Cannabis businesses facing insurmountable debts don’t have access to the typical forms of relief that management teams in other industries might seek, like federal bankruptcy court. This is an emergent problem, as the industry matures to the point that debt becomes a deepening concern for some.
Paul Carey, partner at Mirick O’Connell, says that bankruptcy courts have generally taken a hardline stance against working with businesses and individuals that have even a whiff of the cannabis industry.
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“If there’s enough of a cannabis taint to it, the courts will dismiss the case and/or deny confirmation of any plan because of a number of reasons under the bankruptcy code,” Carey says. Because cannabis remains a Schedule-I substances in the eyes of the federal government, U.S. bankruptcy trustees can’t administer the assets of a debtor without violation federal law. Liquidation and reorganization plans must be proposed “in good faith,” which is to say in a legal manner.
For cannabis businesses, it’s a non-starter.
While there’s not much case law on the books to inform the matter beyond that simple fact, the public record shows how rigid the courts’ stance is on this topic. “The courts have pretty much universally said that a direct participant in the cannabis industry is not going to be eligible for relief in the bankruptcy court,” Carey says.
“Direct participant” can mean growers, manufacturers and distributors, of course, but the specter of any cannabis sales whatsoever can affect the prospects of a bankruptcy filing.
In Florida, for instance, a property owner filed a Chapter 11 bankruptcy case. One of three tenants in the debtor’s commercial building was a cannabis business awaiting approval from the state of Florida to grow and sell medical marijuana. The debtor’s proposal to reorganize assets hinged heavily on whether that medical cannabis business tenant would be approved by the state and thus able to pay rent. Medical cannabis income, then, was a part of the landlord’s bankruptcy relief plan.
According to the court in that case: “[A] bankruptcy plan that proposed to be funded through income generated by the sale of marijuana products cannot be confirmed unless the business generating the income is legal under both state and federal law.”
The court didn’t dismiss the case outright, but instead gave the property owner two weeks to come up with a plan that didn’t involve medical cannabis sales. “The court found that a bankruptcy plan that proposed it to be funded through income generated by the sale of marijuana products cannot be confirmed,” Carey says.
“Until there’s a federal solution to this states-law issue, I don’t know that you’re going to have the direct players—the suppliers, growers—be able to have bankruptcy relief,” Carey says.
There are alternatives for debt-strapped cannabis businesses. Management teams can file for receivership with a state court (in a state that has legalized cannabis for adult-use or medical purposes, of course). This process comes with less legal force than a federal bankruptcy proceeding, but state fiduciaries do act like U.S. bankruptcy trustees—administering assets will reorganizing debt or liquidating.
Also using the state courts system, cannabis businesses may pursue an assignment for the benefit of the creditor. This set-up is similar to bankruptcy, where a state assignee is “charged with the responsibility of gathering all of the Assignor’s assets and selling the Assignor’s right, title and interest in those assets,” according to the American Bar Association. (Assignments for the benefit of the creditor are not available as a legal option in every state.)
There’s always the out-of-court restructuring agreement, as well, Carey points out. Those operating in the cannabis industry know the inherent financial risks; thus, in some cases, creditors may be willing to work out some sort of arrangement by offering relief and continuing to do business with the debtor company.
