Budding Woes: Navigating The Weedy Waters Of Cannabis Companies In Financial Distress

• Published date: 27 July 2023
• Subject Matter: Insolvency/Bankruptcy/Re-structuring, Cannabis & Hemp, Insolvency/Bankruptcy
• Law Firm: Seyfarth Shaw LLP
• Author: Mr William Hanlon

As the cannabis industry matures, there will be winners and losers. Losers lack access to the U.S. Bankruptcy Code. Marijuana related assets cannot be sold free and clear of liens and encumbrances via the tried and true bankruptcy section 363 sale, which leaves the loser's creditors without the best tool to maximize the value of the loser's assets, and deprives acquirers of a federal court order conveying assets. What's the state of play, and what's the alternative for the losers, their creditors, and the companies that would acquire them?

STATE OF PLAY

The United States Trustee Program ("USTP"), as the bankruptcy system watchdog, has long taken the position that the system may not be used as in instrument in committing a crime, and that trustees and estate fiduciaries may not administer assets in violation of federal criminal law.¹ The prohibition extends beyond sellers and growers to landlords who knowingly rent, manage or use property "for the purpose of manufacturing, distributing, or using any controlled substance;" manufacturers of drug paraphernalia, and anyone "who derives profits or proceeds from an offense [of the Controlled Substances Act]."²

Bankruptcy cases have been dismissed where the plan had to be funded with rental income from a dispensary,³ because the plan couldn't be proposed "by means forbidden by law,"⁴ and because the debtor proposed segregating, but continuing to use, proceeds of his medical marijuana business, which is property of his bankruptcy estate.⁵ Similarly, landlord debtors' plans depending on dispensary income were deemed unconfirmable,⁶ and dismissed for "gross mismanagement" due to "criminal activity."⁷ A provider of hydroponic and gardening supplies for cannabis was also denied relief.⁸

ALTERNATIVES TO BANKRUPTCY

Cannabis companies face a challenging landscape: high taxes, oversupply, security concerns. Insolvency relief is available under state law remedies. Acquirers of cannabis assets may also wish to buy those assets at state law foreclosures, for protection against fraudulent transfer, successor liability and junior encumbrancer claims.

Trade Creditor Agreements can be utilized where there is a viable business, and the debtor can obtain the consent of a high percentage of its creditors to defer or reduce repayment. Generally, the debtor presents a plan for repayment to its creditors, and promises to consummate it upon receiving consent of at least 85% of trade creditors. Such agreements are voluntary, but can be...