Medical Marijuana Dispensaries in Chapter 11 Bankruptcy

• Publication year: 2013

Medical Marijuana Dispensaries in Chapter 11 Bankruptcy

Vivian Cheng

MEDICAL MARIJUANA DISPENSARIES IN CHAPTER 11 BANKRUPTCY

Abstract

Since California passed the Compassionate Use Actofl996, the interaction between state and federal medical marijuana laws have been a subject of frequent legal debate. But few have considered whether state-compliant medical marijuana dispensaries may seek assistance from the bankruptcy system. Two dispensaries recently tested their ability to reorganize under chapter 11 of the Bankruptcy Code, but the cases were quickly dismissed. The U.S. Trustees argued that the debtors' business activities constituted "cause" to dismiss, lack of good faith in filing, and a "means forbidden by law, " and left the debtor with little reasonable chance of success.

This Comment argues that the requirements in §§ 1112(b), 1129(a)(3), and 1129(a)(11) to propose and confirm a chapter 11 plan do not foreclose bankruptcy protection for a medical marijuana business. Since medical marijuana dispensaries are legitimate businesses under state statute, there should be no lack of good faith or cause to dismiss the case under § 1112(b). Therefore, chapter 11 plans should also be confirmable since § 1129(a)(3) does not bar confirmation of plans based on the legality of the plan's specific terms, but rather on the legality of the manner of the plan's proposal. Such a plan should not be per se infeasible under § 1129(a)(11), although the risk of federal intervention may be a factor weighing against a finding of feasibility.

Even if a court decides to assess the substance of a dispensary's plan, they may use their discretion to give greater weight to state rather than federal law. Successful state legalization despite federal prohibition suggests the federal government's tacit acceptance of state-compliant dispensaries. Courts should allow dispensaries to pursue bankruptcy to satisfy more creditors and preserve a regulated medical marijuana market that protects patients and produces positive externalities for society. Debtors should be allowed to fund their repayment plans with state-compliant medical marijuana sales and leave constitutional challenges of state legalization policies to their proper forums. One group of marijuana business attorneys noted that if "bankruptcy courts develop a policy of denial of bankruptcy relief to medical cannabis entities, the legitimacy of the industry itself will continue to be stymied."

[Page 106]

INTRODUCTION

Medical marijuana dispensaries sell goods, compete for customers, buy or rent property, pay utility bills, hire employees, borrow from creditors, operate under state licenses, and even pay taxes.¹ Thus, they are subject to the same forces that might steer many other businesses into financial trouble. Unlike the deli next door, however, filing for bankruptcy might not be an available solution for struggling dispensaries due to their uncertain legal status. Rather, distressed medical marijuana dispensaries find their efforts to regain solvency thwarted by the federal government's battle with state legislators as both entities jockey for control over the permissibility of medical marijuana.

The Bankruptcy Code ("Code") does not explicitly prohibit dispensaries from filing for bankruptcy. But a U.S. Trustee has argued that medical marijuana businesses, which are prohibited by federal law, provide sufficient "cause" to dismiss under 11 U.S.C. § 1112(b).² Similarly, another trustee has argued that dispensaries could not possibly propose a good-faith plan that is not forbidden "by law."³

An increasing number of state medical marijuana laws that directly contradict the federal prohibition, coupled with the federal government's lack of enforcement,⁴ call into question whether courts should allow state-compliant dispensaries to reorganize in chapter 11 bankruptcy.

Since 1970, the federal government has prohibited selling, growing, and distributing marijuana through the Controlled Substances Act ("CSA").⁵ In

[Page 107]

Gonzales v. Raich, the Supreme Court confirmed Congress's power to regulate noncommercial, purely intrastate production and use of marijuana for medical purposes.⁶ Although the CSA operates at the outer bounds of Congress's authority under the Commerce Clause, it is clearly constitutional.⁷ Prior to Gonzales, the supreme Court rejected the common law medical necessity defense for crimes of manufacturing and distributing marijuana in United States v. Oakland Cannabis.⁸

Until recently,⁹ every state had prohibited the use and sale of marijuana for nonmedical use since the 1930's.¹⁰ However, after California passed the Compassionate Use Act of 1996 to protect seriously ill patients who rely on marijuana for medical use from "criminal prosecution or sanction,"¹¹ other states began to similarly contradict the CSA to allow medical marijuana.¹² Today, twenty states and the District of Columbia have similar state or local laws that remove criminal sanctions for qualifying patients, physicians, and caregivers.¹³ some of these laws also allow access to medical marijuana via home cultivation or dispensaries.¹⁴

This Comment considers how the direct conflict between state and federal law affects a dispensary's ability to reorganize under federal bankruptcy protection. Part I evaluates whether a medical marijuana business can overcome a motion to dismiss for cause or lack of good faith under § 1112(b) and propose a confirmable plan compliant with § 1129(a). Part II argues that a bankruptcy judge may confirm a plan that relies on the sale and cultivation of marijuana by deferring to state medical marijuana laws over the federal ban.

[Page 108]

Finally, Part III considers how the goals of bankruptcy, other public policy, and potential safeguards suggest that courts should treat medical marijuana businesses no differently than any other businesses permitted to reorganize under chapter 11.

I. BACKGROUND

A. "Cause" to Dismiss Under 11 U.S.C. § 1112(b)

Section 1112(b) permits a party in interest to request the dismissal of a case upon demonstration of "cause."¹⁵ Under the same provision, courts may also dismiss a chapter 11 case sua sponte.¹⁶ The cause standard is intended to further the basic purposes of chapter 11. Its goals include preserving viable businesses while maximizing creditors' return, facilitating negotiations to accommodate each party's interests, and producing a reasonable opportunity for plan confirmation.¹⁷

Section 1112(b)(4) provides a nonexclusive list of sixteen items that constitute grounds for dismissal for cause.¹⁸ Although filing a petition in bad faith is not explicitly included in this list, courts have overwhelmingly held that a debtor's lack of good faith in filing a petition establishes cause for dismissal.¹⁹

Section 1112(b) "measures the value of maintaining the [bankruptcy} process, and also polices the diligence of the debtor or other plan proponent to ensure that the process is proceeding with all deliberate speed and in accordance with the requirements of applicable law."²⁰ The cause standard recognizes that "when there is no reasonable likelihood that the statutory objective of reorganization can be realized or when the debtor unreasonably

[Page 109]

delays," provisions meant to help the debtor accomplish reorganization, such as the automatic stay, begin to run counter to the interests of the creditors.²¹ The bankruptcy court may therefore "effectuate the provisions of the Bankruptcy Code," including the implied good faith requirement, to protect the creditors.²²

This has been reflected in a key test of good faith—whether the plan was "legally and economically feasible."²³ The term "legally" has been used to ensure that the debtor intends to reorganize to satisfy rather than deter or harass creditors.²⁴

Some courts hold that cause to dismiss for lack of good faith arises when "either objective futility or subjective bad faith" is shown.²⁵ Other courts require both a likelihood of ultimate futility and bad faith of the petitioner to create sufficient grounds to dismiss.²⁶

Generally, there are three scenarios that may implicate a lack of good faith: "(1) one-asset (usually real estate) debtor cases; (2) cases that resort to bankruptcy court protection in order to make strategic use of a specific bankruptcy law right or power; and (3) cases that use of bankruptcy to secure a tactical litigation advantage."²⁷

B. Courts Disagree over the Meaning of the 11 U.S.C. § 1129(a)(3) Requirement to Propose a Plan "Not by Any Means Forbidden by Law"

While a court may not dismiss for cause early in the bankruptcy case, the court may later refuse to confirm the debtor's plan.²⁸ Failing to confirm a plan may lead the court to dismiss the debtor's case. A debtor's plan must meet a number of requirements in § 1129(a) to be confirmed.²⁹ Section 1129(a)(3) requires that a plan be "proposed in good faith and not by any means forbidden

[Page 110]

by law."³⁰ Courts generally consider the "good faith" and the "forbidden by law" components of §1129(a)(3) separately.³¹

The "good faith" language in § 1129(a)(3) is distinct from the good faith prerequisite to filing a petition read into § 1112(b).³² Good faith under § 1129(a)(3) is "more narrowly focused, and tests directly whether the debtor's conduct in formulating, proposing and confirming a plan displays the requisite honesty of intention."³³ This is in contrast to the good faith prerequisite to filing a petition in § 1112(b). Still, courts have the discretion to refuse to dismiss the case if it concludes that the creditors would be better served while the debtor remains in bankruptcy.³⁴

The second inquiry in §1129(a)(3), whether a plan is "not by any means forbidden by law," has been overshadowed by the good faith inquiry.³⁵ Courts have focused largely on the plan's ability to reorganize the debtor in a manner consistent with the objectives of the Code when considering this part of §1129(a)(3).³⁶

Courts differ on...