Alternatives to Bankruptcy for Cannabis Companies: Part 1

Alternatives to Bankruptcy for Cannabis Companies: Part 1

The problems facing the cannabis industry due to its status as an illegal federal corporation are numerous and well documented: 280E tax burden, restricted access to banks, exclusion from capital markets, federal intellectual Such as unequal access to property rights protection and inaccessibility to legal regulations. interstate trade flows. The recent woes facing cannabis companies operating in mature markets reveal another key legal hurdle for cannabis companies, their investors and creditors: the inability to access federal bankruptcy protection. However, a number of contractual and state statutory remedies may be available to cannabis companies to deal with bankruptcy and other financial crises.

background

US bankruptcy law is unique globally. No other country has such accessible and lenient bankruptcy procedures for both the general public and businesses. Debtors can make a fresh start by liquidating assets or restructuring debt. Critics say such favorable bankruptcy laws promote entrepreneurship and are at least partially responsible for American innovation. In fact, Congress’ power to enact bankruptcy laws is enshrined in the United States Constitution. Bankruptcy was originally the jurisdiction of various states, as was most law in the United States at the time. It was not until the late 18th century that Congress recognized the importance of uniform protection for debtors and passed the first Federal Bankruptcy Act in 1800. Since then, bankruptcy has been exclusively a federal jurisdiction, and current bankruptcy law is governed by US bankruptcy law.

Yuefang Wang, Attorney Hush Blackwell

But this exclusivity creates problems for state-regulated cannabis businesses. That’s because cannabis is federally illegal from the perspective of the U.S. Trustee Program, the division of the U.S. Department of Justice that oversees the administration of bankruptcy proceedings.Restructuring the Cannabis Business Equivalent to ‘Supervision'[ing] It is an ongoing criminal enterprise, regardless of state law status. Therefore, there is no such thing as state bankruptcy, and even a cannabis company that operates in full compliance with state law is not entitled to bankruptcy protection.1

All financial transactions, whether debt or equity, occur in the shadow of bankruptcy. The basic distinction between debt and equity is based on the assumption that holders of the former are treated more favorably than those of the latter (in the case of liabilities, secured liabilities are treated more favorably than unsecured liabilities). is broken). This is especially true in bankruptcy cases. Even beyond the priority of distribution, the bankruptcy law provisions of automatic suspension, circumvention and discharge fundamentally shape the debtor-creditor relationship. A bankruptcy judge has the power to impose bankruptcy law on a debtor-creditor relationship. previous contractual relationships. Just as the possibility of litigation is the sword of Damocles that hangs over any legal dispute, the prospect of filing for bankruptcy affects negotiations between debtors and creditors from the outset. So when financial troubles arise and a cannabis company has to begin the daunting task of approaching lenders for relief, it’s effective for creditors to sit at a table available to other companies in similar situations. In the absence of good incentives, such efforts will be made.

alternative to bankruptcy

Just as disputing parties often prefer the contractual certainty of a settlement agreement to the whim of a jury, debtors and creditors may choose extrajudicial solutions to bankruptcy. The declining trend in bankruptcies over the past few decades may be partly the result of these out-of-court arrangements, with debtors and creditors seeking alternatives to voluntary or involuntary bankruptcy filings. , increasingly resistant to out-of-court arrangements. While the effectiveness of these solutions will be evaluated with eventual bankruptcy in mind for the non-cannabis industry, they may also be favorable for creditors of defaulting cannabis companies. there is.

Contractual Remedies: Lender Workouts, Exchange Offers and Arrangements

Since the debtor-creditor relationship is essentially contractual, both parties may choose to modify the relationship in mutually agreeable ways. A lender workout is when a financially distressed company is forced to pay its creditors (or often It is an agreement to reconcile debts with multiple creditors). These contractual adjustments may be tailored to specific circumstances and may include deferment of interest or principal payments, extension of maturity dates, contractual remedies (e.g. adjustments to the lender’s asset-to-liability ratio, or other financial covenant adjustments). default event triggers) and/or debt and equity swaps. This last option (including related concepts such as the granting of options and warrants) is particularly prevalent in the cannabis industry, as cannabis companies often do not have traditional bank debt (although at the same time, such Solutions may become increasingly unattractive to creditors given lower valuations and the prevalence of equity as consideration in cannabis merger and acquisition deals.

Brent Salmons, Attorney Hush Blackwell

Similarly, a stock swap proposal would rebuild a struggling company’s capital stack. Companies facing default usually offer new bond or equity securities to stockholders in exchange for outstanding debt securities. New bonds come with more favorable terms, including covenants, default events and maturities. The Exchange Offer has the same goal as the Lender Workout in that it seeks to eliminate classes of securities with imminent maturity dates, defaults or covenant violations.

A structuring agreement is a contractual arrangement between a debtor and its creditors that allows the creditors to restructure their business to meet reduced outflows in future cash inflows. It is an agreement to accept a bond, in exchange for complete bankruptcy of the debtor. Debtors (in which case no one is repaid, or perhaps only the top safe lenders are repaid). These contracts often provide for oversight by a committee of creditors and often require creditors to refrain from exercising their pre-existing rights until a defined triggering event occurs. Includes contractual commitments by

Legal Remedies: UCC Article 9 Sale and ABC

The above contractual remedy is analogous to a Chapter 11 bankruptcy proceeding, in which a company in dire (but ultimately salvageable) distress continues to operate while restructuring its debt. State statutory remedies, if any, are similar to Chapter 7 bankruptcy proceedings. Business is a sinking ship and assets must be liquidated to maximize payments to creditors (in a bankruptcy situation, following the absolute priority rule). Such liquidations are regulated by rules under state law available to cannabis companies.

If the creditor has a security interest in the debtor’s collateral, the most common option is usually a sale under Section 9 of the Uniform Commercial Code (UCC). The UCC is a standardized set of laws and regulations for doing business, including lending. The UCC itself is not law. Rather, it is a codex adopted by most states and usually incorporated into law with some modifications. Section 9 of the UCC deals with collateral transactions and specifically provides for the sale and disposal of collateral subject to a security interest in the event of default by the debtor. Like a ยง363 sale under the Bankruptcy Code, a UCC Section 9 sale provides for a “friendly foreclosure” where the defaulting debtor and its lender work together to facilitate the sale of collateral.

Article 9 imposes certain conditions on such disposal, such as that the sale of the foreclosure be “commercially reasonable”. The UCC stipulates that this means that the collateral is sold in a recognized market in a reasonable and customary manner at market prices then prevailing. If a sale is approved in judicial proceedings by a bona fide creditors’ committee, a creditor’s representative, or a transferee for the benefit of creditors, this creates a presumption of commercial reasonableness under the UCC.

A less common option is assignment for the benefit of the creditor (ABC). Laws governing such quotas vary from state to state and are generally rare, with California being a notable exception where both ABCs are more common and cannabis is legal. ABC is initiated by a debtor, who enters into a contract to transfer its assets to a third party transferee. The third party assignee holds the assets in trust for the creditor’s benefit and is responsible for its liquidation. This is in principle the same as for debtors. bankruptcy trustee.

However, ABC is generally not a good fit for cannabis companies. Third party transferees cannot own a licensed cannabis business or certain assets such as cannabis plants, distillates or other products unless they have obtained a license from the relevant company. state regulators. A similar issue arises with Section 9 sales, requiring the collateral purchaser to obtain a license to own and operate cannabis products, and more importantly, giving the cannabis company operating powers, which is very important. A state-issued license is required. As such; the pool of potential purchasers is therefore limited to those who already have a license or wish to acquire one. Troublesome procedure to obtain a licenseTherefore, the market for such assets shrinks and their value decreases. These issues are addressed in some states by the transferee/seller entering into administrative service agreements with the transferee/buyer, based on the transferee/purchaser effectively managing the operations of the cannabis business. may be resolved. However, care should be taken that these agreements are not deemed to constitute ownership of the business by the assignee/purchaser (until actual transfer of license has taken place) as defined by applicable state law. must be created.


  1. Quite true for “plant-contact” businesses, a recent lawsuit in the United States Court of Appeals for the Ninth Circuit contains cannabis employees and intellectual property operating in contact with the plant. It gives some (fact-wise) hope to cannabis-adjacent businesses, such as corporations. (This structure itself is primarily a solution to address federal misconduct).
Steve
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With two decades of dedicated experience, Nuggs is a seasoned cannabis writer and grower. His journey has been a harmonious blend of nurturing cannabis from seed to harvest and crafting insightful content. A true expert, they've honed strain-specific knowledge, cultivation techniques, and industry insights. His passion shines through enlightening articles and thriving gardens, making them a respected figure in both the growing and writing facets of the cannabis world.

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