Limited Options for Cannabis-Related Company Liquidations
Many companies (both public and private) in the cannabis sector were struggling to raise capital, achieve liquidity or establish sufficient cash flow under prevailing market conditions that were buffeting the industry prior to chaos wrought by the Coronavirus pandemic. The pandemic may prove to be the final nudge that pushes many over the edge. However, because marijuana is still illegal for all purposes at the federal level, these companies will not be able to use the remedy that most failing businesses do: federal bankruptcy law. Instead (absent new federal legislation), they will have to cope with a varied and unpredictable landscape of state laws. This uncertainty is something that all participants in this industry sector must take into account, whether they are acting as an investor, lender, or vendor.1
Companies in the cannabis industry and individuals working in cannabis-related businesses have sought to turn to the federal bankruptcy courts for relief when they became insolvent. While federal bankruptcy courts have taken jurisdiction for bankruptcies of companies focused on federally legal, industrial hemp2, the United States Trustee Program (the arm of the Department of Justice tasked with upholding the integrity of the bankruptcy system) has repeatedly challenged the ability of companies focused on medical or adult use cannabis, and even individuals whose income was derived from such entities, to seek the protection of the bankruptcy courts because marijuana is illegal federally.3 With few exceptions, bankruptcy courts throughout the country have thrown out cases related to medical and adult use cannabis.4 This is true, even where the debtor’s involvement in these areas may be smaller as a portion of its total operation (for example, when only a portion of the debtor’s income is received from a cannabis-related enterprise).
Because bankruptcy is not available, such enterprises must look for state law options to wind down or reorganize their businesses. Some cannabis enterprises have sought receivers under state law. Receivers are officers of the court, and state courts commonly appoint them to run failing businesses, with an eye toward liquidation of the business’s assets or a sale of the operating business. Courts generally have wide latitude in determining what actions a receiver may take in the performance of his or her duties. While a formal court-ordained “reorganization” is theoretically possible for a company banned from bankruptcy court (and hence potentially free of the preemption of many state laws and remedies that arises from the Bankruptcy Code), it is far more likely that a court-approved sale of assets will remain the fundamental model in receiverships. A possible exception would be a case in which equity reinvested, but only after the stability and channeling of a state court receivership had corralled its creditors as a practical matter.
However, this general flexibility is not unlimited. In one of the first (if not only) decisions on receivers for cannabis industry, the Colorado Court of Appeals reversed a lower court decision that had appointed a receiver over a cannabis business because the chosen receiver was not licensed to operate a cannabis business under the state’s regulations.5 The court found that even though it had broad power to appoint a receiver and determine the scope of the receiver’s powers and duties, it could not contravene state law and allow an individual who did not have the appropriate license to run a cannabis business.
Washington State has anticipated this issue and has provided for receiverships of cannabis businesses in its regulations governing such businesses. Under Washington’s marijuana regulations, a receiver or other trustee or fiduciary appointed over a marijuana business may be given written approval to continue selling marijuana, or taking other related actions. The receiver or trustee must be a resident of Washington State, and must pass a criminal background check. Oregon also provides for a receiver to apply for permission to temporarily operate a marijuana business in order to dispose of its assets. These temporary authorizations generally run for 60 days, but may be extended.
After the Yates decision, Colorado also amended its law to allow court-appointed receivers to temporarily manage cannabis businesses upon a certification to the court that it is not prohibited from operating such a business and timely apply to the state for certification. Only a handful of other states have addressed this issue through legislation. For example, Oklahoma, which has not legalized recreational cannabis use, but does allow medical use, has a statute which allows a secured creditor or receiver to operate the medical cannabis business if they apply to the state licensing authority. The Oklahoma statute also contemplates foreclosures or sales of such businesses as going concerns. Also, on March 3, 2020, Michigan’s House of Representatives approved a change to the state’s cannabis law that provides that the regulatory agency may approve the operation of a cannabis facility by a court-appointed receiver or trustee. This legislation has not yet been voted on in the Michigan Senate.
It is likely that in states where cannabis has been legalized, but where the state’s laws or regulations do not provide for permission for receivers to operate cannabis businesses, a result like the one described above in the Yates case will occur, and the receiver will need to be licensed by the state in order to accept the receivership. This could delay appointment of receivers, to the detriment of employees and creditors of distressed cannabis businesses. Because liquidation options are currently limited and in many cases, untested, investors and other stakeholders in the cannabis industry must be prepared to employ creative solutions to address this issue.
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1 This uncertainty is well-illustrated by a recent federal court case from Nevada (where medical and recreational cannabis is legal) in which a lender sued a cannabis cultivation business for breach of contract stemming from failure to repay a loan. Bart Street III v. ACC Enterprises, LLC, Case No. 17-00083 (D. Nev. Apr. 1, 2020) [Dkt. No. 205]. Defendants argued that the entire loan agreement violated the federal Controlled Substances Act (”CSA”) because it involved a cannabis business. However, the court initially ruled that only certain portions of the contract were potential violations of the CSA, including plaintiff’s right of first refusal to obtain equity in the defendant entities if any amounts were still owed under the loan. However, at the pleading stage the court declined to determine whether those portions were severable, which would have left the remainder of the loan contract intact. On April 1, 2020, the court denied summary judgment to both parties on the issue of severability, finding that it did not have sufficient facts to determine whether plaintiff’s motivation in obtaining the right of first refusal was collateral to the overall loan agreement. However, the court did grant summary judgment to defendants on plaintiff’s alternative unjust enrichment theory because the court found the CSA preempted Nevada law and the court could not enforce an illegal contract. In a warning to potential cannabis investors, the court specifically found that “[a]llowing Plaintiff’s recovery for unjust enrichment would undermine enforcement of federal law by giving prospective investors increased confidence in funding marijuana businesses.” Id. at p. 18.
2 See, e.g., In re GenCanna Global USA, Inc., Case No. 20-50133-grs, U.S.B.C. E.D. Ky.
3 Clifford J. White III and Johan Sheahan, “Why Marijuana Assets May Not be Administered in Bankruptcy”, United States Dep’t of Justice
4 See, e.g., In re CWNevada, LLC, 602 B.R. 717 (Bankr. D. Nev. 2019) (dismissing Chapter 11 case of cannabis business); In re Andrick, 604 B.R. 577 (Bankr. D. Colo. 2019) (denying confirmation of a Chapter 13 plan for several reasons, including the Debtors’ request to spend a significant portion of their income on medical marijuana was not reasonably necessary where it was prohibited by federal law).
5 Yates v. Hartman, 2018 WL 1247615 (Colo. Ct. App. Mar. 8, 2018).
