Preparing for Potential Distributor and Retailer Bankruptcies
POSTED BY Chris Kuhner, Nick Conti, Carol Kingery Ritter, David Balter, and John Trinidad
With the expected continuing market correction of the alcohol beverage industry to consumer demand, wine producers are preparing for potential bankruptcies or shuttering of trade purchaser businesses at the distribution and retail levels. This article explores how alcohol beverage producers should prepare for trade disruption caused by bankruptcies.
Bankruptcy is governed by federal law, and bankruptcy cases are exclusively handled in federal bankruptcy courts. When a business files for bankruptcy, its creditors (including suppliers with unpaid invoices) face significant uncertainty as to their ability to get paid.
Alcohol beverage producers should be aware of three key issues that will impact their contracting relationships and products in the market in the context of the bankruptcy of a distributor or retailer: (1) the effect of an automatic stay; (2) the potential for recouping certain inventory; and (3) the potential of having certain payments received from the entity filing for bankruptcy clawed back by the court. Because of the intricacies of bankruptcy law, we highly recommend you seek experienced bankruptcy counsel to help guide you through your options on how to deal with unpaid invoices, remaining inventory, and potential contract termination.
Impact of the Automatic Stay – Once a party files for bankruptcy, federal law imposes an “automatic stay” against most creditors and parties. See 11 U.S.C. § 362. An automatic stay prohibits creditors and parties from taking further action (i.e., sending collection letters or filing lawsuits) against the debtor or the debtor’s property to collect debts. The automatic stay is one of the most powerful protections for a debtor because it provides the debtor breathing room to address it’s financial situation under the supervision of the bankruptcy court. Violation of the automatic stay may result in contempt proceedings and potential damages. However, creditors and parties may still file and prosecute certain types of actions, such as criminal prosecutions, perfection and enforcement of liens, tax administration, and civil contempt sanctions. See 11 U.S.C. § 362(b). If there is any question whether the automatic stay applies, consult with a bankruptcy attorney before taking any action.
The automatic stay also limits the ability of third parties to terminate certain “executory contracts” (which may include certain distribution agreements) without obtaining relief from the automatic stay from the bankruptcy court or an order compelling the debtor to reject (terminate) the executory contract. Moreover, the Bankruptcy Code prohibits the enforcement of contract provisions that would allow parties to terminate a contract due to the bankruptcy or insolvency of another party (often referred to as “ipso facto” clauses). As a result, the ability of a supplier to terminate a distributor that has filed for bankruptcy may be limited even in states that have franchise laws that otherwise allow for termination upon distributor bankruptcy. As a result of the specific and unique constitutional preemption principles that apply to alcohol beverage regulation, there is a colorable, if not strong, 21st Amendment case to be made that federal bankruptcy law does not preempt state alcohol beverage laws, but we’ll save that discussion for another time. Again, if there is a question about the applicability of the automatic stay to contracts relating to the sale of alcohol, consult a bankruptcy lawyer.
45 Day Reclamation of Goods Shipped – If a supplier shipped goods within 45 days of the recipient’s bankruptcy filing, there is a possibility of the supplier reclaiming those goods. A supplier can make a reclamation demand, in writing, to recover such goods under 11 U.S.C. § 546(c). The goods must have been sold in the “ordinary course” of the creditor’s business, and the debtor must have received the goods while insolvent. The creditor must deliver its written reclamation demand within 45 days of receipt of the goods by the debtor, or if the 45 days have expired, the creditor must make the reclamation demand within 20 days after the bankruptcy filing which is a quick time window so it is important to make sure bankruptcy counsel is aware of the bankruptcy filing as soon as possible
Jumping Ahead of other Unsecured Creditors – Under 11 U.S.C. § 503(b)(9), unsecured creditors can elevate their claim status and potentially secure payment. Under this section, if a supplier delivered goods to a debtor in the 20 days before the debtor filed for bankruptcy, and those goods were delivered in the ordinary course of business, then the supplier can obtain administrative claim status of the amount of the goods delivered. See 11 U.S.C. § 503(b)(9). On the priority scheme detailing when claims against a debtor are paid, distributions to holders of administrative expenses are prioritized over other non priority unsecured creditors. In other words, if the administrative claim (which is only for the value of goods, excluding taxes, shipping fees, etc.) is allowed, you could jump ahead of other non priority unsecured creditors. Typically, there is a deadline for seeking a section 503(b)(9) claim set by court order, so it is imperative to closely review all relevant pleadings to ensure no deadline is missed.
90-Day Claw Back – The Bankruptcy Code allows the debtor who has filed for bankruptcy (or a trustee in a chapter 7 bankruptcy) to bring legal actions within its own bankruptcy case to recover funds or property that were transferred by the debtor to third parties 90 days before the bankruptcy petition was filed. See 11 U.S.C. § 547. These legal actions are considered “claw back” or “preference” actions. Under this section, the debtor or trustee is authorized to initiate an action to recover certain payments or property transfers made to a third party during the 90 days immediately preceding filing of the bankruptcy petition, when specified criteria are met. The goal of the 90-day claw back action is for a debtor to recover funds or property from a third-party entity or individual who received them, to then include those funds or property in the bankruptcy estate that is later distributed to creditors on the scale of priority and on a prorated basis. Additionally, for transfers to insiders (i.e., relatives, corporate officers, directors, or affiliates), the look back period is extended to one year before the bankruptcy filing date. See 11 U.S.C.§ 547(b). There are defenses to a preference claim which include payments made in the ordinary course of business, transfers where payment was made contemporaneously (COD), and where additional product was shipped after the payment which remains unpaid ie “new value.” If you think the company paying your invoices may file bankruptcy, best practice is to accept the payment (of course) with the understanding that it may be subject to a preference claim. Since these claims historically settle for much less than the fact value of the claim, a bird in hand is always advisable.
Potential Impact of Certain Statutory Liens – In California, a grower of farm products (including grapes) enjoy an automatic lien, sometimes referred to as a “secret lien,” on all products sold and processed items made from the grower’s produce until the grower is paid in full. See Cal. Food and Agricultural Code §§ 55631, 55633. For wine grape growers, this means that their lien applies not just to the grapes they sold, but the resulting wine produced from those grapes and (arguably) the proceeds of those sales. This lien is considered automatically “perfected” (i.e., valid against third parties) upon delivery of the grapes to a processor and generally has priority over all other liens, claims, or encumbrances. There does not appear to be any case law that expressly addresses whether the grower’s lien (assuming it applies to proceeds from the sale of wine) would also extend to unpaid payments due from a distributor or retailer to the processor. Any such argument presumably will need to overcome the following language found in Cal. Food and Agricultural Code § 55634: “Every lien which is provided for in this article is on every farm product and any processed form of the farm product which is in the possession of the processor without segregation of the product.” (emphasis added).
Disclaimer: This blog post is provided for general informational purposes and does not constitute legal advice. Reading this post does not create an attorney-client relationship. Bankruptcy law is complex and fact specific. For questions about your particular circumstances, please consult a qualified bankruptcy attorney.
Thank you to Chris Kuhner, a partner in the bankruptcy group of Kornfield, Nyberg, Bendes, Kuhner & Little P.C., for co-authoring this blog post with members of DP&F’s Litigation, Business, and Alcohol Beverage Law and Compliance practice groups.
For more information about legal issues surrounding alcohol beverage producer/trade buyer relationships and transactions, reach out to DP&F. For more information regarding bankruptcy law, please reach out to Chris Kuhner at Kornfield Law.
