By Cameron Dale
INTRODUCTION
This article seeks to unpack the current tension between California’s cannabis industry and federal bankruptcy law. Although cannabis is legal for both medical and recreational use in California, among other states, it remains classified as a Schedule I drug under the federal Controlled Substances Act.[1] Because bankruptcy courts are courts of federal jurisdiction, cannabusinesses[2] face serious difficulty in maintaining a bankruptcy case due to federal criminalization of their activities, even when operating legally under state law. This conflict leaves cannabusinesses vulnerable during financial crisis because they are unable to access the Bankruptcy Code’s protections, such as the automatic stay, and remedies, such as liquidation and reorganization. As this article explores the intersection of California’s crashing green revolution and federal bankruptcy law, one question remains: is there a case to be made that cannabusinesses are “honest, but unfortunate”[3] entities that the Bankruptcy Code was designed to protect?
I. The Controlled Substances Act
The Controlled Substances Act of 1970 (“CSA”) established cannabis as a controlled substance under federal law.[4] The CSA classifies substances under five different schedules, and cannabis is classified a Schedule I drug.[5] These classifications are made by determining the substances’ “medical use, potential for abuse, and safety.”[6] Cannabis is currently classified as “having no medical use” and has a “high potential for abuse.”[7] Broadly speaking, the CSA criminalizes nearly every aspect of selling, growing, manufacturing, distributing, and possessing controlled substances, such as cannabis.[8] Additionally, the CSA expressly criminalizes the act of conspiring to commit any offense under the CSA.[9] The CSA conflicts with laws in states that have legalized cannabis to various degrees. In Gonzales v. Raich, the Supreme Court held that the federal scheme to regulate cannabis under the CSA preempts state cannabis laws because of the Supremacy Clause in the U.S. Constitution.[10] Consequently, cannabis creates unique issues in both substantive and jurisdictional law.
The Cannabis Administration and Opportunity Act, first introduced in the 117th Congress in 2021 and later reintroduced in the 118th Congress, proposes to reschedule cannabis from Schedule I to Schedule III under the CSA.[11] Supported by the Drug Enforcement Administration (“DEA”), the federal agency tasked with enforcing controlled substances laws and regulations, including the CSA, and aligned with recommendations from the Department of Health and Human Services, the proposal acknowledges cannabis’s accepted medical use and its lower abuse potential as compared to other Schedule I and II substances.[12] The DEA will hold a hearing on December 2, 2024 regarding the proposed rescheduling.[13]
II. The Importance of Cannabis in California
During the 1960s and 1970s, California became a hub for countercultural movements, and cannabis emerged as a symbol of personal freedom, leading to its cultivation in Northern California’s “Emerald Triangle” (Mendocino, Humboldt, and Trinity counties).[14] By the 1990s, cannabis had become deeply rooted in California’s culture and economy, with the illicit market thriving due to high demand and the state’s favorable growing conditions. The pound price of cannabis in California ranged from $600 to $1,500 depending on quality.[15] However, California-grown cannabis that was transported and sold in other states was priced around $4,000 per pound.[16] Estimates suggest the illegal cannabis market in California generated billions of dollars annually.[17] Continuous cultivation and widespread consumption eventually paved the way for legalization efforts, solidifying California’s reputation as a leader in both cannabis production and rights.
A. California Legalizes Cannabis for Medical Use
California made a groundbreaking move by passing Proposition 215 in 1996, becoming the first state in the United States to legalize medical cannabis.[18] This legislation, known as the Compassionate Use Act, allowed patients with a valid doctor’s prescription to use cannabis for medicinal purposes without facing state-level criminal penalties.[19] Political momentum continued with the passage of California’s Senate Bill 420 in 2003, which established an identification card system for medical cannabis patients and allowed the formation of patient collectives.[20]
B. California Legalizes Cannabis for Recreational Use
The legal landscape in California saw another significant shift with the Adult Use of Marijuana Act, passed as Proposition 64 in 2016.[21] This act legalized recreational cannabis use for adults aged 21 and over and established a comprehensive system to regulate and tax commercial cannabis activities.[22] The legislation sparked a “green revolution,” significantly boosting the state’s economy. By 2021, the cannabis sector in California had created jobs for over 83,000 people.[23] Furthermore, cannabusinesses’ tax revenues had become a vital source of funding for various state programs.[24] In 2022, California collected approximately $1.1 billion in cannabis tax revenue, and in 2023, approximately $1.08 billion was collected. [25] These tax dollars provided substantial support for education, drug abuse prevention, healthcare programs, and public safety.[26]
C. California’s Green Bubble Is Bursting
California’s cannabis sector is facing a severe economic crisis as retail sales and wholesale prices have plummeted and are expected to continue to decline due to an oversaturated market, coupled with a cash-strapped distribution system, which makes it nearly impossible for cannabusinesses to stay afloat.[27] Long established cannabis farms have become unprofitable, and the legally required distributors—who bridge the gap between producers and retailers—are now crippled by unpaid bills due from retailers who are also struggling financially.[28] As producers and distributors continued to supply products on credit, a massive debt bubble formed, and it has now begun to burst.
In the first quarter of 2024, the number of active cannabusiness licenses dropped by over 20%, indicating a decline in operational businesses.[29] The California Department of Tax and Fee Administration (“CDTFA”) reported that 15% of cannabusiness are in tax default, with warnings that the 50% penalty for missing a single tax payment could be catastrophic to the cannabusiness.[30] The CDTFA has also reported that the cannabis sector owes approximately $732 million in overdue taxes—an amount equal to over half of the total taxes collected in 2023 by the California State Treasurer’s office.[31] Of this amount, 72% is unlikely to be recovered, as many cannabusinesses responsible have already shut down.[32]
California’s local regulations are both financially burdensome and inconsistent across the state’s 58 counties.[33] High taxes, licensing fees, and complex legal hurdles have made it difficult for cannabusinesses to compete with a robust black market, which still accounts for roughly 60% of cannabis sales in the state.[34] As a result, prominent companies, like MedMen, which once had a valuation of $3 billion, have declared bankruptcy in Canada, and its U.S. subsidiary was placed into a receivership in California state court.[35] Eaze, the state’s largest cannabis delivery service, announced that it will cease operations by December 31, 2024, signaling wider industry struggles.[36] Given the scale of the financial strain in California’s cannabis sector, there is a growing desire for bankruptcy courts to open their doors to cannabusinesses, providing them with a vital legal avenue for financial relief that is offered to many other businesses.
III. The Interface with The Bankruptcy Code
A. Chapter 7, Chapter 11, & The Fresh Start
The U.S. Constitution grants Congress the power to enact bankruptcy laws, giving it sole authority over this area.[37] Federal courts, including bankruptcy courts, hold exclusive jurisdiction over cases filed under the Bankruptcy Code.[38] The Office of the United States Trustee (“UST”), an arm of the Department of Justice, monitors the administration of cases, including Chapter 7 and Chapter 11 cases.[39] The UST’s primary functions include appointing and supervising trustees, broadly overseeing case administration, and monitoring procedural and legal compliance to ensure that debtors and creditors comply with the Bankruptcy Code and other federal laws.[40]
In a Chapter 7 bankruptcy case, a debtor’s non-exempt assets are liquidated to repay creditors.[41] Chapter 7 is usually chosen by individuals with overwhelming debt and no viable way to resolve it.[42] Upon filing for Chapter 7, the UST appoints an interim trustee to act as the estate’s fiduciary, and the UST becomes the trustee if one is not elected.[43] The trustee manages and controls all estate property, ensuring fair handling of the assets.[44] Trustees also oversee the debtor’s compliance with their obligations under the Bankruptcy Code.[45]
When a bankruptcy petition is filed, an automatic stay is imposed, halting most efforts to collect or enforce debts arising before the filing.[46] The automatic stay provides the debtor with temporary relief from lawsuits, foreclosures, and other collection actions.[47] Once the trustee liquidates the debtor’s non-exempt assets, the proceeds go to creditors pursuant to the priority scheme under the Bankruptcy Code.[48] Individual debtors generally qualify for a discharge, which releases them from personal liability for most prepetition debts, effectively providing a fresh start and barring creditors from pursuing further collection efforts on discharged claims.[49]
Chapter 11 cases take a different approach and are commonly used by businesses to reorganize their financial obligations instead of liquidating assets. While individuals can file under Chapter 11, which can be used for asset liquidation, it is designed to support business restructuring.[50] Unless a trustee is appointed, the Chapter 11 debtor retains control as a debtor in possession (“DIP”), fulfilling trustee-like duties, such as keeping records, reviewing creditor claims, and submitting financial reports to the court.[51] The UST supervises the DIP to ensure that bankruptcy requirements are met and reports are filed accurately. [52] The DIP, or the trustee if appointed, usually proposes a reorganization plan aimed at addressing debts while maintaining business viability unless it is a liquidation.[53] Successful completion of a Chapter 11 reorganization can provide a manageable debt structure and a stronger financial foundation for the business to continue.[54]
A cornerstone of the U.S. bankruptcy system is the “fresh start,” based on the normative idea that individuals and businesses overwhelmed by debt deserve the opportunity to rebuild their financial lives. [55] By discharging certain debts and enabling reorganization, the Bankruptcy Code effectuates the “fresh start” by allowing financial recovery and reintegration into the economy.[56] However, not all debtors are entitled to a “fresh start.” “The [Bankruptcy] Code limits the opportunity for a completely un-encumbered new beginning to the honest but unfortunate.”[57] While the “fresh start” policy promises a new beginning for most, for those in the cannabusiness, there is no fresh green on the horizon.
B. The Dismissal of Cannabusiness Cases
While bankruptcy protection has long existed as a critical tool for struggling businesses, this protection is often unavailable for cannabusinesses because of their involvement with a substance that remains illegal under federal law. In fact, the UST has taken a firm stance against cannabusinesses attempting to use bankruptcy. In a 2017 letter, Clifford J. White III, then Director of the Executive Office for U.S. Trustees, instructed trustees to file motions to dismiss cases involving cannabis assets due to the following reasoning:[58]
First, the bankruptcy system may not be used as an instrument in the ongoing commission of a crime and reorganization plans that permit or require continued illegal activity may not be confirmed. Second, bankruptcy trustees and other estate fiduciaries should not be required to administer assets if doing so would cause them to violate federal criminal law.
Consequently, both the UST and trustees have a successful track record in dismissing bankruptcy cases filed by cannabusinesses on the grounds that the debtor is actively violating the federal CSA.
The Bankruptcy Code provides that a case can be dismissed for “cause.”[59] In cannabusiness cases, courts often grant dismissals based on violations of the CSA. Bankruptcy courts have generally held that debtors seeking protection under the Bankruptcy Code must comply with applicable nonbankruptcy laws, including federal laws like the CSA.[60] As a result, when a cannabusiness files a bankruptcy case, the court may dismiss the case based on the individual’s or business’s ongoing violation of federal law. Courts interpret this as a valid “cause” for dismissal, emphasizing that the bankruptcy process cannot be used to aid activities that contravene federal law, even if state law permits them.
One obvious reason for the active opposition to cannabusinesses using the Bankruptcy Code is that trustees and DIPs (and perhaps the bankruptcy courts) could potentially be complicit in violating the CSA simply by fulfilling their duties. In a Chapter 7 case, in which a trustee assumes control of a cannabusiness’s assets and sells the cannabis inventory, the trustee would be committing a criminal offense under the CSA. Similarly, a Chapter 11 reorganization for an ongoing cannabusiness cannot proceed without violating the CSA because the plan would effectively involve continued illegal activity. Given these limitations, the UST, the watchdogs of the administration of the bankruptcy system, will most likely move to dismiss any bankruptcy case filed by a cannabusiness on the basis that the debtor is actively breaking federal law.
C. Survey of Cannabusiness Case Law
In In re Arenas, Frank Arenas was licensed to grow and sell cannabis. Arenas jointly owned a two-unit commercial building.[61] In one unit, Arenas grew and sold cannabis, and in the other unit, the other joint owner operated a cannabis dispensary.[62] Arenas sought Chapter 7 bankruptcy relief after losing a $40,000 judgment in a state court eviction action, with an additional $120,000 in claims still pending against him.[63] The UST filed a motion to dismiss the case for cause under § 707(a).[64] The UST argued that a trustee would be unable to administer the assets without contravening federal law.[65] Arenas, in his opposition, argued that the trustee could abandon the cannabis-related assets to avoid the legal problems.[66] However, the bankruptcy court rejected this, reasoning that abandonment would not resolve the legal issues because the trustee could still face exposure to federal criminal liability for facilitating, however indirectly, the distribution of federally prohibited substances.[67] Moreover, abandonment might enable the debtor to continue his cannabusiness while still benefiting from the automatic stay and discharge.[68] Such an arrangement would deprive creditors of recovery, thereby undermining one purpose of bankruptcy.[69] Concluding that administration of the estate was legally impossible without violating federal law, the court upheld the UST’s motion to dismiss.[70]
Arenas exemplifies the typical trajectory of cannabusiness cases which proceed as follows:
- A debtor, who is either directly or indirectly involved with a cannabusiness, files a petition for bankruptcy;
- Subsequently, either a creditor, a trustee, or both file a motion to dismiss the bankruptcy petition; and
- The bankruptcy judge reviews and grants the dismissal based on the complications arising from federal versus state laws concerning cannabis.[71]
Despite this usual course, some cases have managed to navigate beyond initial dismissal. In these outlier cases, bankruptcy courts often distinguish the degree of the debtor’s relation to cannabis itself and the attenuation of the debtor’s connection to the cannabusiness.
In In re Callaway, Christopher Callaway was the sole owner of Caliverde, LLC, a retail cannabis dispensary in San Francisco and held a 40% interest in Grassy Castro, LLC, another cannabis dispensary.[72] He also owned interests in various other LLCs and domain names, some of which were also active in the cannabis industry.[73] Callaway filed a Chapter 7 case, and one of Callaway’s creditors and the UST each filed separate motions to dismiss for “cause” under § 707(a). Both argued that the “chapter 7 trustee cannot lawfully administer assets in violation of the CSA, and continuation of the case would force the chapter 7 trustee into such a position.”[74] The bankruptcy court held that while the CSA strictly criminalizes cannabis-related activities, it does not explicitly prohibit owning or disposing of interests in legal entities, such as LLCs that engaged in the cannabis business.[75] The facts showed that Callaway did not personally cultivate or sell cannabis.[76] Rather, his involvement was limited to holding ownership interests in legally established LLCs.[77] The court determined that there was no direct handling of cannabis or of its proceeds by Callaway that would generally warrant a dismissal.[78] His intangible assets, such as ownership stakes and domain names related to cannabusinesses, did not constitute illegal activity under the CSA.[79] The court held that the chapter 7 trustee was capable of legally managing these interests and other intangible assets without contravening federal laws.[80] Therefore, dismissal based solely on the trustee’s potential difficulties in managing assets tied to cannabis operations would be inappropriate.[81] Accordingly, the court denied both motions to dismiss.[82]
Another judicial decision in California ruled that a minimal connection with cannabis-related assets or income does not necessarily result in a dismissal. In In re Hacienda, Lowell Herb Co. was a licensed cannabis grower and distributor.[83] Lowell Herb ceased operations in February 2021.[84] To pay off some debts, Lowell Herb sold land slated for the purpose of cannabis cultivation.[85] As part of winding down its operations, Lowell Herb transferred certain cannabis assets to a publicly traded Canadian cannabusiness.[86] In return, Lowell Herb received a 9.4% ownership stake in the Canadian cannabusiness.[87] Lowell Herb filed a Chapter 11 case in September 2022 and proposed a reorganization plan to repay creditors through the gradual sale of its shares in Canadian cannabusiness or by directly distributing the shares to creditors.[88] The UST moved to dismiss for “cause” under § 1112(b)(1), arguing the debtor could not lawfully administer the cannabusiness’s assets.[89]
The bankruptcy court denied the motion for several reasons.[90] First, the court held that the UST had not demonstrated any ongoing violation of the CSA by the debtor.[91] Lowell Herb ceased both cannabis operations and sales nearly one year before the Chapter 11 filing and had no cannabis or cannabis-related inventory when it filed.[92] The UST argued that Lowell Herb’s prepetition receipt of stock might have violated the CSA, but there was no indication that Lowell Herb, post-petition, intended to reinvest back into a cannabusiness.[93] Instead, any proceeds from either dividends or the stock sale would eventually go to creditors.[94] Lowell Herb’s proposed plan involved liquidating or distributing the stock rather than engaging in cannabis cultivation, sales, or even investments.[95] Accordingly, the court found no basis for an ongoing or inevitable future CSA violation.[96] Second, the court noted that Congress did not adopt a strict “zero-tolerance” approach to CSA violations under § 1112(b). [97] While Congress allows the court discretion in assessing whether dismissal is appropriate given the facts and circumstances, a bankruptcy judge is “not an ombudsman without portfolio, gratuitously seeking out illegalities.”[98] The court emphasized that a rigid policy requiring dismissal for any connection, no matter how attenuated, to cannabis assets would conflict with the purposes of bankruptcy to repay creditors and facilitate a fresh start.[99] Third, the court found that the “unusual circumstances” exception under § 1112(b)(2) applied.[100] Lowell Herb’s termination of its direct involvement with cannabis and the realistic possibility of creditor repayment through stock liquidation warranted preserving the case.[101] The court found that the reorganization plan provided a feasible means for addressing creditor claims without ongoing CSA violations.[102] Finally, the court was clear about not condoning illegal activity.[103] Alternative remedies, such as appointing a trustee or imposing sanctions, could be employed if illegal conduct arose, rather than outright dismissal.[104] This flexible approach would allow the court to balance regulatory concerns with the practical benefits of bankruptcy protections for creditors and the estate.
The Hacienda decision should not be interpreted as broadly permitting bankruptcy filings for cannabusinesses. The specific facts of Hacienda under which a cannabusiness might successfully pursue bankruptcy are challenging to replicate. Such a process would require a cannabusiness to completely cease operations, dispose of its cannabis and cannabis-related assets, and potentially engage in transactions with foreign entities, all of which could result in significant problems, including financial losses. Moreover, it remains uncertain whether other courts would follow the reasoning of the Hacienda case. Various aspects of the transactions involving cannabis proceeds could potentially be seen as violating the CSA, including aiding and abetting or conspiracy. Thus, while Hacienda provides a path for some cannabusinesses, the conditions required may not be practical for many in the industry.
IV. Moving Forward
Even with the potential rescheduling of cannabis under the CSA, the path to bankruptcy remains hazy for cannabusinesses. Rescheduling cannabis to a Schedule III drug may influence more courts to consider maintaining cases in which debtors with tangential or ancillary connections to cannabis. However, cannabusinesses must remain aware that full access to bankruptcy protection will likely require federal legalization of cannabis. Financially troubled cannabusinesses should look to alternative solutions to manage their debts, liquidate assets, and continue operations.
For California cannabusinesses, two potential bankruptcy-like options are: (1) receiverships; and (2) assignments for the benefit of creditors (“ABCs”). Each option could offer unique advantages by providing cannabusinesses with a structured framework to navigate financial distress. Unlike cases under the Bankruptcy Code, receiverships and ABCs are state law remedies. This distinction is critical because cannabusinesses often struggle in bankruptcy proceedings due to federal law violations. By remaining under state jurisdiction, these remedies may allow cannabusinesses to restructure, liquidate, or resolve debts without federal court involvement. They might provide a practical option to address creditor claims and preserve asset value while complying with state cannabis laws and avoiding federal legal issues.
A. Receiverships
Under California law, a court-appointed receiver serves as a neutral agent responsible for managing and preserving property that is the subject of a dispute. [105] While a receivership is often used as a remedy in litigation, where creditors or interested parties seeking judicial intervention to preserve the value of assets, receiverships can also arise in other contexts.[106] For instance, contracts may contain provisions permitting the appointment of a receiver upon default. Additionally, parties may voluntarily agree to appoint a receiver as part of a negotiated resolution, allowing them to avoid litigation and ensure the proper handling of the property in question.
Receivers are granted statutory powers and operate under the court’s authority, managing property for the court, not the parties.[107] The court order appointing a receiver defines the property within the receivership estate and details the receiver’s responsibilities and authorized actions.[108] The receiver’s powers include taking and possessing property, receiving rent, collecting debts, making transfers, and disposing of receivership property with the court’s approval.[109] After selling the receivership’s property, the receiver pays creditors, professionals, and theri fees with court approval, thereby terminating the receivership.[110]
An example of the receivership process involves the bankruptcy of MedMen, filed on April 7, 2024, in Canada.[111] On April 23, 2024, MedMen’s California subsidiary, MM CAN USA, Inc., was placed into receivership in the Los Angeles Superior Court, to facilitate an orderly dissolution and liquidation of its California-based assets.[112] Richard Ormond was appointed as the receiver to oversee the liquidation process.[113] His responsibilities included managing the sale of MedMen’s assets, such as retail licenses and properties, to satisfy the company’s outstanding debts.[114] Reports indicate that MedMen had approximately $560 million in debts, with significant amounts owed to secured creditors like Superhero Acquisition L.P. and Hankey Capital.[115] The receivership proceedings have involved the sale of cannabis and the auction of cannabis-related equipment. In addition, Ormond sold or abandoned various MedMen dispensaries across California.[116] Some locations were sold to interested buyers, while others were returned to landlords.[117] The process aims to maximize the value of MedMen’s estate to repay creditors, though the total asset value is estimated between $70 million and $100 million, falling short of covering the $560 million of debt.[118]
B. ABCs
Under California law, an ABC provides a streamlined liquidation process governed by contract law rather than the court system.[119] In an ABC, a distressed business (assignor) voluntarily assigns all of its transferable assets to a third-party fiduciary (assignee).[120] These assets include anything that can be liquidated to satisfy creditor claims, except for property that is exempt under state law.[121] After assets are sold, the assignee distributes the proceeds to creditors.[122] The assignee handles the sale of assets and negotiations with creditors, allowing a business to address its liabilities in an orderly manner.[123]
For example, CannaCraft, a pioneering cannabis distributor founded in 2014, developed a diverse product portfolio featuring vape cartridges, extracts, concentrates, and edibles, establishing itself as a significant player in California’s cannabis industry. [124] However, by 2019, CannaCraft had encountered financial difficulties, leading to a 20% reduction in its workforce. [125] In 2020, CannaCraft opted for an ABC to address its financial problems. [126] This strategic move enabled the company to restructure its debts while maintaining operations. The ABC process ultimately facilitated CannaCraft’s “merger of equals” with March and Ash, Inc. to form Groundwork Holding Company in April 2022.[127]
- Pros & Cons: Receiverships, ABCs, and the Bankruptcy Code
A receivership and an ABC are two distinct mechanisms for addressing financial distress, each with its own features. An ABC is a voluntary process initiated by the debtor, and in contrast, a receivership is typically initiated by a creditor or other interested party through the courts. Receiverships require court approval and oversight, making them more formal, time-consuming, and costly compared to ABCs. ABCs are generally faster and more flexible, but the debtor has limited control once the assignee begins working independently to benefit creditors. Receiverships, on the other hand, provide a more structured process and are often preferred when protecting collateral or selling the business as a going concern is essential. However, neither mechanism offers two key features of bankruptcy: (1) the discharge of debts, which prevents creditors from pursuing a debtor for the unpaid amount; and (2) the protections of the automatic stay, which halts creditor collection efforts and other legal actions during the bankruptcy process.
In receiverships and ABCs, any unpaid debts remaining after the liquidation of assets are not discharged, meaning creditors may pursue the debtor for the outstanding amounts. Unlike bankruptcy, which may provide a fresh start through the discharge of remaining debts, these mechanisms do not relieve the debtor from personal liability. However, because most cannabusinesses operate as corporations or limited liability companies (“LLCs”), the company’s owners, officers, and directors, may not be personally liable for the debts of the company, thus limiting creditor recovery to the assets of the insolvent corporation or LLC. [128]
Additionally, the automatic stay, a key feature of bankruptcy in 11 U.S.C. § 362, halts creditor collection efforts, including lawsuits, foreclosures, and garnishments, as soon as a bankruptcy petition is filed. This protection is not available in receiverships or ABCs, meaning creditors can continue pursuing collection actions during these processes. For cannabusinesses, which often operate with limited access to traditional banking and face high regulatory costs, the lack of an automatic stay in receiverships or ABCs can leave them vulnerable to aggressive creditor actions. This creates additional financial pressure and can disrupt attempts to restructure or liquidate assets in an orderly manner.
CONCLUSION
This article has examined the legal dilemma faced by California’s cannabusinesses due to the conflict between state legalization and federal bankruptcy restrictions. Although cannabusinesses operate legally within California, they face significant legal hurdles in maintaining a bankruptcy case because cannabis is currently classified as a Schedule I drug under the CSA.
However, is there a case to be made for the cannabusinesses who is “honest, but unfortunate?” Perhaps a narrow one. The Hacienda and Calloway decisions suggest that a cannabusiness which fully ceases operations and maintains no direct involvement with cannabis might be able to survive dismissal if it can realistically achieve repayment to creditors. However, any post-petition violation of the CSA could still result in a dismissal.
Given the hazy path to bankruptcy relief, receiverships and ABCs might be the most viable options to cannabusinesses seeking financial relief. Strategic planning is critical to determine whether receivership, ABC, or bankruptcy offers the best solution. While receiverships and ABCs may provide some relief, their lack of an automatic stay and inability to discharge debts may be significant limitation. This shortcoming emphasizes the need for a reassessment of federal law, including the Bankruptcy Code’s relationship to state-legalized cannabusinesses.
[1] See Controlled Substances Act of 1970 (“CSA”), 21U.S.C. §§ 801-97.
[2] “Cannabusiness” is a cannabis industry term used to refer to any business engaged in the sale of cannabis and similar services that is legal under state law. See Noni Cavaliere, What is a Cannabusiness? Marijuana Mktg. Xperts (Oct. 22, 2021), https://www.marijuanamarketingxperts.com/blog/what-is-a-cannabusiness/.
[3] Grogan v. Garner, 498 U.S. 279, 286 (1991).
[4] See CSA, supra note 1.
[5] See 21 C.F.R. § 1308.11(d)(31) (2023) (Schedule I drugs are those which have no accepted medical use and have a high potential for abuse). See Drug Scheduling, U.S. DRUG ENF’T ADMIN. (July 10, 2018).
[6] See CSA, supra note 1. See also 21 U.S.C. § 811(c) (discussing factors to change the schedule of a substance).
[7] See id. Cf. National Conference of State Legislatures, Cannabis Overview, National Conference of State Legislature (June 20, 2024), https://www.ncsl.org/civil-and-criminal-justice/cannabis-overview (stating that twenty-four states, two territories, and D.C. have legalized small amounts of cannabis for adult recreational uses). Recently, Delaware, Maryland, Minnesota, Missouri, Ohio, and Rhode Island passed laws for adults over 21 to possess cannabis. Except for Delaware, these laws allow home-growing, with limits on the number of plants varying by state. All six states previously legalized medical cannabis. See Id.
[8] See 21 U.S.C. §§ 841(a), 856(a).
[9] See id. at § 846.
[10]Gonzales v. Raich, 545 U.S. 1, 31-33 (2005).
[11] See Cannabis Administration and Opportunity Act, S. 4226, 118th Cong. (2024).
[12] See Letter from U.S. Dep’t of Health & Human Servs. to Drug Enf’t Admin. (Aug. 29, 2023) (recommending rescheduling cannabis to Schedule III). Under a Schedule III classification, cannabis offenses would potentially carry lighter penalties compared to a Schedule I classification. Possession, distribution, and manufacturing penalties for Schedule III drugs are usually less severe, and mandatory minimum sentences may not apply as they do for Schedule I substances.
[13] See Chris Roberts, DEA Picks 25 to Participate in Marijuana Rescheduling Hearing, MJBizDaily (Oct. 31, 2024), https://mjbizdaily.com/25-witnesses-tapped-for-marijuana-rescheduling-hearing/.
[14] See John McCaslin, The Emerald Triangle (CreateSpace Independent Publishing Platform 2012).
[15] See National Drug Intelligence Center, U.S. Dep’t of Justice, California Central District Drug Threat Assessment: Marijuana, United States Department of Justice (May 2001), https://www.justice.gov/archive/ndic/pubs0/668/marijuan.htm.
[16] See id.
[17] See id.
[18] See Compassionate Use Act of 1996, Cal. Health & Safety Code § 11362.5 (West 1996).
[19] See id. Cannabis has been proven to help patients with a wide range of conditions, including chronic pain, epilepsy, cancer-related nausea, multiple sclerosis, and PTSD. See Marija Jovoviv, All the Benefits of Weed, Vol. 3: Cancer, Epilepsy, and Sexual Health, Merry Jane (Jan. 14, 2020), https://merryjane.com/health/all-the-benefits-of-weed-vol-3-cancer-epilepsy-and-sexual-health/. The availability of legal cannabis has also contributed to a decrease in opioid usage, as patients turn to cannabis as a safer alternative for pain management. See id.
[20] See Medical Marijuana Program Act, Cal. Health & Safety Code §§ 11362.7-11362.83 (West 2003).
[21] See Adult Use of Marijuana Act, Cal. Health & Safety Code §§ 11357, 11358, et seq. (West 2016).
[22] See id.
[23] See California Department of Tax and Fee Administration Reports Cannabis Tax Revenues for the Second Quarter of 2023, California Department of Tax and Fee Administration (Aug. 30, 2023), https://www.cdtfa.ca.gov/news/23-09.htm.
[24] See id.
[25] See Cannabis Tax Revenues, California Department of Tax and Fee Administration, https://www.cdtfa.ca.gov/dataportal/charts.htm?url=CannabisTaxRevenues (last visited Nov. 20, 2024).
[26] See id.
[27] See California Marijuana Sales Report 2024, California Cannabis (Oct. 2, 2024), https://californiacannabis.org/business/sales.
[28] See Grand View Research, California Legal Cannabis Market Size, Share & Trends Analysis Report By Source (Marijuana, Hemp), By Derivatives (CBD, THC, Others), By Cultivation, By End-use (Recreational, Medical), And Segment Forecasts, 2024 – 2030.
[29] See Cannabis Sales by County, California Department of Tax and Fee Administration, https://www.cdtfa.ca.gov/dataportal/dataset.htm?url=CannabisSalesByCounty (last visited Nov. 8, 2024).
[30] See id.
[31] See id.
[32] See id.
[33] See Chirsty Getz & Margiana Petersen-Rockney, State of the California Cannabis Industry, Uni. of Cal. Berkeley, Cannabis Research Ctr (Apr. 30, 2024), https://crc.berkeley.edu/wp-content/uploads/2024/05/DCC-65021-Final-Report.pdf.
[34] See Jan Conway, Legal vs. Illicit Cannabis Sales in California in 2019, Statista (May 24, 2022), https://www.statista.com/statistics/1075946/legal-vs-illicit-cannabis-sales-california-us/.
[35] See Grace Noto, Cannabis Firm MedMen Files for Bankruptcy, CFO Dive (Apr. 29, 2024), https://www.cfodive.com/news/cannabis-medmen-files-bankruptcy-liquidation-debt/714618/#:~:text=Following%20plummeting%20stock%2C%20an%20exodus,according%20to%20company%20filings%20Friday.
[36] See Rolando Garcia, California’s Largest Cannabis Delivery Service Closes Down, Lays Off 500 Workers, Benzinga (Oct. 8, 2024), https://www.benzinga.com/markets/cannabis/24/10/41236050/californias-largest-cannabis-delivery-service-closes-down-lays-off-500-workers.
[37] See U.S. Const. art. I, § 8, cl. 4.
[38] See 28 U.S.C. §1334(a).
[39] See 11 U.S.C. §§ 586, 307.
[40] See id. at § 586(a)(3)(F).
[41] See 28 U.S.C. § 704(a)(1).
[42] See 11 U.S.C. § 109(b) (for eligibility); See also 28 U.S.C. § 727(a) (for discharge in Chapter 7).
[43] See 28 U.S.C. §§ 701(a)(1), 702(d).
[44] See 11 U.S.C. §323(a); 28 U.S.C. § 704; See also Fed. R. Bankr. P. 2015(a).
[45] See 28 U.S.C. § 704(a)(4), (6), (7).
[46] See 11 U.S.C. § 362(a).
[47] See id.
[48] See 28 U.S.C. § 726(a).
[49] See id. at § 727(a) (for release of personal liability); see also 11 U.S.C. § 524(a) (for barring creditors).
[50] See e.g., United States v. Whiting Pools, Inc., 462 U.S. 198, 203 (1983) (illustrating the purpose of Chapter 11 to facilitate the reorganization of a debtor’s business).
[51] See 28 U.S.C. §§ 1107(a) (for DIP), 704(a) (incorporating most trustee duties under by § 1106).
[52] See 11 U.S.C. §§ 586, 307.
[53] See id. at § 1123(a)(5).
[54] See, e.g., Whiting Pools, supra note 50 at 198.
[55] See Grogan, supra note 3 at 286.
[56] See City of Chicago v. Fulton, 592 U.S. 154, 165 (2021).
[57] Grogan, supra note 3 at 287.
[58] Clifford J. White & John Sheahan, Why Marijuana Assets May Not Be Administered in Bankruptcy, Dep’t Of Justice, Executive Office For U.S. Trustees (Dec. 2, 2017), https://www.justice.gov/ust/file/abi_201712.pdf/download. See also 28 U.S.C. §§ 586(a)(3)(E), (F) (outlining the duties of the U.S. Trustee).
[59] See 28 U.S.C. § 707(a) (for chapter 7 dismissals). See also id. at§1112(b)(4) (for chapter 11 dismissals).
[60] See e.g., Blumsack v. Harrington (In re Blumsack),657 B.R. 505 (B.A.P. 1st Cir. 2024).
[61] See Arenas v. United States Tr. (In re Arenas), 535 B.R. 845, 847 (B.A.P. 10th Cir. 2015).
[62] See id.
[63] See id. at 847-48.
[64] See id. at 853.
[65] See id.
[66] See id.
[67] See id. at 854.
[68] See id.
[69] See id.
[70] See id.
[71] See e.g., Blumsack, supra note 60 at 505 (upheld a motion to dismiss because the debtor’s income was derived from employment of a cannabusiness); In re ARM Ventures, LLC, 564 B.R. 77 (Bankr. S.D. Fla. 2017) (finding a Chapter 11 plan infeasible because the debtor proposed to fund its plan by using money it received from a cannabusiness); In re Way to Grow, Inc., 597 B.R. 111 (Bankr. D. Colo. 2018) (granting dismissal because the trustee could not administer cannabis-related assets, such a hydroponics and other cannabis specific grow equipment).
[72] See In re Callaway, 2024 WL 3191673 at 4 (Bankr. N.D. Cal. June 26, 2024).
[73] See id. at 5.
[74] See id. at 2.
[75] See id. at 6-7.
[76] See id. at 14.
[77] See id.
[78] See id. at 13.
[79] See id. at 13-14.
[80] See id. at 19.
[81] See id. at 22. See also 28 U.S.C. § 707 (a) (explaining the courts use of discretion).
[82] See id. at 22.
[83] See In re Hacienda Co., 647 B.R. 748, 750 (Bankr. C.D. Cal. 2023).
[84] See id.
[85] See id.
[86] See id.
[87] See id.
[88] See id.
[89] See id.
[90] See id. at 751-58.
[91] See id. at 752-53.
[92] See id.
[93] See id.
[94] See id. at 753.
[95] See id. at 753.
[96] See id.
[97] See id. at 754.
[98] See id. at 752. See also In re Dean, No. 20-20427, 2021 Bankr. LEXIS 831 (Bankr. D. Me. Mar. 31, 2021) (denied the UST’s motion to dismiss, finding that the UST’s speculative reliance on potential future legal outcomes failed to establish sufficient cause for dismissal under 11 U.S.C. § 1112(b), as MR, LLC, an entity connected to the debtor, faced allegations of violating federal drug laws but had not been convicted or had its assets determined to be subject to forfeiture. The court emphasized that a reorganization plan could potentially avoid entanglement with MR, LLC, and the assets, relying instead on disposable income or third-party contributions to fund creditor payments.)
[99] See In re Hacienda, supra note 83 at 752.
[100] See id. at 756.
[101] See id.
[102] See id.
[103] See id. at 758.
[104] See id.
[105] See Cal. Civ. Proc. Code §§ 568-570.
[106] See Cal. Civ. Proc. Code §§ 564(b)(1)-(12), (c), (d) (listing fourteen different contexts in which a receivership may be sought for the court).
[107] See id.
[108] See Cal. Civ. Proc. Code §§ 568-570.
[109] See id.
[110] See Cal. Civ. Proc. Code § 570.
[111] See CFO Dive supra note 35.
[112] See MM CAN USA, Inc., Receivership Order, No. 24SMCP00197 (Cal. Super. Ct. Apr. 23, 2024) (Los Angeles Superior Court, Santa Monica Division).
[113] See id.
[114] See id.
[115] See Brent Salmons, MedMen’s California Receivership Proceeds with Asset Sales to Repay Creditors, Green Market Report (Apr. 25, 2024), https://www.greenmarketreport.com/medmen-california-receivership-proceeds- with-asset-sales-to-repay-creditor/.
[116] See id.
[117] See id.
[118] See id. See also John Schroyer, MedMen creditors likely out millions, trustee and receiver documents say, Green Market Report (June 24, 2024), https://www.greenmarketreport.com/medmen-creditors-likely-out-millions-trustee-and-receiver-documents-say/.
[119] See Cal. Civ. Proc. Code §493.010. See Sherwood Partners, Inc. v. EOP-Marina Business Center, L.L.C., 153 Cal. App. 4th 977, 984 (2007) (explaining that Cal. Civ. Proc. Code §493.010 is not self-executing and ABCs are governed by the law of contract).
[120] See Cal. Civ. Proc. Code §493.010(a).
[121] See id.
[122] Credit Managers Ass’n of S. Cal. v. National Indus. Bus. Alliance, 162 Cal. App. 4th 1076, 1080 (2008)
[123] See id. at 1080.
[124] See CannaCraft, Inc., PitchBook, https://pitchbook.com/profiles/company/234441-37 (last visited Nov. 20, 2024).
[125] See Two More California Cannabis Companies Disclose Layoffs, MJBizDaily (Nov. 12, 2019), https://mjbizdaily.com/two-more-california-cannabis-companies-disclose-layoffs.
[126] See PitchBook, supra note 124.
[127] See id.
[128] See California Corporations Code §§ 200 (establishing that a corporation is a separate legal entity capable of incurring its own liabilities), 17701.04 (establishing that an LLC is a separate legal entity capable of incurring liabilities). See also Automotriz etc. De California v. Resnick, 47 Cal.2d 792, 796 (1957) (establishing this protection generally prevents creditors from holding individuals personally liable for corporate debts unless they can prove grounds to pierce the corporate veil).
