Despite growing public acceptance of marijuana and the wide-spread passage of state laws legalizing marijuana for medicinal and even recreational purposes, marijuana remains a criminal offense under federal law which presents profound implications for those involved in the marijuana industry who seek the protections of the Bankruptcy Code. Even in a growth industry, there remains a need — by debtors and creditors alike — for an orderly process for liquidation or restructuring of failing businesses. To date, twenty-nine states and the District of Columbia have enacted medical marijuana legislation, with eight of those states also permitting its recreational use. However, federal law is clear in treating marijuana as an illegal substance and no change is in sight on the federal level. In fact, there are current indications that the Department of Justice may be reversing the laissez-faire federal response to state-sanctioned marijuana adopted under the Obama administration. What effect then does engaging in business activities legal under state but not under federal law have on access to the bankruptcy process?
There is a developing body of law addressing access to bankruptcy for state-licensed marijuana and related entities. Some issues have been definitively addressed while others remain ambiguous or unanswered. Courts have consistently barred companies or individuals that directly derive ongoing income from the cultivation or dispensing of marijuana from the protections of the Bankruptcy Code. Less certain, however, is the fate of those who, in varying degrees, do business with the marijuana industry.
General structure of the Bankruptcy Code.
Business entities utilize the provisions of chapter 11 to reorganize their debts while continuing to operate. An individual with regular income may use chapter 13 to repay all or a portion of his secured and unsecured debts. In both chapters 11 and 13, the debtor formulates a plan that must be proposed in good faith and not prohibited by law. As an alternative to reorganization, the liquidation provisions of chapter 7 are available to individuals and businesses where a trustee is appointed under the United States Trustee Program (“USTP”) to liquidate assets of the estate for distribution to creditors.
The right to bankruptcy relief, however, is not absolute. Bankruptcy cases may be dismissed for “cause,” which includes, among other things, the bad faith filing of a bankruptcy case. In addition to an improper motive, bad faith includes the filing of a plan that is incapable of being confirmed in compliance with the requirements of the Bankruptcy Code or existing law.
The Controlled Substances Act and the position of the United States Trustee.
The United States Trustee Program has been vigorous in objecting to the bankruptcy filings of businesses and individuals associated with marijuana businesses licensed and legal under state law but illegal under federal statute. The USTP’s response to marijuana-related bankruptcies has been guided by two objectives. First, in the words of the Executive Office for U.S. Trustees, “the bankruptcy system may not be used as an instrument in the ongoing commission of a crime, and reorganizations that permit or require continued illegal activity may not be confirmed.” It is a unique and unprecedented situation where businesses have sought the protection of the bankruptcy courts to continue operations that are illegal, at least in the eyes of the federal government. Typically, companies that have engaged in illegal activities have stopped doing business — or at least the illegal activities — before a bankruptcy filing. Companies such as Enron, Madoff Investment Securities and Tyco were able to utilize bankruptcy and related processes to deal with the aftermath of widespread illegal corporate activity. Second, the USTP does not want to expose bankruptcy trustees and other estate fiduciaries to the administration of tainted assets of the estate if doing so would cause them to violate federal law. In chapter 7 and 13 cases, trustees take possession and control over the assets of the estate which, in the context of a cultivator or dispensary, would directly involve the trustee in the commission of a federal crime.
At present, and for the foreseeable future, marijuana is illegal under federal law. Enacted in 1970, the Controlled Substances Act, 21 U.S.C. § 801, et seq. (“CSA”), embodies the federal program to classify and regulate the manufacture, distribution and use of certain substances. Marijuana falls under Schedule I of the CSA, which is reserved for those drugs considered to have a high potential for abuse and that have no accepted medical benefits. 21 U.S.C. § 812. The illegality under federal law of a business that cultivates and sells marijuana is clear as it is unlawful under the CSA “for any person knowingly or unintentionally to manufacture, distribute, or dispense, or possess with intent to manufacture, distribute, or dispense, a controlled substance.” 21 U.S.C. § 841(a)(1).
The USTP has taken the position that there is no distinction under the CSA between the seller or grower of marijuana and businesses that provide goods or services to marijuana companies. For example, with respect to landlords that lease space utilized by marijuana companies, it is unlawful to “manage or control any place, whether permanently or temporarily, either as an owner, lessee, agent, employee, occupant, or mortgagee, and knowingly and intentionally rent lease profit from, or make available for use, with or without compensation, the place for the purpose of unlawfully manufacturing, storing, distributing, or using a controlled substance.” 21 U.S.C. § 856. Further, the CSA makes it a crime to sell or offer for sale any drug paraphernalia, which is defined to include, among other things, “equipment, product, or material or any kind which is primarily intended or designed for use” in manufacturing a controlled substance. In response to the Congressional intent articulated in the CSA, the USTP has consistently sought the dismissal of bankruptcy petitions filed by growers and dispensers of marijuana as well as certain ancillary enterprises that provide goods and services to such marijuana businesses.
Current case law is definitive in prohibiting business bankruptcy access to direct growers and dispensaries...
