Seyfarth: Bankruptcy Court Approves Cannabis Debtor’s Chapter 11 Plan

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On September 20, 2023, the U.S. Bankruptcy Court for the Central District of California (“Court”) confirmed a plan for a cannabis-related business (“Debtor”) to sell its equity interests in a Canadian cannabis company, Lowell Farms, and distribute the proceeds to its creditors.  In contrast with bankruptcy courts that routinely dismiss cannabis-related business filings primarily due to alleged Controlled Substance Act (“CSA”) violations, the court found that any CSA violations occurred before the bankruptcy, and that the “Debtor’s orderly liquidation of its stock in Lowell Farms, and distribution of the proceeds to creditors is entirely consistent with the objectives and purposes of the Code.” (In re The Hacienda Company, LLC, __ B.R. __, 2023 WL 6143216 (Bankr. C.D.Cal., September 20, 2023))  The court’s ruling may open a new path for  cannabis-related businesses to utilize the U.S. Bankruptcy Courts.

Prior to the bankruptcy, the chapter 11 debtor, The Hacienda Company, LLC (“Debtor”), sold its name and assets to Lowell Farms in exchange for shares of Lowell Farms.  Debtor then filed for bankruptcy, proposing to sell the shares or distribute them to its creditors.  The United States Trustee (“UST”), a quasi-judicial entity charged with overseeing the bankruptcy system, moved to dismiss, claiming that Debtor “is effectively conspiring to continue carrying on its California cannabis business indirectly, through its ownership interest” in Lowell Farms, which operates under the Debtor’s former name, or alternatively, was illegally profiting from the cannabis business, each a violation of the CSA. (In re The Hacienda Company, LLC, 647 B.R. 748, 753 (Bankr. C.D. Cal. 2023)) The Court found that the UST had not carried its burden, and that the “Debtor’s passive ownership of stock, with intent to liquidate that stock to pay creditors, will terminate any connection with cannabis”. (Id. at 754.) Moreover, the Court found that there was no “per se” rule requiring dismissal for a violation of the CSA, analogizing CSA violations to other prepetition violations occurring in cases involving fraud, sexual abuse, tax violations, health and wage violations. (Id. at 755.) The Court refused to find cause to dismiss the case, and that Debtor’s intent to liquidate and pay its creditors was consistent with federal law and a benefit to all creditors. (Id. at 756.)

These findings carried over to the Court’s approval of the Debtor’s plan of reorganization as “proposed in good faith and not by any means forbidden by law”:

Debtor’s temporary retention of [Lowell Farm] stock, while divesting itself of that connection to cannabis, does not foster a single sale of any cannabis products, nor does it add a single dollar to any cannabis-related enterprise.  Although Debtor’s payments to creditors may include distribution of “ill gotten gains” (to the extent that proceeds from U.S. operations violate federal law), such distribution to creditors is what criminal law itself provides.

(In re The Hacienda Company, LLC, __ B.R. __, 2023 WL 6143216, at 4 (Bankr. C.D.Cal., September 20, 2023); See also 11 U.S.C. § 1129(a).)

The Court declined to certify the UST’s request for a direct appeal to the Ninth Circuit.

The Court’s reasoning could apply to debtors who have some relationship with cannabis, but whose circumstance brings them to bankruptcy court.  The landlord with a cannabis-related  tenant.  The service provider with cannabis-related clients.  Putting past violations of the CSA on a par with other criminal violations and exercising discretion not to impose a per se rule against cannabis-related businesses puts them on equal footing with similarly situated businesses and opens the door to the a fundamental mission of the U.S. Bankruptcy Code, maximizing return to creditors.

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