Opening Statements

Courts decline to extend bankruptcy laws to marijuana businesses

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Recent decisions holding that state-compliant medical marijuana growers and dispensaries can't reorganize in bankruptcy are highlighting the sticky problems that result when federal and state marijuana laws conflict.

Most recently, a bankruptcy appellate panel of the 10th U.S. Circuit Court of Appeals at Denver held in August that marijuana businesses can’t get relief in the bankruptcy system even if they’re legal under Colorado state law. The debtors in In re Arenas, licensed marijuana growers and distributors, sought bankruptcy protection after losing a lawsuit against their tenants. But the court held that because their business violated federal law, they couldn’t fund bankruptcy repayment plans with marijuana sales. Similarly, in 2012, a bankruptcy court in California dismissed the Chapter 11 petition of Mother Earth’s Alternative Healing Cooperative, a medical marijuana dispensary, because the group violated the federal Controlled Substances Act.

“If a marijuana business fails, they can’t turn to bankruptcy for a fresh start,” says Jared Ellias, a bankruptcy professor at the University of California’s Hastings College of the Law in San Francisco. “Normally, judges go to enormous lengths to help businesses to do as much as they can within the law to give relief to debtors. Judges constantly innovate within the confines of the law—such as recharacterizing sales transactions as secured loans—to give relief to debtors. There’s no reason to think that bankruptcy judges in the aggregate wouldn’t want to do this with a marijuana business, but there’s a brick wall judges run into with these cases—there’s nothing they can do.” The Arenas court stated that the decision not to allow a reorganization plan “funded from the fruits of federal crimes” was “relatively straightforward,” but at the same time acknowledged the result “is devastating for the debtors.”

Conflicts between federal and state laws are extremely difficult for bankruptcy judges to navigate, and this is just another example of a broader trend, according to Ellias. “When governments decide not to enforce a law, what matters is what’s on the books. This will increasingly intersect with bankruptcy law and continue to be murky.”

So what’s a state-legitimate pot business to do? Depending on the state, there may be avenues for relief in state receivership or insolvency proceedings, Ellias says. Also, lenders that fund these businesses should be aware that such companies cannot go into bankruptcy and then structure deals around that, similar to how some casino, media and airline companies are funded. Lenders could also seek collateral such as homes or cars from dispensary owners or require guarantees from people uninvolved in the business.

But marijuana businesses shouldn’t expect different outcomes from bankruptcy judges. “It’s the right result based on federal law; the Supreme Court would come to the same conclusion,” Ellias says. And Congress is unlikely to amend the bankruptcy code to make an exception to the bad-faith requirement. “That would be a step towards legalization of marijuana, and I think that’s unlikely.”

This article originally appeared in the February 2016 issue of the ABA Journal with this headline: “No Relief: Courts decline to extend bankruptcy laws to marijuana businesses.”

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