Cannabis Companies Without Bankruptcy Protection May Explore Government Options – JD Supra | Vette Leader

As the trend toward legalizing medical and recreational marijuana use continues across the states, federal laws and bankruptcy courts have yet to follow suit.[1] Bankruptcy courts have in the past barred cannabis — and even cannabis-related businesses — from filing for protection under US bankruptcy law[2] because marijuana remains illegal under the Controlled Substances Act (CSA) at the federal level.[3] As a result, financially troubled companies in states where marijuana is legal still have limited restructuring options and must rely on state legal options.

Typically, traditional businesses may file for bankruptcy to give creditors breathing space, restructure debt, and avoid certain litigation and collection efforts. So how can a troubled cannabis company, or a company that provides goods or services to the cannabis industry, avail similar legal relief to compliantly reset the company onto a new path, or even responsibly exit the market? While this lack of bankruptcy protection can be detrimental to many distressed cannabis companies, there are some state options. First, a cannabis company could use an assignment in favor of creditors (ABC). An ABC is a constitutional mechanism for the orderly (structured) liquidation of assets. An ABC is similar to a Chapter 7 bankruptcy proceeding in which the debtor’s estate is wound up in an orderly manner, but ABCs are not subject to the bankruptcy law. Instead, each state’s ABC statute provides a procedure for liquidating a debtor’s assets by assigning the assets to an assignee. The legal successor oversees the liquidation of the assets and distribution to creditors, which is usually quicker and less expensive than bankruptcy proceedings.

Second, a cannabis company may attempt to negotiate a “workout” arrangement directly with the lender to renegotiate the terms of an onerous debt obligation. However, the company may not be able to exercise significant influence in negotiations with a lender, as the company cannot threaten to file for bankruptcy protection if an out-of-court settlement cannot be reached. Nonetheless, an out-of-court restructuring or liquidation negotiated directly with the lender may have the potential to extend debt maturities, change onerous stipulations in contracts, and provide more favorable payment terms, among other benefits.

Banning marijuana businesses from seeking protection under the bankruptcy law impacts all cannabis-related businesses and a wide range of ancillary industries, including suppliers, vendors, financial companies, real estate companies, and anyone else that provides goods or services to the cannabis community offer cannabis industry. The Bankruptcy Code’s provisions on automatic stays, distribution priorities, challenge powers, and dismissal, among other things, are affecting the dynamics of the entire cannabis industry. Until marijuana is legalized at the federal level so that the U.S. Trust Program (USTP) no longer considers the reorganization of such businesses as permitting “continued legal activity,” or until the bankruptcy law is amended to allow cases involving marijuana businesses, the protections will continue offered under the Bankruptcy Act will likely remain unavailable to many cannabis and cannabis related businesses.

Many cannabis companies have attempted to file for bankruptcy protection, and more will continue. A recent Chapter 11 (Restructuring) filing filed by Master Equity Group, LLC in the Western District of Michigan aims to challenge the ban and benefit from the protections that the Bankruptcy Code can offer. (Master Equity Group, LLC, a holding company for several cannabis-related companies, has filed for bankruptcy under Chapter V of Chapter 11, a recent ordinance that allows qualifying small businesses to reduce costs and increase the efficiency of bankruptcy processing.)

As long as marijuana remains illegal at the federal level, bankruptcy courts are unlikely to touch these cases. Despite a highly critical 2017 article published in the American Bankruptcy Institute detailing these injustices regarding cannabis creditors, the Executive Office for US Trustees maintains that it “may not oversee a criminal enterprise in progress, regardless of its status under state law”. However, savvy participants in the cannabis industry should be aware of these limitations and empower themselves by structuring their businesses from the start to take advantage of state law protections and dealing directly with lenders until the tide turns.

[1] Regarding Way to Grow, Inc., 610 BR 338 (D. Colo. 2019) (“Dismissal for “cause” is appropriate if the Chapter 11 debtor operates a business dedicated to servicing the marijuana industry and violates federal law.”)

[2] 11 U.S.C. § 101, onwards. (the “Insolvency Act”).

[3] Regarding Burton610 BR 633 (BAP 9th Circ. 2020).

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