Protection for Cannabis Properties: Bankruptcy, Receivership, and Other Alternatives to Bankruptcy

• Jurisdiction: United States,Federal,California
• Author: Mikhail Parnes and Oren Bitan
• Publication year: 2020
• Citation: Vol. 38 No. 4

Protection for Cannabis Properties: Bankruptcy, Receivership, and Other Alternatives to Bankruptcy

Mikhail Parnes and Oren Bitan

Mikhail Parnes is an Associate Attorney and a member of Buchalter's Cannabis Industry Law Group. His practice includes counseling entrepreneurs, investors, and managers in California's legal cannabis industry regarding various aspects of compliance and litigation.^*

Oren Bitan is co-chair of Buchalter's Cannabis Industry Law Group and advises cannabis businesses on a wide variety of issues, including regulatory advice, banking, lending, financing, intellectual property, receivership, real property development and leasing, and assembling teams of attorneys to provide corporate and employment advice.^*

I. INTRODUCTION

Doing business in California's legal cannabis industry remains a risky proposition. Therefore, entrepreneurs, investors, and lenders who have stakes in state-sanctioned cannabis enterprises expect to see returns which justify the higher level of risk. Much of the unique risk arises from the fact that under the federal Controlled Substances Act ("CSA"), cannabis remains a Schedule I narcotic. The direct conflict between federal and California's treatment of cannabis results in cannabis enterprises lacking access to many institutions that are fundamental to business.

One such institution is bankruptcy, which is not available to California cannabis enterprises. As a result, stakeholders in legal California cannabis enterprises must consider alternatives to bankruptcy to collect what they can on their loans and investments in the event the enterprise becomes insolvent. A well-established alternative to bankruptcy that stakeholders should consider is a court appointed receiver. Through the receivership process, stakeholders may obtain many of the same protections available to them through bankruptcy.

This article proceeds in three substantive parts. First, the article covers cannabis's legal status in the United States, and how the bankruptcy courts have interpreted the foregoing status's effect on access to bankruptcy protection. Second, the article discusses court appointed receiverships, the nature of the remedy, and process for appointment. Third, the article applies the receivership remedy to a hypothetical case of a failing California cannabis enterprise.

II. BACKGROUND

A. Legal Status of Cannabis in the United States

According to Pew Research Center and Gallup polling in late 2019, at least 66 percent of American adults support cannabis legalization.¹ To date, twenty-three states have legalized sales and use of medical cannabis and eleven states plus the District of Columbia have legalized sales and use of recreational or adult-use cannabis in addition to medical cannabis.² The trend continued this November with ballot initiatives in six more states (Arizona, Mississippi, Montana, Nebraska, New Jersey, and South Dakota) to legalize cannabis in some form.³ Moreover, the 116th Congress is currently considering bills focused on access to banking, decriminalization, removing the Drug Enforcement Administration's enforcement authority over cannabis, and the continuation of forbidding the Department of Justice from spending congressionally appropriated funds to enforce federal law against state law compliant cannabis businesses.⁴ Congress will soon vote on the Marijuana Opportunity Reinvestment and Expungement Act of 2019, or the MORE Act of 2019, which seeks to effectively legalize cannabis federally by descheduling cannabis from Schedule I of the CSA.⁵ Nevertheless and as of the writing of this article, the United States federal government continues to treat cannabis as a Schedule I narcotic under the CSA.⁶

[Page 49]

Although outside of the scope of this article, it is worth noting briefly that until Congress passed and the President signed (on December 20, 2018) the Agriculture Improvement Act of 2018 (the "2018 Farm Bill") hemp was subject to nearly all of the same federal restrictions at issue in this article. The 2018 Farm Bill, however, descheduled hemp from the CSA legalizing federally cannabidiol (CBD)⁷ products that are derived from hemp.⁸

With one notable exception, the courts have not limited the reach of the CSA's prohibition of cannabis. The United States Supreme Court has refused to do so twice. In United States v. Oakland Cannabis Buyers' Cooperative, the Court held that the CSA did not contain an exception for medical necessity.⁹ The Court reasoned that the CSA "reflects a determination that marijuana has no medical benefits worthy of an exception" and "that medical necessity is not a defense to manufacturing and distributing marijuana."¹⁰ Four years later, in Gonzales v. Raich, the Court made clear that the CSA's criminalization of manufacturing, distribution, or possession of cannabis between California growers and consumers was a permissible use of Congress's Commerce Clause power where California's Compassionate Use Act permitted such activities.¹¹ Moreover, the Court noted that under the Supremacy Clause, Congress's plenary commerce power (i.e., the CSA) was superior to any state law that sought "to provide for the welfare or necessities of their inhabitants, however legitimate or dire those necessities may be."¹² In Conejo Wellness Center v. City of Agoura Hills, the California Court of Appeal, acknowledged that in all likelihood the CSA would preempt any attempted solution by the California Legislature to excise cannabis's prohibition under the CSA.¹³

A decision by the Ninth Circuit Court of Appeals represents the singular¹⁴ deviation from the foregoing line of cases. In United States v. McIntosh, the Ninth Circuit recognized that Congress can indeed limit federal enforcement of the CSA's cannabis prohibition without fully legalizing cannabis.¹⁵ In December of 2014, Congress enacted a rider to an omnibus appropriations bill, known as the Rohrabacher-Farr Amendment (the "Amendment") (also known as the Rohrabacher-Blumenauer amendment and in the present Congress, the Blumenauer-McClintock-Norton Amendment¹⁶).¹⁷ The Amendment provides:

None of the funds made available in this Act to the Department of Justice may be used, with respect to the States of Alabama, Alaska, Arizona, California, Colorado, Connecticut, Delaware, District of Columbia, Florida, Hawaii, Illinois, Iowa, Kentucky, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nevada, New Hampshire, New Jersey, New Mexico, Oregon, Rhode Island, South Carolina, Tennessee, Utah, Vermont, Washington, and Wisconsin, to prevent such States from implementing their own State laws that authorize the use, distribution, possession, or cultivation of medical marijuana.¹⁸

Relying on the Amendment, ten defendants arising from two cases moved to dismiss United States Department of Justice ("DOJ") indictments of various violations of the CSA.¹⁹ Writing for the Ninth Circuit, Judge O'Scannilain framed the issue on appeal as, "whether criminal defendants may avoid prosecution for various federal marijuana offenses on the basis of a congressional appropriations rider that prohibits the [DOJ] from spending funds to prevent states' implementation of their own medical marijuana laws." The Ninth Circuit answered the question in the affirmative, holding that the Amendment prohibited the "DOJ from spending funds from relevant appropriations acts for the prosecution of individuals who engaged in conduct permitted by the State Medical Marijuana Laws and who fully complied with such laws."²⁰

Notably, the Amendment was restricted to "[s]tate laws that authorize the use, distribution, possession, or cultivation of medical marijuana."²¹ Recognizing that McIntosh and the Amendment did not extend to state law that authorized use, distribution, or cultivation of recreational or adult-use cannabis, the text of the most recent iteration of the Amendment (which is not yet law), the Blumenauer-McClintock-Norton Amendment, does not contain the qualifier "medical" before "marijuana."²²

B. Cannabis's Status Under Federal Law Bars Access to Bankruptcy Protection

California (among other states) has pressed ahead with a comprehensive state statutory²³ scheme under which California enterprises may transact in cannabis and enter into contracts the object of which are cannabis.²⁴ As is true for all businesses, the majority of cannabis enterprises will fail. While bankruptcy trustees "shall manage and operate the property in his possession as such trustee, receiver or manager according to the requirements of the valid laws of the State in which such property is situated, in the same manner that the owner or possessor thereof would be bound to do if in possession thereof[,]"²⁵ the bankruptcy courts demonstrate that the CSA remains an obstacle to uniform application of bankruptcy protections in liquidating interests in cannabis enterprises.

[Page 50]

In In re George and Nansee Lanning, the debtors operated an unlicensed medical cannabis dispensary located on real property which the debtor owned.²⁶ A secured lender filed a motion to dismiss the bankruptcy case because, among other things, the dispensary was in violation of the CSA and applicable California law.²⁷ The court denied the motion.²⁸

In In re McGinnis, a bankruptcy court in Oregon came to an inconsistent outcome.²⁹ There, the court rejected confirmation of the debtor's reorganization plan which would be funded from the debtor's cannabis "grow operation" because such operations violate the CSA.³⁰

In Northbay Wellness Group v. Beyrie, the court dismissed an adversary proceeding between the debtor ("Northbay"), a corporation "set up to sell medical marijuana[,]" and Northbay's former attorney who allegedly misappropriated $25,000 from Northbay's legal defense trust fund.³¹ Northbay sought a nondischargeability order against the attorney under 11 U.S.C. § 523(a)(4).³² Citing Gonzales v. Raich, the court reasoned, "[w]hile the sale of marijuana may be legal under state law...