By John Schroyer
“Can a debtor in the marijuana business obtain relief in the federal bankruptcy court? No.”
That’s a line in the first paragraph of a recent court ruling against Frank Arenas, a Colorado marijuana grower and wholesaler who tried to win federal bankruptcy protection. A U.S. Bankruptcy Court judge initially ruled that Arenas can’t claim such protections because marijuana is still illegal, and an appellate panel affirmed that decision last Friday.
It’s the latest in a string of court decisions on cannabis-related bankruptcy cases dating back to at least 2012, when a judge involved in the Arenas decision issued a similar ruling involving another marijuana company. There have been at least four other such decisions as well in Colorado and California – all with the same outcome as Arenas’ case.
So what can distressed marijuana companies do if they’re on the verge of bankruptcy? The answer may depend on which state a company is in, and how it’s structured.
Arenas, for example, made a big mistake in not keeping his personal assets separate from his business, said Arizona attorney Gary Michael Smith. That’s evident, Smith said, because Arenas tried initially to file for Chapter 7 bankruptcy protection and then convert it into Chapter 13, which is only doable if it’s a personal – not a business – bankruptcy.
“The mistakes he made makes it pretty clear that he conducted business in his personal name, and/or he was personally guaranteeing the debt that his business was assuming, which is horrible,” Smith said. “One should not do that, particularly with those amounts of money.”
Sean McAllister, a Denver attorney who also works closely with the cannabis industry, said one of the best and most obvious ways to avoid such pitfalls is to be careful when setting up a marijuana business at the outset.
“The most important thing for any cannabis company is to be really thinking about this as you make agreements, as you borrow money, as you enter into partnerships, because there are things you can do to limit your liability,” McAllister said. “The lack of bankruptcy protection is a problem, but it’s more of a problem if people have exposed their personal assets.”
As Marijuana Business Daily wrote about last year, there are a number of ways that cannabis companies can prepare for financial hardships and possibly avoid even having to consider bankruptcy.
There may be some additional steps companies can take, depending on the state where a given business is located, Smith said.
For example, a possibly unique precedent was set in Arizona several years ago when a court sided with a cannabis company that owed creditors $500,000, Smith said. The judge tossed a lawsuit brought by two creditors, saying the loans were illegal in the first place because they were given to a business handling cannabis, which is illegal under federal law.
“If that guy walked into my office and had this problem, what I’d probably suggest is he go into a federal lawsuit to have the debt related to the marijuana operation deemed void for illegality,” said Smith, referring to the owner of the Arizona business seeking relief from creditors. That would mean “nobody could enforce those debts against” the company, he added.
That probably wouldn’t work everywhere, said Colorado attorney Rachel Gillette. She said the state put in place protections for such deals, so under Colorado statute such an argument wouldn’t apply.
Still, there are other potential state laws that businesses might be able to take advantage of, said New York attorney Hanan Kolko. Some states have their own versions of bankruptcy protections, he said, that wouldn’t have the same conflicts as federal bankruptcy laws.
“To an extent that a state has that, a cannabis business could use that,” Kolko said.
But that underscores the need for business owners to do their homework and talk to legal counsel, both before companies are founded and if they ever run into financial hardship. And it highlights a need for further reforms.
“It’s just another example which illustrates why we need substantive reform at the federal level,” Gillette said. “It doesn’t work to operate in this sort of quasi-legal arena. The federal law needs to change.”
John Schroyer can be reached at [email protected]