One-Hit Wonders

Bankruptcy Court Doors Swing Open For Cannabis Companies, But Just Slightly

Published

2 years ago

February 2, 2023

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Are bankruptcy doors now opening for cannabis companies? A decision last week from a California bankruptcy court indicates perhaps so, at least for cannabis companies that are no longer operating.

Factual Background

The Hacienda Company, LLC (the “Debtor”) was in the business of wholesale manufacturing and packaging cannabis products. After it ceased operations in February 2021, the Debtor transferred its value, through the sale of intellectual property, to a publicly traded Canadian company, Lowell Farms, Inc. (“Lowell Farms”), receiving approximately 9% of Lowell Farms’ stock in consideration. Lowell Farms’ sole business is cannabis growth and sales.

The Debtor filed its chapter 11 petition on September 21, 2022. In response, the United States Trustee (the “UST”) filed a motion to dismiss the case for “cause” under section 1112(b) of the Bankruptcy Code, arguing that dismissal was required because: (a) the Debtor’s equity ownership in Lowell Farms violated the Controlled Substances Act (the “CSA”); (b) the Debtor is grossly mismanaging the estate because all of its assets are subject to forfeiture under the CSA; and (c) the Debtor filed its case in bad faith because any plan proposed by the Debtor would be funded from sources obtained in violation of the CSA.

The filing of the motion to dismiss could not have been a surprise to the Debtor given the general hostility of bankruptcy courts to cannabis debtors (see Cannabis and District Courts: Are Those Courthouse Doors Closed Too? | Restructuring GlobalView (restructuring-globalview.com, Cannabis and Bankruptcy: 2020 in Review | Restructuring GlobalView (restructuring-globalview.com, Up in Smoke: More Cannabis Companies Get Shut Out of Bankruptcy | Restructuring GlobalView (restructuring-globalview.com). However, and most likely to the shock of both the Debtor and the UST, on December 21, 2022, the bankruptcy court entered an order denying the UST’s motion to dismiss, and on January 20, 2023, the bankruptcy court issued its memorandum opinion.

The Bankruptcy Court’s Opinion

In its opinion, the bankruptcy court began by explaining why violations of the CSA may constitute “cause” for dismissal. The court specifically noted that such violations may evidence a lack of good faith and gross mismanagement of the estate, and further that CSA violations may warrant dismissal under general principals of equity. However, the court recognized the admonition of the Ninth Circuit Bankruptcy Appellate Panel in In re Burton, 610 B.R. 633, 637-638 (9th Cir. BAP 2020) that “the mere presence of marijuana near a bankruptcy case does not automatically prohibit a debtor from bankruptcy relief.” The court also noted that it has “some degree of discretion” in considering dismissal, particularly when there are no ongoing postpetition violations of the CSA. With these general principals in mind, the bankruptcy court examined the particular facts of the Debtor’s case.

First, the bankruptcy court rejected the UST’s argument that the Debtor’s ownership of the Lowell Farms stock constituted a violation of the CSA. The UST argued that ownership of the stock violated section 856(a) of the CSA which makes it illegal to “profit from” a place used to manufacture, store, distribute or use cannabis. Although it noted that the Debtor’s ownership of the stock put it in “uncomfortably close proximity to the cannabis industry,” the bankruptcy court held that the Debtor’s passive ownership of the stock, which it intended to liquidate to pay creditors, would terminate the Debtor’s connection with cannabis and was, in fact, the “opposite of an intent to profit from an ongoing scheme to distribute cannabis.”

Second, the bankruptcy court rejected the UST’s argument that the Debtor was violating the CSA by its postpetition use of the Lowell Farms stock or the stock proceeds. Section 854 of the CSA makes it illegal for a person who has received income derived from a violation of the CSA to “use or invest, directly or indirectly, any part of such income, or the proceeds of such income, in acquisition of any interest in, or the establishment or operation of, any enterprise [engaged in or affecting interstate or foreign commerce].” Because the Debtor did not propose to use any of the stock or proceeds of the stock to invest in any cannabis enterprise but was instead proposing to sell the stock and distribute the proceeds to creditors, the court held that there was no violation of section 854.

Third, the bankruptcy court rejected the UST’s argument that any future bankruptcy trustee would have to engage in illegal activity if the Debtor was found to have cannabis or cannabis-related products. The court noted that should such a contingency arise, a trustee could request the responsible federal authorities to dispose of the cannabis and, in an interesting aside, even hinted that a future trustee might have a duty to administer cannabis assets rather than simply turn the assets over to the federal authorities. In short, based on the record before it, the bankruptcy court found that the UST had not satisfied its burden to show that any future trustee would have to violate the CSA.

Fourth, and perhaps most dramatically, the bankruptcy court rejected the concept of a “zero tolerance” policy under section 1112(b) of the Bankruptcy Code for illegal conduct, including violations of the CSA. The court noted that interpreting “cause” under section 1112(b)(4) in such a way could prevent courts from considering a host of bankruptcy cases where there were prepetition violations of nonbankruptcy laws. In fact, the court noted that some of the largest bankruptcy cases (e.g., Enron Corporation and Bernie Madoff) involved alleged or actual criminal liability and applying the UST’s argument to its natural conclusion would lead to the mandated dismissal of these cases. The court reasoned that this would be contrary to the Bankruptcy Code’s policy of maximizing value for the benefit of creditors and preventing individual races to the courthouse. In light of these concerns, the court adopted a middle ground in interpreting “cause,” writing:

[T]his Bankruptcy Court does not interpret Congress’ mandate that this Bankruptcy Court “shall” dismiss or convert a bankruptcy case for “cause” under § 1112(b) to mean that any violation of criminal law requires dismissal. Rather, this Court interprets the statute as giving discretion to determine whether dismissal is warranted based on all the facts and circumstances.

…

[T]his Bankruptcy Court interprets both § 1112(b) and the UST’s [motion to dismiss] as adopting a middle ground, under which this Bankruptcy Court must exercise its discretion to determine whether, given all 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.

Finally, the bankruptcy court held that even if the UST had established “cause”, there were “unusual circumstances” that prevented dismissal under section 1112(b)(2). Specifically, the court pointed to the fact that the Debtor had divested itself, prepetition, of any direct involvement in the cannabis industry. Further, the court found that there was a realistic possibility of a “substantial” distribution to creditors through the liquidation of the Lowell Farms stock. Based on these facts, the court held that conversion or dismissal was not in the best interests of creditors.

Takeaways

Does the bankruptcy court’s opinion in Hacienda Company change the landscape for struggling cannabis companies? Perhaps to some extent, particularly if the cannabis companies had shut down their cannabis businesses prepetition and are seeking to use Chapter 7 simply to liquidate their remaining assets. In those cases, a court might be open to allowing the bankruptcy case to proceed. Further, cannabis companies in need of bankruptcy relief should be heartened by the court’s conclusion that it would, in lieu or dismissal, “defer to prosecutors … to use their discretion about whether and how to address any violations of nonbankruptcy law.”

The larger, and so far unanswered, question is whether the bankruptcy court’s rationale in Hacienda Company, particularly its rejection of a “zero tolerance” policy and its asserted equivalence between violations of the CSA and other nonbankruptcy law, can be read to support more expansive uses of the Bankruptcy Code by cannabis companies. For instance, can a cannabis company file bankruptcy to sell its assets (operating or not) under section 363 of the Bankruptcy Code? Can a cannabis company utilize chapter 11 to reorganize its affairs? Can a foreign cannabis company utilize chapter 15 to seek U.S. recognition of a foreign insolvency proceeding? Perhaps the only thing we know is that the UST will continue to oppose cannabis bankruptcies and that the outer boundaries of what is and is not permitted will continue to be litigated, at least until Congress removes cannabis from the list of controlled substances.

The UST has appealed the denial of the motion to dismiss. We will monitor the appeal and update our post when a ruling has been issued.

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One-Hit Wonders

Banking On Buds: The Complex Interplay Between Cannabis And Commerce

Published

5 days ago

September 3, 2024

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In the ever-evolving landscape of American policy, the story of cannabis legalization unfolds as a testament to societal change and the complexities of governance. This narrative, however, is not without its dissonances, particularly in the realm of financial services.

Introduction

In a nation marked by its pioneering spirit and the relentless pursuit of progress, the cannabis industry emerges as a vibrant tableau of innovation, marred by the shadows of regulatory uncertainty. As states across the Union chart their own courses, legalizing cannabis for medical and recreational use, they weave a patchwork of policies that stand in stark contrast to the federal government’s steadfast classification of the plant. This discord at the heart of cannabis commerce sets the stage for a deeper exploration into an issue that transcends mere legality, touching upon the very fabric of economic integration and societal values.

The Current Legal and Regulatory Landscape

At the federal level, cannabis remains ensnared in the Schedule I category of the Controlled Substances Act, a classification that denotes a high potential for abuse and no accepted medical use. This designation, rooted in the drug policy of yesteryears, casts a long shadow over the burgeoning cannabis industry, constraining its access to essential financial services and stifling its growth potential. Banks and financial institutions, wary of the legal ramifications of servicing cannabis-related businesses (CRBs), find themselves at a crossroads, caught between the promise of a new market and the peril of federal reprisal.

Cannabis Banking and Legislation Timeline

The following timeline weaves together the historical context, pivotal moments, and potential future developments in cannabis banking and legislation, including the critical role of the SAFE Banking Act and the impact of reclassifying marijuana. It serves as a guide through the evolving relationship between the cannabis industry and the financial sector, highlighting the journey towards regulatory clarity and economic integration.

1970 – Controlled Substances Act (CSA) Enacted: Marijuana was classified as a Schedule I drug, indicating a high potential for abuse and no accepted medical use, severely limiting research, and banking capabilities.
1996 – California Legalizes Medical Marijuana: Marks the beginning of state-led initiatives diverging from federal law, creating a patchwork of regulations, and increasing the need for banking solutions for cannabis businesses.
2013 – Cole Memorandum Issued: Although not law, it provides some protection against federal enforcement in states that have legalized marijuana, signaling a slight shift in federal attitude but leaving financial institutions wary of engaging with cannabis businesses.
2014 – 2019 – Incremental Banking Guidance: The Financial Crimes Enforcement Network (FinCEN) issues guidance for banks on serving cannabis businesses in compliance with the Bank Secrecy Act, but the banking challenges persist due to the overarching federal prohibition.
2019 & 2021 – SAFE Banking Act Proposals: The Secure and Fair Enforcement (SAFE) Banking Act was introduced in Congress, aiming to protect financial institutions that service cannabis-related businesses in states where it has been legalized. Despite passing in the House, it stalls in the Senate.
2020 – Present – Growing Bipartisan Support for Cannabis Banking Reform: As more states legalize cannabis for medical or recreational use, there is increased bipartisan support for federal banking reforms, including the SAFE Banking Act, to provide a safe harbor for banks.
2024 (Not So Hypothetical Future) – Marijuana Rescheduled to Schedule III: In a landmark move, marijuana is reclassified as a Schedule III controlled substance, acknowledging its medical use and lowering barriers for banking and research. This hypothetical future event would significantly alter the cannabis industry landscape. This is happening now.
2024 – 2025 (Future Outlook) – Implementation of the SAFE Banking Act: Following the reclassification of marijuana, Congress passes the SAFE Banking Act, easing many of the remaining financial and banking challenges for cannabis businesses. Financial institutions begin openly serving the cannabis industry, supported by clear federal guidelines.
2025 and Beyond – Normalization and Expansion: With the barriers to banking and finance removed, the cannabis industry sees a period of significant growth and normalization. Financial products and services tailored to the cannabis industry become widespread, and cannabis businesses are integrated into the broader economy.

Navigating the Dissonance: The Case for Reform

Amid the thicket of regulatory challenges and banking quandaries, a beacon of consensus emerges from the legislative realms. On May 2, 2024, the National Conference of State Legislatures (NCSL) issued a compelling appeal to the Department of Justice, urging the reconsideration of cannabis’s Schedule I status. “Currently, a total of 47 inclusive of states, the District of Columbia, and all U.S. territories except American Samoa have legalized cannabis for medical and/or adult recreational use,” the NCSL articulated, highlighting the stark contrast between state-led initiatives and federal policy inertia. This plea for reclassification is not merely administrative; it is a clarion call for alignment, seeking to reconcile the federal stance with the lived realities of millions and the operational exigencies of a burgeoning industry.

Discussion Points

This moment of potential transformation invites a broader reflection on the implications of such a shift. The reclassification of cannabis and the enactment of measures like the SAFE Banking Act could herald a new era for not just the cannabis industry but for American society at large. It prompts us to question the role of federalism in drug policy, the dynamics of change in a conservative sector like banking, and the societal values that underpin our approach to regulation and commerce.

Furthermore, the push for reform illuminates the intricate dance between innovation and regulation. As we stand on the precipice of change, it is imperative to consider how financial institutions can navigate this evolving landscape. The integration of cannabis into mainstream commerce offers a unique opportunity to redefine the relationship between the state, the market, and the individual, challenging us to reimagine the boundaries of entrepreneurship, responsibility, and community in the 21st century.

So…Now What?

The conversation surrounding cannabis banking and federal reform is more than a policy debate; it is a reflection of our collective journey toward a more nuanced understanding of progress, governance, and the human experience. As we ponder the path forward, it is clear that the resolution of this dissonance will require not just legislative change but a reevaluation of societal norms and values. In this endeavor, entities like Ankura play a pivotal role, not as advocates for a particular outcome, but as navigators helping to chart a course through uncharted waters, ensuring that regardless of the direction we take, we move forward with insight, integrity, and an unwavering commitment to the common good.

Solutions: A Blueprint for Navigating the Green Wave Together

In the evolving narrative of cannabis legalization and its implications for the financial sector, the role of consultancy firms becomes not just relevant but indispensable. Amidst this backdrop, Ankura emerges not as a mere participant but as a guiding force, navigating the intricate interplay between regulation, commerce, and innovation. This section, far from a sales pitch, is a contemplation on the utility and insight that Ankura brings to a landscape at the cusp of transformation.

The Art of Navigation in Uncharted Waters

In the realm of cannabis banking, where the regulatory environment remains as fluid as the sea, Ankura stands as the seasoned navigator, charting a course through tumultuous waters. The firm’s approach, deeply rooted in expertise and foresight, transcends the conventional consultancy model. Ankura’s role is akin to that of a cartographer mapping the unknown, transforming the complexities of legislation and market dynamics into a navigable blueprint for its clients.

Crafting Compliance Amid Complexity

The crux of Ankura’s value lies in its nuanced understanding of compliance within the cannabis sector—a field where the ground beneath one’s feet shifts with regulatory whims. The firm’s expertise illuminates the path forward for financial institutions entangled in the Gordian knot of federal and state regulations. Through a bespoke blend of strategic advisory, Ankura empowers these institutions to not only meet the current compliance benchmarks but to anticipate and adapt to the regulatory evolutions on the horizon.

Fostering Growth Through Insight

Beyond the minutiae of compliance, the Ankura vision extends to the broader horizons of growth and sustainability for both financial institutions and cannabis-related businesses. The consultancy’s insights into market trends, consumer behavior, and legislative forecasts act as a beacon for clients navigating the competitive landscape of the cannabis industry. In this capacity, Ankura is more than a guide; it is a partner in cultivation, helping to sow the seeds of long-term success in the fertile ground of opportunity.

A Convergence of Expertise and Innovation

At the heart of the Ankura methodology is a commitment to innovation, a principle that resonates deeply within the cannabis sector. The firm leverages cutting-edge technologies and data analytics to provide solutions that are not only effective but forward-thinking. This approach reflects a broader philosophy: that the challenges of today’s cannabis industry are not roadblocks but catalysts for innovation, driving the development of more sophisticated, transparent, and efficient financial services.

And Finally: A Partnership for Progress

Ankura’s role exemplifies the partnership between expertise and ambition. This narrative is an acknowledgment of the critical role that insight, foresight, and strategic guidance play in navigating the complexities of cannabis banking. As cannabis legislation evolves, Ankura’s contributions are a testament to the power of collaboration and knowledge in shaping the future of industries and economies alike.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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One-Hit Wonders

Driving Under the Influence of Marijuana

Published

8 months ago

January 24, 2024

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No national standard exists to determine how long someone should wait to drive after consuming marijuana. However, experts at the Colorado Department of Public Health and Environment recommend waiting at least six hours after smoking less than 35 milligrams of THC and eight hours after eating or drinking something containing less than 18 milligrams.

For reference, a “typical” marijuana cigarette contains at least 60 milligrams of THC, and most edibles contain around 10 milligrams per serving size. A 12-hour wait is safer, as the high (and subsequent drowsiness) from smoking a typical amount lasts far longer.

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One-Hit Wonders

How can it help distressed cannabis companies today?

Published

1 year ago

April 6, 2023

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Without the option to declare bankruptcy—due to federal illegality—the only recourse for cannabis businesses in distress to become solvent and / or distribute assets to creditors is to enter into an expensive and difficult judicial cannabis receivership. Receiverships are inherently adversarial, and the required input from third-party experts, lawyers and regular engagement with the courts can be incredibly costly.

Meanwhile, businesses operating in mainstream sectors have the ability to declare bankruptcy. This is also a court-ordered procedure that allows companies to satisfy lenders by liquidating assets, restructuring operations and finances, and to enjoy a break of sorts to make deals with creditors and renegotiate contracts and leases. Without a change to federal banking laws, cannabis companies are blocked from the benefits of bankruptcy, and the situation is only getting worse.

Given the current tight capital market environment, the increase in cannabis distressed assets, and the shortage of options to cannabis operators to address said challenges, is there a possible alternative option to alleviate the rather dire situation?

Genesis—Transition from Equity Financing to Debt Financing

Equity financing has been the most prominent way to raise capital in cannabis for the last several years. However,recent data collected by Viridian Capital Advisorsreveals that debt currently makes up 93% of capital raised by U.S. cannabis cultivation and retail companies, compared to 55.7% in U.S. industries overall.

This change in the capital-raising environment, which has led to an increased number of creditors in the sector, combined with continued market pressures on cannabis businesses to remain competitive, make it highly likely that the industry will inevitably see more receiverships.

Ultimately, while debt financiers are willing to lend cannabis businesses money, they expect to be paid back on time and often with high interest. If the business begins to struggle and enters a distressed phase that leads to receivership, the business assets will be sold off and the secured lenders will be the first to get paid, while the business itself is likely not to recover much.

Consider an Administrative and Collateral Agent

With receiverships punishingly expensive and the debt financing landscapebordering on predatorial, distressed cannabis businesses are desperate for any assistance or support available. An Administrative and Collateral Agent (ACA) could be the alternative support required, benefitting borrowers, lenders and regulators alike, and offering a more cost-effective and less punitive option to courts, receivers and lawyers.

Instead of dealing with the courts and an expensive court-appointed receiver, cannabis companies seeking relief could turn to an ACA to facilitate mediation between parties and create alignment within the industry, which does not exist today.

An ACA could create a level of trust, transparency and complementary positioning with industry participants that simply has not yet existed in cannabis. The use of an ACA could challenge the competing perceptions that there is already alignment between regulators, operators and lenders, or that a useful alignment between these parties could ever exist.

An ACA could be a real and valuable tool for state governments and regulators as they begin to understand that it is in their best interests to assist cannabis businesses in their states in the face of continued federal illegality and restrictions. Under a private agreement between parties, the ACA would conduct something more akin to an administrative receivership as opposed to the traditional judicial receivership that is the only current option for insolvent cannabis businesses to seek relief.

Building upon a Cannabis Credit Rating Framework

Ideally, an ACA would work within an industry-specific credit rating system for cannabis businesses in distress in order to work within an established framework for potential investors. If cannabis companies are ranked across an equitable, systematic and formulaiccredit rating system, borrowers, lenders and regulators would benefit from the quantifiable transparency afforded by said rating, and debt financing would have an inherent regulatory-like structure to prevent predatory lending. By avoiding the courts, the distressed cannabis company would save time, money and create a more attractive scenario for potential lenders.

Initial Path to Mitigating Solutions

While the current challenges facing cannabis businesses today are well documented and have risen to both creditors and regulators attention, a viable solution has yet to be identified. Most likely no one solution exists beyond waiting for the economic and capital environments to evolve. Yet, mitigating options do exist.

The introduction of an ACA is one such option. Questions remain as to the mechanics, regulatory, operative and fiscal alike, as well as who to trust to take it on. The introduction of a credit rating framework is the first step to creating a solid foundation from within which an ACA can operate transparently and equitably. Any potential buy-in from regulators, creditors and operators remains an open question.

All of that said, there is today an unprecedented set of market forces that is pushing all cannabis stakeholders to think outside of the box. The still growing opportunities in the cannabis industry, the will of operators to survive and succeed, as well as the increasing exposure from creditors, all point to not only an acceptance for the need of an alternative, but to the drive to do things differently.

Is your cannabis business in distress? Would you benefit from expert guidance and support in deciding on whether to enter into a receivership?Reach out to United CMC today.

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