According to law:

http://www.usflag.org/uscode36.html

.....

THE FLAG CODE
Title 36, U.S.C., Chapter 10
As amended by P.L. 344, 94th Congress
Approved July 7, 1976

 176. Respect for flag:  No disrespect should be shown to the flag of the United States of America; the flag should not be dipped to any person or thing. Regimental colors, State flags, and organization or institutional flags are to be dipped as a mark of honor.

(a) The flag should never be displayed with the union down, except as a signal of dire distress in instances of extreme danger to life or property.

…..

I don’t think a business venture gone sour on account o red tape constitutes EXTREME DANGER to life or property.  Does anybody else? 

Frankly, I think the character Hank Deerfield’s reasons for hanging his flag upside down in the movie In the Valley of Elah represent a more lawful use of the distress signal. 

Not that I’m hung up on it or anything, but I’d have to say the man with liquor license problems is almost certainly in the wrong, and therefore --- jeez this agitates the schit outa me saying this because I hate bullying &/or subjugation by law enforcement, but --- the police probably had reasonable cause to at least cite the guy --- in this instance.  But I’m sure the ACLU could easily spin it another way … you’re probably right, Rossy.