Court Allows Cannabis-Related Company to Liquidate Stock in Bankruptcy

While most bankruptcy cases have denied access to federal bankruptcy courts for cannabis and cannabis-related businesses, a Nevada bankruptcy court allowed a chapter 11 case to continue where the Debtor sought to liquidate, for the benefit of its creditors, its shares in a legal Canadian cannabis business. This decision in In re The Hacienda Company, LLC signifies an increasing comfort level by bankruptcy judges to allow federal bankruptcy relief where the debtor is not continuing to engage in activity in violation of the federal Controlled Substance Act of 1970 (the CSA). [1] We recently reported on another decision, In re Blumsack, where the court refused to allow an individual to receive bankruptcy relief because he was, and continued to be, employed by a cannabis business.[2]

In Hacienda, the United States Trustee filed a motion to dismiss the chapter 11 case of the Debtor who was in the business of manufacturing and packaging cannabis products prepetition but had ceased operations and sold its intellectual property to a Canadian company.  The sale was structured so that the Debtor received equity shares of the purchaser whose sole business was cannabis growth and sales, a legal enterprise under Canadian law. The Debtor filed the bankruptcy case to sell off the shares in an orderly fashion and use the proceeds to pay creditors. The bankruptcy court reviewed decisions where courts have dismissed cases involving cannabis businesses on the basis of violations of nonbankruptcy law because they (a) establish a lack of “good faith” sufficient to warrant dismissal; (b) constitute “gross mismanagement” of the estate where the violation exposes the estate to financial losses and criminal sanctions; or (c) conflict with the judicial oath to uphold the law as a court of equity.  The court noted, however, that ongoing postpetition violations are more problematic than prepetition violations and the degree of indirect connections with illegal activity is an important factor in the court’s exercise of discretion to dismiss the case.

Here, the Debtor’s passive ownership of stock that it intended to liquidate would terminate any connection with illegal cannabis activity. Further, the Debtor was not going to be violating the CSA from use or investment of cannabis proceeds.  The lack of current or foreseeable illegality was grounds for denying the motion to dismiss.  The Hacienda Court did not rest its decision on this ground, but rather, noted that Congress did not include in the statutorily drafted examples of cause for dismissal a violation of the CSA or any other nonbankruptcy laws. Therefore, noting infamous cases involving criminal activity such as Enron and Madoff, the court reasoned that such a violation does not “necessarily” constitute cause for dismissal or conversion.  The bankruptcy courts should be open to the vast majority of cases that have touched upon prior illegal activity for the fair and equitable administration of the estates. The US Trustee’s office has a zero-tolerance policy for cannabis related debtors.  The Hacienda Court adopted a middle ground, under which the court must exercise its discretion to determine whether, given all of the facts and circumstances, a debtor’s connection to cannabis profits and any past or future investment in cannabis enterprises warrants dismissal of this bankruptcy case. Parties that wish to utilize the Bankruptcy Code for a cannabis related liquidation plan should take note of this case, sell the cannabis inventory, cease operations, and then commence a bankruptcy case.

[1] In re The Hacienda Company, LLC, No. 22-15163-NB, 2022 Bankr. LEXIS 3689; 2023 WL345793 (Bankr. C.D. CA Jan, 20, 2023).

[2] In re Blumsack, No. 21-40248-EDK, 2023 Bankr. LEXIS 108 (Bankr. D. Mass. Jan. 17, 2023).

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