Distressed Cannabis Companies Find Hope with New Bankruptcy Ruling, Potential Substance Rescheduling

By Ferdinand Ruplin and Danny Newman

A recent court decision shows an evolving stance toward cannabis companies facing financial distress and seeking bankruptcy protection. Taken together with the U.S. Department of Health and Human Services recommending that cannabis be rescheduled to Schedule III of the Controlled Substances Act (CSA), there is hope that cannabis companies will have the ability to take advantage of federal bankruptcy protection in the near future.

In September 2023, a California bankruptcy judge issued a ruling allowing the Chapter 11 case of The Hacienda Company, a cannabis company, to proceed over objections. This was the second time the court rejected dismissal motions by the U.S. Trustee alleging Hacienda’s proposed liquidation plan would facilitate illegal activity.

The judge acknowledged Hacienda likely violated federal drug laws through a prepetition asset sale and conspiracy. However, the court focused on how “nothing that debtor proposes to do postpetition will foster a single additional sale of cannabis products, nor will it add a single dollar to any cannabis-related enterprise.”

The judge reasoned that dismissing the case would harm innocent creditors and undermine the Bankruptcy Code’s purpose. As the court explained, “Congress did not adopt a ‘zero tolerance’ policy that requires dismissal of any bankruptcy case involving violation of (criminal law).” The court found that paying creditors by selling legally traded stock shares “provides the same type of remedy that criminal law itself provides.”

In light of the Hacienda ruling, the potential rescheduling of cannabis from Schedule I to Schedule III under the CSA will likely lead to an increasing openness of bankruptcy courts to allow cannabis companies a path to restructure or liquidate for the benefit of creditors.

Some commentators have argued that rescheduling cannabis to Schedule III will only provide federal bankruptcy access to cannabis businesses that have properly registered with the Drug Enforcement Administration (DEA) in compliance with the CSA. Under the CSA, to manufacture, distribute, or dispense a Schedule III Controlled Substance, a business must be properly registered with the DEA, complete certain training and/or certification, and be licensed or otherwise compliant under applicable state law. While it ultimately depends on the approach the United States Trustee’s office takes following rescheduling, the Hacienda ruling and the continuous shifting attitudes in favor of cannabis legalization indicate that it is more likely that the United States Trustee will change its policy to allow federal bankruptcy cases for cannabis businesses to proceed.

To be sure, the collisions between state-legal cannabis activity and federal prohibitions are complex and unsettled. Not all courts may follow the lead of the Hacienda ruling. And regulatory change often faces delays and roadblocks. However, these recent developments offer glimpses of how the cannabis industry could enter a new era if creative lawyering combines with further policy shifts.

While cautious optimism is warranted, the potential for cannabis companies to utilize bankruptcy protections and for broader federal reforms signify rays of light after years of darkness. With the right legal strategies and policy momentum, these changes could unleash great opportunities for cannabis businesses and stakeholders in Oregon and nationwide.

Questions on how your cannabis business can possibly take advantage of these developments? Contact the team at Tonkon Torp.

Ferdinand Ruplin is chair of Tonkon Torp’s cannabis group, working with cannabis producers, processors, and retailers within the OLCC and ODA regulatory framework. His broad practice emphasizes mergers and acquisitions, and a range of corporate and business matters. Danny Newman is partner in Tonkon Torp’s litigation department, and co-chair of the government law and disputes group. His practice is focused in bankruptcy and reorganization, representing debtors and creditors in state court litigation and out-of-court workouts.