The struggles of failing marijuana businesses to wind down and pay creditors in an orderly fashion serve no one. Among the problems marijuana businesses face such as lack of access to banking and onerous taxation stemming from IRC 280E is the lack of access to bankruptcy proceedings. This post discusses a Michigan-based medical marijuana company that filed for Chapter 7 bankruptcy and the federal court case affirming the dismissal of the marijuana company’s bankruptcy petition. In re: Great Lakes Cultivation, LLC, No. 21-12775.
The dismissal isn’t much of a surprise given past treatment of marijuana businesses seeking bankruptcy protection. See here. Nonetheless the case highlights significant issues faced by marijuana businesses and persons or companies who lend or invest in the cannabis industry, who may struggle to obtain a return of their investment from failing businesses absent taking special measures to securitize the investment.
Here, the company grew and sold medical marijuana pursuant to a license issued in 2019 by the State of Michigan. The company operated out of a leased building and all of its equipment was used in the manufacture of marijuana and its income derived solely from the sales of medical marijuana. The start-up capital for the venture came from the company’s majority member. After receiving its license, the company additional funding from investors to purchase agricultural and security products. A short time later, Michigan decriminalized marijuana, which increased competition, and caused the business to fail.
Chapter 7 Bankruptcy
The company filed for Chapter 7 bankruptcy protection in June 2021. Chapter 7 bankruptcy is known as a “liquidation” bankruptcy. When a debtor becomes insolvent, a debtor may liquidate its assets or reorganize its debts. Chapter 7 governs the liquidation avenue in which the assets of the debtor are sold off one by one in order to satisfy the debtor’s creditors.
A bankruptcy trustee administers the liquidation in which the company’s operations are terminated and ceases doing business. The trustee assumes control of the entity in order to maximize the value of the debtor’s assets and orderly distribute the assets to creditors based on their priority. Secured creditors are typically at the top of the list, followed by unsecured creditors. For more detail, see here. Businesses filing for Chapter 7 must follow a detailed and proscribed course of conduct. See here.
The dismissal of the marijuana company’s Chapter 7 bankruptcy
The United States Trustee appointed a private trustee to administer the case. (This is common.) At the time of filing, the company estimated its assets as worth approximately $171,500. These consisted of marijuana plants, a security system, office furniture and other office equipment, and the security deposit for its lease. The company reported unsecured debts of approximately $837,000– most of it owed to its landlord, minority members, and other persons who helped fund the business. Not surprisingly, the trustee moved to dismiss the bankruptcy case because of its connection to a schedule I controlled substance: marijuana.
The bankruptcy court dismissed the case for three grounds: 1) the private trustee could not administer the company’s assets, which consisted of marijuana and equipment used to manufacture and distribute marijuana, without violating the Controlled Substances Act (“CSA”); (2) because its business was illegal under federal law, public policy does not support using federal law to benefit marijuana businesses; and (3) the company’s violations of the CSA constituted bad faith, making it ineligible for bankruptcy relief.
The company appealed the dismissal to the federal district court. In summary, the company argued the trustee could administer the estate without violating the CSA because the marijuana plants were abandoned by the trustee and because the remaining assets were not illegal by nature (the office equipment etc.). These arguments went nowhere.
The federal court turned to a seminal marijuana bankruptcy case, In re Arenas, 514 B.R. 887 (D. Bankr. Colo. 2014), for the proposition that numerous courts recognize that “cause” to dismiss exists when a failure to dismiss would cause the trustee to administer assets “that are used for, or generated by, a business prohibited under the CSA.” The rest of the decision affirming the dismissal of the marijuana company’s bankruptcy filing follows from this principal: bankruptcy protections and processes are not available for assets “that are used for, or generated by, a business prohibited under the CSA.” This includes everything from pot to pencils. In short: marijuana businesses and their creditors should expect federal courts to dismiss a Chapter 7 bankruptcy filing.
The lack of bankruptcy protection for marijuana businesses means that failing businesses cannot orderly wind up and distribute their assets in an orderly fashion. Secured creditors of marijuana businesses should take special action to protect their interests, because the priority of payment that comes with being a secured creditor in a bankruptcy proceeding does not mean much if the debtor cannot avail itself of federal bankruptcy protection.