An unusual number of cannabis companies have used a Canadian corporate insolvency law called the Companies’ Creditors Arrangement Act (CCAA) in 2022, a trend that demonstrates both the marijuana industry’s financial challenges and one possible solution to keep businesses from slipping completely underwater.
Fourteen of the 35 CCAA filings in Canada – or 40% – between Jan. 1 and Dec. 22 have involved companies operating in the cannabis space in one way or another:
- Eve & Co. and related companies.
- Choom Holdings and related companies.
- MJardin Group, GrowForce Holdings and related companies.
- Zenabis Global and related companies.
- Sproutly and Toronto Herbal Remedies.
- MPX International Corp. and related companies.
- Speakeasy Cannabis Club.
- Medipure Pharmaceuticals and Medipure Holdings.
- Superette and related companies.
- Flower One Holdings and related companies.
- The Flowr Corp.
- CannaPiece Group.
- Trichome Financial Corp. and related companies.
- Lightbox Enterprises (Dutch Love Cannabis).
“Going back a couple years ago, the markets were very frothy, and the ability to raise equity financing meant that there was a ready supply of cash in the industry,” said Ranjeev Dhillon, a partner with Canadian law firm McCarthy Tétrault and co-lead of the firm’s cannabis law group.
Many businesses proceeded with the expectation that capital would continue to flow, Dhillon added.
“That is no longer the case,” he said.
“And because they have no cash now and this is a relatively thin-margin business and (a) capital-heavy business at times, they have no more means of being able to raise cash anymore or pay back debts.
“And that’s why you’re seeing this increase in CCAA.”
Jane Dietrich, a partner in the restructuring and insolvency group at Canadian law firm Cassels Brock & Blackwell, said the cannabis sector CCAA trend started in 2020 and appears to be accelerating.
In part, she attributes the cannabis CCAA trend to the newness of the regulated industry.
“There’s a lot of rationalization happening as people figure out which of the companies are going to succeed and which are struggling,” Dietrich said.
Filing a CCAA can also be a useful option for certain U.S.-based cannabis companies that don’t have access to Chapter 11 bankruptcy protection in their home country because of the federal illegality of marijuana.
“To the extent they have a Canadian connection or Canadian link, they seek to file up here and then deal with their financial difficulties in a CCAA proceeding,” explained Jamey Gage, national chair of McCarthy Tétrault’s bankruptcy and restructuring group.
For example, Nevada cultivator Flower One Holdings filed for CCAA protection in October via its Canadian parent company.
Understanding the CCAA
The CCAA is one of two Canadian federal insolvency statutes, alongside the Bankruptcy and Insolvency Act.
Gage said the CCAA is generally used for larger companies with more complex restructurings and is common in the cannabis space.
The CCAA is available to companies that meet three criteria:
- They are a Canadian entity – or they have Canadian assets or do business in Canada.
- They have debts of at least 5 million Canadian dollars ($3.7 million).
- They are insolvent.
Those companies may apply for an initial court order “that prevents creditors, contract counterparties and others from exercising their rights and remedies while providing the company with some breathing room to try to negotiate a restructuring of its debts with its creditors, or concurrently conduct a sale process seeking to find a going-concern buyer, or investment financing,” Gage said.
The initial creditor protection order is typically granted for 10 days, after which the company needs an extension.
The insolvent company’s creditors have an opportunity to object to the terms of the initial creditor protection order before it gets extended.
CCAA proceedings usually resolve in one of three ways, Gage explained:
- A “plan of arrangement,” voted on by the creditors and subject to court approval to restructure and continue the business “with a deal worked out with the creditors to reduce the debts (and) maybe raise more capital.”
- A court-approved sale and investment solicitation process (SISP) in which the insolvent company seeks offers to buy or invest in the business.
- A liquidation.
Gage said a SISP generally resolves faster than a plan of arrangement.
Some recent cannabis industry CCAA proceedings have involved debtor-in-possession (DIP) loans and related stalking-horse bids during the sale and investment solicitation process.
DIP loans allow insolvent companies to borrow funding to keep operating during the CCAA process, while the DIP lender receives priority over the company’s other debts.
“That can be a key tool, sometimes, in what may drive companies to file for CCAA protection, when they can’t find any more financing outside of court protection,” Gage said.
That DIP loan may be related to a sales process: In some cases, the DIP lender seeks to acquire the insolvent company – or at least some of its assets.
By putting in a stalking-horse bid as part of the sales process, the DIP lender sets a starting price for all interested bidders.
“The benefit from the (insolvent) company’s perspective is that, by having a stalking-horse bid in place, it creates both a bidding floor and some kind of auction tension to try to drive prices higher,” Gage said.
“But it also creates stability in the meantime so that employees, customers (and) other stakeholders know that there’s going to be a going-concern solution.”
That stability means suppliers might be more comfortable doing business with the insolvent company and employees might be less likely to leave “because they know that there’s more prospect for a job at the end of it.”
The DIP lender doesn’t have to be the stalking-horse bidder, although Gage said that arrangement is common in the cannabis industry.
In one recent example, Toronto-based cultivator The Flowr Corp. sold its assets to its DIP lender after the lender made a stalking-horse bid.
“I think what you’re seeing is … a sales process in which the stalking-horse bidder inevitably ends up taking the assets because there’s not really a large pool of buyers out there for these assets,” Dhillon said.
“And if there are assets to be purchased, they’re being purchased at heavy discounts to the initial capital outlay.”
More cannabis CCAA action expected
Dhillon expects 2023 will be a busy year for cannabis insolvency filings in Canada.
With capital being difficult to raise and corporate debt coming due, he said, “CCAA is one of the only viable options here to see that through.”
For Canadian cannabis companies, Dhillon said deferred government excise tax debts could also lead to new CCAA filings next year.
“At some point, the government’s going to become more aggressive about collecting (those bills),” Dhillon said.
Cassels attorney Dietrich also expects the cannabis CCAA trend to continue into 2023.
“I think it was probably artificially low in 2020 and into the start of 2021,” she said, citing government support for businesses during the COVID-19 pandemic.
“I think that hid a lot of the troubled companies that were out there,” Dietrich added.
“And that’s one of the reasons I think that it will continue, because we’re starting to see more and more of that relief go away and it exposes companies who are having issues.”
Facing up to an insolvent business isn’t easy, but McCarthy lawyer Gage recommends business leaders don’t wait too long to address their financial challenges.
“If you leave it too late, your options are limited and you can get a pretty bad outcome,” he said.
Insolvent companies that have exhausted their cash reserves will have less time to find a way forward, even if they can secure DIP financing, Gage added.
“A short period of time means a shorter sale process, a shorter period of time to negotiate with people, it probably means more drastic cash conservation measures – cost-cutting, letting even more employees go …
“Once you’re cutting into the muscle and not just cutting the fat, you’re starting to hamper the attractiveness of your business as a going concern.”
Solomon Israel can be reached at email@example.com.