives to these unprecedented extraterritorial provi-

sions are incapable of serving that purpose. See Taylor, 477

U.S. at 138. Such direct extraterritorial legislation is invalid as

applied to the plaintiffs and other out-of-state manufacturers.

See Healy, 491 U.S. at 336.

B. Clean Room Requirements

The clean room provisions challenged by the plaintiffs re-

quire that the permit application include plans “for the con-

struction and operation of the manufacturing facility that …

include a clean room space where all mixing and bottling ac-

tivities will occur.” Ind. Code § 7.1.-7-4-1(d)(1). “The manu-

18 No. 16-3071

facturing facility must conduct all mixing and bottling activi-

ties in a clean room.” 2 § 7.1-7-4-6(b)(8). The cleaning and san-

itizing of equipment must be consistent with the Indiana

standards for commercial kitchens in Indiana, and the equip-

ment used in the production process must be “easily cleana-

ble.” § 7.1-7-2-4; 410 Ind. Admin. Code § 7-24-1 et seq.; § 7-24-

27(a). The commercial kitchen standards referenced in the Act

impose detailed requirements for everything from physical

facilities such as the type of sinks and required cleaning

equipment, 410 Ind. Admin. Code § 7-24-270), to production

materials such as types of cleansers and utensils used, 410 Ind.

Admin. Code §§ 7-24-294, -303).

Like the security provisions, the clean room provisions di-

rectly regulate the physical plants of out-of-state manufactur-

ers. The clean room provisions also directly regulate the pro-

duction processes of out-of-state manufacturers. Akin to tell-

ing out-of-state communities how to run their recycling pro-

grams, Indiana has gone so far as to order out-of-state e-liquid

manufacturers to wash their equipment with specific cleans-

ers in specific sinks. Compare National Solid Wastes Manage-

ment Ass’n, 63 F.3d 652, with 410 Ind. Admin. Code §§ 7-24-

270, -294, -303. And again, the potential for inconsistent regu-

lation is obvious. Of the many requirements, from sink size to

cleanser type, there are countless possible variations. That one

state might demand double-basin steel sinks and another de-

mand single-basin porcelain sinks is just one example. The

clean room provisions directly regulate interstate commerce

2

The statute defines “clean room” as any part of the facility where

“the mixing and bottling activities are conducted in secure and sanitary

conditions in a space that is kept in repair sufficient to prevent e-liquid

from becoming contaminated.” Ind. Code § 7.1-7-2-4.

No. 16-3071 19

and, as applied to out-of-state manufacturers, are invalid as

extraterritorial laws.

C. Audits and Additional Provisions

The remaining provisions of the Indiana Act challenged

by the plaintiffs fall into the loose category of “audits.” Indi-

ana Code § 7.1-7-4-1(d)(10) requires the applicant-manufac-

turers to give their consent to the Indiana Alcohol and To-

bacco Commission “to enter during normal business hours …

to conduct physical inspections, sample the product … and

perform an audit.” See also § 7.1-7-4-6(b)(16). Paragraph 7.1-

7-4-1(d)(9) requires the manufacturers to consent to state or

national criminal background checks on anyone listed in the

permit application, and § 7.1-7-4-6(b)(19) prohibits the manu-

facturer or any other person listed on the permit application

from having been “convicted of a felony or an offense involv-

ing a controlled substance.” Another challenged provision is

§ 7.1-7-4-1(d)(6), which requires a permit application to in-

clude the “projected output in liters per year of e-liquid of the

manufacturing facility,” perhaps as the basis for a future au-

dit.

The record and parties’ arguments with respect to the au-

dit provisions are not well developed. The record is sufficient

for us to conclude, however, that audits and on-site inspec-

tions of out-of-state manufacturers are invalid direct regula-

tions of interstate commerce insofar as they relate to enforce-

ment of Indiana’s requirements for facility design and pro-

duction operations. We leave room for future challenges,

based on better developed records and arguments, to audit

provisions such as taking product samples or other inspec-

tions not relating as directly to manufacturing facilities and

production processes.

20 No. 16-3071

D. Commercial Transactions Outside the State

Our conclusion that the Act is an impermissible “attempt

to regulate activities in other states,” see Midwest Title, 593

F.3d at 665, is supported by further analysis of commercial

transactions taking place wholly outside the governing state.

The plaintiffs argue that not only are the regulations direct

extraterritorial regulations, as explained above, but also that

three categories of commercial sales are impermissibly regu-

lated by the Act because they take place wholly outside the

state. See Healy, 491 U.S. at 336. The parties have agreed that

the Act regulates: (1) sales by an out-of-state manufacturer to

an out-of-state distributor if the distributor resells the e-liq-

uids to Indiana retailers; (2) sales by an out-of-state manufac-

turer to an out-of-state online retailer if the online retailer sells

the e-liquid to Indiana consumers; and (3) direct online sales

by out-of-state manufacturers to Indiana consumers. Al-

though not explicitly regulated, these transactions fall within

the scope of the statute because in each case, the Indiana Al-

cohol and Tobacco Commission could enforce the provisions

against a manufacturer whose product, either intentionally or

unintentionally, reaches Indiana vape shops for sale. To avoid

violating the Act, an out-of-state manufacturer who wishes to

avoid regulation by Indiana and has not obtained an Indiana

permit would need to include in its contracts with distributors

and online retailers an effective, perhaps even foolproof,

guarantee ensuring the e-liquid would not be resold to any-

one in Indiana.

The first two categories of transactions are like the loan

transactions in Midwest Title or milk sales in Dean Foods. They

occur entirely outside the regulating state. Indiana’s govern-

ance of these transactions is impermissible extraterritorial

No. 16-3071 21

regulation. See Midwest Title, 593 F.3d 660; Dean Foods, 187

F.3d 609. Whether the third category—the producer-as-

online-retailer selling directly to an Indiana consumer—oc-

curs wholly outside the state may be a more complex ques-

tion. See generally Ind. Code § 26-1-2-401(2) (under UCC sales

provision, title to goods passes at time and place of shipment

unless otherwise specified); Quill Corp. v. North Dakota, 504

U.S. 298, 311–13 (1992) (dormant Commerce Clause requires

out-of-state seller to have substantial nexus with taxing/pur-

chaser state in order for taxing state to collect taxes from out-

of-state seller). In any event, the other extraterritorial aspects

of the challenged provisions are sufficient to hold that they

may not be applied to out-of-state manufacturers, so the an-

swer to the online sales question would not change our ulti-

mate conclusion.

The regulations of clean rooms and security systems for e-

liquid manufacturers are akin to an attempt by Ohio to regu-

late not just milk labeling but also the heating, cooling, venti-

lation, plumbing, and locks for out-of-state barns where the

cows are milked. The Indiana Act directly regulates the pro-

duction facilities and processes of out-of-state manufacturers

and thus wholly out-of-state commercial transactions. It poses

the clear risk of multiple and inconsistent regulations that

would unduly burden interstate commerce. As applied to

out-of-state manufacturers, the challenged extraterritorial

laws violate the Commerce Clause.

* * *

For these reasons, we REVERSE the district court’s grant

of summary judgment to the defendant state officials and

REMAND to the district court to declare the challenged pro-

visions unenforceable against out-of-state manufacturers and

22 No. 16-3071

to enjoin their enforcement against the plaintiffs. These in-

structions apply to the following provisions: Indiana Code

§§ 7.1-7-4-1(d)(1)–(3), (6), (8)–(10); 7.1-7-4-6(b)(8), (10)–(16),

and (19).