As US Cannabis Industry Grows, Produces Distress, Bankruptcy Relief Remains Limited

Published date23 November 2021
Subject MatterInsolvency/Bankruptcy/Re-structuring, Cannabis & Hemp, Insolvency/Bankruptcy
Law FirmMayer Brown
AuthorLeah M. Eisenberg

The U.S. Bankruptcy Code provides relief to debtors to maximize value for the benefit of their creditors and other stakeholders. Such relief is extremely limited when debtors are state-legalized marijuana businesses, as they are denied access to Bankruptcy Courts because the manufacture, distribution, and dispensing of marijuana remain federal crimes under the Controlled Substances Act (CSA), 21 U.S.C Sections 801-971.1

Although the manufacture, distribution, and dispensing of marijuana is currently legal in many U.S. states on the state level, the federal government's designation of marijuana as a controlled substance supersedes contrary state law through application of the commerce clause.2

The Drug Enforcement Agency (DEA), a department of the Department of Justice (DOJ), is the primary federal agency that enforces the CSA and related federal laws. In the last decade a series of memorandums were issued to provide specific guidance and recommendations relating to CSA enforcement, which included, among other things:

  1. Prioritizing the investigation and prosecution of significant drug traffickers
  2. Clarifying that the use of federal funds to enforce the CSA against cancer patients or their caregivers may not be efficient
  3. Clarifying specific enforcement priorities involving the possession, production, and sale of marijuana relating to noncompliance of other state laws and threats to public safety and health
  4. Providing guidelines to financial institutions
  5. Rescinding previous guidelines on enforcement and directing federal prosecutors to use discretion and weigh all relevant factors in their investigations and prosecutions3

The Office of the United States Trustee, also a department of the DOJ, has taken the position that a marijuana-related business cannot seek relief under the Bankruptcy Code because the business itself violates the CSA, regardless of whether such business operations are legal under applicable state law.

The direct consequence to these limitations is that U.S. businesses and individuals involved in the cannabis industry and facing financial distress may not seek bankruptcy relief under the Bankruptcy Code, and if they try, they will face a prompt exit. Yet, as more states continue to legalize/decriminalize marijuana, it is likely that more marijuana-related businesses will enter this industry, where some will face distress but with few avenues to restructure, reorganize, and/or liquidate.

The tension between state laws that legalize or decriminalize marijuana on the one hand, and the CSA's enforcement of marijuana as a controlled substance on the other, can be understood by reviewing decisions made by U.S. Bankruptcy Courts when they have been faced with marijuana-related businesses or individuals who sought relief under Chapter 7, 11, or 13 of the Bankruptcy Code. Bankruptcy Courts generally find that because marijuana violates the CSA, businesses or individuals may not seek relief under the Bankruptcy Code, regardless of whether the state in which the business operates or the individual resides and regardless of whether the particular debtor is directly (such as cultivators and dispensaries) or indirectly (such as landlords) engaged in marijuana.

Decisions in the Plan Context

A number of courts have addressed this issue in the context of the plan process, where the courts found the plan filed by the applicable debtor, while statelicensed to grow/dispense marijuana, did not comply with the two Bankruptcy Code sections that required that the plan (i) be proposed in good faith and not by means forbidden by law, and (ii) be feasible.4 The courts found that because the applicable debtors were engaging in conduct that violated federal law and the funding of the plan would come from income generated from such illegal conduct, the requirements of Sections 1129(a)(3) and...

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