The Sativa Spectrum: US bankruptcy courts display increased willingness to entertain cannabis related bankruptcy filings

The US Bankruptcy Code provides significant advantages to businesses looking to restructure their financial affairs, liquidate assets, and administer claims. But, despite that medical and recreation use of marijuana is legal in certain US states, cannabis remains illegal on the federal level. As a result, US federal and bankruptcy courts have struggled to reconcile this federal prohibition of marijuana with businesses and business activities made legal in a number of US states.

Foundations and a categorical bar

Until recently (discussed below), US bankruptcy courts had consistently—even reflexively—dismissed cases filed by cannabis related entities based upon violations of a US federal statute, the Controlled Substances Act ("CSA").¹ Essentially, those courts found that the bankruptcy process, the bankruptcy court, and the court's agents could not approve a plan of reorganization or administer assets in a manner that would be illegal under the CSA or other federal statute. This perceived categorical bar has prevented US cannabis related entities, and international cannabis related entities with US assets, from using the US bankruptcy process to reorganize their business, restructure debts, or sell assets.

The developing spectrum

Recently, some US bankruptcy courts have pushed back against the perceived per se ban of cannabis related entities. These courts, instead, have looked critically into the bankruptcy debtor's assets and business to discern to what degree that particular enterprise touched and concerned cannabis. According to those courts, where a debtor's business is adequately removed from ongoing violations of the CSA (e.g., the manufacture and distribution of cannabis products) dismissal is not required.

Rather, due to the varying nature and extent of a debtor's potential involvement in the marijuana business, and the wide latitude of discretion granted to bankruptcy courts, a bankruptcy court must make explicit findings to justify dismissal in cases involving marijuana. Instead of a "bright line" rule, bankruptcy courts should look to the totality of the circumstances to determine (1) whether the debtor's connections amount to a violation of the CSA or other federal statute, and (2) even if there exists a violation of the CSA, whether that violation justifies cause to dismiss the bankruptcy case. In particular, these courts have looked to discern the degree of connection to cannabis—"ongoing postpetition violations [of the CSA] are far more problematic."²

Taking advantage of the Sativa Spectrum

Bankruptcy courts' rejection of the a per se test in favor of a spectrum based upon the facts and circumstances may allow certain cannabis related entities to restructure under the auspices of the US Bankruptcy Code. This shift may alter the restructuring landscape for both US and international cannabis related entities. Specifically, US cannabis related entities may look to take advantage of the tools provided by the US Bankruptcy Code. Further, this shift may open the door for Chapter 15 recognition of foreign proceedings related to foreign cannabis related entities.

These recent developments will be discussed and explored in greater detail in the upcoming International Restructuring Newswire.