Opinion: An alternative to bankruptcy for distressed cannabis businesses

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Image of a closed store after final sale

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Bankruptcy can be a helpful tool for distressed businesses.

The process allows a business to stop collection actions, discharge certain debts, cancel unfavorable contracts and provide breathing room to restructure the business.

If your plant-touching cannabis operation is struggling or failing, however, the bankruptcy court will not provide protection to businesses that work with high-THC cannabis, or marijuana.

Enter the state court receivership.

Photo of Paula Durham of J.S. Held
Paula Durham (Courtesy photo)
Photo of Scott Evans of J.S. Held
Scott Evans (Courtesy photo)

Receivership is an equitable remedy that is often employed as a bankruptcy alternative.

A receivership can address business insolvency or be a temporary remedy during legal proceedings between disputing business partners, with control of the enterprise hanging in the balance.

In either scenario, the court-appointed receiver takes control of the business and must assess the posture of the business to determine the best path forward.

The receiver’s options run the gamut from operating the company as-is, restructuring operations to maximize profit, or closing shop and liquidating the business as a whole or in pieces.

The receiver has a fiduciary responsibility to determine the option that best satisfies creditors – similar to duties required of a trustee in a bankruptcy.

What is receivership?

Distressed cannabis companies often are prime candidates for receivership.

Cannabis is a burgeoning industry with huge growth and profit potential.

However, worlds have collided in the “green rush,” where business-minded individuals – often with little knowledge of marijuana – have partnered with individuals well-versed in cannabis culture, cultivation and consumption but with little experience operating a business.

Add complex state laws and regulatory drama, fraud potential due to the all-cash nature of the business, and you’ve created the perfect recipe for insolvency, litigation or both.

In these often-chaotic conditions, it is easy for a cannabis company to become unprofitable.

A receiver can add significant value by stabilizing the business while litigation proceeds or while developing a restructuring plan.

In either case, the goal of receivership is to maximize the value of a business for the benefit of its stakeholders.

If you are considering restructuring options for your cannabis operation, receivership can be an excellent choice.

However, a cannabis receivership is not for the faint of heart.

There are two significant areas that distinguish marijuana receiverships from receiverships involving non-cannabis businesses: the complex regulatory environment and banking.

The importance of having a receiver well-versed in the cannabis industry cannot be overstated.

Making a mistake in these areas can cause more harm than good.

Complex regulatory environment

Cannabis operations are subject to a complicated regulatory framework; receivers unfamiliar with the industry will be behind the curve on Day One.

Although receivership is an excellent restructuring option for cannabis operators in distress, regulations about daily business operations (including receivers) vary by market, with some states having cannabis-specific receivership regulations.

For example, the Colorado Marijuana Enforcement Division (MED) requires court appointees including receivers to register with the state licensing authority as temporary appointees of the court within seven days.

Similarly, Washington state allows receivers or trustees to operate licensed cannabis businesses, but the receiver must be qualified by the Washington State Liquor and Cannabis Board.

Arizona laws do not address cannabis receiverships; nevertheless, the state requires anyone volunteering or working at a dispensary or recreational cannabis store to be registered with the Arizona Department of Health Services as either a dispensary agent or a facility agent.

Therefore, a receiver appointed to oversee an Arizona-licensed cannabis business must obtain the applicable registration in order to take control of the entity.

Hurdles exist nationwide

States that have legalized or decriminalized marijuana often have instituted complex rules surrounding the cultivation, manufacture, wholesale and retail sale of cannabis.

Some states, such as California, do not allow the sale of cannabis business licenses. Other markets, including Colorado, allow for the transfer of commercial cannabis licenses.

It is particularly important to understand options available to liquidate a licensee’s assets.

Upon appointment over a cannabis entity, a receiver becomes responsible for adhering to local regulations.

Accordingly, the receiver must ensure that regulatory shortcomings are identified and corrected to ensure compliance – so, it is critical to engage an experienced receiver.

Banking under receivership

One of a receiver’s most important duties is to identify and secure the assets of the entity in receivership, including cash.

This normally involves the receiver opening a bank account in the name of the business entity and moving cash assets into the controlled account.

Of course, this task is not so easy for plant-touching marijuana operations.

While the federal Financial Crimes Enforcement Network (FinCEN) issued guidance in 2014 that cleared the way for financial institutions to service cannabis businesses, the guidance requires financial institutions to design and implement a thorough customer due diligence review – burdens that come at a cost.

Naturally, compliance costs incurred by banks to service cannabis operators are passed on to the customer, and fees of $2,500 per month per account are not uncommon.

Distressed cannabis operations may not have the cash flow to afford banking services – at least not at the outset of a receivership.

Further compounding the banking problem, some banks that are open to cannabis are not open to receiverships, limiting banking options even more.

A receiver, therefore, must be prepared to quickly secure all cash assets of the receivership entity and ensure appropriate internal controls are in place to control cash.

Paula Durham is a director in J.S. Held’s corporate finance business unit. She can be reached at pdurham@jsheld.com.

Scott Evans is a managing director in J.S. Held’s corporate finance business unit. He can be reached at sevans@jsheld.com.

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