That increasing numbers of breweries in recent years have closed or entered into bankruptcy is not some grim harbinger portending the impending pop of a craft-beer bubble. Rather, the increase in bankruptcy filings can be taken as a sign of the craft-beer industry’s maturity (in any mature industry, the herd needs thinning from time to time).
However, it is undeniable that, given the increased competition within the brewery space and increased competition from wine, spirits, cider, and even new entries such as hard seltzer, a lot of breweries are struggling. And some breweries may seek the relief offered by bankruptcy law to emerge stronger and more profitable than before. After all, General Motors and Chrysler declared bankruptcy in 2009 and emerged stronger than ever.
Indeed, a number of breweries have recently filed for bankruptcy, including Pennsylvania-based Rivertowne Brewing, D.C.’s Hellbender Brewing Company and Capitol City Brewing Company, Indiana’s Tow Yard Brewing Co., and San Francisco’s Magnolia Brewing Company. In other instances, breweries faced foreclosure and saw their assets sold to third parties, as was the case with San Diego’s Green Flash Brewing/Alpine Beer Co. and New Hampshire’s Smuttynose Brewing Company.
In this article, we want to remove some of the stigma and mystery relating to bankruptcy law. Generally speaking, businesses with no value don’t file for bankruptcy—especially for Chapter 11 bankruptcy. Bankruptcy can be an expensive process, and it usually makes sense only if there is a real possibility that the business can come out on the other end and thrive. While, of course, not all businesses that file for bankruptcy survive, many do.
Workout Agreements
First, be aware that there are options short of bankruptcy for modifying debts available to breweries. One such option is a “workout agreement.” A workout agreement is usually an agreement with a bank or other creditor that can involve some measure of loan forgiveness or alteration of payment terms. Workout agreements, however, must be consensual (as between the brewery and its creditors). In the right circumstances, workouts can be much faster and cheaper than filing for bankruptcy. The analysis of righting the financial problems of a brewery should always start here, and if a voluntary workout is not feasible, then a review of bankruptcy options is warranted.
Types of Bankruptcy
The different types of bankruptcy are referred to as “chapters” from the Bankruptcy Code. The two types of bankruptcy pertinent to business organizations are Chapter 11 and Chapter 7.
Under Chapter 11 bankruptcy, also known as reorganization, there are two distinct paths a brewery can take to resolve its financial distress. One path is a “reorganization earn out,” where the brewery gets to retain all its assets and pays back all or a percentage of its debts as part of a repayment plan. In other words, under a Chapter 11 earn out, you can keep the brewery running, keep paying your employees, and keep brewing beer while reorganizing the brewery’s debt.
The second path is a sale of the brewery as a going concern pursuant to section 363 of the Bankruptcy Code. This is the path that GM and Chrysler took. Ownership changes are diluted, but the brewery survives. The idea behind Chapter 11 bankruptcy is that it may be more economically beneficial to allow a distressed company time to continue operations and save value by reorganizing or selling itself as a going concern rather than liquidating and shutting down the brewery.
Chapter 7 bankruptcy, or liquidation, on the other hand, allows a brewery to totally shut down, and an appointed trustee sells off all assets of the brewery and uses the proceeds to pay off creditors. After the conclusion of a typical Chapter 7 bankruptcy, the brewery is out of business, and the brewery’s debts are discharged. On rare occasions, a trustee can continue to operate the brewery and sell it as a going concern.
The Chapter 11 Bankruptcy Process
Unfortunately, declaring bankruptcy isn’t quite as easy as Michael Scott (regional manager of the fictional Dunder Mifflin Paper Company Scranton, Pennsylvania, branch in the television series The Office) would have you believe. Bankruptcy can either be involuntary (i.e., it is filed by the brewery’s creditors against the brewery) or, as is more frequently the case, voluntary and filed by the brewery itself. In order to commence a Chapter 11 bankruptcy, the brewery files a petition in the local federal bankruptcy court. The brewery also needs to file documents, including:
- Schedules of assets and liabilities
- A schedule of current income and expenditures
- A schedule of executory contracts and unexpired leases
- A statement of financial affairs
After filing the petition, the brewery becomes known as a “debtor in possession”—in other words, the brewery keeps possession of its assets while it reorganizes its debts under Chapter 11.
The debtor-in-possession brewery must also eventually file a written disclosure statement and a plan of reorganization. The written disclosure statement must describe the assets, liabilities, and business affairs of the brewery in a manner sufficient to enable a creditor to make an informed judgment about the brewery’s plan of reorganization. The plan of reorganization is a document, in essence, that sets forth the different debts of the brewery and states how the debts will be treated under the plan. Any creditors whose claims against the brewery will be modified by the plan get to vote on the plan. After the votes are collected, the bankruptcy court holds a hearing to decide whether the proposed plan is feasible and whether it will confirm the reorganization plan.
While the brewery is classified as a “debtor-in-possession,” it has certain rights and obligations. The debtor-in-possession must perform many functions that would be performed by a court-appointed trustee, such as accounting for property, examining and objecting to claims, and filing informational reports as required by the court. With the court’s approval, the debtor-in-possession may also hire attorneys, accountants, and other professionals to assist the brewery during the bankruptcy.
The Chapter 7 Bankruptcy Process
In a Chapter 7 bankruptcy, the brewery ceases to exist, its property is liquidated, and the proceeds are distributed to creditors pursuant to a statutory priority scheme. In Chapter 7, the brewery does not file a plan of reorganization; instead a “bankruptcy trustee” gathers all the breweries assets and sells them on behalf of the brewery.
Benefits of Bankruptcy
One of the primary benefits of bankruptcy is what is known as the automatic stay. The automatic stay goes into effect when the bankruptcy petition is filed and, in effect, means that all judgments, collection activities, foreclosures, and repossessions of property by creditors are suspended and may not be pursued against the brewery for any debt or claim that arose before the petition was filed.
Another benefit of bankruptcy is the discharge. The discharge relieves a brewery of debts that arose prior to the date the bankruptcy is filed. After confirmation of the reorganization plan, the brewery is required to make payments set forth in the plan, but a portion of or all prior debts are wiped out.
In addition, “executory contracts” may be rejected. An executory contract is one under which both parties still have some performance left to complete. For example, if a brewery contracted out its hops for three years and there are two years left on the contract, the hops contract could be rejected, and the brewery relieved from its obligation to buy hops for the two remaining years, while limiting the rejection damages.
As competition increases and some breweries struggle to stay in the black, bankruptcy can be a viable option. If done correctly, a Chapter 11 reorganization can give a brewery some breathing room by halting collection efforts, thanks to the automatic stay, and allowing the brewery some room to modify existing debt obligations. With any luck, breweries can emerge from a Chapter 11 bankruptcy stronger than ever with more manageable debt-repayment plans.
This article is intended to provide general information and not provide specific legal advice, and no legal advice is given. Using this article does not create an attorney-client relationship between you and any attorney at Harris Beach, PLLC.