Marijuana Update: Some Bankruptcy Courts Might Dance with Mary Jane

Thirty-three states and the District of Columbia permit some form of marijuana sales, and 11 states and the District of Columbia have enacted laws for the recreational sale and use of marijuana. Yet marijuana remains a “Schedule I” drug under the Controlled Substances Act,[1] equivalent to heroin under federal law. As a result, many bankruptcy courts have held that a debtor engaged in, or even deriving income from, a state legal marijuana business is not eligible for relief under the Bankruptcy Code.[2]

However, there seems to be at least a small shift in viewing such cases, particularly when the debtor is not in the direct business of growing, distributing or selling the product. Several cases have rejected the “automatic” dismissal of such cases.

In Northbay Wellness Group Inc.,[3] the Ninth Circuit reversed the dismissal of an objection to discharge. The debtor was an attorney accused of converting client trust funds. The client was a medical marijuana dispensary, and the funds were proceeds of sales. The bankruptcy court dismissed the complaint seeking to declare the debt nondischargeable on the basis that the doctrine of unclean hands barred Northbay from seeking to recover funds that were the proceeds of marijuana sales. The Ninth Circuit held that the doctrine of unclean hands does not automatically bar relief, but requires balancing of the alleged wrongdoing of each party. “Had the bankruptcy court weighed the parties’ respective wrongdoing, it necessarily would have concluded that [the attorney’s] wrongdoing outweighed Northbay’s, both as to harm caused to each other and as to harm caused to the public.”[4]

In In re Johnson,[5] Chief Judge Scot W. Dales considered a chapter 13 filed by a 66-year-old facing foreclosure on a residence he had owned for four years. He supplemented his Social Security income by providing, under a state law license, medical marijuana to three patients and a licensed dispensary. Noting that “[t]he country's relationship with marijuana is changing, slowly, and one person’s pusher is another’s caregiver,” Judge Dales rejected the U.S. Trustee’s request to dismiss the case, provided that the debtor cease operating in the marijuana business. Recognizing that “[t]he Debtor's business is patently incompatible with a bankruptcy proceeding, but his financial circumstances are not,”[6] the court concluded that the debtor had to choose between continuing the marijuana business and continuing with his bankruptcy case.

In In re Olson,[7] the Ninth Circuit Bankruptcy Appellate Panel (BAP) vacated and remanded the dismissal of a chapter 13 case filed by a 92-year-old woman who was legally blind and residing in an assisted-living facility. The debtor had been, pre-petition, the manager of a limited partnership owning a shopping center. One of the tenants was a state-licensed marijuana dispensary. The evidence included the declaration from the debtor that she wished to end her relationship with the tenant and sell the property. The bankruptcy court, finding that the debtor had accepted post-petition lease payments from the dispensary, dismissed the case. In vacating the dismissal order, the BAP noted that dismissal should be considered pursuant to the statutory framework of the Bankruptcy Code. The BAP stated that dismissal of a case for “cause” under § 1307(c), although not listed, can include “bad faith.” However, the BAP held that such an analysis required both consideration of the “totality of the circumstances” and specific findings. The BAP stated that there had been no finding that the trustee would be administering the proceeds of an illegal business, and no evidence that the rents were to be used to fund the plan.[8]

            Judge Tighe wrote a separate concurring opinion, stressing the question of whether the debtor had “knowingly and intentionally” violated federal law. She also stressed the importance of performing an analysis of both whether the debtor had been violating the Controlled Substances Act, and why the bankruptcy court concluded that dismissal was mandatory, stating, “Bankruptcy courts have historically played a role in providing for orderly liquidation of assets, equal payment to creditors, and resolution of disputes that otherwise would take many years to resolve. Although debtors connected to marijuana distribution cannot expect to violate federal law in their bankruptcy case, the presence of marijuana near the case should not cause mandatory dismissal.”[9]

Perhaps most significantly, in Garvin v. Cook Investments NW SPNWY LLC,[10] the Ninth Circuit affirmed confirmation of a chapter 11 plan where the debtor derived lease income from a tenant in the business of growing marijuana. The Ninth Circuit agreed with the bankruptcy court’s analysis that § 1129(a)(3)’s requirement that a plan be “proposed in good faith, and not by any means forbidden by law,” applied only to the proposal, and not the terms, of the plan.

A recent decision from the Nevada Bankruptcy Court contains an extensive analysis of the state of marijuana bankruptcy cases. The Nevada Bankruptcy Court concluded that under the particular facts of that case, dismissal was warranted, but noted that “[t]here may be cases where Chapter 11 relief is appropriate for an individual or a non-individual entity directly engaged in a marijuana-related business. For the reasons discussed above, this case is not one of them.”[11] However, the court recognized that “[i]f there are 8,700 residents of Nevada employed by the marijuana industry,… then the impact of automatically denying a bankruptcy fresh start to those residents and their dependents would be unconscionable.”[12]

While none of these cases provides assurance that a bankruptcy court will administer a marijuana-related bankruptcy case, they may support the proposition that each case must be determined on its facts, and within the statutory confines of the particular objection made.