Steve Schain of Hoban Law Group.

Most businesses fail, marijuana businesses fail more greatly, but neither marijuana businesses, nor their owners, are entitled to bankruptcy law protection.

Instead, because of marijuana's 100% federal illegality, and because bankruptcy can't be used to facilitate federally illegal activity or administer assets that can't be possessed or sold under federal law, bankruptcy protection is denied to both marijuana growers, processors, sellers and transporters—and the parties that own them.

Stated another way, despite spanning 34 states and generating $10.8 billion domestically in 2018, the legalized marijuana industry is deprived of a rudimentary business tool available to every other sector of commerce and essential to a business' sustainability and investor protection.

With bellwether cannabis deals crashing, marijuana's wholesale price-per-pound plummeting, and publicly traded cannabis stock share prices tumbling 40% during October 2019's second week, providing marijuana-related businesses (MRBs) and their owners with access to bankruptcy relief is beyond overdue.

Bankruptcy Protections

Generally governed by federal law, called the Bankruptcy Code, the bankruptcy system allows debtors to either dismiss or partially satisfy debts they are incapable of fully paying, and, upon filing, creates an "automatic stay" period during which creditors are prohibited from attempting to collect. Bankruptcy petitions are filed in a federal bankruptcy court governed by federal law, although state laws may determine how debtors' property rights are affected (i.e., validity of liens or exempting property from creditors).

Bankruptcy's most common form is a Chapter 7 liquidation in which the court appoints a trustee to collect and sell debtors' nonexempt property and distribute proceeds to creditors. Because most states allow debtors to keep essential property, Chapter 7 bankruptcies are usually "no asset" in which there are zero saleable assets to fund a distribution to creditors.

Bankruptcies allowing debtors to keep some or all of their property, reorganize and use future earnings to pay off creditors fall under Code Chapters 11, 12 or 13. Individual debtors usually file under Chapter 13, business entities file under Chapter 11 and Chapter 12 filings mirror Chapter 13, but are only available to "family farmers" and "family fisherman" and provide more debtor favorable terms.

Marijuana Related Businesses

Marijuana Related Businesses (MRBs) take two forms: plant touching and nonplant touching.

Those cultivating, processing, transporting, distributing or dispensing marijuana, (i.e., literally touching marijuana at some point along the supply chain), are deemed plant touching enterprises, see "FIN-2014-G001: BSA Expectations Regarding Marijuana-Related Businesses," FinCEN, Feb. 14, 2014. Licensed and regulated by the state, plant touching MRB's include those planting, cultivating, harvesting, processing/extracting, testing, packaging, disposing, transporting and dispensing marijuana, see U.S. Senate, "S. 1726: Marijuana Businesses Access to Banking Act of 2015," July 9, 2015; Representatives, H. R. 2076, April 28, 2015. Further, any entity having a financial or controlling interest (regardless of ownership percentage) in a plant touching MRB, including investment or management shell companies, are deemed plant touching MRBs.

Businesses providing products and services to plant touching MRBs, but not directly manufacturing, processing, transporting, distributing or dispensing marijuana, are nonplant touching MRBs and include: advertising, public relations and marketing agencies; banking, payment processing and armored car services; commercial real estate (landlord and property management); construction, plumbing and electrical; professional services (accounting, legal, insurance, lobbying and consulting); hydroponics and cultivation products; packaging and supplies; investment; professional training and education; support items retailer (paraphernalia); security services and equipment; technology and software; and testing and lab services.

The Comprehensive Drug Abuse Prevention and Control Act of 1970 currently lists marijuana next to heroin as a Schedule I controlled substance having "a high potential for abuse" and for which there's "no currently accepted medical use in treatment" and "a lack of accepted safety for use" "under medical supervision." The CSA prohibits marijuana's cultivation, distribution, dispensation and possession and, pursuant to the U.S. Constitution's supremacy clause, state laws conflicting with federal law are generally preempted and void, as in Wickard v. Filburn, 317 U.S. 111, 124 (1942) ("No form of state activity can constitutionally thwart the regulatory power granted by the commerce clause to Congress").

Bankruptcy Protections Denied to MRBs and Their Owners

Because the bankruptcy system cannot be used to facilitate illegal activity and the Code provide no mechanism to administer assets that cannot be legally possessed or sold under federal law, bankruptcy protection is unavailable to both plant touching MRBs and the parties that own them.

First, because the U.S. trustee program prohibits debtors with marijuana-derived income or assets from proceeding, plant touching MRBs, Chapter 7 petitions are usually dismissed upon filing. see April 26, 2017 Letter from Clifford J. White, director, Executive Office for the U.S. Trustee to Chapter 7 and Chapter 13 ("It is the policy of the U.S. trustee program that the U.S. trustees shall move to dismiss or object in all cases involving marijuana assets on grounds that such assets may not be administered under the Bankruptcy Code …. ").

Second, even if a compliant, state-licensed MRB debtor is involved, most bankruptcy courts dismiss cases involving marijuana-derived income or assets, as in In re Arenas, 535 B.R. 845 (B.A.P. 10th Cir. 2015) (denial of marijuana grower/seller and legal dispensary landlord's motion to convert to Chapter 13 and Chapter 7 dismissal because debtor unable to propose feasible plan without violating federal law and the trustee's estate administration duties by selling debtors' assets); In re Medpoint Management, 528 B.R. 178 (Bankr. Az. 2015) (dismissing "owner of intellectual property leased to marijuana products seller" due to "dual risk" of assets' potential forfeiture and trustee's CSA violation in administering estate). Further, segregating plant touching MRB funds from other monies may not help. In re Johnson, 532 B.R. 53, 56-57 (Bank. W.D. Mich. 2015) ("Irrespective of any segregation of funds, the court and standing trustee carrying out respective statutory duties will inevitably support the debtor's criminal enterprise"); In re Olson, BAP 9th Cir. 2018 No. NV-17-1158-LTiF (concurring opinion stating that debtors "connected to marijuana distribution cannot expect to violate federal law in their bankruptcy case . … ").

This "bankruptcy protection denial" also may extend to nonplant touching MRBs in In re Way to Grow, (Bankr. D. Col., Dec. 14, 20l8 No. 18-14330) (because hydroponics equipment seller knew or had reason to believe that customers would use equipment to grow marijuana, bankruptcy dismissed because business deemed illegal under 21 U.S.C. Section 843(a)(7)).

Some jurisdictions allow debtors to re-seek bankruptcy relief after ceasing marijuana related activity, as in In re ARM Ventures, 564 B.R. 77, 86 (Bankr. S.D. Fla. 2017) (denying plan confirmation premised upon leasing commercial property under Section l129(a)(3) to the MRB, but providing the debtor an opportunity to file a plan not dependent on the MRB as an income source); In re Johnson, 532 B.R. 53 (Bank. W.D. Mich. 2015) (despite recognizing that "growing and selling marijuana as a licensed caregiver" the business violated federal law, dismissal not required ordering debtor to cease using any estate property in MRB activities and destroy marijuana plants and byproducts); In re Olson, B.A.P. 9th Cir. 2018 No. NV-17-1158-LTiF (reversing and remanding sua sponte dismissal of "92-year-old legally blind assisted living facility living debtor and licensed dispensary property lessor" because court failed to articulate dismissal's legal basis or make supporting factual findings).

Also, because a distinction exists between a Chapter 11 reorganization plan's proposed activity and its execution and substantive provisions, an exception has been recognized for a plan MRB rent and sale proceeds funded plan not listed in proposed plan, as in Garvin v. Cook Investments NW, 9th Cir. May 2, 2019 D.C. No 3:17-cv-05516-BHS (because Chapter 11 reorganization plan did not specify that portion of funding derived from marijuana grow's rent payments, no Section l129(a)(3) "proposed in good faith and not by any means forbidden by law" disqualification occurred because prohibition regards plan and not actual payments).

Third, although plans founded upon marijuana's cultivation or sale or other CSA violative conduct cannot be confirmed, plans not dependent on any marijuana-related assets may be confirmed. In re McGinnis, 453 B.R. 770 (Bankr. Or. 2011) (because dependent on federal law violating conduct and not satisfying Section l325(a)(3)'s feasibility, Chapter 13 plan funded from leasing property to growers and marijuana sales profits could not be confirmed); Cook Investments NW, W.D. WA 2017 Case No. 3:17-cv-05516-BHS (rejecting trustee's broad Section 1129(a)(3) interpretation and upholding plan confirmation when debtor rejected state-licensed grower's lease and payments were to be made from non-marijuana related income). Questions critical to this determination include whether creditors are being fully paid from other nonmarijuana ­related areas and must the debtor demonstrate that tenant actually vacated or stopped performing under the lease.

Fourth, depending applicable jurisdiction's law's favorability, state court receiverships may provide a workaround to a trustee's inability to liquidate plant touching MRB assets. For example, Washington state's robust "bankruptcy-like" receivership statutes provide an extendable 60-day stay (mirroring 11 U.S.C. Section 362 automatic stay) and authorize courts to appoint a receiver to liquidate an MRB's assets and distribute proceeds to creditors. Similarly, Oregon's "Standards for Authority to Operate a Licensed Business as a Trustee, a Receiver, a Personal Representative or a Secured Party" are statutes and administrative rules bridging the bankruptcy gap by allowing creditors to seize and sell cannabis.

Steve Schain is senior counsel to global cannabis law firm Hoban Law Group. With 17 offices and 52 lawyers, Hoban Law Group is only practice 100% devoted to cannabis and hemp law. Admitted to practice in Pennsylvania and New Jersey, Schain represents entities, governments and individuals in litigation, regulation, compliance, preparing and submitting license applications, entity formation and drafting legislation. Contact him at [email protected].