23 States Legalized Marijuana – Bankruptcy Courts Remind Us That It’s Legal in None of Them

“There was a time a few years ago when the United States was spoken of in the plural number.
Men said ‘the United States are’ — ‘the United States have’ — ‘the United States were.’ But the war changed all that.”   The Washington Post, April 24, 1887.   The phrase “United States” became a singular noun after the Civil War. Its use changed from “the United States are” to “the United States is.” As a result, we are no longer a nation of 50 sovereign states, but instead part of a national union under a set of U.S. laws. Thus, although marijuana is legal in 23 states, it is legal in none of them.

The Federal Controlled Substances Act, 21 U.S.C. § 801 et seq. (the “CSA”) which was enacted in 1970, regulates the manufacture, importation, possession, use and distribution of certain substances. The CSA remains in force today, and classifies marijuana as a Schedule I controlled substance, rendering certain activities involving marijuana a federal crime.

Recently, in September 2014, a U.S. Bankruptcy Court in Denver, in the matter of In re Frank Arenas and Sarah Arenas, 14-11406-HRT (Bankr. D. Co. 2014), denied bankruptcy protection to the individuals in the business of growing and storing marijuana in commercial building in Denver. Such building had been partially leased to a corporate entity that operated a marijuana dispensary. The U.S. Bankruptcy Court ruled that, although their activities were legal under Colorado law, they were violating the CSA. The U.S. Bankruptcy Court denied protection to the debtors under both bankruptcy liquidation and reorganization.

The U.S. Bankruptcy Court denied the Arenas liquidation protection (under Chapter 7 of the Bankruptcy Code) because the Chapter 7 trustee appointed by the U.S. Bankruptcy Court to administer and liquidate the marijuana business, plants and assets would not be able to take control of those assets without himself violating the CSA, including the CSA’s prohibition of distribution of a Schedule I controlled substance. Ultimately, the Court found that administration of that case under Chapter 7 was impossible without involving the Trustee in ongoing criminal violations of the CSA.

Additionally, the U.S. Bankruptcy Court denied reorganization protection (under Chapter 13 of the Bankruptcy Code) to the Arenas because their plan of reorganization would be funded from profits of an ongoing activity that was deemed to be criminal under federal law, precluding satisfaction of the Bankruptcy Code’s requirement that a reorganization plan be proposed “in good faith and not by any means forbidden by law.” 11 U.S.C. § 1325(a)(3).

The Court’s rationale applies to corporate reorganizations under Chapter 11 as similar language is found in 11 U.S.C. § 1129(a)(3). The same U.S. Bankruptcy Court had also previously held in In re Rent-Rite Super Kegs West Ltd., 484 B.R. 799 (Bankr. D. Co. 2012) that “unless and until Congress changes [federal drug] law, the Debtor’s operations constitute a continuing criminal violation of the CSA and a federal court cannot be asked to enforce the protections of the Bankruptcy Code in aid of a Debtor whose activities constitute a continuing federal crime.”

The U.S. Bankruptcy Court in Arenas made no distinction whether the growing operation was conducted personally or through a corporate entity because a corporate form cannot shield its owner from criminal liability. See First Nat. City Bank v. Banco Para El Comercio Exterior de Cuba, 462 U.S. 611, 630 (1983) (“the Court has consistently refused to give effect to the corporate form where it is interposed to defeat legislative policies.”).

The Bankruptcy Court concluded that, although it may be extremely unlikely that the Arenas may never be prosecuted for their violations of the CSA, those violations created significant impediments to their ability to seek relief from their debts under the federal bankruptcy laws in a federal bankruptcy court.  The Court thus dismissed the Arenas’ bankruptcy case.

These rulings in Arenas and Rent Rite issued by a U.S. Bankruptcy Court sitting in Colorado underscore the tension between federal and state laws concerning the marijuana business. The rulings demonstrate that a marijuana business is denied access to the federal business reorganization statutes, and thus cannot restructure or reorganize its business and debts associated with the marijuana business.  In other words, a federal avenue for restructuring and salvaging a business is not available to marijuana businesses under the current legal framework.

While out-of-court workouts may still be pursued and are possible, the unavailability of U.S. Bankruptcy Court protection to a marijuana business may provide extra bargaining power to creditors (both secured and unsecured) as they can currently feel secure that their claims cannot be reorganized in Bankruptcy.  Bankruptcy protection is one less weapon in a marijuana business’s arsenal for negotiation with creditors.

 

The information in this article is for general, educational purposes only and should not be taken as specific legal advice.

About the authors

Ralph Priete, Esq.

Ralph Priete, Esq.

Ralph E. Preite focuses on Bankruptcy and Debtors’ and Creditors’ Rights, and practices as a commercial litigator. With over 23 years’ experience in the bankruptcy arena, Mr. Preite has represented corporate and individual debtors, as well as institutional lenders and securities firms, corporate and individual creditors including secured and unsecured creditors, landlords, purchasers of assets and other parties in interest in bankruptcy court proceedings. He has defended and asserted preference and fraudulent conveyance actions, including representing bankruptcy Trustees appointed by the U.S. Trustee's Office, a division of the U.S. Department of Justice.
Ralph Priete, Esq.

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