United Cannabis Corp.’s Chapter 11 Filing Provide Another Test Case for Industry

On April 20, United Cannabis Corporation filed a Chapter 11 bankruptcy petition for reorganization in Colorado.  The Bankruptcy Court for the District of Colorado has previously dismissed bankruptcy cases for marijuana businesses due to the substances’ federally illegal status.  In In re Rent-Rite Super Kegs W. Ltd., 484 B.R. 799 (Bankr. D. Colo. 2012), the court found that there was “cause” under 11 U.S.C. § 1112(b) to dismiss the debtor’s Chapter 11 case because the debtor was violating the Controlled Substances Act by renting space in its warehouse to parties who were growing marijuana.  Under 1112 of the Bankruptcy Code, the court makes an equitable determination to see if there is “cause” to dismiss.  The court in Rent-Rite found that because a significant portion of the debtor’s income was derived from an activity classified as illegal under federal law, a confirmation of a chapter 11 plan in a federal bankruptcy court was impossible and the case should be dismissed.

Similarly, in In re Arenas, 514 B.R. 887 (Bankr. D. Colo. 2014), although the chapter 7 debtor possessed all of the required licenses and permits necessary to legally produce and distribute marijuana in the State of Colorado, the court dismissed the case because the mere act of estate administration would force the Chapter 7 trustee to commit crimes under federal law.  The “impossibility” of lawfully administering the debtor’s estate constituted cause for dismissal.

United Cannabis’s situation may be different, however, as its focus is on the manufacturing and selling of hemp-derived CBD products, which, subject to several important regulatory requirements, were de-scheduled from the Controlled Substances Act under the 2018 Farm Bill.  It also owns intellectual property in the form of patent that it licenses to medical and recreational marijuana businesses.  The vast majority of United Cannabis’s revenue through the third quarter of last year came from sale of its CBD products and only a small portion was derived from licensing and consulting related to marijuana.  United Cannabis could make the argument that their primary business is legal, while any marijuana-related activity is insignificant and indirect.

Following a strict directive to move to dismiss all marijuana-related bankruptcy petitions, the U.S. Trustee will likely move to dismiss United Cannabis’s case.  How the court treats such a motion will be closely watched and will have a ripple effect on other businesses in the industry looking to utilize federal bankruptcy protection

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