Page 4 - Corporate Restructuring And Bankruptcy

S4 | MONDAY, DECEMBER 5, 2016 | Corporate Restructuring and Bankruptcy | NYLJ.COM
Up in Smoke: Why Marijuana Companies Can’t File Bankruptcy and How That Could Change
BY ELOY A. PERAL
V oters in eight states, including California and Florida, recently approved ballot initiatives to legalize the recreational
and medical use of marijuana. Presently, 28 states permit the use of marijuana to differ- ent extents.
Even before the entry of these states to the market, the multi-billion dollar marijuana industry was growing quickly. As the industry has grown, so has the number and variety of individuals and businesses, including sophisticated investors, who have jockeyed to pro t from its growth. However, despite its growth in recent years, the industry faces a host of challenges stemming from the reality that using or pro ting from marijuana in any fashion, even if it is legal under state law, remains a federal crime under the Controlled Substances Act of 1970 (the CSA).1 This article examines one of these challenges: the ability to take advantage of the Bankruptcy Code.
Recent court decisions have made it clear that individuals and businesses that under
ELOY A. PERAL is an attorney at Wilk Auslander in New York.
Recent court decisions have made it clear that individuals and businesses that under state law lawfully earn income that in any way derives from marijuana are entirely foreclosed from seeking bankruptcy protection. Because of this broad exclusion, even businesses that are not directly involved in the production, distri- bution, or sale of marijuana may be denied the protection of the bankruptcy courts.
§1112(b) of the Code, which provides that a case may be dismissed for “cause.” Rent-Rite is the only reported decision to address this issue under Chapter 11. The judge in Rent-Rite appeared to be hostile to what he considered the debtor’s open disregard of the CSA.
More recently, the courts have adopted a more nuanced approach in addressing the ability of individuals who derive their income from marijuana businesses. In In re Arenas3 the debtors, a married couple, jointly owned a commercial building in Denver that consisted of two units. One of the debtors grew and sold marijuana in one unit and the other unit was leased to a non-af liated marijuana dispen- sary. The debtors derived approximately 70 percent of their income from marijuana and the remainder of their income was obtained from a pension and Social Security income.
The debtors led a petition under Chapter 7 of the Code (the liquidation chapter). During the bankruptcy case, the non-af liated dispen- sary expressed an interest to the Chapter 7 trustee to purchase the property. The Of ce of the U.S. Trustee (an agency within the U.S. Department of Justice (the DOJ) responsible for overseeing the administration of bank- ruptcy cases) led a motion to dismiss the case, arguing that it would be impossible for the Chapter 7 trustee to sell the property, which was entirely used by two marijuana businesses, without violating federal law. The debtors opposed the U.S. Trustee motion to dismiss and led a motion to convert their case to one under Chapter 13 of the Code (the chapter for individuals who want to adjust their debts rather than liquidate). The bank- ruptcy court found that there was “cause” to dismiss the Chapter 7 case (under §707(a)) and to refuse to convert the case to a Chapter 13 (under §1307(c)).
The Bankruptcy Appellate Panel (BAP) af rmed the dismissal of the case and refused to convert the case for two reasons. First, the BAP agreed with the bankruptcy court that neither a Chapter 7 nor Chapter 13 trustee could lawfully administer the bankruptcy estate’s assets, because doing so would require a trustee to knowingly violate fed- eral law (the CSA). Second, the BAP agreed that the debtors did not have suf cient non- marijuana derived income to feasibly fund their Chapter 13 plan of rehabilitation.
In In re Johnson4 the Michigan bankruptcy court, applying reasoning slightly different than in Arenas (and relying on distinct sec- tions in Chapter 13), came to the same con- clusion, i.e., that income and other assets illicitly obtained under federal law cannot be administered in a bankruptcy case. Johnson was a Chapter 13 case in which the debtor was a licensed “caregiver” and marijuana grower under the Michigan Medical Mari- huana Act. The debtor earned nearly half of his income from his marijuana business (the remainder was social security » Page S9
state law lawfully earn income that in any way derives from marijuana are entirely foreclosed from seeking bankruptcy protection. Because of this broad exclusion, even businesses that are not directly involved in the production, distribution, or sale of marijuana may be denied the protection of the bankruptcy courts. However, a close examination of these cases reveals their limitations and potential opportunities for certain individuals and busi- ness to seek bankruptcy protection, despite receiving income from marijuana sales.
In re Rent-Rite Super Kegs W. Ltd. (Rent-Rite) was the rst reported decision to address how the con ict between the CSA and state law affects the ability of a business that pro ts from marijuana to seek bankruptcy relief.2
In Rent-Rite, the debtor led a bankruptcy petition under Chapter 11 (the reorganiza- tion chapter) of the U.S. Bankruptcy Code (the Code) in Colorado. The debtor owned a warehouse and leased space to certain ten- ants for the cultivation of marijuana. The rent received by the debtor equaled 25 percent of its income. The bank who held a mortgage on the warehouse led a motion to dismiss the bankruptcy case on the grounds that ling for bankruptcy was illegal under the CSA. The bankruptcy court agreed, holding that, even though the debtor’s business operation was legal under Colorado law, it had discretion to dismiss or convert the bankruptcy case due to the debtor’s violation of the CSA based on: (1) the unclean hands doctrine and; (2)
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