U.S. Trustee To Marijuana Businesses: 'NIMBC' - Not In My Bankruptcy Court

On June 8, 2017, Clifford J. White III, director of the U.S. Trustee Program("UST Program")1, proclaimed before a congressional subcommittee that "debtors with assets or income derived from marijuana may not proceed through the bankruptcy system."

The statement, made by White while testifying before a House judiciary subcommittee on oversight of the UST Program, reiterated the position taken by U.S. trustees in bankruptcy cases. It is unclear, however, the types of businesses the UST Program will deem to have assets or income derived from marijuana.

To date, bankruptcy courts have denied relief under the United States Bankruptcy Code to marijuana cultivators and dispensaries, as well as their landlords, on the ground that those businesses violated the Controlled Substances Act (the "CSA")—the federal law that regulates controlled substances such as marijuana.2 In each case, bankruptcy courts found that the cultivators and dispensaries violated a particular CSA provision because they either manufactured, distributed or dispensed marijuana,3 or because the landlords owned property being leased and used for the manufacture or distribution of marijuana.4 In at least one case, however, involving an entity that licensed its brand name to a dispensary, the violation in question hinged on an accomplice theory of liability for violating the CSA.5 This more attenuated violation may be consistent with the UST Program's broadly written position.

Nevertheless, as discussed below, the application of the UST Program's position and the limitation of bankruptcy relief has not been addressed at this stage, let alone settled, with respect to businesses that are ancillary to the core business of growing, processing, and dispensing marijuana, such as lighting, security, software and growing equipment entities (ancillary businesses). Moreover, there are options that may still be available for both marijuana businesses and ancillary businesses to manage their debt.

Limitations in Bankruptcy Cases Under Chapters 11, 13 and 7

Plans Must Be Proposed in Good Faith and Not by Means Forbidden by Law

A chapter 11 proceeding is used primarily by business entities to reorganize their debts while they continue to operate. A chapter 13 proceeding is also used to reorganize debts, but it is used by individuals rather than businesses.6 Under each of these chapters, the debtor creates a plan under which the debtor proposes to repay all or part of its debts. Pursuant to the Bankruptcy Code, the plan must be proposed in good faith and not by any means forbidden by law. "[N]ot by any means forbidden by law" requires that the plan comply with not just the Bankruptcy Code but other applicable federal and state statutes as well. Bankruptcy courts have held, in both chapter 11 and chapter 13 cases, that a plan providing for payments funded by an activity violating the CSA is proposed by means forbidden by law. Such plans are therefore deemed patently unable to be confirmed/approved by a bankruptcy court and, as such, are not deemed to be proposed in good faith.

Further, because the plan payments come from prohibited activity, which may trigger a penalty of forfeiture, any payments made under such plans are potentially subject to forfeiture which would make them illusory.7

Trustees Must Be Able to Administer Assets

Alternatively, rather than reorganize, a debtor may choose to liquidate. In a chapter 7 proceeding, the assets (that are not exempt from creditors) are collected, liquidated and distributed to creditors by a trustee appointed to the case under the UST Program. In a chapter 13 case, the debtor's assets and the payments made under a chapter 13 plan are also administered by a trustee appointed to the case under the UST Program.8 Bankruptcy courts have held that for a trustee (whether in a chapter 7 or 13) to take possession and control over a cultivator or dispensary's marijuana plants or of a landlord's leased real property utilized for growing and distributing marijuana, it would directly involve the trustee in commission of federal crimes.

Moreover, the prospect of a possible forfeiture or seizure of the assets and real property that the trustee would need to administer poses an unacceptable risk to a chapter 7 estate and to a chapter 7 trustee.9

Cases May Be Dismissed for Cause

Each of the bankruptcy cases (whether a chapter 11, 13 or 7) can be dismissed for cause (as long as the dismissal is in the best interests of creditors and the estate). "Cause" includes, among other things, filing of a bankruptcy case in bad faith. Bad faith does...