Does Receivership Work for Cannabis Business Investors?

November 16, 2020 Cannabis Business

While filing for bankruptcy as a cannabusiness operator isn’t an option, receivership could work. This involves having an appointed trustee restructure your company and is especially helpful for business owners interested in exiting the cannabis sector and recouping some of the resources invested in the business.

But why is a receiver appointed? And what is the role of a receiver?

While we can use receivership for limited purposes, it also works as an alternative to foreclosure. Let’s talk about how receivers and receivership and how they can work for cannabis business investors.

Many cannabis business operators have found themselves in dire situations following the market downturn. We’re observing some bankruptcies move to Canada because it’s federally legal there. But some operators are finding it increasingly challenging to cope with the downturn as customers are stuck at home, and partners cannot operate the business properly.

Since Federal regulations prohibit cannabis, filing for bankruptcy protection isn’t an option for those operating in cannabis. This being the case, struggling cannabis business operators have an option called receivership.

Receivership is a financial process that allows a trustee to step in and restructure the company to bypass bankruptcy. Through this process, a court-appointed person can either try to improve the business or assist in liquidating assets and paying off obligations that could include debt owed to those who’ve invested.

If you’re a cannabis investor who has taken on a debt note rather than an equity stake in the company, receivership is usually an effective option. If you opted for an equity arrangement, the company has no obligation to pay you back. With this in mind, you might have to exit the receivership arrangement of the cannabusiness with nothing.

On the other hand, if you’re in a debt-relationship, you could use receivership to recover some of your financial resources from the cannabusiness. This could also work if you entered into a joint venture deal with a cannabusiness and the company owes you money from the arrangement. If this is the case, this is viewed as a debt that must be repaid.

If you have a debt note or a loan out to a cannabusiness, you can request that the court force the business into receivership. If this happens, the business will be taken over by a court-appointed receiver, and the current operator will no longer have a say.

You don’t need to be a third party investor to enter into receivership. While you can be a third party investor, you might be a founder who has funded the business on the books. This initial capital contribution could have been journaled as a loan to the canna-company. You might have equity in the business too. But if you made a loan to the company, that’s a debt that it owes you. This, of course, is contingent on the details of the agreement.

If you decide to trigger receivership for a cannabusiness you’ve invested in, here’s what you can expect:

Role of Receivership for Cannabis Business Investors

Who can appoint a receiver? The court.

Court-appointed receiver duties include managing the cannabusiness’s properties and assets. This is comparable to the role of a bankruptcy trustee.

The receiver acts as new management, managing, selling, or maintaining assets with the primary goal of attempting to pay creditors and stabilize the company to the point of recovery. 

Even though the receiver gets to decide what they should handle first, their responsibilities and duties are put in place by the court. The judge sets the receiver’s powers, and if the receiver cannot recover the business, the court could order asset liquidation and assign a liquidator.

But what’s the difference between a receiver and a liquidator?

The Court Grants Power to the Receiver

Unlike liquidators, the power a receiver gains over a canna-company depends on the circumstances and the court’s orders. These duties go more in-depth to resolve problems within a company.

You can use a receivership for a limited purpose. For example, you could implement a receivership to preserve a property pending a foreclosure sale or lawsuit judgment. It can also be used as an alternative to foreclosure, putting someone in charge of managing assets rather than claiming them as collateral.

In some cases, a receivership can be a possible alternative to bankruptcy. This is when a stakeholder wants to liquidate a property and requests the court assign a receiver to handle the liquidation responsibly.

What are the Benefits of Receivership?

A receivership could be the right move for your cannabusiness. But ultimately, it depends on your situation. Here’s how you can benefit from a receivership.

Receivership can preserve assets and even stop fraud. This is beneficial in instances when you’re worried about embezzlement damaging your business.

In some cases, a loan could be backed by assets, such as a building or pricey equipment. These assets can become damaged, stolen, or misused. With this in mind, a court could appoint a receiver accountability over that asset. This can prevent mismanagement or intentional misconduct.

Sometimes, employees or stakeholders within your business might be purposefully committing fraud, damaging your business, or diverting cash. In these instances, a receiver can be a useful ally. If you’re nervous that a company or individual might damage or waste company property or assets, it’s ideal to appoint a receiver to ensure this doesn’t happen.

Receiver relationships can also insulate a secured creditor from lender liability. Lender liability ensures that lenders don’t mistreat their borrowers. If they don’t, the lender could be held liable for any resulting damage to the borrower. A receiver helps you bypass this issue by controlling how the borrower (the cannabis business) is treated and directed.

Receiverships also benefit creditors. A receiver has the ability to freeze and stop all other creditor actions and ensures your claim is honored before others. This is especially helpful when other creditors have a personal relationship with the cannabis business operator or attempt to take advantage of the business in another manner.

With a receiver, you also may have the option to purchase the business using your initial investment. While the receiver comes in to set the company up to recover, the recovery plan might not work out. Then, the receiver needs to liquidate.

As the receiver begins selling off the assets, the creditor’s initial investment (your initial investment) can act as an opening bid to purchase the whole business. If you think you can effectively run the company profitably, this could be a good option for you.

The Receivership Process

The receivership process looks different for each company. However, the process has four main phases:

  1. Receiver tries to stabilize the business. At this stage, the receiver is trying to get the company to a state of profitability. This can involve negotiating with creditors and lowering expenses.
  2. Receiver determines why receivership was essential. The receiver attempts to gain an understanding of the problems that caused the need for intervention. They then must either initiate litigation or convince insurers to abide by the original policy terms and conditions.
  3. If they find litigation is essential, the receiver files a lawsuit if they believe investors will benefit from it. The lawsuit is only filed if the claim will benefit all investors in the entity in receivership. If the claim only helps some investors, it won’t be filed. Thus, if your case isn’t aligned with the mission of the receivership, it could be best to pursue an individual claim.
  4. The receivership concludes with distribution. Assets are distributed to investors at the end of the receivership. This phase can take months or even years, depending on who can claim certain parts of the business. In some cases, investors receive less than 5% of their losses. However, others can recover nearly 100% of their investment losses.

Considering entering into receivership? Feel free to contact us at any time for assistance.