Marijuana And Bankruptcy: Not A Good Mix

Readers know all too well by now that generally speaking, the feds and state-legal marijuana businesses do not play nicely together. (For those who need a refresher, check out Medical Marijuana Raids: A Thing of the Past? and The Federal Government’s Ongoing War Against Cannabis.) But we are constantly encountering new ways in which federal prohibition makes life challenging for those engaged in a cannabis business (see Cash Payments to the IRS? Prepare to Pay the Penalty). As Floridians become familiar with these issues, a recent piece in the New Times Broward Palm Beach, aptly titled, “When Your Medical Marijuana Business Fails, You’re Screwed,” highlights yet another way federal law and policy continues to frustrate marijuana entrepreneurs. The source of this frustration? United States bankruptcy courts.

Bankruptcy courts are a creature of federal law, created under the authority delegated by the United States Constitution to Congress. Individuals and businesses alike may seek bankruptcy protection. Bankruptcy affords debtors the opportunity to discharge some or all of their current debts, or create a plan to repay creditors over time. This is generally viewed as a compromise that helps debtors get back on their feet and ensures that priority creditors recoup some (if only a little) of the value of their claims. But the doors of the bankruptcy courts are not open to everyone, as those in the state-legal marijuana business (and even those benefitting even indirectly from such businesses) are finding out.

The New Times piece mentions three bankruptcy cases: one each from Oregon, Colorado, and California.

In the Oregon bankruptcy proceeding, the debtor proposed making plan payments with three different income sources, including his own MMJ business and rental income received from a MMJ grow tenant. The court would not approve the plan because it determined the plan itself must comply with bankruptcy rules and procedures AND any other applicable state and federal law. Thus, the federal prohibition of marijuana precluded the debtor from bankruptcy protection.

Similarly, the Colorado case involved a debtor who indirectly received 25% of his income from marijuana through his tenant’s growing activities. The debtor freely admitted to leasing the warehouse to an MMJ business, but argued he had never been accused or convicted of violating federal law. The court nonetheless found him to be in continuing violation of the CSA. On that basis, the court held that the debtor came to court with “unclean hands” (an equitable doctrine where a plaintiff’s own bad acts preclude a right to a remedy), and that cause existed to dismiss the case.

In California, Mother Earth’s Alternative Healing Cooperative sought bankruptcy protection when it found itself overextended on obligations to creditors, with most of its assets tied up in marijuana inventory. Noting that bankruptcy proceedings would preserve an illegal business, the court held that the Cooperative’s assets were subject to forfeiture, rendering a payment plan or reorganization impossible.

So it seems that bankruptcy is not a viable option for troubled businesses, whether they are directly involved with cannabis, or operate an ancillary business. The Colorado case (and, to the extent the Oregon case was based upon the rental income) is particularly disturbing because of the indirect nature of the debtor’s relationship to federally-prohibited marijuana. The rationale could theoretically be applied to a whole host of other kinds of businesses: software companies providing inventory programs to canna businesses, laboratories performing testing on marijuana products, even companies supplying innocuous paper and packaging for state-legal marijuana. Ganjapreneurs often seek out vendors who specialize in cannabis clients, but these decisions make it clear that such vendors are especially exposed in bankruptcy court, because most (if not all) of their income comes from marijuana.

As an arm of the federal government, it makes sense that bankruptcy courts are uncomfortable extending the privilege of bankruptcy liquidation or reorganization to an industry that is still federally illegal or of questionable legality. Still, as marijuana businesses becoming increasingly legitimate and integrated into the business environment generally, there will be an increasing need to protect debtors and creditors (for, when a business goes under without the orderly claims process of a bankruptcy proceeding, no one wins). Just one more area of federal law overdue for an overhaul.

In discussing the lack of bankruptcy protection, the New Times also correctly points out the need for cannabis entrepreneurs to insulate their other enterprises and their personal assets from their cannabis ventures. Watch here for our take on that soon.