As most of us know, bankruptcy is just not an option for the cannabis industry or those even affiliated with it. To date, courts have generally ruled that debtors who work in the cannabis industry or derive meaningful income from cannabis activity (directly or indirectly) cannot use bankruptcy. This is in response to the U.S. Trustee’s office practice of filing motions to dismiss bankruptcy cases where the debtor has a direct or tangential connection to the cannabis industry.
While its availability has been litigated here and there (see here, for our last case study), it’s likely that the demand for such an option will increase as the market continues to grow. In the latest and greatest, and perhaps in response to the rising demand, the Ninth Circuit Court of Appeals shed some hope for the future. Garvin v. Cook Investments NW involved five real estate holding companies that filed Chapter 11 reorganizations in Washington. One of those five debtors leased property to a company that used the land to grow cannabis in compliance with Washington state law. After filing for bankruptcy, the debtor-landlord continued to accept rent from the cannabis business.
The debtor-landlord proposed a plan of reorganization that would pay off its debts, which included some of the rent received from the cannabis business. The U.S. trustee objected, and the debtor-landlord reformulated its plan by removing all references to use of the rent proceeds. The debtor-landlord specifically noted that it would earn enough revenue from other sources to pay its creditors. However, the debtor-landlord admitted it would continue accepting rent from the cannabis tenant because the tenant had the right to remain in possession of the premises so long as it continued paying rent, and it had showed no interest in abandoning that right.
A company that seeks relief under Chapter 11 of the Bankruptcy Code is entitled to confirm a plan of reorganization if it meets certain conditions. The U.S. Trustee objected to plan confirmation, arguing that under 11 U.S.C.A. § 1129(a)(3), “[t]he court shall confirm a plan only if all of the following requirements are met … [t]he plan has been proposed in good faith and not by any means forbidden by law.” The U.S. Trustee essentially argued that the debtor-landlord could not meet this standard if it continued to rent property to a tenant engaged in the cannabis business because the debtor-landlord was deriving income (rent) from an illegal enterprise. This argument historically has prevailed.
The Ninth Circuit didn’t agree with the U.S. Trustee, however, and confirmed the plan of reorganization. In reaching its conclusion, the Court held that it was not faced with a conflict between federal and state drug law but, rather, a straightforward question of statutory interpretation. In their opinion, Section 1129(a)(3) didn’t mean it could reject a plan of reorganization if the underlying components of the plan were unlawful; rather, the proposal itself would have had to been made in an illegal manner (such as fraud, duress, etc.). The Court explained that Section 1129(a)(3) “directs bankruptcy courts to police the means of a reorganization plan’s proposal, not its substantive provisions.” Under that analysis, the plan of reorganization was not proposed by any means forbidden by law and had to stand.
While the Ninth Circuit’s opinion now suggests that the courts may be more willing to allow debtors involved with the industry to enter the bankruptcy courts, the real implications for the industry remain unclear. Notably, an even more recent decision from the Eastern District of Michigan took exactly the opposite approach: it not only dismissed the cannabis-related bankruptcy case, but expressly rejected the Ninth Circuit’s ruling. Only time will tell, but given the growing amount of power and support for the industry, we’re sure that future decisions will provide answers sooner than later.
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Author: Jihee Ahn