Limitations on Marijuana Industry’s Use of Federal Bankruptcy Law

February 10th, 2021, Adult-use, Business & Corporate, Litigation, Medical

By: Kellie Fisher, Esq.

As the marijuana industry continues to grow, marijuana-related businesses will inevitably encounter financial difficulties and may seek to restructure.  Although the marijuana industry has been legalized in numerous states, it remains illegal under federal law.  Because bankruptcy courts are federal courts that apply federal law, businesses and individuals in the marijuana industry are likely ineligible for the protections afforded by the Bankruptcy Code and the federal bankruptcy process.

Marijuana remains a Schedule I drug under the Controlled Substances Act, which means that it is illegal to grow, distribute, or possess it.  Because marijuana remains illegal under federal law, Courts have held that federal bankruptcy courts cannot be used to facilitate the possession or sale of illegal assets.  It is the policy of the U.S. Trustee Program that U.S. Trustees shall move to dismiss or object to all bankruptcy cases involving marijuana companies or assets on the grounds that such assets may not be administered by the Bankruptcy Code. Therefore, bankruptcy cases filed on behalf of businesses and individuals that cultivate or sell marijuana will likely be dismissed at the outset of the case.

However, it is not only businesses that grow or sell marijuana that are prohibited from utilizing the bankruptcy process to reorganize.  Numerous bankruptcy courts around the country have also refused to allow businesses and individuals to utilize the federal bankruptcy process when the debtor has a tangential relationship with a marijuana company, or when a business or individual receives income from a marijuana operation. 

If a debtor files a chapter 11 or chapter 13 bankruptcy case, the debtor must propose a plan to reorganize its debts, which must be confirmed by the bankruptcy court.  A debtor’s plan must meet a number of requirements set forth in the Bankruptcy Code to be confirmed.  Sections 1129(a)(3) and 1325(a)(3) of the Bankruptcy Code requires that a plan be “proposed in good faith and not by any means forbidden by law.”  Courts have held that a debtor cannot fund its plan of reorganization, directly or indirectly, with assets related to or funds obtained from the operation of a business engaged in the cultivation or sale of marijuana because a plan providing for payments funded by an activity violating the Controlled Substances Act is proposed by means “forbidden by law.” For example, Courts around the country have refused to confirm plans and/or dismissed bankruptcy cases when a debtor leased real property to a marijuana business, when a debtor derived income from selling equipment to marijuana growers, and when a debtor provided management services to a marijuana company. A debtor’s inability to propose a confirmable plan of reorganization may lead to dismissal of the bankruptcy case.

Although several courts have ruled that bankruptcy relief is not available to companies with tangential ties to the marijuana industry, the Ninth Circuit, which encompasses Alaska, Arizona, California, Hawaii, Idaho, Montana, Nevada, Oregon, and Washington, has suggested that bankruptcy may be available within that jurisdiction for businesses and individuals with indirect ties to the industry. See Garvin v. Cook Investments NW SPNWY LLC, 922 F.3d 1031 (9th Cir. 2019) (debtor allowed to proceed in chapter 11 bankruptcy and confirm a plan of reorganization notwithstanding that it derived rental income from a tenant that was a cannabis grower).   

Marijuana-related bankruptcy remains a rapidly-evolving area of law, and the Department of Justice’s stance on marijuana-related bankruptcy filings will be closely monitored.  If you have any questions about bankruptcy law or possible alternatives to restructuring a company with ties to the marijuana industry, please reach out to a member of our Bankruptcy, Restructuring, and Creditors’ Rights Group.