On October 4, 2011, Real Mex Restaurants and Chef Solutions Holdings filed for bankruptcy relief in Delaware under Chapter 11 of the Bankruptcy Code. The very next day, Friendly’s Ice Cream, known for its old-style East Coast ice cream parlors and restaurants, also filed for protection from its creditors under Chapter 11.

These three companies run the gamut in the food industry. Real Mex Restaurants is one of the largest full service, casual dining Mexican restaurant chains in the United States. In 2006, an affiliate of Sun Capital Partners, based in Boca Raton Florida, purchased Real Mex Restaurants for $359 million. An affiliate of Sun Capital also invested in Friendly’s, the owner and franchiser of about 490 restaurants and ice cream parlors along the East Coast. Chef Solutions, on the other hand, provides prepared foods under brand names such as Orval Kent, Pennant, Yoder’s and La Francaise.

The filing of any one of these Chapter 11 Cases triggers concern among suppliers and customers as to whether a supplier should continue to ship goods to the Chapter 11 debtor and on what terms. They are also concerned with whether the debtor will secure financing to continue to produce goods for their respective customers.

Therefore, suppliers and customers of a Chapter 11 debtor should take immediate action to protect their rights upon learning of a bankruptcy filing. For example, if you are one of the critical vendors of a company in bankruptcy, you may be entitled to negotiate a deal where you are paid a portion of your pre-petition claims in exchange for agreeing to certain credit terms on a going forward basis. You also may be entitled to a priority claim for goods shipped and delivered within twenty days of the filing date. Finally, if you received any payments within ninety days of the filing of the Chapter 11 Case, you may receive a demand letter, or possibly a complaint, requiring that you return all payments received within that time period.

These preference demands are subject to many defenses often reducing or eliminating any potential exposure you may have. Therefore, it is critical at the outset of a Chapter 11 Case to understand your rights, preserve any claim you may have to a distribution and protect yourself against a lawsuit for payments you received within ninety days of the bankruptcy filing.

With the present economic conditions and rising food prices, sales have declined greatly in the food and restaurant industry. Many more middle class households are deciding that it is more economical to eat at home. When you mix in above market rents you have a recipe for disaster. While we expect the wave of bankruptcy filings to continue, it is important to stay vigilant in monitoring the companies for whom you do business and protect, to the best of your ability, your right to recover any amounts due.

Many of these issues can be addressed in advance of the bankruptcy filing when you notice that the days from invoice to payment have increased along with the total outstanding receivables. It is important to stay ahead of the game; otherwise, you may find that you have bitten off more than you can chew.

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The FBN Blog is sponsored by my firm, Arnstein & Lehr, LLP.  This change will bring in fresh perspectives from members of the new Food, Beverage & Nutrition Law Practice Group and provide our readers with great information they can use in their business beyond just dietary supplements. 

In the coming weeks and months you will be introduced to my partners and associates who represent a range of manufacturers, distributors and sellers of food, beverage and nutritional products.  In the process, the blog will expand its focus to address the challenges food, beverage and nutrition industry companies face in the areas we practice in including:

• Labor and Employment
• Intellectual Property
• Corporate Finance, Securities and Mergers & Acquisitions
• Bankruptcy and Creditors’ Rights
• Regulatory and Governmental Affairs

We hope you like the new look.  We expect you will enjoy reading what our blog offers in future and that you continue to find the information and viewpoints here valuable to your business.  Thank you for your support now and in the future!

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Earlier this year, President Obama signed the Food Safety Modernization Act (FMSA), which amends various portions of the United States Code relating to FDA’s powers to detain and regulate domestic and imported food products.  While the law was primarily drafted to grant the FDA some preventive measures to protect the American public from recent food scares (e.g., tainted peanut butter and eggs in 2009 and 2010 respectively), the language of the act will also have an effect on the dietary supplement industry.  However, the question is whether the FMSA, which will become effective on July 3, 2011, will have a material impact on the way most dietary supplement firms run their business.

Generally, the FMSA grants the FDA the authority to detain food products that it reasonably believes is adulterated for up to 30 days, and it also requires food importers to disclose whether their products were denied entrance in other countries.  While FDA’s expanded authority to detain foods is certainly material to the dietary supplement industry, the second rule is rather periphery unless a dietary supplement firm relies on imported food ingredients.  In addition to these two broader rules, the FMSA also amends some language in the Food, Drug & Cosmetic Act (FDCA) governing new dietary ingredients.  More specifically, the new law requires the FDA to notify the DEA whenever an application for a new dietary ingredient lacks sufficient substantiation proving that the ingredient is free from steroids or steroid analogs.

First, it is important to note that the FMSA lessens the burden of proof required by FDA to invoke its power under 21 U.S.C. 334(h)(1)(A) to detain adulterated food products from credible evidence to reasonable belief.  Whereas Black’s Law Dictionary defines the “credible evidence” standard as “evidence that is worthy of belief,” it also defines the “reasonable belief” standard as “to believe a given fact or combination of facts under circumstances in which a reasonable person would believe.”  Further, the “credible evidence” standard is generally considered a relatively easy burden to prove compared to other standards; however, under the FMSA, 21 U.S.C. 334(h)(1)(A) is abrogated to include an even lesser burden of proof standard.  Thus, if the FDA reasonably believes a given dietary supplement is adulterated—a catchall term that includes violations of the FDCA that range from relatively harmless violations such as improper structure and function claims to more egregious infractions such as the presence of harmful contaminants—the dietary supplement in question would be subject to federal detention for up to 30 days.

Second, section 113 of the FMSA also amends 21 U.S.C. 350b by adding the following language:

If the Secretary determines that the information in a new dietary ingredient notification submitted under this section for an article purported to be a new dietary ingredient is inadequate to establish that a dietary supplement containing such article will reasonably be expected to be safe because the article may be, or may contain, an anabolic steroid or an analogue of an anabolic steroid, the Secretary shall notify the Drug Enforcement Administration of such determination. (Emphasis added)

This provision is clearly designed to prevent the market and sale of unlawful steroid and steroid-analogs under the guise of dietary supplements.  While the language is putatively consistent with the Dietary Supplement Health & Education Act of 1994 (DSHEA) insofar that the burden rests with FDA in proving that a given ingredient does not comport with the law, it seems rather presumptuous to immediately conclude that the absence of documentation showing a dietary ingredient does not contain steroids or steroid analogs means it is, or contains, the steroid or steroid analog.

Nevertheless, the addition of these two new rules under the FMSA will likely affect the way dietary supplement firms operate their businesses, but it is unlikely that compliance with the FMSA will present the same challenges as CGMP compliance.  Yet, dietary supplement firms should be acutely conscious of the detention provision because the FDA is legally permitted to take proactive steps to detain products by satisfying a lesser burden (i.e., it is easier for the FDA to detain potentially adulterated products).  Coupled with the possibility of criminal sanctions under the Park Doctrine, dietary supplement firms should navigate the changing regulatory landscape cautiously and adopt super-adequate protocols that comport or exceed the requirements set forth in 21 C.F.R. 110 and 111.  Similarly, firms engaged in the manufacture, distribution, market, or sale of new dietary ingredients should take deliberate steps to dispel any suspicion that an ingredient is adulterated with steroid or steroid-analogs by submitting the necessary documentation.

Shafiel A. Karim earned a B.A. from California State University, Fullerton and an M.A. from California State University, Long Beach.  He is currently a J.D./M.B.A. candidate at Southwestern University School of Law and the Peter F. Drucker and Masatoshi Ito School of Management at Claremont Graduate University.

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As FDA continues to inspect dietary supplement manufacturers under the new CGMP framework, it is clear that many manufacturers share similar deficiencies.  Recent FDA warning letters show that many manufacturers are still struggling with structure function claims, the required pre- and post-production qualitative and quantitative testing requirements, and strong quality control units that have the necessary authority and resources needed to comport with CGMPs.  (See, e.g., here, here, here, here, here, and here.)  When coupled with recent administrative guidance suggesting FDA may resort to reprimanding non-complying firms under the Park Doctrine, which imposes strict criminal liability for non-compliance with CGMPs, it is imperative that dietary supplement firms understand the potential consequences arising from serious CGMP violations.

Indeed, last year FDA sent a letter to Senator Charles Grassley (R-IA) explaining its intention to reintroduce the possibility of imposing criminal charges for misdemeanor violations of the Federal Food, Drug and Cosmetic Act (“FFDCA”) under the Parks Doctrine.  The Park Doctrine imposes strict liability, which means that the violating firm’s senior management need not have intent or knowledge of the violations to be found guilty.  Therefore, given FDA’s publicly stated intention of imposing harsher punishments for CGMP non-compliance, are future violations similar to those recorded thus far likely to result in criminal sanctions under the Park Doctrine?

The Park Doctrine is derived from United States v. Park, 421 U.S. 628 (1975), a landmark case decided by the Supreme Court.  In Parks, the president of Acme Markets, Inc., a large national food retailer, was convicted of violating sections of FFDCA for failing to sufficiently rectify unsanitary conditions at some of Acme’s warehouses, and for allowing adulterated food to be distributed in interstate commerce.  The Court reasoned that “[t]he requirements of foresight and vigilance imposed on responsible corporate agents are beyond question demanding, and perhaps onerous, but they are no more stringent than the public has a right to expect of those who voluntarily assume positions of authority in business enterprises whose services and products affect the health and well-being of the public that supports them.” Parks, 421 U.S. at 672.  A dietary supplement is considered adulterated if it is prepared, packed or held in conditions that do not comply with CGMPs, or if it contain poisonous or unsafe ingredients.  21 U.S.C.A. 342.

While FDA has enumerated several “serious” violations of FFDCA during routine CGMP audits, the severity of the violations found do not necessarily pose a serious public health risk as seen in Parks.  For example, FDA’s recent warning letter to Gaspari Nutrition cites several deficiencies in the company’s customer complaint recording procedures.  While the absence of customer complaint recordation procedures may (substantially) delay the recall of an adulterated dietary supplement product that poses a public health risk, it is not aconduct that is necessarily an imminent public health risk.

In fact, the majority of violations found in dietary supplement firms—as recorded in FDA’s published warning letters—stem from a lack of documentation, validation, or pre- and post-production testing.  In Parks, however, the violations were more obviously deleterious; FDA inspectors found chronic rodent infestations in some of Acme’s warehouses.  However, this is not to say that deficiencies in documentation, validation, and testing cannot result in the manufacture or distribution of dietary supplements that pose a public health risk.  On the contrary, such deficiencies may simply be telltale indicators of more substantive public health risks.  For example, if a dietary supplement firm cannot confirm the identity or purity of an ingredient through documentation, it is logically plausible to conclude that the dietary supplement may contain ingredients that are injurious to public health.

Dietary supplements that are processed in operations that do not comport with CGMPs are more likely to be contaminated by virtue of the fact that such operations lack the necessary infrastructure and procedural controls necessary to prevent cross-contamination and adulteration.  Smaller dietary supplement firms are less likely to have made the necessary investments in air handling and water purification systems, both of which are potential sources of adulteration.  If a cleaning procedure is not validated though quantitative testing, how can the manufacturer verify that the equipment has been sufficiently cleaned to prevent potential microbial growth or product cross-contamination?  To be sure, firms that lack validated operating procedures risk improperly cleaning equipment and facilities without sufficiently eliminating the potential for adulteration.

Despite these deficiencies, anecdotal consensus suggests that any future Parks Doctrine enforcement will stem from gross violations of FFDCA and CGMPs that are so pervasive that they pose a substantial and imminent risk to public health.  And, using Parks’ factual circumstances as a guide, habitual or repeated violations will likely be a prerequisite for a Parks Doctrine prosecution.  From a procedural vantage, if FDA intends to pursue criminal sanctions under the Park Doctrine, it must notify its Office of Criminal Investigations accordingly, which is then required to conduct further due diligence.  Unfortunately, FDA has not supplied a bright-line rule articulating what kinds of violations will warrant criminal sanctions.  Instead, firms are left with a series of factors, which includes repeated violations and illegal conduct, inter alia.

Although the likelihood of FDA imposing criminal sanctions to owners and senior decision-makers of dietary supplement firms for minor violations of CGMPs is unlikely, repeated violations that engender public health risks will certainly be candidates for the draconian consequences that arise from the Parks Doctrine.  Accordingly, it is in the dietary supplement industry’s best interest to adopt super-adequate quality control and quality assurance protocols.  Instead of waiting for FDA’s inexorable audit, dietary supplement firms should be conducting regular internal audits to ensure compliance with CGMPs and other relevant regulatory rules.  Such measures will engender good will with consumers of dietary supplement products as well as government agencies.

Shafiel A. Karim earned a B.A. from California State University, Fullerton and an M.A. from California State University, Long Beach.  He is currently a J.D./M.B.A. candidate at Southwestern University School of Law and the Peter F. Drucker and Masatoshi Ito School of Management at Claremont Graduate University.

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Irwin Naturals, one of the nation’s leading suppliers of natural dietary and herbal supplements, announces that it has reached a settlement with a California task force that named seven of its hundreds of products as being mislabeled or falsely advertised according to California law. The company has resolved all issues raised in the investigation.

The task force alleged that several Irwin products did not carry the proper lead warning label as required by California’s unique Proposition 65 law, but not that any of them contained an unsafe amount of lead. No product recall was or will be instituted as a result of the settlement, and no products were reformulated in response.

Proposition 65 requires a warning label for any product that contains an identifiable amount of a chemical or heavy metal on a daily dose basis. However, according to Prop. 65, the level of lead at which a product is considered unsafe is about 28 times greater than the level at which a warning on a label is required. As a result, Prop. 65 warnings have become ubiquitous throughout California on everything from wine bottles to Disneyland.

“We stand by our products, as we have for 15 years, and this settlement acknowledges that our products are safe and that we are in compliance with California laws,” said company spokesperson Rebecca Pearman. “As a trusted name in the nutritional supplement business, we are committed to best industry practices in manufacturing, quality assurance and labeling to ensure the quality and safety of our products and our continued leadership position in the industry.”

The task force also alleged that their tests failed to find Hoodia in some of the company’s products labeled as containing the herb. However, the company could not confirm these findings because no validated test method exists for identifying Hoodia in the softgel product form used by the company. The company relied instead on the industry standard method of confirming the input of Hoodia, and all manufacturing records confirmed that Hoodia had been put in to the products. The investigation did not result in either a product recall or reformulation.

Pearman said that while the company does not agree that it intentionally mislabeled or falsely advertised its products, it has no dispute with the task force’s fundamental objective to bring greater oversight to the nutritional supplement industry.

“For more than 15 years, we have staunchly supported the evolving standards under which our industry operates,” said Pearman. “California has some of the most stringent labeling laws in the nation, and in complying with those, we will continue to strive to meet or exceed all national requirements for our industry.”

Unrelated to the labeling claims was an allegation that the company failed to refund consumers who met the company’s refund policy. The task force did not identify specific complaints or consumers, but the company has set up a limited restitution fund. Consumers with questions about eligibility for refunds under the settlement can call the company at (800) 941-9098.

For the official announcement and more contact info on Irwin Naturals please visit 24-7 press release.

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The purpose of the letter is stated as to “address the significant public health problems posed by products that are marketed as dietary supplements but that contain the same active ingredients as FDA-approved drugs, analogs of the active ingredients in FDA-approved drugs, or other compounds, such as novel synthetic steroids, that do not qualify as dietary ingredients.”

The letter states that the FDA has received numerous reports of serious adverse events associated with consumer use of those FDA-approved ingredients, which are generally undeclared in the labeling, that are being included in dietary supplements without warning to consumers. These adverse events include strokes, acute liver injury, kidney failure, pulmonary embolisms and death.

The FDA has been investigating supplements in order to discover whether or not they include ingredients that are deemed to be FDA-approved drugs. The areas in which the FDA found the highest rate of products marketed as dietary supplements but containing hidden ingredients include products for weight loss, sexual enhancement and body building. This includes a recall of more than 70 products marketed for sexual enhancement, 40 products marketed for weight loss and more than 80 products marketed for body building.

Although warning letters and recalls have been the primary source of action by the FDA, the letter states that the government may initiate criminal investigations to hold accountable those who violate the Federal Food, Drug, and Cosmetic Act and endanger the public. The letter makes sure to point out that individuals, not just companies, can also be brought up on charges when it states “Responsible individuals, even if the individual did not participate in, encourage, or have personal knowledge of the violation, can be criminally prosecuted under the Act.”

The FDA’s recommendation in this letter is that all firms that manufacture, import, distribute, or sell dietary supplements understand and investigate their full supply chain and review their manufacturing and quality assurance activities to ensure the lawfulness, quality and safety of their products. The FDA also encourages the industry to report any suspected tainted supplements and has offered an anonymous reporting method.

The FDA is hoping that this letter is spread widely throughout the industry in order to eradicate the use of chemicals regulated as drugs in nutritional supplements. It is also seeking continued input from people within the industry to help strategize a way to combat this problem.

To read the letter, click here.

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Alaven Consumer Healthcare, Inc. manufactures and sells Colonix non-prescription herbal supplements and intestinal cleansers under its house brand DrNatura.  Alaven sued DrFloras LLC for trademark infringement, unfair competition, false advertising and other claims for using the trademark DrFloras for similar products.  The federal district court dismissed the infringement and unfair competition claims without trial because the judge decided that DrNatura and DrFloras were not confusingly similar trademarks. 

On appeal, the federal appeals court for the 11th Circuit concluded that the district court judge was right that there was insufficient evidence of likelihood of consumer confusion to require a trial.  Alaven Consumer Healthcare, Inc. v. DrFloras, LLC, No. 10-1131 (11th Cir., 10/12/2010).

Both companies have federal registrations and/or pending applications for their trademarks.  The marks look like this:

The side-by-side visual similarities are the “Dr” and “ra” elements of the marks and leaves in the design.  As a whole, however, they don’t have the same appearance, pronunciation or meaning and the district court judge thought they were reasonably distinct from each other. 

It is not unusual for trademarks for supplements to include “Dr” or a variation of “Natural” or “Nature.”  There are over 200 active registrations and pending applications for trademarks for supplements containing “Dr” and over 400 for marks containing variations of “Natural” or “Nature.” 

It looks like this case may have resulted from some tough marketplace competition between the products, which are similar and are marketed and distributed on the Internet to the same types of customers.  Without an obvious showing of bad faith or any evidence of consumers who were confused to tip the balance, Alaven did not have a strong enough case to go to trial.

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Schiff Nutrition International (NYSE: WNI) is reportedly “on the prowl” for new acquisitions after a sale of approximately 25 percent of its shares to TPG Growth, a private equity firm affiliated with TPG Capital of Forth Worth and led by William McGlashan Jr.  

McGlashan is familiar to the nutritional supplements industry as a co-founder of Pharmanex Inc. McGlashan will become a member of Schiff’s board along with TPG managing partner Matthew T. Hobart.

Based in Salt Lake City, Utah, Schiff develops, manufactures, markets and distributes branded and private label vitamins, nutritional supplements and nutrition bars in the United States and throughout the world, including recognized brands marketed through mass markets (including club stores) and, to a lesser extent, health food stores. 

TPG acquired its shares from Weider Health & Fitness, which before the deal controlled approximately 93% of the company’s voting shares and approximately 53% of all Schiff shares outstanding.  Weider Health’s Eric Weider will continue to serve as chairman of the board.

The deal signals a renewed strategy of growth through acquisitions of other companies in the supplements industry.  According to recent reports, Schiff has already looked at a number of deals in the market.  And their timing seems right, as activity in the industry remains strong, including reported acquisitions by The Carlyle Group of its rival NBTY and ramped-up efforts by strategic buyers such as Nestle, which in September launched Nestle Health Science, committing significant resources to its efforts in this segment.

For more information about the deal and Schiff, click here.

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Greg Doherty of Poms & Associates

Guest Post: Greg Doherty of Poms & Associates Insurance 

Deals in the supplement space are heating up.  That’s why it’s important to remember to pay attention to details like Extended Reporting Provision (“ERP”) or “tail” coverage options available in insurance policies that can protect the business going forward in the event of claims.

Liability insurance for supplement raw materials suppliers, contract manufacturers and retailers is offered on a “claims made” basis almost exclusively. When a dietary supplement company is acquired, the Seller–and the Buyer– need to be aware of the uniqueness of how the claims made coverage must be structured around the transaction, so as to protect both of them after the deal closes.

Central to understanding this subject is the coverage trigger for claims made insurance. A policy has to be in effect when the claim is made against the supplement company, not necessarily when the claim actually occurred. Often there is a long delay between when a claim happens and when a lawsuit is filed. With claims made coverage if no claims made policy is in force when the claim comes in, there is no coverage, regardless of when it occurred.

 Many M&A deals are “assets only” acquisitions these days, reinforcing the importance of covering the Seller, who is left with past liabilities as part of the transaction.. That means the Seller retains the liabilities—including future claims that come in from something that happened when he DID own the company, This is usually backed up by an indemnity agreement from Seller to Buyer in the agreement of sale.

The first inclination of the Seller is to cancel his liability policy on the closing date because ostensibly he doesn’t need it anymore. Not so with a claims made policy. If Seller does that and does not exercise the Extended Reporting Provision (“ERP”) or “tail” coverage option in his policy, he will have no policy if a claim comes in, and thus no coverage.

Let’s use an example an injury that happened pre-close but is not made until six months after close. Remembering that it is the making of the claim that triggers the coverage, NOT when the injury occurred, at if the ERP coverage is NOT purchased by Seller:

 -At the time the claim is made, the Seller will have no insurance coverage , and

-Neither will Buyer as their policy is going to effectively bar any claims that happened before the acquisition.

So in the absence of ERP coverage, neither party will have any insurance coverage for the claim. This is also why savvy Buyers will often require the Seller to purchase ERP coverage as part of the overall transaction, the fear being that if Seller is long gone and without coverage, the courts will assign him liability anyhow, in spite of the contractual agreement in the sale document that the claim should be paid by Seller.

ERP coverage for Sellers in a M&A deal should not be overlooked by either Seller or Buyer.

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In a statement, commission chairman Jon Leibowitz said, “We expect more from a great American company than making dubious claims – not once, but twice – that its cereals improve children’s health. Next time, Kellogg needs to stop and think twice about the claims it’s making before rolling out a new ad campaign, so parents can make the best choices for their children.”

In a joint statement, Leibowitz and commissioner Julie  Brill used stronger language: “As a trusted, long-established company with a presence in millions of American homes, Kellogg must not shirk its responsibility to do the right thing when it advertises the food we feed our children.”

Kellog had a run-in with the FTC over its Frosted Mini-Wheats that resulted in the company’s admission that health claims made for the cereal were false and a settlement order in February 2009. Kellogg agreed not to claim “benefits to cognitive health, process, or function provided by any cereal or any morning food or snack food unless the claims were true and substantiated,” according to the statement on the Rice Krispies order.

Leibowitz and Brill said in their joint statement that even as Kellogg was pulling back on the Mini-Wheats claims, it must have been moving forward with health claims on the Krispies cereals.

“The company clearly has the means and ability to carefully test its children’s food products to determine if the products in fact provide health benefits for kids,” the commissioners said. “We are also confident that Kellogg has the wherewithal to carefully develop truthful and nonmisleading advertising about such health benefits.”

Kellogg responded with a statement saying that it stands behind the validity of product claims and research. “So we agreed to an order that covers those claims,” their statement said.

The expanded order now prohibits Kellogg from “making claims about any health benefit of any food unless the claims are backed by scientific evidence and not misleading.”

This is familiar ground for makers of nutritional supplements, but not so much for a manufacturer whose advertising icons include three guys in hats and a cuckoo bird. (Cocoa Puffs had the claim, too.) Kellogg, and General Mills whose Cheerios heart-health claims drew a warning letter from the Federal Drug Administration, are now learning what it’s like when you emblazon words like “immunity” and “antioxidants” on product packaging.

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