15 April 2024

Bankruptcy Appellate Panel Blocks Cannabis Employee's Chapter 13 Relief But Rejects Bright-Line Bar Of Eligibility To Be A Debtor In A Federal Bankruptcy Case

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In a March 2024 decision, the U.S. Bankruptcy Appellate Panel for the First Circuit (the "Panel") followed existing case law prohibiting debtors in businesses related to cannabis...
United States Insolvency/Bankruptcy/Re-Structuring
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In a March 2024 decision, the U.S. Bankruptcy Appellate Panel for the First Circuit (the "Panel") followed existing case law prohibiting debtors in businesses related to cannabis from availing themselves of federal bankruptcy protections. The Panel, however, declined to follow a bright-line rule categorically denying bankruptcy relief to employees of cannabis businesses. This decision opens the door to individual debtors in states where marijuana employment is legal to filing and confirming a chapter 13 case if they can fund the case with assets that were not derived from and were segregated from federally illegal cannabis activity. This decision does not change the state of the law regarding the ineligibility of cannabis businesses to liquidate or reorganize cannabis assets under chapters 7 or 11 of the U.S. Bankruptcy Code.

In 2023 we wrote about a bankruptcy case of first impression. In In re Blumsack, 647 B.R. 584, 587 (Bankr. D. Mass. 2023), the U.S. Bankruptcy Court for the District of Massachusetts (Central Division) denied chapter 13 bankruptcy relief to an individual who worked at a marijuana dispensary and proposed using his wages to fund a plan of reorganization. The worker, a "budtender" at a state-legalized retail cannabis dispensary in Massachusetts, sought to avail himself of the protections of chapter 13 of the Bankruptcy Code by using his wages to repay creditors in installments.

State law in Massachusetts allows retail distribution of marijuana, though it remains a Schedule 1 controlled substance under the Controlled Substance Act of 1970 (the CSA). The CSA imposes criminal liability on anyone who manufactures or distributes the plant; possesses with intent to manufacture or distribute it; or aids and abets those activities. For that reason, the Trustee in Blumsack objected to the confirmation of the debtor's plan and sought to dismiss the case – arguing that the debtor's employment violated federal law. The debtor tried to distinguish his case on the basis that he was a mere employee without any ownership interest in the cannabis business.

The Bankruptcy Court sided with the Trustee. It concluded that the debtor's petition and plan were not filed in good faith (a requirement to confirm a chapter 13 plan) because he had been engaging in – and benefitting from – activities that violated the CSA. To carry out the plan, the Bankruptcy Court determined, would involve the Trustee administering money derived from the debtor's participation in a criminal enterprise, which the court refused to authorize. The Bankruptcy Court dismissed the case, leaving the employee unable to obtain a discharge of claims against him. The employee appealed.

On March 5, 2024, the U.S. Bankruptcy Appellate Panel for the First Circuit affirmed the dismissal but on different grounds. See Blumsack v. Harrington, No. MW 23-003, 2024 Bankr. LEXIS 560 (B.A.P. 1st Cir. Mar. 5, 2024). The Panel agreed with the Bankruptcy Court's conclusion that the debtor's plan of reorganization improperly contemplated using funds derived from his work at the dispensary, in violation of the CSA, which "would have placed the chapter 13 trustee in the untenable position of knowingly administering assets derived from an activity illegal under federal criminal law." Id. at *15.

The key issue, according to the panel, was not whether the debtor had violated the CSA but rather "the degree of connection between that criminal activity and the debtor's reorganization efforts." Id. at *23. Here, the debtor's income that would fund the plan continued to be from working in cannabis businesses and he could not show that segregated, non-cannabis assets would have been used to fund the plan. The debtor's plan was doomed because it would run afoul of case law that prohibits a trustee from possessing and administering assets that constitute proceeds of activity that violates the CSA.

The Panel, however, stopped short of endorsing a blanket prohibition on bankruptcy relief for those involved with cannabis. The Panel acknowledged that whether a debtor has acted in good faith in filing a bankruptcy petition depends on the totality of the circumstances, not any single consideration, such as the legal status of the debtor's employment.

According to the Panel, the good faith requirements "are not referenda on the debtor's conduct generally" and must be considered in the context of the debtor's pursuit of bankruptcy relief. The Panel concluded that the Bankruptcy Court erred by categorically barring from bankruptcy those with conduct that violates the CSA, noting that a "policy choice to close the doors to the bankruptcy court categorically, without regard to individual circumstances, is one more appropriately left to the legislature."

The Panel's decision leaves the possibility of bankruptcy relief open to certain debtors who were engaged in commercial cannabis activities that violate the CSA, ceased from doing so, and, under a totality of the circumstances, can propose a plan in good faith by having segregated non-cannabis related assets (a heavy lift for most) used for distribution to creditors. For corporate entities that continue to operate a dispensary or growth facility, federal bankruptcy relief remains a dead end for reorganizing or liquidating cannabis assets.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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