Can a cannabis business file for bankruptcy? Unfortunately, even after paying millions of dollars in tax revenue to the states and having impeccable bookkeeping practices, these legitimate businesses still don’t have support from the federal government.
The government’s response to the COVID-19 pandemic has offered assistance to companies across a plethora of industries and individual taxpayers. However, the state-legalized cannabis industry has been excluded.
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Even though the cannabis industry is quite lucrative, some businesses have failed for one reason or another. But unlike companies operating in other sectors, when cannabis businesses aren’t successful, they don’t have the option to file for bankruptcy.
Why Do People File for Bankruptcy?
If this is your first time being in this situation, you might be wondering, “Why do people file for bankruptcy?” Understanding bankruptcy is easier when you know the definition.
According to Investopedia, business bankruptcy is a legal proceeding for a person or business that cannot pay back their outstanding debts. The process starts with a petition the debtor–usually, the business owner–files with the federal government.
In essence, the business owner requests aid from the federal court to eliminate and repay their debt. Business bankruptcy also involves protection and guidance from a bankruptcy court.
Most businesses can file for bankruptcy under three types. But this depends on the business’s structure. The following are the standard options for business bankruptcy:
- Chapter 7: Business Bankruptcy or Liquidation – This is when the business’s debts are excessive to the point that it’s not economically possible to restructure them. Most of the time, the business is dissolved.
- Chapter 11: Business Reorganization – This is when the company is restructured and winds down its operations under a court-appointed trustee. After creating a plan to outline how the business will recover, it’s filed to the creditors and put to a vote as to whether or not the plan is acceptable.
- Chapter 13: Personal Bankruptcy – Sole proprietors can file for Chapter 13. This involves filing a repayment plan with the bankruptcy court.
Most legal experts in the cannabis sector agree that cannabis business operators are ineligible to file for these bankruptcies. So far, courts have mostly ruled that debtors working in cannabis or extracting significant income from cannabis-related activities (both directly or indirectly) aren’t permitted to use bankruptcy.
However, this could change in the future as the cannabis sector continues to progress.
Cannabis and Bankruptcy: Current Options for Cannabis Companies
Typically, if a business fails, it can file for bankruptcy protection. This is when a company can eliminate debt and facilitate restructuring with minimal financial pressure.
Unfortunately, cannabis and bankruptcy don’t go hand-in-hand; there’s no cannabis business bankruptcy protection available. While one might expect some bankruptcy protection for cannabis companies, as long as cannabis is a controlled substance, canna-companies will not receive bankruptcy protection from the state.
Even with the states collecting tax revenue from cannabis businesses, federal law still governs cannabis and bankruptcy in the U.S. With this being the case, the U.S. Bankruptcy Trustee cannot administer or control assets deemed illegal without violating the law. Thus, bankruptcy protection for cannabis businesses is not available.
The lack of protection is disadvantageous for investors in the cannabis sector. However, the following options are available:
Assignments for Benefit of Creditors
Like Chapter 7 bankruptcy, some canna-business operators find they can use an assignment for benefit of creditors. This is commonly referred to as an “ABC.”
An ABC lets a business assign its assets to a third party. This third party can then decrease the company’s affairs without stopping its operators all at once.
Since ABCs are part of state law, in some instances, they can be a viable option for a business operating under state law. This can even be the case if the company is violating federal law in a way that makes it ineligible for bankruptcy protection.
Love this post? Check out our other article on cannabis business ROI before you leave!
In some cases, appointing a receiver over the canna-company is an option. If a creditor decides to litigate, one remedy for cannabis business operators is to request the court appoint a receiver to run the company.
Even though this takes control of the company out of the hands of current management and puts it into a receiver’s hands, this could be beneficial in some scenarios. This could allow the company to negotiate to ensure favorable provisions in the receivership order.
Favorable provisions could include allowing the receiver to sell off the company’s assets or the entire company. In turn, the company can realize proceeds beyond the debt it owes.
One of the best alternatives to filing bankruptcy in cannabis is to engage in workout negotiations with the company’s creditors. This should occur before litigation or ABC. Since workouts are conducted outside of the court system, they depend on all parties coming to a mutually acceptable solution.
The workout process usually involves simple negotiations. It can also include mediation for multi-party disputes.
Can a Cannabis Business File for Bankruptcy? Fortunately, We Still Have Options!
So can a cannabis company file for bankruptcy? While most cannabis businesses cannot file for bankruptcy, we have options available.
Though it’s unfair to the cannabis industry, we can expect bankruptcy filing to become a safety net available for all businesses as it progresses. This, of course, includes the businesses that sell cannabis.
We’re still seeing progress happening each day throughout the industry. For instance, in the Garvin v. Cook case, the court highlighted that the Bankruptcy Code doesn’t mandate that courts manage the provisions of a bankruptcy plan.
As long as the overall bankruptcy plan isn’t violating federal law, it’s a valid plan that can continue onward. The court’s duty is to determine whether the plan has been proposed in an unlawful way. But that’s the gist of it.
However, we’ve seen other cases that only complicate things. For example, the Way to Grow, Inc. case involved a creditor moving to dismiss the company’s bankruptcy claim. The credit claimed that Way to Grow was violating the Federal Controlled Substances Act (CSA), despite the company not directly growing or distributing cannabis.
Since the business model depends on the income from cannabis sales, Way to Grow could not restructure its business profitably without selling to cannabis businesses. This resulted in the bankruptcy court ruling against Way to Grow. However, the ruling is under appeal.
Interested in learning what options are available for your cannabis business? Contact us today for expert assistance.