Legacy bankruptcy snare

The largest bankruptcy case to hit the wine industry in years is shaping up to be a bruising legal battle that could jeopardize the fate of several renowned wineries, including Glen Ellen's Arrowood Vineyards & Winery.

The Legacy Estates Group, owners of Freemark Abbey Winery in St. Helena since 2001, filed Chapter 11 bankruptcy last month, nine months after acquiring Arrowood and Byron winery, in Santa Maria.

The group purchased the two wineries in March from Constellation Brands, using a $53 million loan from a Houston-based hedge fund.

In its Nov. 18 bankruptcy filing, the company claims it owes $83 million to more than 450 creditors. The company lays much of the blame for its predicament at the feet of the hedge fund, Laminar Direct Capital. Legacy claims the interest rates it is being charged on three loans are so high - 11 percent to 16 percent - that they are an "onerous obligation" sapping the company of the cash it needs to operate.

Legacy officials initially told the company's 67 employees that it hoped the bankruptcy would prevent the hedge fund from breaking up the company and allow it to quickly find new financing.

But now, the case appears headed for a long, nasty fight.

Laminar contends that Legacy officials tricked it into loaning the money by lying about the company's finances.

"You hope that this will straighten itself out, but I have my doubts and concerns," said Richard Arrowood, who no longer owns the winery but remains head winemaker.

Legacy is owned by brothers Calvin and Dev Sidhu, who grew up in Washington state and Canada and whose family has a long history of farming in India.

Calvin Sidhu, chief executive of Legacy, claims he was working hard to find additional financing, but was limited because the loan structure was "inflexible" and carried heavy penalties for paying off the loans in the first year.

"(The loans ensure) Laminar will be able to take over the company the moment the company is faced with even a minor financial hurdle," Sidhu said.

But Laminar says the financial problems at Legacy are anything but minor.

The fund accused Legacy officials of lying about a key $5 million transaction. The company was supposed to raise $8 million in private investment as a condition for the $53million loan. But Laminar says $5 million of the $8 million in "equity" Legacy claimed to have raised was not equity at all, but an advance on future sales from its distributor, Wilson-Daniels, a division of Young's Market Co.

"The Debtor's statements were false and appear to have been designed to defraud Laminar into funding the loans when the condition was not met," Laminar states in the filings.

The allegation Laminar is making is a serious one, akin to a mortgage applicant's lying to a bank about the source of his or her down payment, said David Freed, a principal in Silverado Premium Properties, a Napa vineyard investment firm.

Silverado is one of 36 growers who sold grapes to Legacy wineries this year and claim they are owed a total of $5.1million. Silverado claims it is owed $232,720, according to filings.

The timing of the bankruptcy could not be worse for growers, Freed said, because it comes at the end of harvest, when growers have their own bills to pay.

"Growers are being hurt because they don't know how many cents on the dollar they're ever going to be able to get out of this thing," Freed said.

Legacy officials have publicly said they will repay all their creditors in full. Freed laughs at the claim, citing the company's $83 million in debts against an unknown amount of assets.

The value of the three wineries is a point of contention in the case. Legacy claimed in its filings that its wineries were worth a total of $90 million to $110 million. But Laminar challenged Sidhu's valuation claims, calling them "unfounded" and "hearsay."

"Amazingly, the Debtor does not even name the investment bankers or the appraisers, much less include any written work product or declarations from these investment bankers or appraisers," Laminar writes.

David Hendricksen, chief operating officer of Legacy, said he was not able to address the details of Laminar's claims, but called them "posturing."

"We are confident that their characterization is inaccurate," Hendricksen said.

The company will outline additional facts in upcoming filings soon, he said. The next court date is set for Wednesday.

While the biggest, Laminar is far from the only group owed large sums of money by the Sidhus.

Legacy and a related company controlled by the Sidhus, Connaught Capital Partners, owe $21.4 million to John Bryan, one of the founders of Freemark Abbey.

Winemaker Richard Arrowood worries the longer the case drags on, the worse the potential damage to the company's reputation and grower relationships he worked so hard to develop over the years. While he is concerned about the Arrowood name, he says his primary concern is in preserving the winery's reputation for the sake of its employees.

"I'm going to do everything I can do to make sure that no matter how this shakes out, the name Arrowood will not be brought down in this," Arrowood said.

Vic Motto, a St. Helena wine industry consultant, said the Freemark Abbey, Arrowood and Bryon brands are excellent, but their good name is imperiled by the bankruptcy.

"Those brands are very well regarded through the country, and they've been put in the hands of other people, and that is causing a lot of problems," Motto said.

Hedge funds are not big players in wine industry financing, but their influence is on the rise.

"It is very limited, but it is on the rise because it's going from none to some," said Vic Motto of MKF, a wine industry consulting firm.

Once the domain of groups of wealthy investors, hedge funds have become increasingly popular in recent years, leaving them flush with cash and in search of new investment opportunities, Motto said.

At least three wine industry acquisitions on the North Coast have been financed through hedge funds in recent years, according to Napa vineyard owner David Freed.

The Legacy Estates deal involved $53 million in loans from Laminar Direct Capital, a Houston-based division of the D.E. Shaw Group.

360 Global Wine Co., a publicly traded penny stock company in Napa, purchased Viansa Winery & Italian Marketplace in July using $34.5million from the Cayman Island-based Laurus Master Fund.

A third, smaller transaction involved a vineyard in the Rutherford area of the Napa Valley, Freed said.

Hedge funds are complex tools designed to help wealthy investors limit their risk. They offset risks to one investment by using aggressive trading strategies in other investments.

They are not regulated by the U.S. Securities and Exchange Commission like stocks and mutual funds. They generally take larger risks than traditional investments, and therefore charge high interest rates on loans, Freed said.

"That is very expensive money," Freed said of the three Laminar loans, which ranged from 11 percent to 16 percent.

Despite the risks, additional sources of capital are good for an industry that will need to expand its production infrastructure as it continues to grow, Motto said.

The Legacy bankruptcy risks harming the entire industry by creating an unwarranted impression of the industry's being a risky investment, Motto said.

"It's a shame that we're having this kind of activity so early in the period when we're drawing new capital to the wine industry," Motto said.