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Not So High on Bankruptcy – Limited Options for Medical Marijuana Companies Facing Insolvency

Not So High on Bankruptcy – Limited Options for Medical Marijuana Companies Facing Insolvency
by Sean Sonnenberg

November 7, 2018

By: Jason Johnson & Tara Tedrow

It may be hard to believe, but it’s been 22 years since California became the first state to permit the legal use of medical marijuana. In the years since, it has been impossible to ignore the changing tide of public opinion on marijuana, or at least on the use of marijuana as a medicinal treatment. Since 1996, a total of 31 states—including Florida—have legalized the use of marijuana as a drug.

As a result of such state-level laws, an entire industry—from growers to dispensaries and every imaginable type of ancillary services—has sprouted and flourished nationwide. As a result of the industry’s widespread success, significant marijuana-related assets have been accumulated. From stock options, real estate, analytical and processing equipment, to patents and trademarks, marijuana companies own significant assets that could be at risk depending on their financing.

What happens, though, when businesses in this industry aren’t successful? One option a struggling business might normally consider is filing for bankruptcy protection. Bankruptcy is a tool used by millions of businesses and individuals each year to restructure and eliminate debt, jettison cumbersome contracts and leases, and otherwise operate as a financial pressure relief valve. It might not be available to a business or individual with marijuana assets, though.

All bankruptcy cases are heard in federal court, as our bankruptcy laws are codified under federal law (specifically, Title 11 of the United States Code). Believe it or not, bankruptcy cases make up a full two-thirds of all cases in the federal courts system. So why might a business or individual not be able to avail themselves of this process? Though there are many different ways to explain it, they all stem from one ultimate answer: the Controlled Substances Act, found at 21 U.S.C. § 801, et seq (“CSA”). Because the CSA still classifies marijuana as a Schedule I drug that is illegal to grow, process, distribute or prescribe, the bankruptcy system cannot be used to facilitate illegal activity and the Bankruptcy Code does not provide a means to administer assets that cannot legally be possessed or sold under federal law.

Unfortunately for those in the medical marijuana industry, state laws permitting the cultivation, distribution and sale of medical marijuana run afoul of, and are therefore preempted by, the CSA. Accordingly, any assets obtained as a result of such activities are assets that cannot legally be possessed or sold, at least as far as federal law is concerned.

This ultimately means that any business or individual with marijuana assets filing for bankruptcy is subject to the almost-certain filing of a dismissal motion by the United States Trustee—the arm of the Department of Justice tasked with overseeing and protecting the integrity of the bankruptcy system. The basis of such motion is that allowing the debtor to stay in bankruptcy would require the trustee administering the case to violate federal law by having to dispose of assets that may not be legally possessed or sold under federal law, or that a business or individual would not be able to confirm a plan that would be funded from activities forbidden under federal law. The Director of the Executive Office for United States Trustee has instructed that such dismissal motions are to be filed in all bankruptcy cases involving marijuana assets, and such motions are almost always granted.

The lack of protection in bankruptcy for businesses and individuals involved in the medical marijuana industry is one of many obstacles the industry has to navigate, and it is perhaps the unintended impact most detrimental to those who would otherwise be able to deal with their creditors in an orderly manner. Since the current stance of the United States Trustee is unlikely to change (short of an overhaul to the CSA), businesses should carefully review the terms of their financing agreements. For those in considering their options for marijuana industry financing and protecting the assets of their business long-term, consulting with a lawyer knowledgeable in the field is always advised.

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