In a recent bankruptcy ruling by the Ninth Circuit Bankruptcy Panel (“BAP”), the BAP had an opportunity to examine some of the intricacies of the Bankruptcy Code’s interaction with the cannabis industry. Burton v Maney, 610 BR 633 (BAP 9th Cir. 2020) (“In re Burton”). While a suspected debtor generally may not enjoy the protection of bankruptcy law when growing, growing, or selling marijuana, recent court rulings have begun to define how far the limits can be stretched. A court recently summarized the dilemma as follows:
If the uncertainty of outcomes in marijuana-related bankruptcy cases were an opera, Congress, not Justice, would be the fat woman. Whether and under what circumstances federal bankruptcy proceedings can be initiated despite links to the locally “legal” marijuana industry remains up to date with federal bankruptcy law. Despite the extensive development of case law, considerable gray areas remain. Unfortunately, the dishes are in one fell swoop; Every time a case is published, another appears with a novel edition in a new shade of gray. This is exactly such a case. In re: Sandra Mulul, 614 BR 699, 701 (Bankr. D. Colo. 2020) (“In re Mulul”).
In right Burton
Re Burton was a Chapter 13 case filed in Arizona. Debtors Kent and Carly Rae Burton disclosed certain information about their bankruptcy plans indicating they had a 65% interest in Agricann, LLC (“Agricann” ) owned. Agricann was a “unit that grew and sold marijuana”. Located in re Burton, 610 BR, 634. While medical marijuana sales were legal in Arizona at the time the debtors filed for bankruptcy (2018), it remained (and will continue to be) illegal under federal law.
After the debtors filed for bankruptcy, Agricann (which apparently ceased operations in 2016) sued two other companies in a state court for “damages for breach of contract under which Agricann was supposed to grow, grow and sell medical marijuana.” I would. Both the Chapter 13 trustee’s attorney and a creditor in the case moved the case to be dismissed because of the “Burtons’ involvement in the medical marijuana industry.” I would. The debtors alleged that since Agricann was no longer operating, no proceeds from that company would be used to fund their Chapter 13 reorganization plan. However, the bankruptcy court found that reclaiming the dispute in a state court would “result from conduct that is illegal under federal law”. I would. The bankruptcy court ultimately dismissed the case and the debtors appealed the decision to the BAP.
As the BAP noted, “… filing for bankruptcy by an individual or company with ties to a marijuana business raises difficult questions about the debtor’s involvement in that business, and yet it can be filed under the law [Bankruptcy] Code. “I would. The BAP went on to say that case law in this area is evolving and there are very few light-line tests. However, the BAP also noted that a principle emerges from case law:” … just that Presence of marijuana near bankruptcy proceedings does not automatically prohibit a debtor from obtaining bankruptcy discharge. “I would.
After examining some of the case law on marijuana assets in bankruptcy proceedings, the BAP found that the bankruptcy court had not unfairly dismissed the debtors’ case. The dismissal under 11 USC Sections 105 (a) and 1307 (c) was appropriate “because continuation of the case would likely require the trustee or court to be involved in the administration of the Agricann litigation, of which the court is implicitly found that it was tainted as the proceeds of an illegal business. ” I would. at 639.
In re Mulul, In re Green Earth and In re Ginsburg decisions
Following the In re Burton case, the In re Mulul decision was issued by the Colorado Bankruptcy Court. Of particular interest was the evaluation of two other bankruptcy decisions by the Colorado Bankruptcy Court in making the decision. The in-re-mulul decision helps further define when a debtor can potentially enjoy the protection of bankruptcy law.
The first ruling discussed by the In re Mulul Court was Green Earth Wellness Ctr., LLC v Atain Specialty Ins. Co., 163 F. Supp. 3d 821 (D. Colo. 2016) (“In re Green Earth”). Re Green Earth involved a lawsuit brought by a cannabis company against its insurer. The plaintiff sued the insurer for failing to compensate the company for marijuana plants and equipment destroyed in a fire. The insurer alleged that it had been exempted from performing the insurance contract because of the unlawfulness of the transaction. The court in In re Green Earth did not invalidate the insurance policy for reasons of public order. As the court in In re Mulul stated:
[T]The operational decision point in Green Earth Wellness was Judge Krieger’s careful distinction between ordering the insurer to pay for damage to certain items (i.e., marijuana plants) and merely ordering compliance with the contract without any indication of the presence of Marijuana could be obtained as an asset. Probably if the insurance contract expressly stipulates this [the insurer] To replace the marijuana plants instead of just compensating Green Earth for their value, the outcome would have been different. In right Mulul, 614 BR at 707-708.
The second decision analyzed by the In re Mulul court was Ginsburg v ICC Holdings, LLC, No. 3: 16-CV-2311D, 2017 WL 5467688 (ND Tex. November 13, 2017) (“In re Ginsburg”). In re Ginsburg, there was a loan to a medical marijuana company. Ginsburg, who was the lender, eventually sued ICC Holdings for, among other things, breach of contract due to loan defaults, violations of state and federal securities laws, and the federal law on the influence and corruption of corrupt organizations.
ICC moved to dismiss the action “because the purpose of the [promissory notes] [was] Fund the cultivation, possession, and sale of marijuana in violation of federal law, [and] the [promissory notes] [were] void and unenforceable because they violate public order. “In re Ginsburg, 2017 WL at * 3. As the court of In re Mulul stated:“… die [Ginsburg] Due to the fungibility of the currency, repayment of the banknotes would not require ICC Holdings to “manufacture, distribute, distribute or own” marijuana. In re Mulul, 614 BR, 708 (internal citation omitted).
What do we do now?
Given these decisions, is there a pattern that emerges from case law? Part of the answer is yes. The key takeaway is that if the debtor and their earnings are directly related to the marijuana industry (e.g. cultivation, sale, etc.), most likely they will not enjoy the protection of bankruptcy law. However, when the link between cannabis revenues and business weakens, there is a higher chance that the debtor can move forward with a bankruptcy case.
There is also an air of fairness and justice in these decisions, particularly with regard to Ginsburg and Regarding Green Earth. It would be fundamentally unfair for a party to knowingly run a marijuana business and then attempt to decline its commitments for “illegality” or the like. While the law is not always “fair,” it can sometimes be.
The bankruptcy process is a very powerful tool that allows debtors to accomplish things that they could never do outside of bankruptcy. If a party is deprived of that right, there is no other equivalent under the law. The only remaining options are liquidation without judicial oversight or the jurisdiction of a state court. Hopefully, in time, those in the cannabis industry will have the right to file for bankruptcy protection without the mental gymnastics the industry is currently experiencing. However, this requires changes to the federal law.