Bankruptcy Isn’t an Option For The Cannabis Industry Though it’s Essential

In the wake of the COVID-19 pandemic, many prognosticators are forecasting a potentially substantial increase in bankruptcy filings across a myriad of industries. Under current law and policy bankruptcy is not an option for companies within the steadily contracting and expanding cannabis industry. The Justice Department continues to prevent struggling cannabis businesses and their workers from accessing bankruptcy to weather the coronavirus-related downturn, even in states that determined medical cannabis is an essential industry during the pandemic.

US Policy Says Bankruptcy Can’t Protect Federally Illegal Businesses

A longstanding US Justice Department policy says bankruptcy can’t be used to protect federally illegal businesses, including state-approved cannabis companies.  During 2019, there was the first circuit-level opinion in the bankruptcy/cannabis space that appeared to open the door to bankruptcy courts, albeit only slightly. Yet also had lower court opinions slamming that door shut.

More recently the US Supreme Court set a precedent when they rejected the argument that cannabis that is used for medical purposes creates an exception to the application of the Controlled Substance Act. Without any such exception, the debtors’ use of medical cannabis, though legal under state law, remains illegal under federal law.

United Cannabis Corporation (“United Cannabis”) and its wholly-owned subsidiary, UC Colorado Corporation, filed for Chapter 11 bankruptcy protection in the Bankruptcy Court for the District of Colorado in April 2020. United Cannabis’s primary line of business is operating extraction facilities to convert compounds of industrial hemp flower into finished CBD products. Interestingly, United Cannabis owns a patent for concentrated liquid formulations of CBD, THC, and THCa. Per SEC filings, the company also licenses these formulations to medical and recreational cannabis businesses.

Restrictions Can Even Apply to Ancillary Businesses

The U.S. Trustee Program generally has moved to dismiss all cannabis-related bankruptcy petitions, regardless of legality at the state level in which a debtor operates. While other bankruptcy judges have dismissed cases filed by ancillary companies – the judge asked the debtor and the U.S. Trustee to show cause why this case should not be dismissed since the debtor licenses a patent in the marijuana industry and therefore “appears to be engaged in the marijuana industry.” These restrictions have now been extended even to landlords that lease space to cannabis businesses or companies that produce equipment utilized in the cannabis industry.

While bankruptcy may be unavailable to domestic cannabis companies, the availability of bankruptcy relief for cross-border insolvencies has not, to date, been tested. For instance, the legal cannabis industry in Canada under stress for many reasons, including a black market for cheaper cannabis. Many Canadian cannabis companies also have operations and assets in the US. This issue is very likely to be addressed in the near future, as the Canadian cannabis market restructures.

Bankruptcy is also a creature of federal law, and thus allowing cannabis businesses to seek bankruptcy relief would put federal courts and bankruptcy trustees in the precarious position of having to administer assets that although legal within the particular state, remain illicit under federal law. This has created a unique obstacle for cannabis businesses that otherwise operate legally under state law and are experiencing financial distress.