As the cannabis industry matures, there will be winners and losers. Losers lack access to the U.S. Bankruptcy Code. Marijuana related assets cannot be sold free and clear of liens and encumbrances via the tried and true bankruptcy section 363 sale, which leaves the loser’s creditors without the best tool to maximize the value of the loser’s assets, and deprives acquirers of a federal court order conveying assets. What’s the state of play, and what’s the alternative for the losers, their creditors, and the companies that would acquire them?
STATE OF PLAY
The United States Trustee Program (“USTP”), as the bankruptcy system watchdog, has long taken the position that the system may not be used as in instrument in committing a crime, and that trustees and estate fiduciaries may not administer assets in violation of federal criminal law.[1] The prohibition extends beyond sellers and growers to landlords who knowingly rent, manage or use property “for the purpose of manufacturing, distributing, or using any controlled substance;” manufacturers of drug paraphernalia, and anyone “who derives profits or proceeds from an offense [of the Controlled Substances Act].”[2]
Bankruptcy cases have been dismissed where the plan had to be funded with rental income from a dispensary,[3] because the plan couldn’t be proposed “by means forbidden by law,”[4] and because the debtor proposed segregating, but continuing to use, proceeds of his medical marijuana business, which is property of his bankruptcy estate.[5] Similarly, landlord debtors’ plans depending on dispensary income were deemed unconfirmable,[6] and dismissed for “gross mismanagement” due to “criminal activity.”[7] A provider of hydroponic and gardening supplies for cannabis was also denied relief.[8]
ALTERNATIVES TO BANKRUPTCY
Cannabis companies face a challenging landscape: high taxes, oversupply, security concerns. Insolvency relief is available under state law remedies. Acquirers of cannabis assets may also wish to buy those assets at state law foreclosures, for protection against fraudulent transfer, successor liability and junior encumbrancer claims.
Trade Creditor Agreements can be utilized where there is a viable business, and the debtor can obtain the consent of a high percentage of its creditors to defer or reduce repayment. Generally, the debtor presents a plan for repayment to its creditors, and promises to consummate it upon receiving consent of at least 85% of trade creditors. Such agreements are voluntary, but can be effective if the debtor has decent prospects and at least fair relationships with its creditors.
Assignment for the benefit of creditors (“ABC”) is another voluntary transaction where the cannabis debtor transfers its assets to an “Assignee,” whose job is to liquidate the debtor’s assets and distribute the proceeds of those assets to creditors. If the Assignee is experienced and transparent, most creditors are satisfied with a voluntary plan of action for liquidation of assets, and will stand down on collection activities. Because most ABC’s are not court-supervised, some creditors will not deem it trustworthy. Additionally, issues concerning transferring licenses arise both regarding the Assignee and any prospective acquirer.
Foreclosure proceedings offer a statutory model for conveying real estate and personal property free and clear of junior liens. While effective at transferring assets, neither a mortgage foreclosure nor a private or public disposition under the Uniform Commercial Code (“UCC”) can transfer a license to sell or grow cannabis. Mortgage foreclosures and UCC sales can be judicial or non-judicial, but most UCC sales are non-judicial.
State law receiverships are often modeled after the bankruptcy code, and contain analogous protections and provisions. In cannabis legal states, a receivership can result in a court order permitting the transfer of assets free and clear of liens and encumbrances, and is an effective tool for “washing” the cannabis assets. The downside of state law receiverships is that they rarely permit existing management to operate the business. Issues often arise regarding a receiver’s statutory authority to operate a licensed cannabis business without a license, which is both an impediment to receivership and opportunity for the licensee to play a role in the receivership.
Until Congress joins the majority of states that have legalized cannabis, industry players should look to one or more of the above state law remedies for insolvency relief.
[1] “Why Marijuana Assets May Not Be Administered in Bankruptcy.” American Bankruptcy Institute, 1 Dec. 2017, https://www.abi.org/abi-journal/why-marijuana-assets-may-not-be-administered-in-bankruptcy. [subscription required]
[2] Controlled Substances Act, 21 U.S.C. §§ 801 et seq.
[3] In re Arenas, 535 B.R. 845 (10th Cir. B.A.P. 2015).
[4] In re Mother Earth’s Alternative Healing Cooperative, Inc., case no 12-10223-LT11, Dkt no. 54 (Bankr. S.D. Cal October 23, 2012).
[5] In re Johnson, 532 B.R. 53 (Bankr. W.D. Mich. 2015).
[6] Arm Ventures, LLC, 564 B.R. 77 (Bankr. S.D. Fla 2017).
[7] In re Rent-Rite Super Kegs West Ltd, 484 B.R. 799 (Bankr. D. CO 2012).
[8] In re Way to Grow, Inc., 597 B.R. 111 (Bankr. D. CO 2018)
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