Business Reorganization

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]

It’s OK to Be Selfish: In re Monticello and Courts’ Continuing Deference to Creditors’ Interests

By: Corey Trail

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In In re Monticello Real Estate Investments, LLC, a bankruptcy court held that a creditor did not act in bad faith when it purchased unsecured debt from another creditor in order to have the votes necessary to veto a debtor’s reorganization plan. In Monticello, the debtor was a realty investor that took out a $1.185 million loan to finance the purchase of an office center. After the debtor failed to satisfy the loan by its five year maturity date, the bank and the debtor entered into two loan modifications that extended the maturity date of the loan. The debtor soon failed to adhere to the loan modifications and the bank began foreclosure proceedings. In response, the debtor filed a chapter 11 bankruptcy petition and requested authority to use cash collateral. The court granted the debtor’s request and instructed the parties to submit an agreed upon order authorizing the use of cash collateral that set forth a tentative agreement to restructure the bank’s debt. As part of the agreement, the bank required the debtor to sign two promissory notes that it claimed contained “standard loan documents.” However, the debtor rejected the standard loan forms and responded with a modified loan agreement, which the bank rejected. The debtor filed the new agreement (“the Plan”) without the required new loan documents. The court issued a second cash collateral order, which was again dependent on the execution of new loan documents. Subsequently, the court scheduled a hearing to confirm the Plan. Both the bank and a credit card company filed claims against the debtor. In order to ensure that the debtor’s Plan was not able to acquire the requisite amount of votes, the bank purchased the claim from the credit card company to obtain enough votes to block the Plan’s confirmation. The bank explained that had the Plan been confirmed, the FDIC would negatively rate the debt. The debtor moved to have the bank’s ballots designated pursuant to 11 U.S.C. section 1126(e), stating that the bank’s desire to dictate the terms of the new loan documents, the cessation of negotiation on the new terms before the expiration deadline, and the purchasing of other claims exhibited a lack of good faith required by the statute. The court however, disagreed, finding that because the execution of a new loan agreement on the bank’s terms was crucial to protecting the bank’s interests, the purchase of other claims to ensure that the Plan would not receive the necessary votes was not in bad faith.

When a Priority is Not a Priority

By: Lindsay Lersner


St. John’s Law Student


American Bankruptcy Institute Law Review Staff


The culmination of a chapter 11 case is typically a plan that provides for payment to creditors in accordance with the priority scheme in Section 507 of the United States Bankruptcy Code (“Code”).[1] In In re Jevic Holding Corp. , the Third Circuit held that in certain rare circumstances, bankruptcy courts have the discretion to approve structured dismissals, which do not comply with Section 507 of the Code.[2] A structured dismissal is a settlement proposed to the court that provides for the distribution of the debtor’s assets to creditors.[3] In In re Jevic , the debtor proposed a structured dismissal after reaching a consensus with a majority of its creditors.[4] The Jevic truck drivers (“Drivers”), former employees of Jevic with a Worker Adjustment and Retraining Notification (“WARN”) claim,[5] however, did not agree to the settlement.[6] In opposing bankruptcy court approval of the settlement and the structured dismissal, the Drivers argued that (1) the Code does not allow for structured dismissals and (2) the settlement paid the creditors with claims junior to the Drivers’ WARN claims and therefore violated the priority scheme established under Section 507.[7] Bankruptcy settlements generally follow the absolute priority rule, which requires that creditors be paid in the order of their priority under Section 507.[8] The bankruptcy court overruled the Drivers’ objection and approved the settlement providing for the dismissal of the debtor’s chapter 11 case upon payment of certain administrative and tax expenses which were lower in priority than the Drivers’ claims.[9] On appeal, the district court affirmed the bankruptcy court’s decision.[10] The Drivers appealed again, and the Court of Appeals for the Third Circuit also affirmed.[11]

In re 56 Walker LLC—The Resurrection of the Gifting Doctrine?

By: Brianna Walsh

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in In re 56 Walker LLC, a bankruptcy court overruled a debtor’s objection a secured creditor’s proposed order providing for the distribution of the proceeds from the sale of real property that was the debtor’s sole asset pursuant to the debtor’s confirmed plan of reorganization even though the secured creditor “gifted” a portion of its recovery to a junior class because, among other reasons, the court found that the distribution scheme would not violate the absolute priority rule. In 56 Walker, the debtor pledged a six-story mixed-use building, its sole asset, as security for an $8 million mortgage loan. After the debtor defaulted one year later, the bank that had acquired the mortgage loan from an FDIC receivership commenced a foreclosure action in New York state court. Subsequently, the debtor filed for bankruptcy under chapter 11 of the Bankruptcy Code in order to stay the foreclosure proceeding. This first case was ultimately dismissed. Following dismissal of the debtor’ first chapter 11 case, the bank resumed the foreclosure action in state court and moved for summary judgment. The debtor then crossed-moved for summary judgment, arguing that the bank had not provided adequate proof that it was the assignee of the mortgage or the note and that the bank was liable for certain lender-liability claims. The state court granted the bank’s motion for summary judgment of foreclosure and denied the debtor’s cross-motion. The debtor timely filed a notice of appeal. Prior to the state court entering the bank’s proposed judgment of foreclosure, the debtor filed a second chapter 11 case. Ultimately, the debtor confirmed a consensual plan of reorganization and sold the property for $18 million. After selling the property, the debtor objected to, among others, the bank’s claim. In its decision, the court overruled the debtor’s objection and directed the bank to settle an order to provide for the distribution of the sales proceeds. The bank then filed a proposed order, providing that (i) the bank would have a distribution in the amount of $15.1 million, (ii) another mortgage lender would have a distribution in the amount of $150,000, (iii) a mechanic’s lien holder would have a distribution in the amount of $400,000, (iv) another mechanic’s lien holder would have a distribution of $350,000, (v) the debtor’s counsel would have an administrative claim for fees and expenses capped at $250,000, and (vi) the remaining funds would be distributed to the debtor’s unsecured creditors. Equity would not receive a distribution under the proposed order. The debtor objected to the proposed order, arguing, among other things, that the proposed distribution to a mechanic’s lien holder was premature because the debtor’s previous objection to the mechanic’s lien holder’s claim was still pending. The court, however, overruled the debtor’s objection to the proposed order, noting that the only reason the mechanic’s lien holder would receive anything was the bank’s willingness to forgo part of its claim and “gift” it to the junior secured creditors.

Chapter 11 Non-Debtor Release Provisions: The High Burden Officers and Directors Must Meet

By: Ashraf Mokbel

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

Recently, in National Heritage Foundation Inc. v. Highbourne Foundation, the Fourth Circuit held that a non-debtor release provision in a chapter 11 reorganization plan was not warranted by the circumstances of the case because the court found that the bankruptcy case would not be adversely affected if the provision was not included in the plan.

Breach of the Covenant of Good Faith Leads to Equitably Subordinated Debt and the Possibility of Losing Millions

By: Lauren Casparie

St. John’s Law Student

American Bankruptcy Institute Law Review Staff


In In re LightSquared, Inc.,[i] a bankruptcy court recently equitably subordinated the claim of an entity that the founder, chairman of the board, and controlling shareholder of a competitor of the debtor created in order to circumvent a credit agreement’s restrictions on transferring the debt to certain parties. In particular, the LightSquared court determined that the entity breached the implied covenant of good faith by effectively acquiring the debt on behalf of the competitor’s controlling shareholder.[ii] In LightSquared, the debtor entered into a credit agreement that restricted transferring the debt to certain disqualified companies and all natural persons.[iii] When a competitor company inquired about purchasing the debt, it discovered that the agreement’s schedules listed competitor as a disqualified company.[iv] Since the competitor could not purchase the debt directly, its controlling shareholder formed an investment vehicle for the exclusive purpose of buying the debt, thereby circumventing the credit agreement’s restrictions on transferring the debt, in order to give the competitor effective control over the debtor’s reorganization.[v] The investment vehicle was under capitalized, resulting in the creditor funding multiple purchases by transferring money from his personal account.[vi] Eventually, the investment entity purchased enough debt to give it a blocking position and the power to enforce certain rights during the debtor’s subsequent bankruptcy.[vii] After this purchase, rumors started to circulate that the controlling shareholder of the competitor was behind the purchasing.[viii] After hearing of these rumors, the debtor’s management strongly suspected that the controlling shareholder was behind the investment vehicle’s acquisition of the debt but never inquired into this suspicion.[ix] A month after obtaining a blocking position, the controlling shareholder made presentations to the competitor’s board of directors, informed them that he was behind the purchases of the debt, and proposed that the competitor submit a bid seeking to acquire the debtor’s assets.[x] Later, without informing the board of directors, the controlling shareholder submitted a bid on the competitor’s behalf for the debtor’s assets.[xi] This bid would have resulted in the investment entity being paid in full on the debt with an additional $140 million profit.[xii] Subsequently, the debtor filed for bankruptcy under chapter 11 of the Bankruptcy Code.[xiii]

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