“You wanna get high?”
I hadn’t been asked that since college.
“I’ve got some good green for you.” His words oozed from the phone, pre-rehearsed on a dozen other fiends before me. This Tony Montana wanna-be loved his job, at least today.
“I can’t believe I’m considering this. Call me back.” I hung up on my broker-turned-dealer. “Getting high” was his teaser for marijuana 1 stocks gaining momentum from recent state legislation giving the nod to midnight tokers everywhere — or at least within their borders.
Marijuana, now legal for medical purposes in 20 states2 and D.C., and for recreational purposes in two states,3 is like any other fledgling industry. It needs cash. Currently, it seems to be feeding capital needs primarily through private investors or day traders praying they’re not chasing pump-and-dumps with college funds. But what happens when the high starts to wear off and investors liquidate to buy Doritos futures? Who’ll save the day? For example, I’ve yet to meet an asset-based lender that isn’t genuinely enamored by “deals with a little hair,” the “tough situation” or things “traditional lenders won’t touch.” Financing weed seems to fit the bill.
Setting aside whether marijuana should be legal,4 there are serious considerations in respect of financing the marijuana industry, many of which arise in bankruptcy. So sit back, relax and, if you’re reading this from Colorado, remember there’s only one way truly to test your would-be inventory collateral: Weigh it. (What were you thinking?)
Using and Selling Marijuana-Related Assets
Under §363,5 a trustee or debtor-in-possession may use, sell or lease estate property in or outside of the ordinary course of business.6 But is this true when the debtor is involved in the marijuana industry? Under the Controlled Substances Act, thou shalt not grow marijuana, thou shalt not possess marijuana and thou shalt not sell or distribute marijuana.7 Remember, the only reason the aboveground marijuana industry exists is because the U.S. Department of Justice is turning a blind eye on its participants, including, so far, lenders.8 A change in enforcement philosophy, however, always remains a mere election away.
The conflict between §363 and the Controlled Substances Act is problematic. It questions the ability to operate marijuana-related businesses or to dispose of their assets to pay creditors in bankruptcy. Also questionable is whether secured creditors can acquire otherwise illegal assets by way of credit bid,9 let alone obtain the protections of “good faith” buyers10 in the process.
Where two federal statutes conflict, courts have a duty to give full effect to both, if possible.11 In order for one statute to be ousted, courts must undertake a detailed analysis of the specific statutory provisions and find a clear congressional intent that one statute was meant to override another.12 It seems unrealistic that a court would interpret §363, a largely civil statute, to authorize criminal acts.13 This interpretation also would inherently contradict Congress’ express intent that a bankruptcy filing will not stay commencement or continuation of criminal actions or proceedings.14
One of several requirements to confirm a Chapter 11 plan is that it “has been proposed in good faith and not by any means forbidden by law.”15 Courts have interpreted this provision to deny plan confirmation where the plan’s contents contradict applicable law.16
Whether the plan provides for a sale17 or traditional reorganization of business operations, the fact that its contents otherwise are illegal under federal law appears to bar confirmation under §1129(a)(3). Moreover, unlike the non-plan sale provisions of §363, which at least create a conflict potentially reconcilable in favor of “economic justice” for creditors, no such conflict exists under §1129(a)(3). Illegal Chapter 11 plans simply cannot be confirmed.
It’s All a Bunch of Crop
Because the marijuana industry is farming at its core, borrowers qualifying as “family farmers with regular annual income” might seek relief under Chapter 12.18 Chapter 12 nevertheless shares infirmities with Chapter 11 insofar as marijuana is concerned. While the authority for non-plan asset sales under Chapter 12 is “in addition” to that of §363,19 sales still would contravene federal criminal statutes. Chapter 12 plans also cannot be confirmed if forbidden by law.20
Many secured creditors never face preference liability for payments received within 90 days before a borrower’s bankruptcy. These payments seldom exceed what secured creditors would have received if the payments weren’t made, and they instead were paid in a hypothetical Chapter 7 liquidation (a necessary finding in order to establish a prima facie preference claim).21
Assume your collateral is $50,000 of inventory and you received a $10,000 payment within 90 days before a borrower’s bankruptcy. In a hypothetical liquidation, the trustee either would sell the inventory and pay you $50,000 in proceeds, or abandon the inventory for resale or to be retained in full or partial satisfaction of the debt. Either way, the $10,000 payment didn’t leave you any better off than if you hadn’t received it and instead were paid in a liquidation. In short, no preference.
Change the facts. Assume your collateral is $50,000 of marijuana inventory. In a hypothetical liquidation, a bankruptcy trustee arguably couldn’t sell this inventory under §363, leaving abandonment as the only option. There’s a credible argument, however, that because federal law would prohibit you from selling the inventory or even retaining it in full or partial satisfaction of the debt, you were better off receiving the $10,000 — you couldn’t have been paid otherwise. In short, potential preference.
Let’s Roll This Up
There are several practical takeaways here. First, if you’re going to finance the marijuana industry, but your appetite for risk doesn’t border on the munchies, consider borrowers involved only in providing legal ancillary goods or services, and not borrowers that grow, possess, sell or distribute marijuana. That isn’t to say these “Tier Ones and Twos” are free from risk, but they appear better insulated where bankruptcy is concerned. Remember also that simply limiting your collateral base, for example to machinery and equipment, doesn’t solve the problem if the borrower nevertheless grows, possesses, sells or distributes marijuana. The marijuana inventory will be an asset. Just because it’s not collateralized doesn’t mean it won’t complicate your overall exit as a secured creditor.
Second, remember to price-in the risk of marijuana-related loans. Bankruptcy aside, it’s hard to imagine a more sweeping risk to collateral than criminal seizure. Also, guarantors convicted of an offense could be rendered wholly uncollectible due to asset forfeiture.22
Third, avoid forcing borrowers into bankruptcy unless, of course, you want to be a test case. Should judicial oversight become necessary, consider instead looking to state law remedies (e.g., a receivership) where the state has “legalized” the operations.
Finally, remember that guarantors have an obvious interest in top-dollar collateral sales or successful reorganizations. Bankruptcy ensures neither where the borrower is involved in the marijuana industry. Remind guarantors of this when they threaten to play the “bankruptcy card” for a borrower.
The advent of the marijuana industry raises more questions than answers concerning its collision with bankruptcy. Speaking of questions, in case you’re wondering, my broker-turned-dealer called back with several opportunities. I just said no.
Rocco I. Debitetto is a partner in the Cleveland office of Hahn Loeser & Parks LLP, co-chair of the firm’s Creditors’ Rights, Reorganization and Bankruptcy Area, and Legal Personnel director. He is recognized nationally in such publications as Best Lawyers in America and Super Lawyers, and recently was profiled in Who to Watch in Law by Crain’s Cleveland Business. Special thanks to Shannon M. Byrne, Esq. for her assistance in researching this article.
Marijuana is a derivative of cannabis. It’s also known, among other things, as pot, weed, dope, doobie, doobage, ganja, herb, Mary Jane, maryjuana, bud, dank, cheeba, chronic, grass, green, whacky tabaccy and shit. See Wikisaurus, http://en.wiktionary.org/wiki/Wikisaurus:marijuana (last visited January 14, 2014). With that knowledge, you’re one step closer to pitching Law & Order, S(pecial) A(ssets) U(nit), or at least keeping up with that hoodlum next door.↩
Alaska, Arizona, California, Colorado, Connecticut, Delaware, Hawaii, Illinois, Maine, Massachusetts, Michigan, Montana, New Hampshire, Nevada, New Jersey, New Mexico, Oregon, Rhode Island, Vermont and Washington.↩
Colorado and Washington.↩
Nothing in this article expresses, or is intended to express, any opinion by the author or Hahn Loeser & Parks LLP regarding the legalization of marijuana for any purpose. Obtain advice of counsel before entering into any transaction.↩
All “Section” references are to the United States Bankruptcy Code.↩
11 U.S.C. §363(b)(1) & (c)(1).↩
21 U.S.C. §841 & §844.↩
James M. Cole, Deputy Attorney General, U.S. Dept. of Justice, Memorandum for All United States Attorneys: Guidance Regarding Marijuana Enforcement (August 29, 2013) (discussing updated enforcement priorities due to state initiatives legalizing marijuana-related activities); Dept. of the Treasury, Financial Crimes Enforcement Network, Guidance, BSA Expectations Regarding Marijuana-Related Businesses (February 14, 2014) (acknowledging DOJ’s stance on state initiatives and providing guidelines — but not assurances — for financial institutions seeking to provide services to marijuana-related businesses). ↩
11 U.S.C. §363(k) (authorizing secured creditors to credit bid their debt in §363 sales).↩
11 U.S.C. §363(m) (preserving the validity of asset sales to good-faith buyers, even if sales are reversed or modified on appeal).↩
See, e.g., Morton v. Mancari, 417 U.S. 535, 551 (1974).↩
See, e.g., Credit Suisse Sec. (USA) LLC v. Glen Billing, 551 U.S. 264, 284-85 (2007) (holding that securities statutes precluded application of conflicting antitrust statutes in action by investors against IPO underwriters).↩
Trollinger v. Tyson Foods, Inc., 2007 U.S. Dist. LEXIS 38882, at *30 (E.D. Tenn. 2007) (“To the extent there is a conflict between a criminal and civil statute, obviously the criminal statute prevails.”).↩
11 U.S.C. §362(b)(1).↩
11 U.S.C. §1129(a)(3).↩
See, e.g., In re Cajun Elec. Power Coop., 230 B.R. 715, 737 (Bankr. M.D. La. 1999) (trustee’s plan violated established energy cooperative law; therefore, could not be confirmed under §1129(a)(3)).↩
11 U.S.C. §1123(b)(4) (a plan of reorganization may provide for a sale of substantially all of estate property).↩
11 U.S.C. §109(f); §101(18)-(21).↩
11 U.S.C. §1206.↩
11 U.S.C. §1225(a)(3).↩
11 U.S.C. §547(b)(5).↩
21 U.S.C. §853.↩