With zilch in the till and creditors crashing through the door, what’s a respectable Cannabis business to do?
Although federal bankruptcy protection is presently unavailable, Marijuana Related Businesses (“MRBs”) may obtain financial distress relief via “workouts” or state law receivership’s or assignments for the benefit of creditors (“Creditors’ Assignment”).
While not providing an “automatic stay”, and often resulting in a loss of control, workouts, receivership’s and Creditors’ Assignment reassure creditors of debtor’s debt parameters, financial viability and commitment to repay, cost effectively and swiftly resolve a dispute, and enable an MRB to resume operations and pay its debts.
“Plant Touching” and “Non-Plant Touching” MRBs
Marijuana Related Businesses take two forms: “Plant Touching” and “Non Plant Touching”. Licensed and regulated by the state, Plant Touching MRB’s include those planting, cultivating, harvesting, processing/extracting, testing, packaging, disposing, transporting, and dispensing marijuana. “FIN-2014-G001: BSA Expectations Regarding Marijuana-Related Businesses,” FinCEN, February 14, 2014; 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 MRB’s. “FIN-2014-G001: BSA Expectations Regarding Marijuana-Related Businesses,” FinCEN, February 14, 2014.
Businesses providing products and services to Plant Touching MRB’s, but not directly manufacturing, processing, transporting, distributing, or dispensing marijuana, are “Non Plant Touching” MRB’s 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.
Bankruptcy’s Unattainable Protections
Generally governed by federal law, called the “Bankruptcy Code” (“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 (ex., 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’ non-exempt property and distribute proceeds to creditors. Because most state allows debtors to keep essential property, Chapter 7s 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 Chapter 13s, business entities file Chapter 11s, and Chapter 12 filings mirror Chapter 13 but are only available to “family farmers” and “family fisherman” and provide more debtor favorable terms.
Because of marijuana’s one hundred percent (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 “Plant Touching” and “Non-Plant Touching” MRBs. Comprehensive Drug Abuse Prevention and Control Act of 1970, 21 U.S.C. §§ 801, Et. Seq (1970).
First, because the United States Trustee Program prohibits debtors with marijuana-derived-income-or-assets from proceeding, Plant Touching MRB’s Chapter 7 petitions are usually dismissed upon filing. April 26, 2017 Letter from Clifford J. White, Director, Executive Office for the United States Trustee to Chapter 7 and Chapter 13.
Second, even if a compliant, state licensed MRB debtor is involved, most bankruptcy courts dismiss cases involving marijuana-derived-income-or-assets. 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 trustee’s estate administration duties by selling debtors’ assets); In re Medpoint Management, LLC, 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).
This “bankruptcy protection denial” also may extend to Non Plant Touching MRBs. In re Way to Grow, Inc., (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. §843(a)(7)).
A non-judicial process through which a financially distressed business negotiates with creditors individually or en masse to restructure debt’s amount and establish repayment terms, workouts are the first and most powerful line of defense.
Similar to a Chapter 11 bankruptcy, workouts allow a debtor to propose terms in a “composition agreement” defining exactly what is owed, proposing a restructuring of debtor’s “universe of debt”, providing a pro rata payment schedule of both arrearage and to-be-incurred debt payments, and listing defined source of funds from which payment will be made.
Beyond reassuring creditors of debtor’s universe of debt, financial viability and commitment to repay, workouts cost effectively and swiftly resolve a dispute, enable a debtor to confidently resume or fortify operations, and triggers repayment stream into creditors hands.
Often initiated by disgruntled owners or concerned creditors, “receiverships” mirror
Chapter 11 bankruptcy in being a non-liquidating judicial process and requires a state court filing following which a court appointed receiver guides a financially troubled MRB through its insolvency.
The receiver’s efforts span from operating troubled company “as is”, restructuring entity’s operations (ex., hiring/firing, debt payment hierarchy and workouts, winding-down or eliminating operational components), and selling business either in whole or in pieces.
Unlike a workout, which usually leaves leadership intact and presumes “pre-workout operations resumption” at its conclusion, a company in receivership’s stakeholders generally are unable to either select the receiver or run the company following the proceeding’s close. Stated another way, because it forms a “current leadership ‘no confidence’ vote”, receiverships usually result in prior leadership’s permanent removal (whom are often also smaller entities’ owners), recruiting new management, and ensuing uncertainty and growing pains resulting from a managerial shift.
Further, although not expressly prohibited (like under federal law), state law issues and uncertainty may impede extent to which receiver can operate, and dispose assets of, a Plant Touching MRB. First, a “license” to grow, process, sell and transport is often MRB’s greatest asset and each of the 34 legalized marijuana state’s programs have strict rules regard both licenses’ transfer and sale of shares in licensee. Second, only
three (3) states, California, Oregon, and Washington, have promulgated “disposition of assets” regulations under their respective enabling statutes authorizing “third party cannabis businesses operations”. Thus, in the absence of supporting “black letter law”, forging consensus among decision makers or obtaining judicial support may be difficult.
Third, although “receiverships” are equitable proceedings in which the court may authorize a receiver to operate, and dispose of the assets of, an MRB, approval from the respective state regulators may be necessary.
Assignment for Benefit of Creditors
Mirroring a Chapter 7 bankruptcy liquidation proceeding, 38 states have Creditors’ Assignment statutes in which the debtor MRB transfer its assets to a trust administered by an “assignee” selected by the MRB, which, in turn, liquidates the assets and distributes the proceeds to the MRB’s creditors.
Because the MRB has divested itself all of its assets and is, essentially, judgement proof, barring rights to collect against third parties like guarantors, unsecured creditor claims against the asset-less MRB are rendered worthless. Parties rights that are secured by the MRB’s assets travel with the assets and any secured party like a mortgage or Uniform Commercial Code lien holder can proceed directly against the transferred asset.
Creditors Assignments are usually swifter and cheaper than Chapter 7 bankruptcy liquidation and, unlike a receivership, allow financially distressed MRB to select its assignee. However, in light of the cannabis industry’s nuanced and highly regulated nature, selecting an assignee deeply knowledgeable of the industry’s operations and applicable law will be critical.
Also, as with receiverships, because each of the 34 legalized marijuana programs have strict respective rules regarding licenses’ transfer and sale of shares in licensee, state law issues and uncertainty may impede extent to which assignee can dispose of Plant Touching MRB’s assets.