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Smoke & Mirrors: Bankruptcy Relief Remains Elusive for Marijuana Businesses and Their Creditors

By: Todd Kingston Plummer

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

            In In re Medpoint Management, the United States Bankruptcy Court for the District of Arizona held that cause existed under Section 707(a) of the United States Bankruptcy Code (“Bankruptcy Code”) to dismiss an involuntary chapter 7 petition filed against a bankrupt medical marijuana distributor.[1]  Although Arizona permits its Department of Health Services to register dispensaries “operated on a not-for-profit basis” for the legal sale of marijuana,[2] the drug remains a Schedule I substance under the federal government’s Controlled Substances Act (“CSA”).[3]  Because Arizona law requires dispensaries to maintain a nonprofit nature, there has been a “proliferation of dispensary-management entities which serve as repositories of dispensary revenues.”[4]  When Medpoint Management LLC, a marijuana dispensary, defaulted on several loans and obligations, a group of creditors filed an involuntary chapter 7 petition against Medpoint.[5]  The petitioning creditors’ claims against Medpoint included unpaid amounts under two promissory notes, unpaid fees arising under two distinct consulting agreements, and over $500,000 in outstanding loans.[6]  Medpoint moved to dismiss arguing that the “unclean hands doctrine” prevents not only any marijuana-related business but also any of their creditors from seeking relief from the federal bankruptcy courts.[7]  At a hearing on Medpoint’s motion, the United States Trustee voiced staunch concern regarding a trustee’s ability to administer a bankruptcy estate consisting of substances that are illegal under federal law: “So, you’re going to ask a trustee to look at a management contract for illegal activities, essentially. So what is that trustee going to do?”[8]  The court agreed with Medpoint and the United States Trustee and dismissed the involuntary petition.[9]

            Section 707(a) of the Bankruptcy Code provides that a court may dismiss a chapter 7 case for cause, which is determined on a case-by-case basis.[10]  Bankruptcy courts have consistently dismissed chapter 7 petitions involving medical marijuana companies finding that federal courts cannot grant relief where the administration of the bankruptcy estate would violate the CSA.[11]  For example, in Arenas, the court reasoned that the “inevitable illegality” of the trustee’s administration of marijuana-related assets constituted cause to dismiss under Section 707(a).”[12]  In In re Vel Rey Properties Inc., a trustee wanted to operate a debtor’s property in violation of local housing regulations in order to increase its sale value.[13]  The bankruptcy court denied a trustee’s request for insulation from personal liability for noncompliance with the housing regulations noting that it could “simply dismiss the case for cause under § 707” instead of compelling the trustee to violate the housing regulations.[14]  In another marijuana bankruptcy case, a debtor landlord received twenty-five percent of its revenue from a marijuana entity.[15]  The court found that renting to a marijuana business exposed the debtor to criminal liability and therefore constituted cause for dismissal under 707(a).[16]

            Fifty-two percent of Americans support the legalization of marijuana, twenty-four states have legalized its medical use, and four states plus the District of Columbia have made the substance fully legal.[17]  Although marijuana-related business entities may enjoy legal status under state law, as long as the drug remains illegal under the CSA, the far-reaching protections of federal law, such as the availability of bankruptcy relief will remain unavailable to them.

 

 

 

 



[1] See In re Medpoint Management, LLC, 528 B.R. 178, 180 (Bankr. D. Ariz. 2015).

[2] See Arizona Revised Statutes §§ 36—2081—2819.

[3] See 28 U.S.C. § 812(c).

[4] See In re Medpoint Management, LLC, 528 B.R. at 180.

[5] See id. at 182.

[6] Id.

[7] See id. at 182—83.

[8] See id. at 183—84; see also ECRO audio file of Jan. 29, 2014 hearing (DE 46).

[9] See In re Medpoint Management, LLC, 529 B.R. at 183.

[10] Perlin v. Hitachi Capital America Corp., 497 F.3d 364, Bankr L. Rep. (CCH) P 80984 (3d Cir. 2007) (holding that bankruptcy court must consider “all of the facts and circumstances surrounding the debtor’s filing for bankruptcy”); In re Evatt, 497 B.R. 483 (Bankr. D. S.C. 2013) (finding that although debtor had transferred property to his non-debtor spouse to shield it from creditors, dismissal of his case was not warranted for cause under 707(a) based on property being underwater notwithstanding transfer); In re Alvarado, 496 B.R. 200 (N.D. Cal. 2013) (holding that debtor’s failure to comply with credit counseling requirement established cause for dismissal though this is not explicitly stated in 707(a)).

[11] In re Arenas, 514 B.R. 887, 891—92 (Bankr. D. Colo. 2014) (arguing that for trustee to take possession of debtor’s property and marijuana inventory would “directly involve him in the commission of federal crimes”); Northbay Wellness Group v. Beyries, 2012 WL 41220409, AT *4 (N.D. Cal. Sept. 18, 2013) (holding that unclean hands doctrine prevented bankruptcy court from granting relief to plaintiff medical marijuana business seeking voluntary bankruptcy protection because it was engaged in activity illegal under federal law); In re Rent-Rite Super Kegs W. Ltd., 484 B.R. 799, 802—03 (Bankr. D. Colo. 2012) (renting to marijuana entity exposed debtor landlord to criminal liability and constituted “gross mismanagement of the estate” and was cause to dismiss under 11 U.S.C § 1112(b)(4)(B)).

[12] See In re Medpoint Management, LLC, 529 B.R. at 183 (citing In re Arenas, 514 B.R. at 892).

[13] See 174 B.R. 859, 866 (Bankr. D.D.C. 1994).

[14] See id.

[15] See In re Rent-Rite Super Kegs W. Ltd., 484 B.R. at 802—03.

[16] See id.

[17] Colorado, Alaska, Washington and Oregon have made marijuana fully legal. See Christopher Ingraham, These are the states that could legalize pot next, WA. Post (Jul. 19, 2015), http://www.washingtonpost.com/news/wonkblog/wp/2015/07/19/these-are-the-....