The Cannabis Conundrum: Can Cannabis Companies File Chapter 15?

• Published date: 23 May 2022
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Cannabis & Hemp, Corporate and Company Law, Insolvency/Bankruptcy
• Law Firm: Sheppard Mullin Richter & Hampton
• Author: Ms Catherine Jun and Colin Davidson

Recreational cannabis is now legal in 19 states and Washington D.C., driving the growth of legal cannabis sales estimated at $33 billion this year-up 32% from 2021-and expected to reach $52 billion by 2026.¹ This movement signals that financial investment in cannabis is not abating but accelerating notwithstanding the impact of the lingering COVID-19 pandemic. This growth in the cannabis industry, of course, also means that operators and their investment partners face commercial risk, including insolvency.

It has, however, become axiomatic that cannabis companies are barred from relief under the U.S. Bankruptcy Code.² A line of court opinions, in fact, has held that cannabis companies cannot seek a chapter 11 restructuring or chapter 7 liquidation. The reasoning is, stated simply, marijuana is a schedule 1 controlled substance under the federal Controlled Substances Act (the "CSA")³and, therefore, it is illegal under federal law "to manufacture, distribute, or disperse, or possess with intent to manufacture, distribute, or dispense, a controlled substance"⁴-notwithstanding any contrary state law. Given its criminalized acts, a marijuana business that intends to continue to operate as such cannot propose a chapter 11 plan of reorganization "in good faith," which has led bankruptcy courts to routinely dismiss such cases for "cause" pursuant to section 1112(b)(1) of the Bankruptcy Code.⁵ Nor can cannabis companies avail themselves of chapter 7, as any appointed bankruptcy trustee would then be required to sell marijuana and marijuana-related assets of the liquidating company and, in so doing, violate federal law.⁶

Compare this to Canada. In Canada, the federal Cannabis Act (2018) legalized cannabis nationwide, while the provinces maintain certain regulatory powers related to the distribution, sale and use of cannabis. For cross-border cannabis operators then, a potential avenue for bankruptcy relief is for the company to first commence an insolvency proceeding in Canada and then seek recognition of that foreign proceeding in a U.S. bankruptcy court under chapter 15 of the Bankruptcy Code. Upon recognition as a "foreign main proceeding," the automatic stay, the power to continue to operate the debtors' business, and a number of other bankruptcy protections become available to that debtor company regarding assets located in the United States.⁷ If a bankruptcy judge determines that the Canadian proceeding is "non-main" rather than "main," the rights provided in the foreign proceeding are not automatically available, but may still be requested by the foreign representative and granted at the bankruptcy judge's discretion.⁸

While direct access to bankruptcy relief in the United States remains closed to cannabis and cannabis-adjacent companies, chapter 15 could potentially open the proverbial side door-i.e., the company first seeks insolvency protection in Canada and then seeks recognition of the Canadian proceeding in the U.S. bankruptcy court. That's because chapter 15 sidesteps the hurdles that have historically barred bankruptcy relief to cannabis companies. In a chapter 15, no bankruptcy estate is created that a chapter 7 trustee must administer, and no chapter 11 plan of reorganization is proposed. Nor are traditional grounds for dismissal in a chapter 11 or 7 proceeding such as "bad faith" applicable in a chapter 15 proceeding.⁹ That said, a cannabis company's access to chapter 15 may turn on whether a bankruptcy court invokes the so-called "public policy exception"-which, while very rarely invoked, allows a court to abstain from acting under chapter 15 if doing so would be "manifestly contrary" to U.S. public policy.¹⁰

The...