In addition to intellectual property and banking law, bankruptcy law remains a complicated field for marijuana companies to access, let alone navigate. In the United States, The U.S. Trustee Program (“USTP”) is the component of the Department of Justice (“DOJ”) responsible for overseeing the administration of bankruptcy cases. The USTP appoints and supervises the 1,100 private trustees who handle every bankruptcy case across the country under federal bankruptcy laws.
The bankruptcy process ordinarily allows individual and commercial debtors to obtain a “fresh start” from debts and offers fair and equitable treatment of creditors. But in December 2017, DOJ director Cliff White and trial attorney for the Executive Office for the USTP John Sheahan issued letters to all trustees of the USTP. The letters reminded the trustees that due to marijuana’s illegal status at the federal level under the Controlled Substances Act (“CSA”), and the supremacy of the federal prohibition against marijuana over state laws, the federal bankruptcy system remained unavailable to any cannabis-related company in need of liquidation and/or restructuring relief. The policy has been in effect for two presidential administrations and three Attorney Generals.
The government’s rationale for preventing cannabis-related companies from utilizing the federal bankruptcy system is based on two concepts. The first is that the government will not be an instrument or accomplice in ongoing crime and cannot facilitate a reorganization plan that requires ongoing continued illegal activity. The second concept is that the DOJ does not want to encourage bankruptcy trustees and other estate fiduciaries to aid and abet the violation of federal criminal laws by selling cannabis in the process of administering assets.
The USTP also distinguished marijuana businesses from other businesses that engaged in other types of illegal activity. With other businesses that involved illegal assets, the criminal activity had usually terminated already prior to bankruptcy proceedings and the bankruptcy court simply resolved creditors’ competing claims for compensation; one example is when a company claims insolvency after a failed Ponzi scheme endeavor. In contrast, a cannabis company seeking to file for bankruptcy openly proposes to continue its illegal activity during and after the proceeding and wants the bankruptcy court to assist in that ongoing criminality.
The reminder letter was a product of growing concern over a recent increase in the number of bankruptcy cases involving marijuana assets. When claiming financial insolvency, federal bankruptcy applicants must list all valuables and agree to sell some of them to pay off financial obligations. Marijuana companies have been kicked out of proceedings for attempting to list marijuana assets to be used to pay off their debts.
Notably, the right to bankruptcy relief is not absolute and cases may be dismissed for cause—one possible cause being the bad faith filing of a bankruptcy case. Such a bad faith filing could arise when a cannabis company’s bankruptcy plan is incapable of complying with existing federal law. Therefore, the USTP recommends that private trustees notify the USTP when they uncover a marijuana asset in any of their assigned cases to avoid a murky legal conundrum.
Equally important, the parties impacted by the DOJ’s stance stretch beyond clear-cut cannabis companies and extend to any “downstream” participants in the chain of production and distribution in the marijuana industry. It encompasses those who lease property to, sell growing products to, extend loans to, offer intellectual property management services to, and receive stock ownership dividends from any cannabis companies. This is because the CSA’s various provisions do not distinguish between actual sellers and growers of cannabis and these other—arguably more passive—participants in the marijuana industry.
And for businesses looking for relief that cannot be obtained through the federal bankruptcy system, there are many potential state law alternatives to be aware of and consider. The first option is an assignment for the benefit of creditors (“ABC”). ABCs are governed by state law and result in liquidation of the debtor’s assets for the creditor’s benefit. The debtor selects its “assignee” to take legal and equitable title to the debtor’s assets, sell the assets, and distribute those proceeds to the debtor’s creditors pursuant to priorities established by applicable state law. This is a potentially effective solution for cannabis companies seeking to continue operating and avoid debt restructuring.
Next is a cooperative foreclosure sale under the Uniform Commercial Code (“UCC”). This option avoids the costs of a judicial foreclosure and bankruptcy sale and is great for when the value of the assets to be sold is less than the secured debt.
But because Article 9 of the UCC sales are not direct sales, secured creditors may have to comply with state licensing requirements when engaging in the sale of marijuana, so pro-marijuana states should amend their UCC statutes to eliminate any licensed entity requirements on behalf of the buyer.
Additional options include a receivership, which is the process by which an appointed third-party takes control over the debtor’s business, operates the business, and liquidates some or all of its assets. Pro-marijuana states such as Washington and Oregon have adopted receivership statutes that specifically permit the sale of marijuana assets.
Another option is non-court supervised liquidation of some or all of the cannabis debtor’s assets through negotiated contractual settlements. This is an effective option for debtors with assets sufficient to satisfy a reasonably high percentage of the outstanding debt and/or debtors with a small number of creditors.
Another thing to keep in mind is that although courts often have been swift in dismissing commercial cannabis-related bankruptcy filings, some courts have shown a willingness to make Chapter 13 bankruptcy relief available to individual debtors who stop their marijuana operations and can fund a Chapter 13 repayment plan with untainted income.
One such example is In re Jerry L. Johnson, 532 B.R. 53 (Bankr. W.D. Mich. 2015). Mr. Johnson, a disabled 60-year-old man, grew medical marijuana on a small scale in his basement as a state-licensed caregiver for his patients. The court gave Mr. Johnson the opportunity to remain in bankruptcy by discontinuing his medical marijuana business. His plan was confirmed after he ceased all marijuana activity, destroyed all marijuana plants in his possession, and abandoned the plants as an estate asset.
Bankruptcy treatment of ancillary companies is still an open question. Would federal bankruptcy relief be available to a company that sells goods unintended for use with cannabis but is aware that marijuana companies buy the goods for that exact purpose? What about a landlord who rents his entire building out to tenants but knows that a few of his tenants use marijuana recreationally in a recreational-approved state? Or non-managerial employees at cannabis businesses—will their personal bankruptcy privileges be at stake?
Interestingly enough, case law has yet to address marijuana businesses as creditors and whether they will be permitted to file claims and receive distribution in bankruptcy cases for debtors unrelated to the marijuana industry.