Colorado Bankruptcy Judge Kicks Cannabis Debtor Out of Court
Cannabis Practice Update
Date: January 19, 2021
The bankruptcy cases of United Cannabis Corporation (“UCANN”) and its wholly owned subsidiary UC Colorado Corporation (“UC Colorado”) sit at the intersection of state-legal marijuana and the federal Controlled Substances Act. The U.S. Bankruptcy Court for the District of Colorado showed an intense skepticism that the debtors were allowed to be in bankruptcy from the beginning before ultimately dismissing the cases with the consent of the debtors.
UCANN and UC Colorado originally sought bankruptcy protection to prevent one of their primary creditors, Miner’s Delight, LLC, from executing an ex parte prejudgment writ of attachment in Colorado state court, which would have shut down the companies completely. However, the companies also faced a significant drop in CBD prices in 2019 and declining sales caused by the COVID-19 pandemic. Almost immediately after the petitions were filed, the Bankruptcy Court entered orders to show cause as to why the cases should not be dismissed and to show whether the debtors were participants in the marijuana industry. In response, UCANN and UC Colorado indicated that they were not involved in the marijuana industry and did not derive any income from illegal activity. UC Colorado operates facilities that extract and convert components of the legal industrial hemp flower into CBD products. UCANN does not have any operations but holds (i) various patents that claim liquid cannabinoid formulations and related licenses that do not generate royalties, (ii) interests in a handful of non-operational subsidiaries and which are currently not producing revenues, and (iii) shares in a publicly traded Canadian medical marijuana company. The U.S. Trustee and multiple creditors also filed responses to the orders to show cause both in favor of and against dismissal.
Citing a concern about the accuracy of the debtors’ responses to the show cause order, the Court ordered the appointment of an examiner to investigate whether the debtors were engaged in illegal businesses. In its report, the examiner made several findings, including:
- the debtors had unequivocally violated the Controlled Substances Act prior to bankruptcy;
- no distinction should be drawn between UCANN and UC Colorado;
- the debtors’ finances were inextricably linked to illegal cannabis-related activities;
- funds derived from the sales of legal hemp-derived CBD products had not been kept separate from funds derived from marijuana-related activities;
- the debtors were not currently actively engaged in the possession, manufacture or distribution of illegal cannabis; and
- there is probable cause that the debtors are currently aiding and abetting the illegal cannabis industry, as a result of the various cannabis-related patents and the debtors’ interests in other companies that do violate the Controlled Substances Act.
Unsurprisingly, the debtors objected to the examiner’s findings.
The U.S. Trustee and another creditor ultimately moved for dismissal for cause under Section 1112 of the Bankruptcy Code, arguing that the bankruptcy estates were suffering a substantial and continuing loss or diminution, with no reasonable likelihood of reorganization. The U.S. Trustee also argued that the estates were being grossly mismanaged and, citing the examiner’s report, that the debtors’ assets and operations were connected to the marijuana trade, along with other procedural violations by the debtors that warranted dismissal. In response, the debtors conceded the procedural violations and that they were currently operating at a loss, but vehemently denied that they were involved in the marijuana industry. At the hearing on the motion to dismiss, the debtors consented to dismissal, and there was not a substantive discussion of which grounds supported dismissal. However, the judge made clear that marijuana debtors were still not welcome in his court:
“[T]he bankruptcy judges in districts like Colorado where marijuana is medicinally and also recreationally legal are put in a very difficult position in cases where debtors seek relief from the bankruptcy court and their business either did or does or will encompass the marijuana cannabis field…I would not have given a Chapter 7 trustee the minefield such trustee would have faced. And I think, basically, in all the seminars I've gone to on the intersection of cannabis and bankruptcy law, the mantra that I hear is cannabis cases belong in state court, which certainly has jurisdiction.”
On January 12, 2021, the Bankruptcy Court dismissed both UCANN and UC Colorado’s cases in a short order that did not elaborate on which ground supported dismissal.
What is clear from these cases is that bankruptcy courts, despite the laws in a majority of the states, remain hostile to marijuana and cannabis. The Court took several actions on its own initiative, including entering orders to show cause and ordering the appointment of an examiner, to specifically determine whether the debtors were participants in the marijuana industry. How long that hostility remains depends on what the federal government does next, whether that be legalizing marijuana or carving out special protections for lenders and bankruptcy trustees.
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Sean A. Gordon
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