In this photo taken Tuesday, May 14, 2013, Medical marijuana prescriptions vials are filled at the Venice Beach Care Center medical marijuana dispensary in Venice, Calif. Los Angeles politicians have tried and failed for so long to regulate medical marijuana that it was only a matter of time before voters got a chance to control shops that have proliferated. Complicating matters, there are three measures on Tuesday’s ballot that would allow sick people to get the drug, but either limit the number of shops, raise taxes or do both. (AP Photo/Damian Dovarganes) (Damian Dovarganes)
This November, Florida voters will consider a proposed state constitutional amendment to allow the cultivation, distribution and sale of marijuana for medical use. Supporters are confident the referendum will pass, and recent polls suggest their confidence is justified. Not surprisingly, entrepreneurs are preparing to capture part of what some estimate will be a $785 million industry.
But like all businesses endeavors, some will succeed and some will fail. Pioneers in this new industry must consider not only their entry into the market, but their exit. Companies wanting to lend, lease or sell to medical marijuana facilities must consider how doing so may impact their own options as debtors and creditors, because without a change in federal drug policy, bankruptcy relief will not likely be an option.
Bankruptcy courts in California, Colorado and Oregon, where medical marijuana is already legal under state law, have rejected attempts by medical marijuana facilities and their owners to reorganize or discharge debts under the Bankruptcy Code. The courts’ rationales have varied, but the key issue has been the same—marijuana sales are still illegal under the federal Controlled Substance Act.
For example, in California, a medical marijuana dispensary attempted to reorganize under Chapter 11 of the Bankruptcy Code. The bankruptcy court dismissed the case because the only source of funding for the plan was the sale of marijuana in violation of federal (but not state) law.
Therefore, from the court’s perspective, any proposed plan of reorganization would be by illegal means, and any plan payment would be subject to forfeiture. The bankruptcy court also refused to convert the case to a liquidation under Chapter 7 of the Bankruptcy Code because it could not force a Chapter 7 trustee to engage in illegal activities—specifically, the possession and sale of marijuana inventory to satisfy the dispensary’s creditors.
Bankruptcy filings by nongrower and nonseller debtors in the supply chain may also be affected. In a Colorado case, a commercial landlord attempted to reorganize under Chapter 11. The bankruptcy court dismissed the case because 25 percent of the landlord’s revenue was from tenants growing marijuana in violation of federal law.
Similarly, in an Oregon case, a bankruptcy court refused to confirm a personal debt repayment plan proposed by an individual under Chapter 13. The individual owned a company that leased a warehouse to marijuana growers who were in compliance with state law. The court wouldn’t accept the plan because it would be funded through income the individual received from his company, which the court considered proceeds from criminal activity.
The bad news is not limited to debtors who want bankruptcy protection. Bankruptcy courts may also turn away creditors who want to force a debtor into bankruptcy. If the creditors knew the debtor was in the medical marijuana business, a bankruptcy court may dismiss the creditors’ petition based on their “unclean hands”—the creditors were providing goods or services to help the debtor sell illegal drugs.
The good news for creditors, however, is that without bankruptcy protection, debtors cannot obtain a discharge of their liabilities under judgments or personal guaranties, debtors cannot stall pending lawsuits and foreclosure actions, and debtors cannot cram down reorganization plans against creditors’ wishes.
While those in the medical marijuana supply chain could still look to state insolvency options, such as assignments for the benefit of creditors, those options do not provide many of the key tools of debtors in bankruptcy.
Therefore, while the decisions of bankruptcy courts outside of Florida are not binding here and arguments may yet be made that could sway a Florida bankruptcy court otherwise, people and businesses looking to enter into this emerging market, or interested in providing goods or services to those in the market, must assess and manage their financial risks and liabilities assuming that they will be operating in a world where bankruptcy can be neither a sword nor a shield.
Even more so than usual, owners of medical marijuana facilities must closely scrutinize personal guaranties and obtain asset protection advice. They must also obtain advice on how to structure and operate their businesses in a way that minimizes risks to themselves and affiliated businesses.
Vendors, lessors and lenders to medical marijuana facilities must pay special attention to the extent of their reliance on income from those businesses, and they must maintain tight credit controls so that they do not risk their own financial distress.