In Los Angeles (as you’d expect), the first cracks are showing in the prohibition keeping cannabis businesses out of bankruptcy court.
The January 20 opinion by Bankruptcy Judge Neil W. Bason could be read to allow a cannabis business to sell its assets and distribute the proceeds in bankruptcy.
The debtor had been in the business of wholesale manufacturing and distribution of cannabis products. The business ceased operations in February 2021. Before bankruptcy, the debtor sold its assets, chiefly intellectual property, to a public company in Canada that legally grows and sells cannabis products in Canada. As consideration for the sale, the debtor received 9.4% of the buyer’s stock.
The debtor filed a chapter 11 petition in September 2022, avowedly to file a plan to sell the buyer’s stock and distribute the proceeds to creditors.
The U.S. Trustee filed a motion to dismiss, claiming that the debtor’s prior illegal activities and the proposed sale of stock in a cannabis business were “cause” for dismissal under Section 1112(b)(1) and (b)(4). Judge Bason denied the motion.
“A violation of nonbankruptcy law is not expressly listed as ‘cause’ for dismissal under § 1112(b)(1) & (4),” Judge Bason said. Still, “it appears to be undisputed that violations of nonbankruptcy law can be cause for dismissal.” [Emphasis in original.] He went on to give several reasons why illegal activity “might establish cause for dismissal.”
Citing a decision by the Ninth Circuit Bankruptcy Appellate Panel in 2020, Judge Bason said that “the degree of connection [to illegal activity] appears to be important to deciding whether to dismiss the case” and that “[o]ngoing postpetition violations are far more problematic than prepetition violations.”
In the case before him, Judge Bason said that the U.S. Trustee had not identified any ongoing violations of the Controlled Substances Act and had not shown that a subsequently appointed trustee “would have to engage in a violation of the CSA.” Furthermore, he said that the plan “to liquidate that stock to pay creditors[] will terminate any connection with cannabis.” [Emphasis in original.”
Judge Bason held that “the lack of any demonstrated illegality, now or in the foreseeable future, is one ground for denial of the [U.S. Trustee’s motion to dismiss].”
Even if there were a violation of the CSA, Judge Bason said “that is not enough.” Again citing the BAP, he said there is no congressionally adopted “‘zero tolerance’ policy that requires dismissal of any bankruptcy case involving violation of the CSA (or other activity that might be proven to be illegal).”
“Dismissing every case that had a connection with illegal activity would be contrary to Congress’ directives under the Bankruptcy Code” and “would harm the constituencies that Congress attempted to protect,” Judge Bason said.
For example, dismissal would result in a race to the courthouse and would shield parties who could be sued in bankruptcy court, such as recipients of avoidable transfers. In fact, the “biggest creditors” could be victims of illegal activities, and they “might be the most severely harmed by dismissal.”
Judge Bason did “not interpret Congress’ mandate that this Bankruptcy Court ‘shall’ dismiss or convert a bankruptcy case for ‘cause’ under § 1112(b) to mean that any violation of criminal law requires dismissal.” [Emphasis in original.]
“Rather,” Judge Bason “interpret[ed] the statute as giving discretion to determine whether dismissal is warranted based on all the facts and circumstances.” Under “this standard,” he concluded that the U.S. Trustee had not shown “sufficient cause for dismissal.”
Indeed, Judge Bason said that the court “would be overstepping its role, and acting contrary to Congress’ directives within the Bankruptcy Code, if it were to deny creditors, debtors, employees, equity investors, and other constituencies the benefits and protections of bankruptcy based on the facts and circumstances presented.”
Judge Bason denied the motion to dismiss.
In Los Angeles (as you’d expect), the first cracks are showing in the prohibition keeping cannabis businesses out of bankruptcy court.
The January 20 opinion by Bankruptcy Judge Neil W. Bason could be read to allow a cannabis business to sell its assets and distribute the proceeds in bankruptcy.
The debtor had been in the business of wholesale manufacturing and distribution of cannabis products. The business ceased operations in February 2021. Before bankruptcy, the debtor sold its assets, chiefly intellectual property, to a public company in Canada that legally grows and sells cannabis products in Canada. As consideration for the sale, the debtor received 9.4% of the buyer’s stock.