Bankruptcy Courts Remain Closed For Marijuana Businesses

As Seen in Law 360

The legality of marijuana in the United States is in a state of flux. Four states – Alaska, Colorado, Oregon, and Washington – have decriminalized marijuana for personal use, and others are considering similar measures. Medical marijuana use is also legal in a number of other states. All told, roughly half the states in the nation permit the use of marijuana in some fashion.

At the same time, marijuana remains a Class One Controlled Substance under the federal Controlled Substances Act, 21 U.S.C. § 801 et seq. (“CSA”), making its use and sale punishable under federal law even in those states where it is legal under state law. This conflict between federal and state law puts businesses with marijuana-related operations in an uneasy position. This tension has manifested itself in an unlikely forum – the nation’s bankruptcy courts.

Over the last few years, bankruptcy courts have held that marijuana businesses could not obtain bankruptcy protection. See, e.g., In re Arenas, 514 B.R. 887 (Bankr. D. Colo. 2014); In re Rent-Rite Super Kegs W. Ltd., 484 B.R. 799 (Bankr. D. Colo. 2012). The reasoning for these decisions was that bankruptcy courts, being federal courts of equity, could not grant relief under the Bankruptcy Code where the debtor’s business involved violations of federal law. Now, a court has determined that a marijuana-related debtor’s creditors cannot force it into bankruptcy either.

In re Medpoint Management, LLC, 2015 Bankr. LEXIS 1125 (Bankr. D. Ariz. Apr. 6, 2015) concerns a business that once operated a medical marijuana dispensary under the Arizona Medical Marijuana Act. At the time it was forced into bankruptcy, Medpoint’s only significant asset was a marijuana-themed trademark for which it received a licensing fee. Four of Medpoint’s creditors commenced involuntary bankruptcy proceedings against Medpoint pursuant to 11 U.S.C. § 303.

Medpoint moved to dismiss the petition, arguing that a bankruptcy trustee could not lawfully administer its estate, which Medpoint alleged arose from the marijuana industry. Alternatively, Medpoint argued that its petitioning creditors all knew that Medpoint was involved in the marijuana business, and they therefore had “unclean hands.”

Medpoint’s creditors acknowledged that courts had dismissed prior cases involving the disposition of marijuana-related assets, but they asserted that this case was different for two reasons. First, Medpoint’s income did not directly arise from the cultivation or sale of marijuana; it instead came from the intellectual property license that other companies used to market marijuana products. Second, the creditors cited the recently-enacted “Cromnibus Act,” which prohibits the use of Department of Justice funds to prosecute marijuana businesses that are otherwise legal under state law.

The Court rejected the petitioning creditor’s arguments and dismissed the involuntary petition. The Court adopted the reasoning of the Arenas and Rent-Rite cases that a debtor’s estate could not be lawfully administered where that estate involved marijuana-related property and that requiring a trustee to oversee the estate would put that trustee in an “untenable position.” The fact that Medpoint’s only significant asset was its trademark license did not make a difference to the Court. To the contrary, the Court found that Medpoint could conceivably be prosecuted under an accomplice liability theory under the CSA, thereby exposing its assets to forfeiture. The Court deemed this possible forfeiture or seizure of Medpoint’s property to be too great of a risk for a trustee to administer the estate.

The Court also was unmoved by the recent passage of the Cromnibus Act. The Court’s reasoning on this point was that the Cromnibus Act does not prohibit prosecution for marijuana-related offenses, but instead only bars the Department of Justice from using its own funds to prosecute such crimes. Nothing stops the DOJ from using other funds to prosecute CSA offenders, and the Court identified money obtained through the DOJ’s Asset Forfeiture Program as a possible source of funds to bring such actions. Further, the Court noted that the Cromnibus Act’s prohibition on enforcement extends only through September 30, 2015 and therefore could be revoked by future legislation.

The Court also found that the petitioning creditors clearly knew that Medpoint’s assets arose from the marijuana business. Three of those four creditors signed agreements stating that Medpoint was in the medical marijuana business, and the fourth signed an agreement with Medpoint to build a marijuana cultivation facility. Since the marijuana business violates federal law, the creditors’ hands were unclean, and they could not take advantage of the equitable powers of the United States Bankruptcy Code.

Finally, the Court denied Medpoint’s request to find the petitioning creditors in bad faith and impose sanctions upon them. While the Court believed that the creditors’ involuntary petition was improvident, the record reflected that Medpoint could not pay its debts and that the propriety of an involuntary petition against a marijuana-related business was a novel issue of law. As a result, the facts did not support a sanctions award. Medpoint has appealed the Court’s order to the Bankruptcy Appellate Panel for the Ninth Circuit, presumably to challenge the Court’s sanctions ruling.

The Medpoint case, even more than the Arenas and Rent-Rite cases before it, highlights the risks and difficulties faced not only by marijuana businesses, but by their creditors. Despite the fact that Medpoint’s income did not directly arise from marijuana and the Cromnibus Act limited the ability of the DOJ to prosecute marijuana-related offenses, the Court still dismissed Medpoint’s case. If Medpoint could not be administered in bankruptcy under the current legal framework, it is hard to imagine a marijuana-related business that could be.

While not addressed in detail by the Court, it also is significant that Medpoint was an involuntary case that Medpoint opposed. Thus, Medpoint was able to use its marijuana operations as a shield to keep itself out of bankruptcy. If this result is followed by other courts, creditors of marijuana-related businesses will lose a significant option for obtaining relief against their debtors. Arenas is currently on appeal, so this legal landscape is certainly subject to change. But until it does, businesses must consider the potential absence of federal bankruptcy relief before they participate in, or do business with, marijuana-related companies.