Cannabis Bankruptcy 101

24 Aug Cannabis Bankruptcy 101

In a prior post, we discussed some of the emerging trends for cannabis-related companies that seek bankruptcy protection (click here to view the prior post). But, in the first instance, the question is whether a cannabis-related company can file for bankruptcy relief? This post will examine the first decision from Arizona in the case of In re Medpoint Management, LLC, Case No. 2:14-bk-15234-DPC., which was issued on April 6, 2015. The Medpoint decision was rendered by the Honorable Daniel P. Collins, who was the Chief Judge for the District of Arizona at the time of this decision.

The Medpoint case commenced with an involuntary petition filed by three petitioning creditors of Medpoint. Once an involuntary petition is filed, the purported debtor has a chance to answer the petition and seek to dismiss the case. That is exactly what happened in the Medpoint case.

Background Facts

Medpoint is a limited liability company formed under the laws of Arizona. Medpoint was a dispensary-management company that operated under Arizona Nature Wellness’ (“ANW”) dispensary certificate. Medpoint formerly managed ANW’s marijuana business, business relationships, and cultivation operations. ANW had no employees, but Medpoint employed approximately 70 people. Medpoint purchased an interest in another entity that held the management contract with ANW. In May 2014, ANW terminated its relationship with Medpoint because ANW was dissatisfied with Medpoint’s performance under the management agreement. Medpoint defaulted on a variety of other agreements with the petitioning creditors.

Issues

While Medpoint made several arguments for why its case should be dismissed, the primary argument related to whether a debtor can lawfully administer a marijuana-related business without violating the Controlled Substances Act (21 U.S.C. §801 et. seq.).

The operative section of the Bankruptcy Code for seeking dismissal of a case is 11 U.S.C. § 707(a), which provides, in relevant part,

The court may dismiss a case under this chapter only after notice and a hearing and only for cause, including—(1) unreasonable delay by the debtor that is prejudicial to creditors; (2) nonpayment of any fees or charges required under chapter 123 of title 28; and (3) failure of the debtor in a voluntary case to file, within fifteen days or such additional time as the court may allow after the filing of the petition commencing such case, the information required by paragraph (1) of section 521(a), but only on a motion by the United States trustee.

Thus, the question before the Court was whether cause existed for the dismissal of Medpoint’s Chapter 7 case. Medpoint and the U.S. Trustee argued that dismissal was warranted, while the petitioning creditors argued that the Court should enter the order for relief under the Bankruptcy Code.

In reaching its decision that Medpoint’s case should be dismissed, the Court canvassed decisions from other districts that dealt with similar issues. Below is the discussion from the Court regarding the three cases it relied upon.

In Arenas, the bankruptcy court found cause to dismiss the debtor’s case because the debtor’s assets included marijuana and marijuana-related assets. In re Arenas, 514 B.R. 887, 892 (Bankr. D. Colo. 2014) (“The impossibility of lawfully administering the Debtors’ bankruptcy estate under chapter 7 constitutes cause for dismissal of the Debtors’ case under 11 U.S.C. § 707(a).”). The Arenas court held that “Debtors’ chapter 7 trustee . . . [could not] take control of the Debtors’ Property without himself violating §856(a)(2) of the CSA,” nor “liquidate the inventory of marijuana plants Mr. Arenas possessed on the Petition Date” without violating § 841(a) of the CSA. Id. at 891. Because the trustee was unable to perform his duties, the court found the bankruptcy case was futile.

In Vel Rey, the chapter 7 trustee wanted to operate the debtor’s property to increase its sale value. In re Vel Rey Properties, Inc., 174 B.R. 859 (Bankr. D. D.C. 1994). The trustee asked the bankruptcy court for immunity from liability for any noncompliance with D.C.’s housing regulations while he readied the property for sale. Id. at 863. The court denied the trustee’s request, noting that if either the trustee or the United States Trustee refused to serve for “concern[] about personal liability . . . the court could simply dismiss the case for cause under § 707.” Id. at 866 (citing Ohio v. Commercial Oil Serv. Corp., Inc., 58 B.R. 311 (Bankr. N.D. Ohio 1986)).

In another District of Colorado bankruptcy case, the debtor-in-possession was a landlord who received approximately 25% of its revenue from a marijuana entity. In re Rent-Rite Super Kegs W. Ltd., 484 B.R. 799, 802–803 (Bankr. D. Colo. 2012). The bankruptcy court found that renting to the marijuana entity exposed debtor to criminal liability and forfeiture of the real property. Id. at 809. Because of the risks associated with the marijuana tenant, the bankruptcy court held that the debtor’s continuing lease with the marijuana entity constituted “gross mismanagement of the estate” and was cause to dismiss under section 1112(b)(4)(B). Id.

Based upon the foregoing, the Court in Medpoint was strongly persuaded by the reasoning in these lines of cases, and thus, dismissed the Medpoint involuntary petition.

Conclusion

Several courts have found “cause” existed to dismiss bankruptcy cases when the putative debtor was directly involved in a cannabis business. At least regarding these types of businesses, the law is clear – a company that is directly involved in growing, cultivating, manufacturing or selling cannabis will not be eligible for bankruptcy protection. Where the law is less clear is when a debtor has a more attenuated relationship with a cannabis business. For those debtors, the only real options may be state court receivership or an unsupervised liquidation. The case law is continuing to evolve in this area.