Bankruptcy cannot protect legal marijuana businesses

Bankruptcy courts are all federal, not state, entities

As the marijuana industry continues to grow, individuals and organizations that provide goods or services to cannabis-based businesses may face legal consequences few have considered.

While many individuals involved in marijuana businesses want little to no federal intervention when it comes to enforcement of laws, they may fail to understand the potential loss of the protections afforded under federal law, including bankruptcy.

Those involved in the marijuana industry — including those who lease space or sell equipment used in the production, distribution or sale of marijuana — may not be able to seek bankruptcy protection if their business fails. Federal bankruptcy courts — bankruptcy courts are federal, not state — cannot offer bankruptcy protection to debtors whose business activities constitute a federal crime. Federal criminal law creates challenges when marijuana businesses contemplate filing for bankruptcy protection, putting the companies themselves at risk, as well as anyone who does business with them.

 

Federal law

The Controlled Substances Act makes it illegal to “manufacture, distribute, or dispense, or possess with intent to manufacture, distribute or dispense, a controlled substance.” In addition, the Controlled Substances Act prohibits possession or distribution of “any equipment, chemical, product or material which may be used to manufacture a controlled substance … having reasonable cause to believe, that it will be used to manufacture a controlled substance.” As a result, it is illegal under federal law to sell any equipment that will be used to grow or process marijuana.

Marijuana businesses: Businesses directly involved in the marijuana industry cannot file for bankruptcy protection. Courts have held in order for a bankruptcy trustee to liquidate a growers’ assets, the trustee would violate federal law, meaning any payments made to a trustee pursuant to a bankruptcy of a marijuana business would be the product of a criminal enterprise in violation of federal law. Therefore, marijuana businesses cannot obtain bankruptcy relief.

– Landlords: Businesses that do not directly grow or distribute products containing cannabis can also be denied bankruptcy protection as a result of sales to marijuana businesses. In a recent case, a bankruptcy court dismissed a landlord’s bankruptcy petition because the landlord, a warehouse owner, rented space to a marijuana grower. Although the marijuana company was legal under Colorado law, the court held that the landlord had knowingly violated federal law and denied the landlord bankruptcy relief because the bankruptcy trustee would have been required to possess and administer assets in violation of federal law.

Gardening supplies: Another recent case in Colorado involved debtors that sold hydroponic and gardening-related supplies to marijuana and non-marijuana businesses. Although the equipment could be used for many crops, the expansion of indoor gardening supplies is largely dependent on the cannabis industry in Colorado. Although the court seemed reluctant to do so, it found that the debtors’ business violated the Controlled Substances Act because a portion of the equipment sold would be used to manufacture a controlled substance. The debtors participated in cannabis industry trade shows, gave away promotional materials associated with marijuana use, engaged in promotions with cannabis dispensaries and contributed prize money to “grow-offs.”

Selling hydroponic equipment did not demonstrate a specific intent to assist customers in violating federal law. However, the bankruptcy court found the debtors sold “equipment, chemical, product or material … knowing, intending, or having reasonable cause to believe, that it will be used to manufacture a controlled substance.” Because the equipment sold would be used to grow marijuana in violation of the Controlled Substances Act, the court dismissed the debtors’ bankruptcy petition.

 

A Note of Caution

Businesses that derive income from the sale of products used by marijuana businesses face significant risks and may be denied protection afforded debtors pursuant to the federal Bankruptcy Code. As long as the products sold could be used for growing marijuana, and the seller has “reasonable cause to believe” that products may be used to manufacture a controlled substance, the debtor will not be afforded bankruptcy protection.

As more cannabis-based businesses open, landlords, vendors, suppliers and others that do business with them must consider the potential risks of establishing business relationships with entities operating cannabis businesses in violation of federal criminal law, even if legal under state law.

 

Kenneth C. Pickering is a partner in Mirick O’Connell’s Business Litigation Group and chair of the firm’s Government Investigations Response and Compliance Team. He is a former special assistant district attorney and has tried more than 20 civil and criminal cases to verdict in Massachusetts and U.S. district courts. He has also represented clients in arbitration proceedings and has argued appeals in both state and federal appellate courts.

Angela J. Benoit is an associate in Mirick O’Connell’s Litigation Group. She focuses her practice on business and securities litigation and in representing clients in response to state and federal government investigations.

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