Can Hemp Companies Declare Bankruptcy?
By Charles S. Alovisetti, Partner; Phil Silverman, Counsel; Jason Adelstone, Law Clerk
Sep 27, 2019
One of the many issues arising out of the tension between state and federal law in the cannabis industry is whether cannabis companies can access the protections of federal bankruptcy law. Almost all bankruptcy courts faced with this question have clearly stated that cannabis companies cannot access the federal bankruptcy system.
Courts uniformly agree that businesses growing or selling cannabis may not take advantage of federal bankruptcy laws, even in the case of liquidation. A bankruptcy court in Colorado dismissed a case noting that, “a federal court cannot be asked to enforce the protections of the Bankruptcy Code in aide of a Debtor whose activities constitute a continuing federal crime.” That court further noted that the debtor was barred from bankruptcy protections by the doctrine of unclean hands.1 Other cases have been dismissed because a trustee or debtor-in-possession cannot take control of a debtor’s property, or liquidate the cannabis company’s inventory, without violating federal law. Some courts have also suggested that dismissal of cases involving marijuana companies might be warranted based upon the theory that such cases involve gross mismanagement of the bankruptcy estate, per se, or based upon theories of abstention due to the Controlled Substance Act (CSA) violations.
It’s not just licensed cannabis companies that are barred from Bankruptcy courts. Judges have also barred landlords (renting to a cannabis company is prohibited by § 856(a) of the CSA and sellers of hydroponic grow equipment (it is a crime to distribute equipment used to manufacture a controlled substance under § 843(a)(7) of the CSA).
With the passage of the 2018 Farm Bill, hemp was removed from the definition of marijuana in the CSA – opening the door for hemp businesses to operate in compliance with Federal law. However, some hemp derived products will still not fully comply with federal law – the FDA has taken a clear position that pursuant to the Federal Food Drugs & Cosmetics Act (FFDCA), CBD cannot be sold as a food ingredient or supplement (explained in more detail here and here). But will bankruptcy courts view violations of the FFDCA the same way they have viewed violations of the CSA? Two recent bankruptcy court rulings appear to suggest that courts focus on the CSA and not the FFDCA, but this issue is not dealt with in enough detail to provide much guidance.
In In the Way to Grow, the Appellants filed a motion of stay pending appeal in which they argued that, with the passage of the 2018 Farm Bill, they could pivot their business to focus on commercial and industrial hemp to avoid violating the CSA.2 The court, however, did not consider this argument persuasive and noted that since the business historically advertised as a cannabis business, there was no way the company could ensure that new customers were buying hydroponic equipment only for legal hemp operations.
On June 3, 2019, the United States Bankruptcy Court for the District of Nevada addressed, albeit in dicta, the question of whether a hemp company could avail itself of the federal bankruptcy court system, stating that a “Debtor’s CBD Business . . . may no longer be prohibited under federal law as a result of the [2018 Farm Bill].”3 The court continued by highlighting the importance of hemp’s removal from the CSA in the 2018 Farm Bill and that the Food and Drug Administration was placed in the position to regulate such products. The court thought it was important that the Debtor’s CBD business might not be in violation of the CSA (assuming the CBD was derived from hemp). But the court did not address the FFDCA at all, and there was no discussion of whether a violation of the FFDCA would bar a company from the federal bankruptcy system.
The examples above do not provide much guidance, so cannabis industry participants should continue to monitor ongoing developments in bankruptcy law and the possibility that CBD companies may still be denied access to federal bankruptcy protections. At the same time, CBD companies should monitor FDA developments, which may resolve the legal issues surrounding CBD and make the bankruptcy issue moot.
1 In re: Way to Grow, Inc., 597 B.R. 111, 117 (Bankr. D. Colo. 2018) (citing In re Rent-rite Super Kegs West Ltd., 484 B.R. 799 (Bankr. D. Colo. 2012).
2 In re: Way to Grow, Inc., 2019 WL 669795 (Bankr. D. Co. 2019).
3 In re: CWNevada LLC, 602 B.R. 717 (Bankr. D. Nev. 2019)