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Every election it seems like the country inches closer to cannabis being legal at the federal level. Until that day comes, however, the question of whether those in the cannabis industry can seek bankruptcy relief remains. Because cannabis remains illegal under the federal Controlled Substances Act (CSA), for the past decade bankruptcy courts have routinely held that cannabis businesses are ineligible to seek bankruptcy relief (see In re Burton, 610 B.R. 633 (B.A.P. 9th Cir. 2020);see also In re Malul, 614 B.R. 699 (Bankr. D. Colo. 2020)).

Earlier this year, however, the United States Bankruptcy Court for the Central District of California opened the door for distressed cannabis businesses to pursue bankruptcy under federal law. The court in In re: Hacienda Company, LLC denied the trustee’s motion to dismiss, even after the trustee argued that the bankruptcy should be dismissed due to the debtor’s engagement in the sale of cannabis products in violation of the CSA. The court held that the trustee failed to establish the debtor was still violating the CSA because the debtor had recently transferred its intellectual property to a Canadian cannabis business in exchange for stock in that company — meaning the debtor was no longer operating a cannabis business. Additionally, the court reasoned that Congress did not adopt a “zero tolerance” policy for any illegality and that violation of the CSA is not enough to dismiss the bankruptcy. Critically, the court highlighted that the specific facts of the case warranted the denial of the motion to dismiss, thus emphasizing that future cannabis-related bankruptcy decisions will depend heavily on the facts.

Six months later, the trustee filed a second motion to dismiss based on similar grounds. The court again denied the trustee’s motion to dismiss, but this time for different reasons. The court agreed that the debtor had “likely” violated the CSA post-petition because it continued to own the stock of the company it transferred its assets to, which still grew and sold cannabis. Yet again, the court emphasized that Congress did not adopt a “zero tolerance” policy for illegality and that “[c]ongress has shown an intent not to ‘punish’ a debtor when the real victims would be innocent creditors.” The court also observed that business bankruptcies, such as landlords and restaurants, often have ongoing health and safety violations during the bankruptcy, and that it can take time for the debtor to divest from any connection to ongoing illegality. The court pointed to Enron, Bernie Madoff, and PG&E as examples of this delay.

While the decision may appear to be a major victory for the cannabis industry, this case could have gone in a different direction had the debtor still been operating a marijuana business at the time the bankruptcy was filed. This case does, however, seem to stand for the proposition that businesses formerly engaged in the cannabis industry can seek relief in bankruptcy court. Time will tell if the trustee seeks an appeal of the court’s decision.

Due to the ever-evolving legal landscape for distressed cannabis businesses, seeking legal counsel is even more critical to assist with navigating available options for liquidation or restructuring. Bradley attorneys have deep knowledge and experience with issues involving bankruptcy, creditors’ rights, workouts, receiverships and other similar matters, and we are prepared to help guide cannabis clients through these unsettled waters.