Cannabis Ruling Offers Narrow Path to Bankruptcy Perks

A recent California court opinion allowing a former cannabis company to continue its Chapter 11 case offers a new but narrow pathway for similar businesses to pursue bankruptcy.

The US Trustee’s policy largely bans cannabis companies from filing bankruptcy because cannabis is illegal at the federal level. But the US Bankruptcy Court for the Central District of California’s published Jan. 20 opinion allowed the Hacienda Company’s Chapter 11 to proceed, saying the company had removed its wholesale cannabis product manufacturing and packaging business by the time it filed and was not looking reorganize as a cannabis concern.

Judge Neil W. Bason’s opinion espoused a “middle road” interpretation of the bankruptcy code, in which a court assesses a would-be debtor’s facts and circumstances before deciding whether to let a Chapter 11 case continue.

The opinion, while limited to the court’s jurisdiction, offers a glimmer of hope that businesses with former cannabis connections, and the right set of facts, could use bankruptcy to liquidate and pay off creditors.

“I think that this is a roadmap for cannabis companies that are unfortunately in financial distress, and they’re throwing in the towel,” said Mark Salzberg, a bankruptcy attorney at Squire Patton Boggs.

The US Trustee, which is the Justice Department’s bankruptcy watchdog, has opposed cannabis companies’ efforts to seek bankruptcy protections. Bason’s opinion shifts away from what’s been seen as the US Trustee’s zero-tolerance policy on cannabis-related debtors and toward a more fact-driven analysis.

“I think this opinion is a movement away from a slavish following of the UST’s policy decision – to seek to deny any form of bankruptcy relief to debtors,” said James L. Day, a Bush Kornfeld LLP partner.

Bason’s ruling also bats down the US Trustee’s attempt to toss Hacienda’s Chapter 11 case.

The DOJ didn’t respond to a request for comment.

‘Middle Road’

In his opinion, Bason cited a 2020 Ninth Circuit Bankruptcy Appellate Panel opinion called Burton v. Maney, which said “the mere presence of marijuana near a bankruptcy case does not automatically prohibit a debtor from bankruptcy relief.”

Bankruptcy provides debtors protections, including a litigation reprieve, an orderly way to pay creditors, and the ability to get out of contracts and leases.

The Hacienda Company, based in Beverly Hills, Calif., stopped operating in February 2021 and transferred its property to Lowell Farms Inc., a public Canadian company. In return, Hacienda received 9.4% of Lowell’s shares, according to the court. Lowell sells and grows cannabis in Canada, where it is legal.

Hacienda filed for Chapter 11 in September 2022, and has proposed a plan to liquidate after paying creditors with either its Lowell shares or the proceeds from selling the shares.

Bason found that Hacienda’s passive stock ownership and intent to liquidate would end any connection with cannabis. That moots the US Trustee’s arguments that a company shouldn’t be able to use bankruptcy to eventually profit from an ongoing scheme to distribute cannabis, the court found.

The judge said the “middle road” approach—in which a bankruptcy court uses its discretion based on facts and circumstances—would determine whether a debtor’s connections to cannabis profits or past or future investments in cannabis warrant dismissal of its Chapter 11 filing.

“Dismissing every case that had a connection with illegal activity would be contrary to Congress’ directives under the Bankruptcy Code,” Bason wrote.

Cannabis v. DOJ

The judge’s opinion pushes back on US Trustee policy, which says bankruptcy and reorganization plans can’t be used as part of the “ongoing commission of a crime.”

The policy, laid out in a 2017 public letter, is based on the idea that a bankruptcy judge can’t require bankruptcy trustees and other estate fiduciaries to administer estate assets that would mean them violating federal law.

Bason also seemed to indicate that the presence of cannabis products by a debtor wouldn’t automatically eliminate its Chapter 11 case. Even in such cases, a bankruptcy trustee should be given some room to operate, depending on the facts and circumstances, he said.

The decision is bound to be invoked by other cannabis-adjacent businesses across the US, said Joseph Cioffi, a partner at Davis+Gilbert.

“The court here brings a new perspective, one that articulates the need for a more holistic analysis that encompasses social policies, criminal law, bankruptcy goals and the consequences for all interested parties if the case was dismissed,” Cioffi said.

Ninth Circuit

Clifford J. White, a former director of the US Trustee who co-authored the 2017 letter, told Bloomberg Law that Bason’s opinion, while thoughtful, is wrong.

“I disagree with the Court that administering/selling stock in a bankruptcy case is materially different from selling the underlying asset itself,” White, now retired, wrote in an email.

Still, White predicted that Hacienda could notch a win after the US Trustee’s appeal.

The Ninth Circuit has recently shown more leniency toward cannabis proponents than other circuits, White said.

The US Trustee’s office already suffered one of its few cannabis-related losses in Garvin v. Cook Investments, which was cited by Bason.

In the 2019 ruling, the US Court of Appeals for the Ninth Circuit affirmed a bankruptcy court’s approval of a Chapter 11 reorganization plan of a real estate firm that leased property to a cannabis grower in Darrington, Wash.

An appeal of the Hacienda ruling “may meet the same fate,” White said.

Bason’s opinion also provides potential upsides for the bankrupt companies’ creditors, said Zachary Kobrin, a regulatory, transnational, and cannabis law attorney with Akerman LLP.

Creditors could end up getting treated better with a bankrupt debtor’s reorganization or liquidation plan than trying to get paid outside of bankruptcy, he said.

Creditors could also avoid a “race to the courthouse” because the opinion provides an opportunity for businesses that remove their cannabis inventory to then proceed with an orderly wind-down in bankruptcy, said Jason Rosell of Pachulski Stang Ziehl & Jones.