In March 2016, an article appeared in the “Affairs of State” column of the American Bankruptcy Institute Journal that discussed the quandary of medical marijuana in the context of banking and cannabis dispensaries’ need for banking services during a bankruptcy case.(( Jay D. Befort, “Ongoing Saga of Medical Marijuana: What’s a Bank and a Debtor to Do?” XXXV ABI Journal 3, 32-33, March 2016. )) Since then, the legalization of medicinal and recreational marijuana has expanded significantly with several additional states enacting laws that authorize and regulate the sale of cannabis products. As of June 2021, only five states—Idaho, Wyoming, Kansas, Tennessee, and South Carolina—maintain the fully illegal status of marijuana, and, even in some of those states, legislative efforts are pending to partially legalize the sale of medicinal marijuana.(( See https://disa.com/map-of-marijuana-legality-by-state. )) The remaining 45 states and the District of Columbia have legalized its use, primarily for medicinal purposes but, in some states, for both medicinal and recreational use.(( Id. ))
Unchanged over that five-year period, though, is marijuana’s continued classification as a Schedule I drug in the same category as heroin, hallucinogens, and ecstasy under the federal Controlled Substances Act (CSA).(( 21 U.S.C. §§ 801 et seq. ))1 The U.S. House of Representatives passed legislation removing marijuana from the list of Schedule I drugs when it passed the “Marijuana Opportunity, Reinvestment, and Expungement Act of 2020” (the “MORE Act) by a vote of 228 to 164 on December 4, 2020.(( See H.R.3884 – 116th Congress (2019-2020): MORE Act of 2020 | Congress.gov | Library of Congress. )) The Senate, however, did not consider the legislation on the floor, and it died, along with any hopes of removing marijuana from list of Schedule I controlled substances, before the close of the 116th Congress.(( MORE Act of 2020 (2020; 116th Congress H.R. 3884) – GovTrack.us, https://www.govtrack.us.congres/bills/116/hr3884 )) On July 14, 2021, though, Senate Majority Leader Chuck Schumer made public the Cannabis Administration and Opportunity Act which again proposes to remove marijuana from the Controlled Substances Act and to largely leave it to states to decide how to regulate its use.(( See https://www.natlawreview.com/article/us-senate-s-cannabis-administration-and-opportunity-act-clarifies-how-federal ))
The conflict between states which have legalized marijuana for medicinal and recreational purposes and the continued classification of marijuana as illegal under federal law, applicable in the federal bankruptcy courts, presents a conundrum for assistant attorneys general who represent state taxing authorities and regulators. Absent any of the proposed congressional changes to the classification of marijuana, the current status involving the treatment of debtor cases involving marijuana assets remains the same: the trustees cannot legally liquidate or otherwise administer marijuana or marijuana-related assets in the course of a bankruptcy case.(( See Directive of the Executive Office of the United States Trustee, April 26, 2017, available at https://www.justice.gov/ust/marijuana_assets.pdf/download. See also https://www.justice.gov/ust/file/abi_201712.pdf/download. )) Despite being the normal gateways for seeking relief from financial collapse, the bankruptcy courts must adhere to the dictates of the CSA and continue to deny relief to debtors or debtor companies that peddle marijuana. This bar applies regardless of whether the marijuana assets are employed for medicinal or recreational purposes or whether the underlying state in which the debtor or debtor business operates has legalized the sale of marijuana products for some or all uses.(( Consumer and Creditor Information (justice.gov) available at
https://www.justice.gov/ust/frequently-asked-questions-faqs-consumer-information#marijuana_faq4 ))
While the action of the House of Representatives in passing the MORE Act in 2020 and Senator Schumer’s filing the Cannabis Administration and Opportunity Act in 2021 suggest movement to declassify marijuana as a Schedule I drug, efforts to seek relief in bankruptcy for individuals or businesses with marijuana-related assets have remained stymied. This is not for want of trying by creative debtor’s counsel and debtors who present credible and feasible cases for reorganization, absent the albatross of marijuana assets. A sampling of cases from recent years reflects the continuous denial of relief in bankruptcy to debtors with marijuana-related assets:
In In re Way to Grow, 597 B.R. 111, 2018 WL 7357408 (Bankr. D.Colo., Dec. 14, 2018), Judge Romero reviewed prior decisions in In re Rent-Rite Super Kegs West, Ltd., 484 B.R. 799 (Bankr. D. Colo., Dec. 19, 2012) and In re Arenas, 514 B.R. 8872 Ultimately, the bankruptcy court dismissed that pending bankruptcy case based on the debtors’ illegal business activity, i.e. continued use and reliance on marijuana-related assets, which would violate the provisions of the Controlled Substances Act.
The bankruptcy court in In re CWNevada, LLC, 602 B.R. 7173
In re Burton, 610 B.R. 633 (9th Cir. B.A.P., January 14, 2020) involved the Chapter 13 case of spouses who owned a majority interest in a company that had previously cultivated and sold marijuana legally under applicable Arizona law. The bankruptcy court entered an order to show cause why the case should not be dismissed due to the debtors’ ownership interest in the former marijuana business. The debtors argued their previous marijuana-related business no longer operated, and their Chapter 13 plan would not rely on any funds from any cannabis operations illegal under federal law, so they should be able to rely on the third prong under Way to Grow (the inquiry should focus on the marijuana-related activities of the debtor during the bankruptcy case.) The business, however, remained involved in two lawsuits related to the former marijuana business, and the recovery of any proceeds from those lawsuits would necessarily have derived from the same unlawful business. The bankruptcy court concluded, and the Ninth Circuit Bankruptcy Appellate Panel affirmed, that dismissal was required because the presence of assets derived from the marijuana business would require the court and trustee to administer assets acquired in violation of the CSA.(( In re Burton, 610 B.R. 633 (9th Cir. B.A.P., January 14, 2020). )) Permitting this administration would also require the trustee to violate the April 26, 2017, directive from the United States Trustee not to administer marijuana assets.(( Directive of the Executive Office of the United States Trustee, supra at note 8. ))
Colorado’s Judge Romero was able to address another nuance in the application of federal bankruptcy law to marijuana-related businesses in the case of In re Malul, 614 B.R. 699 (Bankr. D. Colo., March 24, 2020). Judge Romero introduced his opinion with a reference to an operatic finale:
If the uncertainty of outcomes in marijuana-related bankruptcy cases were an opera, Congress, not the judiciary, would be the fat lady. Whether, and under what circumstances, a federal bankruptcy case may proceed despite connections to the locally “legal” marijuana industry remains on the cutting-edge of federal bankruptcy law. Despite the extensive development of case law, significant gray areas remain. Unfortunately, the courts find themselves in a game of whack-a-mole; each time a case is published, another will arise with a novel issue dressed in a new shade of gray. This is precisely one such case.(( In re Malul, 614 B.R. 699, 701 (Bankr. D. Colo., March 24, 2020). ))
The court granted conditional approval to reopen the Chapter 7 case to include litigation claims from equity investments in a defunct Colorado cannabis company. The debtor sought to exempt the state law claims from the estate, and the claimants then objected to the exemption. The debtor then moved to abandon the claims because they were derived from a marijuana-related business and could not be administered by the U.S. Trustee. The U.S. Trustee then moved to vacate the conditional reopening of the case on the grounds the debtor impermissibly attempted to parlay the bankruptcy into improving the debtor’s state court litigation position.
The bankruptcy court was left to determine whether the litigation claims arising from the investment in the marijuana-related business were sufficiently connected to CSA-forbidden cannabis activity to require vacating the order reopening the Chapter 7 case. The court concluded that the original investments were criminal violations of the CSA and therefore could not be administered by the bankruptcy court or the U.S. Trustee. The motion to vacate the order reopening the case was granted. Whether the debtor had intended in bad faith to seek reopening of the case to improve her position in the state court claim litigation was secondary to the court’s conclusion that the assets themselves were tainted under the CSA. The illegal nature of the marijuana-related assets doomed any efforts by the debtor to have the assets administered under the umbrella of federal bankruptcy law, even if only to have the assets remanded to her own custody and control.(( Id. ))
This sampling of cases is certainly not exhaustive, and the presence of legalized marijuana in the majority of states will increase the likelihood of more individuals or businesses with cannabis-related assets seeking bankruptcy relief. The saga of how to reconcile an ever more-tolerant state law regime for marijuana-related enterprises with the resistance of Congress to making any changes in the CSA is an example of the irresistible force meeting the immovable object. In the meantime, the bankruptcy courts are left to try to strike a balance between granting relief to the extent possible as the cases move ever further away from the direct taint of the marijuana business and the unequivocal mandate of the CSA. Absent congressional action to clarify the classification of marijuana under the CSA, it seems clear that the next five years will be little different than the last five in how bankruptcy reacts to cases involving the “killer weed.”
- Controlled Substances – Alphabetical Order (usdoj.gov), https://deadiversion.usdoj.gov/schedules/orangebook/c_cs_alpha.pdf [↩]
- Bankr. D. Colo; Aug. 28, 2014), Arenas v. United States Trustee, 535 B.R. 845 (10th Cir. B.A.P., 2015), and identified three propositions when analyzing the bases for denying bankruptcy relief in cases involving marijuana assets: first, the debtor cannot seek equitable bankruptcy relief while the debtor continues to be in violation of federal law; second, the court cannot grant bankruptcy relief where the trustee or a debtor-in-possession will necessarily be in possession of and administer “assets which are either illegal under the CSA or constitute proceeds criminalized by the CSA”; and third, the inquiry should focus on the marijuana-related activities of the debtor during the bankruptcy case and not necessarily before the filing of the bankruptcy.(( In re Way to Grow, 597 B.R. 111 at 120, 2018 WL 7357408 (Bankr. D. Colo., Dec. 14, 2018). [↩]
- Bankr. D. Nev., June 3, 2019) reviewed the application of the equitable maxim of the “unclean hands” doctrine alluded to in Arenas and cited to by Judge Romero in Way to Grow. The court in CWNevada clarified that denial of relief to a bankruptcy debtor will not be due solely to “unclean hands,” but rather to all the circumstances of each case, including the fact that assets of the estate were related to a marijuana-related business, relying once again on the mandates of the CSA.(( In re CWNevada, LLC, 602 B.R. 717 ((Bankr. D. Nev., June 3, 2019). [↩]
