Last Dance with Mary Jane? Faltering Cannabis Businesses May Have a Bankruptcy Option in Addition to State Law Remedies

For at least the past decade, federal bankruptcy courts have routinely prohibited cannabis businesses from seeking protection under federal bankruptcy law, regardless of whether a cannabis business is legally operating under state law. The reason is that cannabis remains illegal under the federal Controlled Substances Act (CSA), which, in addition to criminalizing the direct growing or selling of marijuana, also prohibits more indirect or downstream components connected to the enterprise, such as renting, managing, or using property for the purpose of manufacturing, distributing, or using any controlled substance.  A bankruptcy trustee tasked with administering the estate of a cannabis debtor in bankruptcy and liquidating assets like equipment, inventory or fertilizer, or collecting rents or profits of a marijuana business would, consequently, be violating the CSA.   

Recently, the United States Bankruptcy Court for the Central District of California broke from the routine and highlighted a path through which a distressed cannabis business may be able to pursue bankruptcy under federal law. The court in In re: The Hacienda Company, LLC allowed a former cannabis company to continue its Chapter 11 bankruptcy where the debtor company had, prior to filing its bankruptcy petition, stopped operating as a cannabis business itself and had transferred its intellectual property to a Canadian cannabis business in exchange for stock in that foreign company. The court paid homage to the CSA and to why violations of non-bankruptcy laws such as the CSA might establish cause to dismiss a cannabis debtor’s bankruptcy proceedings, but drew a distinction between pre-bankruptcy petition violations of law and post-bankruptcy petition violations, which it viewed as more problematic. Using that dichotomy as a guide, the court applied what it called a “middle road” approach — in which a bankruptcy court uses its discretion based on facts and circumstances — to determine whether the debtor’s connections to cannabis profits or past or future investments in cannabis warrant dismissal of its petition. The court noted that although indirect connections with illegal activity might violate non-bankruptcy law, the degree of the connection to that activity is important in deciding whether to dismiss the case. The court allowed the debtor’s Chapter 11 to proceed because the company had removed its wholesale cannabis product manufacturing and packaging business by the time it filed and was not looking to reorganize as a cannabis going concern. The Hacienda opinion marks a significant shift away from the U.S. trustee’s traditional “zero-tolerance” approach to cannabis and cannabis-related debtors and toward a more fact-based, case-by-case assessment and determination. After Hacienda, there is at least a glimmer of hope for failing cannabis businesses and creditors of accessing remedies under federal bankruptcy laws, but only time will tell if its reasoning will catch hold in other jurisdictions.

While Hacienda signals promise for the future insolvent cannabis debtor, current cannabis debtors (and investor/lenders) are experiencing lagging economic conditions, supply chain issues, and other external factors that continue to significantly impact profitability in the industry. Cannabis businesses in Oregon, California and Colorado, among other states, have recently seen factors such as inflation and overproduction of cannabis push median prices for useable cannabis down considerably and deflate sales over the past year as consumers spend more on groceries, gas and utilities. In Mississippi, where the Medical Cannabis Program is in its infancy, lagging patient enrollment numbers and license approval backlogs are impacting producers and dispensers, raising concerns over whether owners and investors in this fledgling industry are financially able to continue operations long enough to turn a profit.  Compounding those issues is the looming license renewal deadlines for cannabis business license holders in Mississippi, which will cost cultivators between $15,000 (Tier 1) and $150,000 (Tier VI) and dispensaries $25,000.  The imminent financial pressures that accompany many of the startups in this industry could ultimately lead to ownership disputes, creditor defaults or other situations that may result in the need for restructuring or liquidation sooner rather than later.    

Without available bankruptcy options, debtors and creditors engaged in a cannabis business operating legally under state law may need to turn to state law remedies and non-bankruptcy restructuring or liquidation proceedings such as statutory common-law receiverships and assignments for the benefit of creditors. These alternatives are often not as “user friendly” as bankruptcy; they do not provide for an automatic stay or debt discharge as a remedial option, nor do they typically provide a well-developed and defined set of rights, powers and remedies as bankruptcy law. Nonetheless, these alternatives can provide effective forms of relief, particular where there are multiple competing creditors.  

In Mississippi, receivership proceedings are governed by statute, and the appointment of a receiver rests exclusively within the discretion of the trial court. Mississippi imposes very few statutory restrictions on the authority of a receiver, which is typically limited only by the order of appointment or agreement of the parties. As a result, a receiver in Mississippi can be vested with broad authority and discretion to tailor workouts, restructures, or liquidations that are consistent with (and are usually drawn from or influenced by) established bankruptcy principles and can possibly do so in a more efficient and economical manner than traditional bankruptcy proceedings.