Bankruptcy: A Legal Strain on Marijuana-Adjacent Businesses

Since the beginning of state-legalization of marijuana in the United States, non-marijuana businesses have struggled to exist in the gray area created between the implications of the Controlled Substances Act (“CSA”) and state medical and adult-use programs. The Controlled Substances Act classifies marijuana as a Schedule I substance, meaning all production, manufacturing, distribution, possession, or use of marijuana remains federally illegal and subject to federal prosecution¹. Additionally, the CSA provides that anyone who conspires to commit any offense in violation of the CSA is subject to the same penalties and punishments as those committing the violations². With 38 states having legalized marijuana medically and 24 states have further legalized it for adult use, the continuing federal illegality creates many questions for non-marijuana businesses that may interact with marijuana businesses. A non-marijuana business that interacts with a marijuana business, also known as a “marijuana-adjacent business,” may include a landlord who wishes to lease to a marijuana business, a lending institution who may want to issue a loan to a starting grow operation, or a packaging manufacturer who is interested in producing the packaging for the marijuana business. The federal government had indicated that it does not prioritize prosecuting those involved with state-compliant marijuana business and marijuana-adjacent businesses. However, the threat of federal prosecution is not the only risk factor a business must take into a consideration when contemplating doing a deal with a marijuana business.

Bankruptcy is a legal process under federal law that allows individuals and businesses to restructure or discharge debts that they are unable to pay. Although mentioned in the Constitution, bankruptcy is not a legal right; a debtor must still meet requirements delineated in Chapter 11 of the U.S. Code. While there is no explicit provision denying bankruptcy protection for those engaged in illegal activity, marijuana businesses and marijuana-adjacent businesses have been denied bankruptcy protection under federal law. The Bankruptcy Code allows for the dismissal of bankruptcy cases under Chapter 7 liquidation or Chapter 11 reorganization “for cause,” including bad faith or the totality of the circumstances³. The bankruptcy courts have recognized that allowing marijuana businesses and those with interests in marijuana businesses to use the bankruptcy process would not only require bankruptcy trustees to violate federal law in possessing, selling, or distributing marijuana assets, but also would provide federal protection for those continuing to violate federal law⁴. This creates another layer of risk for those interested in investing in or doing business with marijuana businesses – if a business decides to lease to, invest in, insure, or otherwise do business with a marijuana business, it risks its ability to get the protections of bankruptcy should the business become insolvent or need to reorganize. However, it seems that with the progression of state legalization, bankruptcy courts in a few areas are taking a more lenient approach to marijuana-adjacent businesses and individuals.

In 2015, a Michigan Bankruptcy Court denied a dismissal action brought by the trustee where a debtor’s income was based on both Social Security payments and medical marijuana sales under Michigan’s medical marijuana regulatory scheme. The court allowed the debtor’s case to move forward provided that the debtor destroy his current home grow operation and cease his marijuana activity while the bankruptcy case was pending⁵. In California, a debtor who had sold his marijuana manufacturing and packaging business to a Canadian marijuana business in exchange for equity shares in the company was permitted to continue in bankruptcy, over the objection of the trustee, because the debtor was no longer engaged in the business and the equity constituted a substantial amount of his estate. Without allowing the case to go forward and the equity shares to be sold, the creditors would never get paid. Thus, the court decided that based on the totality of the circumstances, dismissal was not warranted and that a violation of criminal law did mandate a dismissal per se⁶. Most notably, the Ninth Circuit affirmed a Chapter 11 plan for a real estate company that leased one of several properties to a marijuana grow operation. The Ninth Circuit interpreted the requirement of a plan to not be proposed “by any means forbidden by law” as required by 11 U.S.C. § 1129(a)(3) to refer to the proposal of the plan itself, not the terms of such plan. The court did acknowledge that the plan could be challenged under other provisions, but affirmed the lower court’s finding that the plan met the requirements of 11 U.S.C. § 1129(a)⁷. Other bankruptcy courts have acknowledged that it could be appropriate in the future for a marijuana-adjacent businesses or even marijuana businesses themselves to have access to bankruptcy protections⁸. With continuing state legalization and proposed rescheduling or descheduling of marijuana from the CSA, among other federal legalization efforts, the ability to invest, cooperate, and do business with marijuana businesses may soon be available without the threat of losing bankruptcy protections.

1. 21 U.S.C. § 841.
2. 21 U.S.C. § 846.
3. 11 U.S.C. § 707(b)(3); 11 U.S.C. § 1112(b)(4).
4. See In re Way To Grow, Inc., 597 B.R. 111 (Bankr. D. Colo. 2018), aff’d sub nom. In re Way to Grow, Inc., 610 B.R. 338 (D. Colo. 2019).
5. In re Johnson, 532 B.R. 53 (Bankr. W.D. Mich. 2015).
6. In re Hacienda Co., LLC, 647 B.R. 748 (Bankr. C.D. Cal. 2023).
7. In re CWNevada LLC, 602 B.R. 717 (Bankr. D. Nev. 2019)