D.C. Bankruptcy Court Authorizes Rejection of Alcoholic Beverage Distribution Agreement

04.26.2017

According to the U.S. Brewers Association, craft breweries are experiencing exponential growth – the number of craft breweries jumped from 2,420 in 2012 to 5,234 in 2016. As is typical with any rapid market expansion, speculation is rampant as to whether and when the craft brewery bubble will burst. The natural assumption is that struggling smaller breweries will either be liquidated or acquired by larger breweries – but is that necessarily the case? Can a microbrewery, instead, be restructured?

The success of a brewery, particularly a microbrewery, often hinges on the brewer’s relationship with its distributor. Ideally, a distribution agreement fair to both sides is negotiated by the parties. But what happens when the brewery is saddled with a one-sided agreement that does not adequately set out the performance criteria of the distributor? The brewery is put in a precarious position, with no effective means of redress, and it may ultimately fail as a result.

In a case of first impression in D.C., the U.S. Bankruptcy Court for the District of Columbia recently authorized Hirschler Fleischer client Hellbender Brewing Company, LLC, an independent craft brewery, to free itself from the constraints of a disadvantageous distribution agreement. In 2013, Hellbender had entered into a written distribution agreement that gave the distributor exclusive rights to distribute Hellbender’s beer and malt beverage products within D.C. The terms of the distribution agreement were highly unfavorable to Hellbender, which ultimately concluded that the agreement threatened its survival. Unable to renegotiate the agreement consensually, Hellbender engaged Hirschler to explore its legal options, and filed a chapter 11 bankruptcy petition in November 2016. As part of its overall plan to restructure its debts and improve its operations, Hellbender then sought to “reject” the distribution agreement under the Bankruptcy Code.

After a two-day trial, the bankruptcy court authorized Hellbender to reject the distribution agreement, thereby giving Hellbender the right to self-distribute its products in D.C. Rejection of the distribution agreement relieved Hellbender from the constraints of the agreement, but gave the distributor the right to assert a damages claim against Hellbender. The distributor asked for damages equal to seven times its annual profit under the agreement, but the bankruptcy court allowed a claim of only two times annual profit, facilitating Hellbender’s path toward a successful bankruptcy reorganization.

Following entry of the bankruptcy court’s rulings, Hellbender filed a plan of reorganization in April 2017, which proposes to pay all general unsecured creditors, including the distributor, in full on the effective date of the plan. Hellbender anticipates exiting bankruptcy by mid-summer.

Local laws regarding a brewer’s right to distribute product vary greatly. A brewery should understand both its rights under local law and the Bankruptcy Code before seeking to modify (or even enter into) a distribution agreement.

Lawrence A. Katz is a bankruptcy attorney and member of Hirschler Fleischer’s Bankruptcy & Creditors’ Rights Practice Group. He has represented debtors and creditors, including lenders, real estate and hotel developers, business entrepreneurs, creditors’ committees, bankruptcy trustees and individuals in Chapter 11 bankruptcy reorganizations, liquidations and out-of-court restructurings. He has served as a Chapter 11 trustee and represented plaintiffs and defendants in preference, fraudulent conveyance and other bankruptcy court litigation.