In a landmark decision, the court in In re Hacienda Co., LLC, No. 2:22-BK-15163-NB, 2023 WL 6143217 (Bankr. C.D. Cal. July 11, 2023) confirmed a California cannabis company’s bankruptcy plan of reorganization, staving off pressing creditors and enabling it to raise working capital through gradually selling off shares.

In providing a cannabis grower and seller with previously forbidden bankruptcy protection, the Hacienda opinion fortified the cannabis industry by creating access to this essential debtor’s tool and placing the industry on equal footing with all other legitimate businesses.

Bankruptcy and cannabis law overview

Governed by federal law called the Bankruptcy Code, the bankruptcy system allows debtors to either dismiss or partially satisfy debts they are incapable of fully paying, and upon filing, creates an “automatic stay” period during which creditors are prohibited from attempting to collect. Bankruptcy petitions are filed in a federal bankruptcy court governed by the code although state laws may determine how debtors’ property rights are affected (ex., validity of liens or exempting property from creditors).

Bankruptcy’s most common form is a Chapter 7 “liquidation” in which the court appoints a trustee to collect and sell debtors’ non-exempt property and distribute proceeds to creditors.  Because most states allow debtors to keep essential property, Chapter 7s are usually "no asset" in which there are zero saleable assets to fund a distribution to creditors.

Bankruptcies allowing debtors to keep some or all of their property, reorganize and use future earnings to pay off creditors fall under code Chapters 11, 12 or 13.  Individual debtors usually file Chapter 13s, business entities file Chapter 11s, and Chapter 12 filings mirror Chapter 13 but are only available to "family farmers" and "family fisherman" and provide more debtor favorable terms.

In a Chapter 11 or 13 reorganization, the court imposes an “automatic stay” preventing creditors from proceeding against the debtor, and the debtor submits a plan of reorganization detailing its strategy to pay its creditors, which, if confirmed by the bankruptcy court, prevents a Chapter 7 liquidation, repays creditors and helps return the debtor to profitability.

Those cultivating, processing, infusing, transporting or dispensing cannabis are deemed to be “plant-touching” marijuana related businesses (MRB), and despite being legal in 38 American states, cannabis remains federally illegal. The Controlled Substance Act, 21 U.S.C. §§ 801, Et. Seq (1970) (CSA) currently lists marijuana next to heroin as a Schedule I controlled substance having “a high potential for abuse” and for which there’s “no currently accepted medical use in treatment” and “a lack of accepted safety for use” “under medical supervision”. 21 U.S.C. §812(b)(1). The CSA prohibits marijuana’s cultivation, distribution, dispensation and possession, and pursuant to the U.S. Constitution’s Supremacy Clause, state laws conflicting with federal law are generally preempted and void. U.S. Const., Art. VI, cl. 2; Wickard v. Filburn, 317 U.S. 111, 124 (1942)(”[N]o form of state activity can constitutionally thwart the regulatory power granted by the commerce clause to Congress”).

Because of marijuana’s 100% federal illegality, and because bankruptcy can’t be used to facilitate federally illegal activity or administer assets that can’t be possessed or sold under federal law, bankruptcy protection has been denied to both "plant touching" and "non-plant touching" MRBs. Comprehensive Drug Abuse Prevention and Control Act of 1970, 21 U.S.C. §§ 801, Et. Seq (1970).  April 26, 2017 Letter from Clifford J. White, Director, Executive Office for the United States Trustee to Chapter 7 and Chapter 13; In re Arenas, 535 B.R. 845 (B.A.P. 10th Cir. 2015) (denial of marijuana grower/seller and legal dispensary landlord’s motion to convert to Chapter 13 and Chapter 7 dismissal because debtor unable to propose feasible plan without violating federal law and trustee's estate administration duties by selling debtors' assets); In re Medpoint Management, LLC, 528 B.R. 178 (Bankr. Az. 2015) (dismissing “owner of intellectual property leased to marijuana products seller” due to "dual risk" of assets’ potential forfeiture and trustee's CSA violation in administering estate).

The Hacienda case

Forming one of the first federal rulings to provide an MRB with bankruptcy relief, the Hacienda opinion provides a road map for cannabis growers, processors, transporters or sellers to pursue “reorganization.”

Hacienda Co, LLC, a California cannabis wholesale, manufacturer, packager and distributor, transferred its assets, including intellectual property and drug-related goods, to LFI, a publicly traded Canadian company, in exchange for a 9.4% share in LFI.

After experiencing difficulties, Hacienda filed for bankruptcy protection under Chapter 11, and as part of its reorganization plan, proposed a capitalization strategy of gradually liquidating its LFI shares to avoid flooding the market and diluting the shares’ value which would maximize repaying creditors.

Arguing that the reorganization plan formed a conspiracy to violate federal criminal laws proposing to repay creditors with assets derived from alleged criminal activity (i.e. selling stock in a cannabis organization), the trustee moved to dismiss Hacienda’s bankruptcy petition pursuant to Section 1112(b) of the Code (which authorizes dismissing a Chapter 11 case for “cause”).

In rejecting the trustee’s argument, the Hacienda court deemed that that there is flexibility when private parties seek to enforce marijuana-related contracts, the trustee failed to show how the stock sale was inconsistent with federal bankruptcy policy of maximizing payment to the creditors, and Section 1112(b) granted discretion in determining whether “a debtor’s connection to cannabis profits and any past or future investment in cannabis enterprises warrants dismissal of this bankruptcy case.”

In denying the trustee’s dismissal motion, the court cited Hacienda’s indirect connection with any criminal law violation, Hacienda’s intent to liquidate and pay creditors, and the benefits of the monetization of this stock. The Hacienda court found that any CSA violations occurred before the bankruptcy filing, punishing Hacienda for pre-filing divestment of cannabis involvement and attempting to maximize the value of the estate to the benefit of creditors undermined bankruptcy system’s appropriate use and any pre-petition illegal acts by Hacienda were reasonably justified so long as it cured such violation of law within a reasonable amount of time through the post-petition sale of LFI’s stock.

Hacienda case's impact

While not immediately providing MRBs with full bankruptcy protection, the Hacienda opinion grants the courts an enormous amount of discretion when ruling on similar cases and provides a roadmap for MRBs to pursue bankruptcy reorganization.

First, unlike automatically bouncing an MRB’s bankruptcy petition based on the petitioner’s identity, the Hacienda opinion indicates that “bankruptcy relief access” should be determined on a case-by-case basis based on whether debtor is actively cultivating, processing, infusing, transporting or dispensing cannabis.

Thus, not only should “re-trenching plant touching MRBs” be eligible for bankruptcy protection, the Hacienda opinion instructs businesses providing products and services to plant-touching MRBs but not directly “manufacturing, distributing, or dispensing marijuana”, i.e. "Non Plant Touching" MRBs (ex., landlords, attorneys, accountants and hydroponics and cultivation providers), should not be denied bankruptcy relief.

Second, for plant-touching MRBs seeking a Chapter 11 organization, offering a plan maximizing creditor repayment through sale of assets, and not manufacturing, distributing, or dispensing marijuana, has the greatest likelihood of being confirmed by the bankruptcy court.

Third, by providing a cannabis grower and seller with previously forbidden bankruptcy protection, the Hacienda opinion strengthens the cannabis industry by arming it with a critical business tool. Beyond helping to survive an inevitable business downturn, bankruptcy relief enables cannabis companies like Hacienda to martial its assets and repay its creditors which, in turn, helps with fundraising.

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