August 2018

No BK for You! Cannabis Enterprise Kicked Out of Ch. 11 Line

By Tyler McQuillan

Bremer Whyte Brown & O'Meara, LLP

Those familiar with the blossoming cannabis industry are readily familiar with certain limitations imposed upon the “legal” cannabis business. From tax inefficiencies spurred by Internal Revenue Code 280E to limitations on change in ownership (i.e., M&A), navigating the capital markets can be an exercise of corporate and securities gymnastics. And through In re Healing Nature, LLC,1 the United States Bankruptcy Court has confirmed that ancillary companies may also lose their place in the Chapter 11 line.

The business enterprise described in the United States trustee’s motion to dismiss describes a business enterprise familiar to the cannabis space: an operating entity, a property owning “landlord” to the same, and a service providing “management company” to the same. The businesses all shared common ownership though engaged one another through commercial relationships. The debtor here was the landlord entity, leasing real property to the plan touching-operating entity. 

In a diatribe sure to make the current Attorney General proud, the trustee dutifully recited those provisions of the Controlled Substances Act implicated by the business’s operations. The trustee contended that, in line with precedent out of Colorado, the Chapter 11 plan should be dismissed because the debtor could not lawfully reorganize. The lease of real property to a “criminal enterprise” is in gross mismanagement of the estate, so the story goes.

Now, to be fair, the debtor was no poster child of a Chapter 11 candidate. The enterprise held no insurance on the commercial property, had filed incomplete and inaccurate financials (at best), was untimely in filing documents with the trustee, and apparently had no reported income on paper. If this were indeed Seinfeld's “Soup Nazi” line, this landlord would not have even made it through the entrance door.

So given the court flowed a litany of case law — some coming from traditionally “legal” states like Colorado and Oregon — what is the significance here? Perhaps sadly, not much. Though the Ninth Circuit has issued canna-friendly case law on certain 280E matters, there is yet to be a similar allowance granted in the bankruptcy context. For the time being, it seems the industry will just have to enjoy the soup available and make do without its bread.

1 Bankr. E.D. Penn., Case No. 18-111121-amc.