05.01.15

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Be Not a Borrower or a Lender…of a Marijuana Business

PRACTICE GROUPS

The disconnect between federal law and that of an increasing number of states, marijuana-related businesses and their landlords, vendors, and lenders are confronted with dicey legal issues.  The availability of bankruptcy relief is one of the latest.

A bankruptcy court was recently asked to decide whether it could (or should) enter an involuntary order of relief against a medical marijuana dispensary management entity, even though the debtor-entity’s business activities are illegal under federal law.  In re Medpoint Management, LLC, 528 B.R. 178, 182 (Bankr. D. Az.).  The court answered in the negative, consistent with earlier cases barring bankruptcy relief for debtors engaged in the marijuana business or in leasing to marijuana businesses.

In Medpoint, the debtor owned a marijuana products trademark that it licensed to another company, generating the debtor’s sole source of revenue, and previously managed a dispensary entity under contract.  The debtor did not directly own any marijuana, marijuana products, or dispensaries, but all of its assets were “marijuana-related.”  Id. at 184.  Four creditors petitioned for an involuntary chapter 7 against the debtor.  The debtor had breached contracts with two of the petitioning creditors—one, a consulting agreement related to “grow house construction,” and the other, the debtor’s seller-financed purchase of a dispensary management entity and a related consulting agreement.  Id. at 182.  The other two petitioning creditors made loans to the debtor that it failed to repay.  Id.  The debtor moved to dismiss the case on the grounds that the court could not administer the estate’s marijuana related assets without violating the Controlled Substances Act, 21 U.S.C. § 801, et seq.

The court agreed with the debtor, relying on In re Arenas, 514 B.R. 887, (Bankr. D. Colo. 2014), a case in which the Colorado bankruptcy court held that “the inevitable illegality of the trustee’s administration of illegal estate assets constituted cause to dismiss under section 707(a)” of the Bankruptcy Code.  Medpoint, 528 B.R. at 183 (citing Arenas, 514 B.R. at 891–92); 11 U.S.C. § 707(a).  Arenas was about an individual debtor in the business of producing and distributing marijuana, who held all permits necessary to do so legally under Colorado law.  Arenas, 514 B.R. at 888.  The Arenas court ruled:

For the Trustee to  take possession and control of the Debtors’ Property and marijuana inventory would directly involve him in the commission of federal crimes.  To allow the Debtors to remain in a chapter 7 bankruptcy case under circumstances where their Trustee is unable to administer valuable assets for the benefit of creditors would allow them to receive discharges without turning over their non-exempt assets to the Trustee.  That would give the Debtors all of the benefits of a chapter 7 bankruptcy discharge while allowing them to avoid the attendant burdens. The impossibility of lawfully administering the Debtors’ bankruptcy estate under chapter 7 constitutes cause for dismissal of the Debtors’ case under 11 U.S.C. § 707(a).

Arenas, 514 B.R. at 891–92 (emphasis added).

The Medpoint court also relied on the reasoning of In re Rent-Rite Super Kegs W. Ltd., 484 B.R. 799 (Bankr. D. Colo. 2012).  Rent-Rite was a chapter 11 case in which the debtor owned a warehouse worth $2.3 million, encumbered by a deed of trust securing a $1.8 million note.  The debtor leased the warehouse to tenants cultivating marijuana, which accounted for 25% of the debtor’s revenues.  Id. at 803.  The bankruptcy court found that the debtor was violating the CSA, which subjected the warehouse to the risk of forfeiture under federal law and placed the secured creditor’s collateral at risk.  Id. at 803–04, 806.  The court further found the debtor’s ongoing violation of the CSA constituted “gross mismanagement” of the chapter 11 estate and thus “cause” to dismiss or convert the case.  Id. at 809.

Based on Arenas and Rent-Rite, the Medpoint court reasoned that “the appointment of a chapter 7 trustee would place that trustee in an untenable position.  A trustee would have good reason to worry about his/her risk [of] exposure relating to the administration of a marijuana-related entity’s assets.”  Medpoint at 184.  Congress stated its interest in protecting the public health and safety when it enacted the Controlled Substances Act, and a bankruptcy trustee must yield to that interest.  Id. at 185.  The court found that “the prospects of a possible forfeiture or seizure of Medpoint’s assets poses an unacceptable risk to a chapter 7 estate and a chapter 7 trustee.”  Id.  This risk was not eliminated by Congress’s passage of the 2015 appropriations bill, which prohibits the Department of Justice from using federal funding on marijuana enforcement in states where it is legal (at least until September 30, 2015).  Id. at 185–86; Consolidated and Further Continuing Appropriations Act, Pub.L. 113-235, § 538 (2014).

The Medpoint court further found that because the petitioning creditors knew or should have known that the debtor’s activities were illegal under federal law, they came to the court with unclean hands and could not, therefore, seek relief from the bankruptcy court.  Medpoint at 187.  The court explained:

[A]s a federal court, this Court must adhere to federal law.  Neither the alleged lack of enforcement funding nor the apparent lack of political will to enforce the [Controlled Substances Act] alters the fact that a person engaged in marijuana related business activities in Arizona is in violation of federal law.  Petitioning Creditors may themselves have also violated the CSA and attempted to profit from those violations.

Id. at 188.

Under Arenas, individual debtors engaged in the marijuana business should be aware that the bankruptcy discharge is probably not available to them.  Debtors who simply lease space to marijuana businesses can expect to be barred from obtaining relief under the Bankruptcy Code under Rent-Rite.  Under Medpoint, anyone considering extending loans or trade credit to marijuana businesses should proceed with the utmost caution and cannot count on seeking a remedy in bankruptcy court if a marijuana business fails to pay.


Author:  Hilary Mohr