When an alcohol distributor files for Chapter 11 bankruptcy, suppliers can suddenly find themselves facing a number of difficult questions. What happens to unpaid invoices? What happens to the inventory the distributor is holding? Will the distributor continue operating? Can you move your brands to another distributor? What happens to your distribution agreement?
For alcohol beverage suppliers, these questions can be particularly complicated because the relationship between a supplier and distributor is governed not only by the parties’ contract and federal bankruptcy law, but also by state alcohol beverage laws. Depending on the circumstances, state franchise or distributor-protection laws may affect a supplier’s ability to terminate or change a distributor—even when the distributor is experiencing significant financial difficulties.
A distributor’s Chapter 11 filing does not necessarily mean that the business is immediately shutting down. Chapter 11 is generally intended to allow a business to reorganize while continuing operations. However, a bankruptcy filing can significantly affect a supplier’s relationship with the distributor and requires suppliers to act carefully and promptly.
What Does a Chapter 11 Filing Mean for Suppliers?
Chapter 11 allows a financially distressed business to reorganize its operations and financial obligations under the supervision of the bankruptcy court. The distributor may continue operating as a debtor in possession, subject to the requirements of the Bankruptcy Code and oversight of the bankruptcy court.
For suppliers, this can mean that the distributor may continue ordering, selling, and distributing products while simultaneously addressing its pre-bankruptcy debts.
One of the first questions a supplier should determine is whether the distributor intends to continue operating and, if so, under what terms. A supplier should not assume that a bankruptcy filing automatically means that its distribution relationship has ended.
The bankruptcy filing also generally triggers the automatic stay, which restricts creditors from taking certain actions to collect pre-bankruptcy debts or exercise control over property of the bankruptcy estate.
This is important because a supplier may have outstanding invoices and other claims against the distributor, but collection efforts generally need to be evaluated in the context of the bankruptcy case.
1. Determine How Much the Distributor Owes You
One of the first practical steps is to determine exactly how much money is outstanding.
This may include:
- Unpaid invoices for products already delivered;
- Credit memos or deductions;
- Accrued billbacks or other amounts;
- Promotional or marketing obligations;
- Disputed invoices;
- Amounts relating to returns or damaged product;
- Amounts owed under other agreements; and
- Potential damages resulting from the distributor’s failure to perform its contractual obligations.
Suppliers should reconcile their own accounting records against the distributor’s records and the information provided in the bankruptcy case.
It is also important to distinguish between amounts owed for products delivered before the bankruptcy filing and obligations arising after the filing. The treatment of those amounts may be very different under bankruptcy law.
2. Watch the Bankruptcy Case and Filing Deadlines
Once a distributor files for Chapter 11, suppliers should obtain and review the bankruptcy filings and monitor the case for important deadlines and motions.
Depending on the case, suppliers may receive information regarding:
- The bankruptcy petition;
- Schedules of assets and liabilities;
- A list of creditors;
- A proposed claims bar date;
- Motions concerning the use of cash collateral;
- Financing arrangements;
- Sale of the distributor’s assets;
- Assumption or rejection of contracts;
- Proposed distributions to creditors; and
- A plan of reorganization.
A supplier should not simply wait for the distributor to contact it. Bankruptcy cases can move quickly, and missing a deadline can affect a supplier’s ability to assert certain rights.
3. File a Proof of Claim When Appropriate
If the distributor owes money to the supplier, the supplier may need to file a proof of claim in the bankruptcy case.
The amount and classification of the claim matter. A supplier should carefully document the amount owed and identify the basis for the claim rather than simply submitting an invoice total without reviewing the underlying records.
There may also be circumstances in which a supplier has rights beyond those of a general unsecured creditor.
For example, the Bankruptcy Code provides certain protections for sellers of goods, including potential reclamation rights for qualifying goods received by the debtor while insolvent within the statutory period. The Bankruptcy Code generally requires a written reclamation demand within specified time periods, including a 45-day period in many circumstances and, if that period expires after the bankruptcy filing, a shorter period following commencement of the case.
These rights are highly fact-specific, and suppliers should evaluate them promptly rather than assuming that filing a general unsecured claim is the only available remedy.
4. Review Recent Shipments and Inventory
Suppliers should determine what product was delivered to the distributor immediately before the bankruptcy filing and what product remains in the distributor’s possession.
This can be particularly important for alcohol beverage companies because inventory may represent a substantial portion of the supplier’s outstanding exposure.
Consider identifying:
- Product shipped shortly before the bankruptcy filing;
- Product received by the distributor but not yet sold;
- Product held in distributor warehouses;
- Product that has been sold to retailers but for which payment has not been received;
- Product subject to returns or credits;
- Product held on behalf of the supplier under any special arrangement; and
- Any inventory that may be subject to a security interest or other competing claim.
Do not assume that simply because the distributor physically possesses the product, the supplier has no potential rights relating to that inventory. Ownership, possession, payment terms, contract provisions, and applicable bankruptcy and state law can all matter.
5. Understand What Happens to Your Distribution Agreement
One of the most important issues for an alcohol supplier may be the status of its distribution agreement.
A distributor’s bankruptcy filing does not necessarily terminate the agreement. Depending on the terms of the agreement and the distributor’s treatment of the contract in bankruptcy, the distributor may seek to assume or reject an executory contract under Section 365 of the Bankruptcy Code.
This creates several important questions:
- Is the distribution agreement still in effect?
- Does the distributor intend to assume the agreement?
- Has the distributor moved to reject the agreement?
- What defaults existed before the bankruptcy filing?
- What obligations must be cured if the agreement is assumed?
- Does the agreement contain termination provisions?
- Are there change-of-control or assignment provisions?
- What state franchise or distributor-protection laws apply?
A supplier should review the agreement carefully before concluding that it can simply terminate the relationship and appoint another distributor.
6. Do Not Assume You Can Immediately Move the Brand to Another Distributor
This is particularly important for alcohol beverage suppliers.
In a typical commercial relationship, a supplier experiencing serious payment problems might consider terminating the distributor and appointing a new one. In the alcohol beverage industry, however, state law may impose restrictions on terminating or changing distributors.
Many states have laws governing supplier-distributor relationships, including provisions concerning termination, nonrenewal, notice, good cause, successor distributors, and disputes over distribution rights.
The applicable rules can vary significantly by state and by beverage category.
As a result, a supplier should evaluate the laws of each state in which the distributor represents its products before taking action. A bankruptcy filing may be an important fact, but it does not necessarily eliminate state-law requirements governing the supplier-distributor relationship.
This is especially important where a supplier has invested substantial time and resources in building a brand in a particular territory and needs to preserve its distribution rights while addressing the distributor’s financial distress.
7. Determine Whether the Distributor Will Continue Operating
A Chapter 11 filing does not necessarily mean the distributor will stop doing business.
The distributor may continue operations while attempting to reorganize, obtain financing, sell assets, or restructure its business.
For suppliers, the key question is whether continuing to do business with the distributor makes commercial sense—and, if so, under what terms.
Suppliers may want to evaluate:
- Whether new orders will be paid on time;
- Whether the distributor has adequate financing;
- Whether the distributor is continuing to service the brand;
- Whether sales personnel and brand support remain in place;
- Whether the distributor is maintaining appropriate inventory;
- Whether retailers are continuing to receive product;
- Whether the distributor is current on post-petition obligations; and
- Whether the supplier should change its credit terms.
In some circumstances, a supplier may consider requiring tighter payment terms or cash-in-advance arrangements for new shipments. Any change in terms should, however, be evaluated in light of the bankruptcy case and applicable state alcohol laws.
8. Carefully Evaluate New Shipments
Suppliers should be particularly cautious about continuing to extend credit after a distributor files bankruptcy.
A supplier may have an established relationship with the distributor, but the supplier should not automatically assume that post-bankruptcy shipments will be treated the same way as pre-bankruptcy receivables.
Before continuing shipments, consider establishing a clear process for:
- Credit approval;
- Payment terms;
- Purchase orders;
- Outstanding balances;
- Shipping documentation;
- Proof of delivery;
- Inventory reconciliation; and
- Payment of post-petition invoices.
The goal is to understand the financial exposure created by continuing the relationship rather than allowing additional unpaid balances to accumulate.
9. Review Your State Registrations and Brand Authorizations
A distributor bankruptcy can also create regulatory and operational issues.
Suppliers should identify every state in which the distributor is authorized to sell or distribute their products and determine what happens if the supplier ultimately changes distributors.
Depending on the state, this may involve:
- Brand registrations;
- Distributor designations;
- Territory information;
- Product registrations;
- State-specific notices;
- New distributor appointments;
- License information; and
- Regulatory filings.
These requirements can vary considerably by state. TTB regulates federal aspects of the alcohol industry, while states impose their own licensing and distribution requirements.
A supplier should therefore consider the regulatory consequences of any proposed change in distribution before implementing it.
11. Monitor Any Proposed Sale of the Distributor’s Business
A Chapter 11 distributor may ultimately seek to sell some or all of its business or assets.
For suppliers, a sale could potentially result in a new owner, new management, or a new distribution platform.
If a sale is proposed, suppliers should review the proposed transaction carefully. Important questions may include:
- What assets are being sold?
- Is the distributor’s inventory included?
- What happens to supplier contracts?
- Are distribution agreements being assumed or assigned?
- Who will be responsible for post-closing obligations?
- Will the buyer become the distributor for the supplier’s brands?
- Are state approvals or notices required?
- Does the supplier have an opportunity to object?
A proposed sale may ultimately provide an opportunity to transition the business to a financially stronger distributor, but suppliers should not assume that a sale automatically resolves their contractual or regulatory concerns.
12. Consider the Commercial Relationship, Not Just the Bankruptcy Claim
It can be tempting to focus entirely on recovering unpaid invoices. For an alcohol beverage supplier, however, the distributor relationship often represents much more than an outstanding account receivable.
The distributor may control:
- Retail relationships;
- Sales personnel;
- Market data;
- Inventory;
- Warehousing;
- Delivery infrastructure;
- Brand development;
- Pricing and depletion information; and
- Relationships with other members of the three-tier system.
Accordingly, suppliers should evaluate both the financial claim and the future of the brand.
A distributor that is financially distressed today may still be capable of providing meaningful market coverage. Conversely, continuing to rely on a distributor that cannot adequately service the brand could create longer-term commercial problems.
What Should Alcohol Suppliers Do Immediately After a Distributor Files Chapter 11?
A practical initial checklist may include:
- Confirm the bankruptcy filing and case number.
- Identify all outstanding invoices and other amounts owed.
- Determine what products were recently shipped and what inventory remains with the distributor.
- Review the distribution agreement and related agreements.
- Identify applicable state franchise and distributor-protection laws.
- Determine whether a proof of claim or other bankruptcy filing is required.
- Evaluate potential reclamation or other creditor rights promptly.
- Review the status of current and future orders.
- Monitor the bankruptcy case for motions affecting contracts, inventory, or the distributor’s business.
- Determine whether the distributor intends to continue operating or pursue a sale or restructuring.
- Review state licensing, brand registration, and distributor appointment requirements.
- Develop a plan for protecting the brand and maintaining distribution while the bankruptcy case proceeds.
The Bottom Line
A distributor’s Chapter 11 bankruptcy can create significant uncertainty for alcohol beverage suppliers, but it does not necessarily mean that the supplier must immediately abandon the relationship or that its only option is to file an unsecured claim.
Suppliers should look at the situation from several angles: the money owed, the inventory being held, the distribution agreement, the bankruptcy case, applicable state alcohol laws, and the long-term needs of the brand.
Most importantly, suppliers should act promptly. Bankruptcy cases involve deadlines and procedural requirements, and alcohol beverage distribution relationships can be subject to state-specific rules that make an immediate change in distributors more complicated than it might appear.
How Lindsey Zahn P.C. Can Help
Lindsey Zahn P.C. assists alcohol beverage suppliers in navigating regulatory and business issues that can arise when a distributor experiences financial distress or files for bankruptcy. This may include reviewing distribution agreements, evaluating state-specific distributor and franchise requirements, assessing issues involving inventory and outstanding receivables, and helping suppliers understand the regulatory considerations involved in changing distributors.
For suppliers considering their options after a distributor files Chapter 11, we can also assist with developing a state-by-state strategy for protecting the brand, evaluating potential distributor changes, and addressing related federal and state alcohol beverage regulatory requirements.
Contact us today to schedule a consultation and learn how we can assist your company.
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Disclaimer: This article is provided for informational purposes only and does not constitute legal advice. Reading this article does not create an attorney-client relationship. Because every situation is unique, you should consult qualified legal counsel regarding your specific circumstances.