Although title 11 of the United States Code (the “Bankruptcy Code”) does not explicitly prohibit cannabis businesses from filing for bankruptcy, there are many hurdles that continue to preclude cannabis industry participants from obtaining bankruptcy relief. Chapter 11 of the Bankruptcy Code provides a debtor with an opportunity to reorganize its financial affairs in order to continue to operate while providing the fair and equitable distribution among creditors. When the continuation of the debtor’s business is not viable, chapter 7 of the Bankruptcy Code provides a court-supervised procedure for liquidating the debtor’s assets to pay creditors. Under both forms of relief, bankruptcy courts have routinely held cannabis-related debtors may not obtain relief under the Bankruptcy Code pursuant to provisions governing bankruptcy procedures, despite debtors’ compliance with state law.
Principally, cannabis is classified as a Schedule I controlled substance by the Federal Controlled Substances Act (the “CSA”). “The CSA criminalizes virtually every aspect of selling, manufacturing, distributing and profiting from the use of controlled substances.” The CSA even criminalizes cannabis-adjacent activity including the sale of equipment used in the manufacturing of cannabis and leasing premises to be used in the manufacturing or distribution of cannabis.
Consequently, a violation of the CSA has served as the basis for denying cannabis-related debtors bankruptcy relief. In Chapter 11 cases, a debtor’s first challenge is that such a violation may serve as “cause” for dismissal or conversion under section 1112(b) of the Bankruptcy Code. If the debtor’s case is not dismissed for cause at this stage, a court may later choose not to confirm the debtor’s Chapter 11 plan of reorganization because the plan fails to meet the requirements of section 1129(a)(3). Moreover, in the Chapter 7 context, a court may dismiss a debtor’s case because a trustee could not legally administer the liquidation of the debtor’s assets. Accordingly, bankruptcy courts are largely unavailable to such debtors today. However, under the right circumstances in the Ninth Circuit, cannabis-adjacent debtors may be able to proceed with bankruptcy relief.