Herbl collapse signals wider fallout in California marijuana industry

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California-based marijuana distribution giant Herbl is going to the courts in a bid to recover some of the roughly $10 million it claims retailers owe the company, which fell into receivership in June.

At the same time, according to court and investor documents, at least one of Herbl’s former brand partners – Sunset Connect – is suing to recover a six-figure debt the San Francisco maker of pre-rolls claims that Herbl owes and refuses to pay, records show.

The unprecedented struggle over what’s left of the once-prominent distribution company is a wave in a broader ripple effect that observers fear could sink more California cannabis businesses amid a cash squeeze plaguing the state’s marijuana industry.

In terms of what’s left of Santa Ana-based Herbl, retailers, brands, investors and creditors as well as state and federal tax collectors appear to be in a race to be the first to collect money from a rapidly vanishing pot.

Herbl’s unprecedented collapse is also a test case for the U.S. marijuana industry as a whole.

Federal prohibition means cannabis companies can’t use typical avenues for businesses in such financial straits, including bankruptcy proceedings that would allow for debt to be restructured and certain assets protected.

In Herbl’s case, “it is understood from the terms of the receivership that investors and claimants will be prioritized over the brands seeking payment,” said Alexis Lazzeri, a Los Angeles-based attorney at Manzuri Law.

In addition to Pasadena-based East West Bank, Herbl’s main lender, Herbl’s investors include New York City-based Roystone Capital Management, sources close to the situation told MJBizDaily.

Roystone did not respond to a request for comment.

It’s unclear how much Herbl may owe its erstwhile brand partners, but observers said those cannabis companies may be least likely to recover money owed.

Herbl has yet to make a public statement about its collapse.

Nor did it directly inform its partners, some brands told MJBizDaily.

‘Destined to happen’

The Herbl situation is also amplifying the voices of critics who argue that California’s mandatory distribution model as well as current state tax structure are unworkable.

That’s particularly true in a bear market in which creditors are seeking either unrealistically quick returns on their investments or calling back their capital from cash-poor businesses.

“I think this was destined to happen, the way the California market is set up,” said Griffen Thorne, a Los Angeles-based attorney and corporate law specialist at Harris Bricken, an international firm with a specialized cannabis practice.

“I don’t think it’s an Herbl thing. It’s just a symptom of the way the industry was set up and the way the market is going right now.”

“There’s going to be a lot of fighting over unsecured debt,” he added.

“There’s a lot of people out there vying for money, and it’s going to be hard for those folks to get paid.

“This is going to be the first of many failures and flameouts we’re going to see as a result of the creditor crunch.

“It’s just not going to be clean, and, unfortunately, this is where we’re at with the industry.

Anatomy of a struggle

Court records in Los Angeles and Orange counties show Herbl is suing at least 10 retailers and delivery services for unpaid debts.

Past-due amounts range from $22,000, owed by Southern California-based General Verde Organics, to more than $123,000 owed by Urban Buds, a Los Angeles-area delivery service, according to court records.

Urban Bud did not respond to MJBizDaily requests for comment. General Verde could not be reached for comment.

Herbl’s collection efforts began earlier this spring, before the company’s struggles became publicly known, though attorneys for Herbl filed several complaints seeking past-due bills in June, court records show.

How much Herbl, in turn, owes the brands whose products it distributed is not known.

Also unknown is Herbl’s potential overdue tax liability to the state and the IRS.

Herbl fell into receivership in early June after the company’s main lender, East West Bank, called in a key loan, as MJBizDaily first reported.

The bank’s aggressive collection efforts set off a chain reaction that broke the already weakened company.

According to an undated investor update from Herbl founder and CEO Mike Beaudry obtained by MJBizDaily, East West canceled Herbl’s line of credit in March.

Herbl was already “in desperate need of new capital” after an attempted raise the previous August resulting in no new investors “despite (the company’s) willingness to extend extremely favorable terms,” Beaudry told investors in the update.

At the same time that East West canceled Herbl’s line of credit, the bank demanded the company start repaying a $5 million loan “in increments of $250k per week or face immediate foreclosure proceedings,” Beaudry wrote.

‘Uniquely vicious’

That “bloodthirst” was “uniquely vicious, but not surprising given that the distribution model essentially makes distributors act as banks to the cannabis industry, fronting money for retailers,” Manzuri Law’s Lazzeri said.

“It might also be an indication of a loss in trust in the state of the cannabis industry and a lack of incentive to continue to hold it up,” she added.

Herbl made the bank payments, but the resulting cash crunch – coupled with spiraling overdue accounts-receivable from retailers that ballooned to “nearly $10 (million), of which $7M+ is significantly in arrears” – “forced us to begin missing payments with our brand partners,” Beaudry wrote.

“That, in turn, caused our brand partners to begin exiting our platform.”

The resulting downward spiral came to a head in June. Brands publicly announced they were leaving Herbl before Herbl employees posted farewells on social media.

“We are working with East West Bank on next steps, which we anticipate will involve a process of liquidating HERBL’s assets,” Beaudry noted in the investor update.

Beaudry did not respond to an MJBizDaily request for comment.

David Hafner, a spokesperson for California’s Department of Cannabis Control, told MJBizDaily that regulators are ‘informed that Herbl is in receivership and is communicating with the licensee and receiver to address issues related to the licenses.”

“As with any licensed business in California, cannabis licensees who have unpaid invoices can avail themselves of any applicable legal processes to recover funds,” Hafner continued.

“We encourage our licensees to seek out the appropriate, legal solutions to resolve their matters.”

Herbl also does business in Nevada, where its operations are so far unaffected, Beaudry wrote in the investor update.

Brands left out

One of those brands, Sunset Connect, did just that.

In a June 20 lawsuit filed in San Francisco Superior Court, Sunset Connect is seeking compensation for more than $130,000 worth of pre-rolls that Herbl sold to retailers.

That product was sold and Herbl collected payment, but then Herbl informed the brand that “they would not be paying,” the lawsuit alleges.

Ali Jamalian, Sunset Connect’s founder and owner, told MJBizDaily via text that Herbl “did a great job as a full-service distributor.”

However, the subsequent “lack of transparency and willingness to make so many brands a casualty of said lack of transparency is not excusable,” he added.

“I for one never even received any communications announcing their receivership or inability to pay, not sure if other brands did but I doubt it.”

Chris Roberts can be reached at chris.roberts@mjbizdaily.com.