Marijuana Businesses Barred from the Bankruptcy Courts: But How Far Will the Bar Extend?
As more and more states pass laws allowing the sale of marijuana, whether for medicinal or recreational purposes, investors will try to claim their share of what is certainly going to be a lucrative market. However, even in a growing market, private enterprises fail or need restructuring. This raises the question of whether distressed marijuana businesses, and those doing business with marijuana businesses, can seek relief under the Bankruptcy Code.
Since the George W. Bush Administration, the Office of the United States Trustee (the “UST”) has taken the position that marijuana businesses cannot seek bankruptcy relief. This position was reaffirmed in Congressional testimony given in June 2017 by Clifford White, the Director of the Executive Office for U.S. Trustees, and more recently in an article written by Mr. White and John Sheahan, a trial attorney for the UST, which was published in the December 2017 edition of the American Bankruptcy Institute Journal.
Underlying the UST’s position is the primacy of the federal Controlled Substances Act, 21 U.S.C. §§ 801, et seq. (the “CSA”) over conflicting state laws. According to the UST, the CSA raises two impediments in any marijuana business bankruptcy. First, “the bankruptcy system may not be used as an instrument in the ongoing commission of a crime, and reorganization plans that permit or require continued illegal activity may not be confirmed.” Second, “trustees and other estate fiduciaries should not be required to administer assets if doing so would cause them to violate federal criminal law.” Based upon these principles, the UST takes the position that it will move to dismiss any bankruptcy case filed by a marijuana business. In fact, bankruptcy courts have already rejected bankruptcy cases filed by businesses engaged in the legal cultivation and sale of marijuana or by their principals who would use marijuana business income to fund their individual plans. See In re McGinnis, 453 B.R. 770 (Bankr. D. Or. 2011) (court refused to confirm a Chapter 13 plan which would be funded by income generated by cultivating and selling marijuana); In re Johnson, 532 B.R. 53 (Bankr. W.D. Mich. 2015) (court held that Chapter 13 case would be dismissed unless the debtor stopped operating marijuana business, even though only part of the debtor’s income came from cultivating and selling marijuana); In re Mother Earth’s Alternative Healing Coop., Inc., Case No. 12-10223, Doc. No. 43 (Bankr. S.D. Cal. Oct. 23, 2012) (court dismissed Chapter 11 case filed by medical marijuana dispensary on the basis that the debtor was violating the CSA).
The UST’s position is not surprising when it is applied to companies directly involved in the cultivation and distribution of marijuana. However, the position becomes less tenable when it is applied to businesses that are ancillary to growers and distributors. For instance, under the CSA there is no distinction between a seller or grower of marijuana and those more downstream, such as landlords renting space to the seller or grower. See 21 U.S.C. § 856 (making it illegal to “manage or control any place, whether permanently or temporarily, either as an owner, lessee, agent, employee, occupant, or mortgagee, and knowingly and intentionally rent, lease, profit from, or make available for use, with or without compensation, the place for the purpose of unlawfully manufacturing, storing, distributing, or using a controlled substance.”). The UST will treat the landlord the same as the dispensary itself since both are acting in violation of the CSA.
This is perhaps the most troublesome aspect of the UST’s position. For instance, take the example of a commercial landlord who owns fifty commercial properties that it leases to various businesses. If one of those businesses was a medical marijuana dispensary opened in a state that permits medical marijuana, the landlord would not be able to access the bankruptcy courts simply because of its one dispensary tenant. This is exactly the result that has been reached in bankruptcy cases filed by landlords who leased properties to tenants legally engaged in the marijuana business. See In re Rent-Rite Super Kegs, 484 B.R. 799 (Bankr. D. Colo. 2012) (court dismissed Chapter 11 case filed by landlord who derived 25% of its revenue from marijuana business tenant); In re Arm Ventures, LLC, 564 B.R. 77 (Bankr. S.D. Fla. 2017) (court rejected Chapter 11 plan that was funded by income generated by rental payments received from marijuana dispensary, holding that the funds supporting a plan had to be legal under both state and federal law). The reasoning employed by the courts in dismissing the cases, namely that the landlords cannot fund a plan based upon property used in violation of the CSA or proceeds generated by the property, could even apply as you get further down the line from the actual marijuana business itself and could potentially impact any entity that derived income through business transactions with marijuana companies, no matter how small or insignificant that business relationship may be.
It remains to be seen how far the UST intends to push its position. Will the UST move to dismiss a bankruptcy case filed by a landlord who drives only an insignificant portion of its revenues from a legal marijuana business? Will a company that sells fertilizer to a legal marijuana grower be permitted to access the bankruptcy courts? Or will the UST seek to bar these companies from the bankruptcy court? The answers to these questions is uncertain. What is certain, however, is (a) that the UST will continue to oppose bankruptcy relief for marijuana businesses, and those related to the marijuana businesses, until the CSA is amended to permit the cultivation and distribution of marijuana, and (b) that state law permitting marijuana-based businesses will have no effect on questions of bankruptcy eligibility.