Cannabis Business Bankruptcies? Not so Fast

It appears that the same holds true for cannabis businesses
It appears that the same holds true for cannabis businesses.

CGO Enterprise, LLC, is a Denver-based medicinal cannabis cultivator. Judge Michael Romero of the US Bankruptcy Court in Denver, Colorado, recently dismissed CGO Enterprise’s bankruptcy action, stating that the company had filed an “incomplete bankruptcy case” and also failed to respond to the Court’s request for additional financial statements. Is this case just another blow to the cannabis industry’s fight for standard business rights, or has CGO succeeded in accomplishing the goal of avoiding the scrutiny of bankruptcy? Most certainly, it is the former.

On May 1, 2012, CGO Enterprises filed for Chapter 11 bankruptcy. Chapter 11 bankruptcies are intended primarily to reorganize businesses in debt. A Chapter 11 petition must be filed in good faith, meaning that “the debtor has proposed or can propose a legally and economically feasible plan of reorganization.” In Matter of Strung-Division, LLC, 375 B.R. 445, 449 (Bankr. N.D. 11. 2007). In its petition, CGO reported $800,000 owed to its landlord and assets of around $130,000 in un-harvested plants. The petition neither included a detailed account of the company’s financial situation, nor did it specify the exact number of un-harvested plants in its possession. A few days after filing the petition, the Court submitted a notice of deficiency, requiring CGO to submit more financial details about its operation by May 15, 2012.

On May 16, 2012, Richard Wieland, a US Trustee, filed a motion urging Judge Romero to dismiss CGO’s bankruptcy case. In his motion, Wieland stated two separate reasons for dismissing CGO’s case: (1) CGO’s petition was not filed in good faith; and (2) CGO failed to comply with the notice of deficiency.

To prove CGO’s alleged lack of good faith, Wieland claimed CGO could not confirm a reorganization plan in compliance with the Bankruptcy Code because any plan CGO could devise would involve cultivating and selling medical cannabis, which is a criminal violation of the Federal Controlled Substances Act. Wieland argued that because any proposed plan would necessarily involve illegal action it could not comply with the Bankruptcy Code. Wieland further argued that it was proper to dismiss the case because any such plan would ultimately violate Federal law.

Wieland then argued that CGO’s failure to respond to the Court’s notice of deficiency was another basis for dismissal. That notice of deficiency required CGO provide the necessary financial information to the Court by May 15, which CGO had failed to do. The notice of deficiency stated that CGO’s failure to “timely file the missing documents” would result in the dismissal of the case.

As a final note, Wieland also argued that the case could not be converted into a Chapter 7 bankruptcy because the primary use of CGO’s assets “relates to illegal activity, [and] a Chapter 7 Trustee cannot administer such assets in a manner that is consistent with law and public policy.”

On May 25, 2012, CGO, responded to Wieland’s motion to dismiss. Surprisingly, CGO not only supported the motion to dismiss, but  also provided a new reason for dismissal. CGO explained that state law would prohibit an orderly administration of the Chapter 11 proceeding. Under Colorado law, CGO only owns medical cannabis plants for the benefit of named individual patients, and, therefore, “state regulators do not believe that a trustee could exercise any control or dominion over medical marijuana plants.” As a result, state law might limit a trustee’s authority to allocate a company’s assets. Additionally, CGO stated that, subsequent to the filing of its petition, but prior to May 15, CGO informed the US Trustee that it did not intend to move forward with the petition or file any additional financial statements.

Judge Romero ruled that it would be impossible to reorganize CGO’s finances around its main asset, cannabis, without violating federal law. This raises serious issues for the legitimacy of the cannabis industry (medical or recreational) as bankruptcy is a fundamental escape hatch for most entities and their creditors. Should bankruptcy courts develop a policy of denying bankruptcy relief to medical cannabis entities, the legitimacy of the cannabis industry itself will continue to be stymied.