In a recent opinion, the U.S. Bankruptcy Court for the Northern District of California in the matter of In re Callaway, No. 24-30082-DM, 2024 WL 3191673 (Bankr. N.D. Cal. June 26, 2024), created a potential loophole for plant-touching cannabis businesses desiring bankruptcy protection when it denied two separate motions to dismiss an individual's Chapter 7 bankruptcy case. In particular, the court found that the simple administration of certain ownership interests of retail cannabis dispensaries "is not in and of itself necessarily equivalent to administering marijuana assets." And, as such, a Chapter 7 trustee could administer and monetize these ownership interests without violating the law.
Background
In this case, Christopher Michael Callaway (the debtor) owned and operated several retail cannabis dispensaries in San Francisco. One of the dispensaries never opened due to litigation with the M. Dattani Credit Trust (the Dattani Trust), which litigation ultimately led to the debtor filing for bankruptcy relief under Chapter 7 of the Bankruptcy Code.
In addition to the cannabis dispensaries, the debtor also had other noncannabis businesses along with certain intangible property such as domain names. The debtor did not list any tangible assets related to cannabis in his Schedules A/B (the debtor's property) because all of the cannabis assets were owned by the debtor's LLCs "and as such, were not property of the bankruptcy estate." Additionally, the debtor scheduled claims for accrued but unpaid distributions as a minority owner of one of the cannabis dispensaries, which he claimed was valued at several hundred thousand dollars. In his Schedule I (the debtor's income), the debtor reported post-petition monthly income from a cannabis business.
Analysis
Following the commencement of the debtor's bankruptcy case, both the U.S. Trustee (the UST) and the Dattani Trust moved to dismiss the debtor's case under Section 707(a) of the code. Section 707(a) provides that a bankruptcy court may dismiss a case "for cause." In this case, the movants asserted that "cause" existed to dismiss the debtor's case as the trustee, to the extent he administered the cannabis-related assets of the debtor's estate, would run afoul of the Controlled Substances Act (the CSA). However, the court distinguished the debtor's membership interests in the cannabis-related LLCs from the actual businesses operated by those LLCs.
In reaching its decision, the court examined the provisions of the CSA relating to the manufacturing and distribution of marijuana and noted that the CSA explicitly precludes: the use of the internet to engage in cannabis business; conspiring to commit cannabis business; deriving income from a management role in a cannabis business; investing cannabis proceeds in an open-market or any other enterprise that may affect interstate or foreign commerce; deriving profits or proceeds from a cannabis business; and leasing or maintaining space that is used for cannabis. See 21 U.S.C. Sections 841(h), 846, 848, 854-56.
In light of the foregoing, the court found that none of these enumerated prohibitions under the CSA prohibited or forbade the ownership or disposition of an interest in an entity that engages in cannabis operations, or owning cannabis intangible assets such as domain names conveying messages about marijuana.
In support of its decision, the court also cited to the U.S. Court of Appeals for the Ninth Circuit Bankruptcy Appellate Panel's decision in Burton v. Maney (In re Burton), 610 B.R. 633 (9th Cir. BAP 2020), noting that courts have been reluctant to adopt a bright-line rule regarding the disposition of bankruptcy cases involving cannabis. Also, the court recognized that there have been recent decisions that have seemed to open the doors of the bankruptcy courts to individuals in the cannabis industry. See In re Hacienda, 647 B.R. 748 (Bankr. C.D. Cal. 2023); In re Blumsack, 657 B.R. 505 (BAP 1st Cir. 2024).
However, the court recognized that there is a significant amount of prior case law wherein courts have dismissed a debtor's bankruptcy case based upon the debtor's involvement in the cannabis industry. In distinguishing these cases, the court observed that most of them involved either Chapter 11 or Chapter 13 cases where the debtors were, in fact, using post-petition income or funds from cannabis businesses to fund/effectuate their reorganization. As this case was a Chapter 7 case, the debtor's post-bankruptcy income derived from any of his business operations (be it cannabis-related or not) is, by statute, not part of his estate. Thus, the court determined that the debtor's post-petition income (and, more importantly, the source of such income) should not be considered a factor in determining whether the case should be dismissed.
In addition to and unlike the other cases where the underlying bankruptcy case was dismissed, the court found that the debtor was a separate entity from the LLCs that owned and operated the dispensaries and, as such, there was "no danger" for a trustee in administering the Debtor's estate. Simply put, the court determined that any potential monetization of the debtor's ownership interests in his cannabis businesses would not, in and of itself, be a violation of the CSA since such interests are not considered "cannabis property" or "cannabis proceeds." The court also found that the enforcement of rights and sale of intangibles related to cannabis not directly referenced by the CSA are, in and of themselves, insufficient and do not constitute "cause" to dismiss a Chapter 7 debtor's case.
The court also noted that to the extent a trustee would have difficulty monetizing these intangible assets, there are other bankruptcy tools available to the trustee―including, without limitation, the abandonment of any unduly burdensome property back to the debtor pursuant to Section 554 of the code―that the trustee could utilize while, at the same time, administering the noncannabis related assets.
Finally and as additional support for its decision, the court observed that: the Justice Department has taken a "hands-off approach" in enforcing the CSA when it comes to the manufacturing and distribution of cannabis within states where cannabis has been legalized; and "it seems that the only arm of the executive branch with an explicit mission to enforce the CSA against state-regulated marijuana businesses is the UST … in seeking to dismiss bankruptcies." Accordingly, the court rejected the movants' arguments that a Chapter 7 trustee could not lawfully administer the debtor's assets (in this case) and found that there was insufficient "cause" warranting a dismissal of the case pursuant to Section 707(a) of the code.
Conclusion
As previously seen by the decisions in Hacienda and Blumsack, courts seem to be much more receptive to permitting cases to remain open for cannabis-related debtors. With a growing leniency in denying motions to dismiss for asserted violations of the CSA and the anticipated rescheduling of cannabis, it appears that bankruptcy relief may become a viable option even for plant-touching and cannabis-related businesses. The only word of "caution" is that these decisions are extremely fact-specific and, thus, there will always be a risk that the particular facts will not support a debtor's desire to remain in bankruptcy.
Reprinted with permission from The Legal Intelligencer, © ALM Media Properties LLC. All rights reserved.
