Even in good times, the wine business is tough: Wine may be liquid, but a lot of winery balance sheets aren't. The business requires a lot of capital, because compared with most others, the investment in fixed assets is high, the return on assets is low, and the lead time before raw materials are sold as finished products is immense.

In hard times, the wine business is even tougher, as wineries have hit the recession trifecta: Consumers (and especially business entertainment expense accounts) cut discretionary spending; parts of the distribution channel become slow pay or "pray-they-pay;" and the credit crunch means wineries facing a cash squeeze can't borrow more against their assets or find an easy exit by selling the business to a buyer who uses lender funds to make the deal.

Growers and wineries also are discovering (as did so many residential real estate developers in the past two years) that while the rising tide of land prices can float a lot of boats, the tide can go out suddenly and very far.

The bad news for growers (if they find a home for their grapes) and suppliers is that they now face an almost unprecedented risk of steep and multiple losses from winery bankruptcies and insolvencies. The good news is that, like many other challenges, the risk can be managed and reduced with appropriate care.

Hanging out with the right crowd
The best protection, of course, is to avoid problems altogether. And that means knowing your customer:

• What is the winery's history? Who are the owners? Have they weathered downturns before?

• What is the winery's reputation for timely payment? For cooperating with sellers? (One of the advantages of a small, tight-knit sector like the wine industry is that reputations are often quickly established and well known. One of the disadvantages is that those reputations are not always accurate or current.)

• Does the winery provide references, such as from other growers, vendors or its bank?

• Are there clear and appropriate channels of communication? It matters whether the winemaker or the controller is raising quality concerns.

Where there is doubt, there is no doubt
The need for diligence does not end when the contract is signed. For example, a grower should consider monitoring and documenting crop inspections to make sure that legitimate quality issues are addressed before it's too late--and that questionable claims are not raised after the fact.

Don't ignore nagging warning signs until it becomes too late to protect yourself. Legally, a seller who has "reasonable grounds" to feel insecure about the buyer's ability to pay may ask for "adequate assurance" that the buyer is able to perform. If the buyer cannot provide those assurances, the seller may refuse to perform.

What constitutes "adequate assurances" depends on the circumstances, but delivery of financial statements, letters of credit, collateral, personal guarantees, advance payment or cash-on-delivery terms are all possibilities. A seller who discovers that a buyer is insolvent also has the right to stop deliveries and, for a limited period of time (generally 10 days, but longer if the buyer misrepresents its solvency before shipment--another reason to monitor and ask) to reclaim grapes or other goods already shipped. If a winery files for bankruptcy, you can generally deliver a demand to reclaim a recent shipment up until 20 days after the bankruptcy filing.

Once the grapes or goods are shipped, a grower or supplier needs to carefully monitor payment status. Here, there are two risks. First, there is a risk that the vendor will not be paid at all. This risk is particularly acute in the wine industry, where vendor payments are frequently extended into the months following harvest in order to better match winery cash flows. As in most industries, the more stale the account, the harder it is to collect. Conversely, our experience and the experience of our clients is that early and persistent (but polite) attention does indeed often result in payment and cooperation.

Second, once a delinquent winery pays, payments received by a grower or supplier within 90 days of a winery's filing for bankruptcy may have to be surrendered to the bankruptcy court as a "preference." Sellers have defenses against these claims, but the cost of raising those defenses is something you want to avoid.

Above all, if you have any questions or concerns, ask. As often as not, even businesses in financial stress are eager to protect their relationships and reputations, and will try to work with creditors who approach them in an open, business-like way. Most wineries especially value their relationships with growers of quality grapes, and if the winery is unresponsive or uncooperative, that speaks volumes and gives you a data point on how to proceed.

Lien on me
California grapegrowers are used to relying on their statutory producers lien (Food and Agricultural Code Sections 55631-55633), the so-called "growers lien," to protect against the risk of non-payment. There are similar lien rights in many other states, such as Oregon. Even outside these states, growers can satisfy the much more restrictive conditions to get federal Perishable Agricultural Commodities Act (PACA) lien rights. PACA lien rights require, however, specific notices to the winery as well as payment terms of no more than 30 days, which limits their usefulness to most growers.

When put to the test in a highly stressed financial environment, many vineyard owners find that even their growers liens have serious limitations as a practical means of securing prompt payment. In California, the growers lien exists as a matter of law and is given to "producers" (growers) selling "farm products" (grapes) to "processors" (wineries). It attaches to the sold grapes and resulting wine, even if blended with the grapes or juice of others. It is automatic, requires no filing or documentation, and has priority over most liens other than wage/hour and warehouseman's liens.

This seems to be a grower's silver bullet, but in fact it has serious limitations. You cannot exercise self-help by repossessing and selling the grapes or juice yourself, but instead must sue to foreclose, which is time-consuming and expensive. The lien is possessory: It extends only to grapes and wine in the possession of the processor, and may not cover grapes sold to wineries that produce through custom crush arrangements. Once the winery sells the wine or juice, the lien is gone, except for the obligation to pay the grower out of the cash proceeds, which isn't always honored. It is unclear whether the lien extends to proceeds (cash receipts) of any wine sold by the winery, and it generally won't follow the money once it is spent.

A grower should consider having a provision in the grape contract granting a UCC (Uniform Commercial Code) security interest in the sold grapes and resulting wine. The language can be simple, and this opens up additional rights and remedies--such as non-judicial foreclosure and continuation of the lien notwithstanding sale of the resulting wine to a third party--not available with a grower's lien.

A UCC security interest also authorizes a grower to file a UCC-1 to alert other creditors to your lien on the juice and wine produced from your grapes. If you file a financing statement, you'll at least get a short period of notice before a lender forecloses. (You should be aware, however, that there are some potential priority issues if a bank forecloses on the wine inventory and sells it, instead of the winery selling it.)

Other winery suppliers have even more limited statutory protections: There are limited lien rights for repairmen and others who work on personal property (a garage mechanic is a good example), harvesters and warehousemen. These are limited to specific situations and do not cover the sale of most supplies or services.

As with growers, the best answer is careful monitoring, credit enhancements such as letters of credit or guaranties, and, if possible, a consensual UCC security interest. In particular, a UCC security interest in goods sold--provided it is properly and timely perfected (filed)--is a "purchase money security interest" that has special priority under the law. As a result, some vendors are adding to their standard terms and conditions agreed to by winery customers the grant of a security interest in whatever they've sold, with the right to file a financing statement to perfect the lien.

Finally, both growers and other suppliers should be concerned when there's also a third party processor/entity storing the wines, because they may have competing lien rights for unpaid fees, which may be senior to your lien and complicate your efforts to repossess the wine.

Other contract protections
In addition to UCC security interests, winery vendors should consider building in other contract protections.

Attorneys' fees are part of the allowed claims for secured creditors in bankruptcy (and, perhaps, to unsecured creditors as well). The threat of paying your lawyers' fees can discourage a debtor from throwing up frivolous roadblocks when you try to collect payment. And this means that you may ultimately get paid even for what you spend trying to get that payment. Include an attorney's fees clause that covers all of your costs and fees of collection, including those in a bankruptcy (not just fees for a "prevailing party," which is language that doesn't much apply in a bankruptcy or liquidation.)

You did not volunteer to be your buyer's unpaid bank. Every voluntary lender is charging the winery for the use of their money, and you should too. If nothing else, this gives the winery an incentive to pay you earlier, and something you can give up if they do pay you by a new deadline. State usury laws sometimes limit the amount of interest you can charge, but even in California, which has relatively restrictive usury laws, cases have held that you can charge a 1.5% late fee per month for late payments. It makes sense (and sometimes dollars) to put a late fee in your contract for when you're not paid on time.

Growers should not subordinate their grower's lien rights to other secured lenders' liens, unless they are getting paid a big chunk up front (or somehow otherwise being compensated) to take that risk as part of the deal.

If the winery is late-paying and wants to work out some deal, consider adding to any deferred payment agreement the above protections. In that context you could also add a provision whereby the winery agrees that if it files bankruptcy, growers should be represented by a growers' committee at the bankruptcy debtor's expense. This gives you a seat at the table if the worst happens.

When patience fails
An unpaid winery vendor, of course, can always sue or (if the contract so provides) arbitrate to try and collect money owed. These can be long, expensive processes at best and may be unrealistic for many smaller claims. If that is the case, or you were unable to negotiate a security interest or other recommended protections up front--or the buyer is simply recalcitrant--you might also consider pre-judgment attachment to get the other side's attention.

Pre-judgment attachment allows a creditor to attach (basically freeze) a debtor's unpledged assets. This does require filing a lawsuit and posting a (usually small) bond. To obtain an attachment there must be an underlying contract involving a claim of more than $500 where the creditor has a reasonable probability of success. The purpose of pre-judgment attachment is to preserve assets if the creditor ultimately proves its case, but its more important practical effect is the leverage it provides the creditor to force the other party to the negotiation table.

All else has failed
Unfortunately, bankruptcies are not as rare in the wine industry as was once the case. Bankruptcy is a broad enough topic for an article by itself, and we have already mentioned several steps creditors can take (UCC liens, provision for interest, pre-agreement on a creditors' committee) to improve their chances in a winery Chapter 11. But the important thing to remember is that a winery bankruptcy changes the rules and in many cases can expose a creditor to significant liability or loss if he or she fails to pay attention to these new rules.

Working it out
It often makes sense to work with a winery customer and stretch out payment terms--or even (sometimes) to accept less than everything you are owed--in order to get some payment. Workouts are often negotiations between old debt and new money (an investor or buyer will put money in, but only if it doesn't all go to pay old debts) or between different classes of creditors: The secured bank will extend its loan and not foreclose, but only if the growers and suppliers also work with the winery so that the bank's position does not get worse. And there are practical limits to what you can get when there is truly not enough money to go around.

Almost everyone is better off if the winery is not liquidated in foreclosure at "fire sale" prices--at least if the winery is managing expenses (and not paying excessive insider salaries).

This is still a small industry with long memories facing significant economic challenges. We recognize that in this environment many growers and suppliers may not feel that they have the leverage to negotiate the protections we recommend, or they may be reluctant to face the cost or rancor of aggressively pursuing claims against a delinquent buyer.

Most wine people are practical and, in our experience, the growers, suppliers and wineries that have been most successful in navigating times like these are those that accept the reality of each others' situations, treat each other with respect, communicate in a businesslike way and look for the best deal that preserves both their business and the relationship.

These suppliers and wineries are willing to consider trading price or terms for collateral, guarantees or longer contracts. They think in the long term. To survive to the long term, be practical, professional and prudent in getting paid what you're owed in the tough years, so that you can thrive in the ones beyond.

Dean Gloster and Matt Lewis are partners in Farella Braun + Martel's San Francisco office. Reach them at (415) 954-4400. To comment on this article, e-mail edit@winesandvines.com.