With few exceptions, a cannabis-related business (CRB) will be denied access to relief under the U.S. Bankruptcy Code (11 U.S.C. § 101, et seq.) (Bankruptcy Code) because marijuana remains a controlled substance under the federal Controlled Substances Act (21 U.S.C. 801, et seq.) (CSA). Even if cannabis is rescheduled from Schedule I to Schedule III, the rationale of the cases denying bankruptcy access still would apply. [See Impacts of Cannabis Rescheduling on Bankruptcy]
The protagonists in those cases generally are not the creditors of the CRBs, who often would support bankruptcy proceedings for those companies. Rather, they are the local offices of the United States Trustee (UST), the “watchdog” of the bankruptcy system. They enforce the policies set by the Executive Office of the United States Trustee Program (EOUST), which is an arm of the U.S. Department of Justice.
Until now, the USTs have opposed bankruptcy relief for CRBs, and also for individuals who work for CRBs. See In re Blumsack, 657 B.R. 505 (1st Cir. BAP 2024). Typically, a UST will attempt to prevent a CRB from obtaining relief under the Bankruptcy Code by filing a motion to dismiss the debtor company’s or debtor individual’s bankruptcy filing. However, a new case may indicate a change in direction from the EOUST, or at least one local UST.
The court in In re Callaway, 2024 WL 3191673 (Bankr. N.D. Calif. June 26, 2024), recently denied a UST motion to dismiss a chapter 7 liquidation case of an individual who owned substantial ownership interests in limited liability companies engaged in marijuana retail businesses. The reasoning of the decision was straight-forward:
Based on the facts of this case and applicable law, the court holds that administering the ownership interests of LLCs that engage in marijuana business is not necessarily equivalent to administering marijuana assets.
*****
In sum, possible sales of interests in LLCs, enforcement of LLCs’ contractual rights and sale of other intangibles related to marijuana, but not directly implicated by the language of the CSA, are not sufficient for this court to find cause to dismiss an otherwise eligible individual debtor’s chapter 7 case.”
Id. at **2 and 7
Ultimately, the court in Callaway analyzed the body of previous case law dealing with the dismissal of CRB bankruptcy cases and concluded that, in the context of a Chapter 7 liquidation, there was no violation of the CSA that would prevent affording bankruptcy relief to this debtor.
Bankruptcy Judge Dennis Montali of the U.S. Bankruptcy Court in San Francisco said that it was curious the EOUST seemed to be out of sync with the approach the Justice Department has taken to state-regulated marijuana manufacture and distribution entities: “In 2024, it seems the only arm of the executive branch with an explicit mission to enforce the CSA against state-regulated marijuana businesses is the UST Program in seeking to dismiss bankruptcies on the basis of a trustee or estate’s potential administration of assets in violation of the CSA.” Id. at *4 (citing Clifford J. White III and John Sheahan, Why Marijuana Assets May Not Be Administered In Bankruptcy, 36 Am. Bankr. Inst. J. 34 (Dec. 2017)).
The holding of the case is not particularly remarkable in the context of the facts and the prior case law. See, e.g., In re Hacienda Co., 647 B.R. 748, 754 (Bankr. C.D. Cal. 2023); In re Burton, 610 B.R. 633 (9th Cir. BAP 2020). “Section 109(b) [of the Bankruptcy Code] does not lock the bankruptcy court’s doors to exclude individuals in the marijuana business.” Callaway, at *4. What is more remarkable is that the UST did not appeal Judge Montali’s decision.
The Callaway case now stands as persuasive authority, at least in the Northern District of California, and possibly beyond, opening the bankruptcy door to similarly-situated debtors. Does the failure to appeal indicate a change of position by the EOUST? Will the USTs now allow other similarly situated debtors to remain in bankruptcy by no longer filing motions to dismiss their cases? For example, if a prospective debtor has assets that include passive interests in a CRB (such as stock in a Canadian publicly traded CRB or an LLC membership interest in a state-chartered CRB, etc.), will the bankruptcy doors (at least the ones for chapter 7) now be open to these individuals?
Time will tell whether the UST’s failure to appeal the Callaway decision is a one-off or marks the beginning of a policy shift by the EOUST towards certain cannabis-related enterprises.
