By Danny Newman
While states continue to legalize cannabis, and the federal government continues to consider softening its stance, difficult questions persist at the intersection of cannabis and bankruptcy. As the cannabis industry continues to evolve in 2020 and beyond, those questions only become more acute.
The United States Court of Appeals for the Ninth Circuit’s decision in Garvin v. Cook Investments NW, SPNWY, LLC, upheld the confirmation of a Chapter 11 reorganization plan where the debtor leased land to a marijuana farmer under state law but in violation of federal drug law (previously discussed in an article by my colleague Ava Schoen).
Garvin ruled that the Bankruptcy Code does not require courts to police substantive provisions of a bankruptcy plan and held that a plan contemplating future income from cannabis tenants was not “proposed by any means forbidden by law.” Industry observers hoped Garvin signaled a continuing shift to protect cannabis industry debtors and creditors under the Bankruptcy Code.
However, some federal courts across the country since Garvin have narrowly construed — or even openly criticized — the Ninth Circuit panel, denying debtors federal bankruptcy protection (see In re Way to Grow, Inc. and In re Basrah Custom Design, Inc.) Those courts dismissed Chapter 11 debtors or refused to confirm their plans because either (1) their go-forward business plan or preexisting business included income from cannabis-related businesses, which constituted “gross mismanagement” under the Bankruptcy Code, or (2) abstained from providing protection and dismissed the cases as not in the debtors or creditors best interests.
Many national commentators have thus opined that the bankruptcy door is still shut to cannabis debtors. Yet, a close reading of the decision In re CWNevada LLC, in conjunction with Garvin, provides real hope for debtors in the Ninth Circuit.
The Garvin court specifically avoided the question of whether accepting or anticipating revenue from cannabis-related entities was “gross mismanagement” under the Bankruptcy Code because the U.S. Trustee had not properly raised the issue. But that avoidance indicates that there should be facts under which courts in the Ninth Circuit should find a cannabis-related debtor is not “grossly mismanaging” the estate. Indeed, the CWNevada court stated that there “may be cases where Chapter 11 relief is appropriate for an individual or a non-individual entity directly engaged in a marijuana-related business.”
And it had to; the Garvin court instructed bankruptcy courts not to police the conduct of debtors' underlying reorganization plans writing the Bankruptcy Code "does not require that the contents of a plan comply in all respects with the provisions of all non-bankruptcy laws and regulations."
The CWNevada debtor’s business was too intertwined with marijuana for that court’s liking. Where exactly that “too intertwined” line is, however, has not been sufficiently fleshed out, and it may in fact be different for bankruptcy courts in more cannabis-friendly states. As the cannabis industry continues to grow — $725 million in Oregon alone according to a recent Portland Business Journal article — more well-funded businesses with remote connections to cannabis will seek bankruptcy protection, helping establish the line.
Importantly, too, the CWNevada court indicated that the portion of the debtor’s business based on CBD and legal hemp under the federal Agriculture Improvement Act could be restructured under Chapter 11 because hemp and CBD are no longer prohibited under the Controlled Substances Act. The court abstained from restructuring the CBD business because, among other things, the debtor had not set forth sufficient evidence that its business actually involved legal CBD and that it could restructure around that business. On different facts, the CBD/hemp business in CWNevada may have been protected and potentially restructured under the Bankruptcy Code.
The CWNevada court also broke ranks with its trial level counterparts outside the Ninth Circuit by rejecting abstention under the “unclean hands” doctrine—a doctrine that by its nature treats cannabis-related businesses as “dirty” and puts it on par with racketeering and violent enterprises.
In short, CBD and hemp businesses and those that deal with them may be able to seek protection of federal bankruptcy courts in the Ninth Circuit. 12020 is likely the year a cannabis debtor, who cannot reach an out-of-court restructuring with its creditors, will seek bankruptcy protection in Oregon. It appears that the courts’ doors may finally be open, though how the courts will react is still unclear.
If you have questions on the debtor-creditor options available to businesses in the cannabis/hemp industry, contact Danny, or any of his colleagues in Tonkon Torp's Bankruptcy & Creditor Rights group, or your regular contact at Tonkon Torp.
1 On Feb. 6, 2020, hemp and CBD giant Gencanna Global USA Inc., filed a Chapter 11 bankruptcy case with over $100 outstanding liabilities in the federal bankruptcy court in Lexington, Kentucky.