Tenth Circuit affirms dismissal of marijuana-related business’s bankruptcy petition

Sep 09, 2015   

Wednesday, September 9th, 2015

On August 21, 2015, the United States Bankruptcy Appellate Panel of the Tenth Circuit affirmed the District Court for the District of Colorado’s dismissal of the Chapter 7 Bankruptcy petition filed by a debtor who was engaged in the production and distribution of marijuana. The case is yet another stark example of the difficulties marijuana-related businesses face due to marijuana remaining a Schedule I drug under the Controlled Substances Act. A copy of In re Arenas can be read here.

  1. Introduction

Although 21 states and the District of Columbia have legalized marijuana in various forms and to various degrees, federal law still lists marijuana as a Schedule I controlled substance under the Controlled Substances Act (“CSA”) 21 U.S.C. § 801 et seq. As a result, the possession, use, and distribution of marijuana remain crimes under federal law. This distinction is critical in understanding the Court’s decision.

  1. In re Arenas

In Arenas, a debtor couple who operated a marijuana production and distribution business filed for Chapter 7 Bankruptcy protection. The United States Trustee then moved to dismiss the bankruptcy petition arguing that because the assets of the bankruptcy estate were used and derived from the production and sale of marijuana, the Trustee could not administer the estate without violating federal law. In response, the debtors moved to convert their case to Chapter 13 bankruptcy. (While the differences between Chapter 7 and Chapter 13 are beyond the scope of this article, generally speaking Chapter 7 requires a debtor to liquidate property to satisfy his debt, and Chapter 13 allows a debtor to satisfy his debt through a repayment plan that does not require a liquidation). Ultimately, the District Court denied the motion to convert to Chapter 13 and dismissed the entire case.

In finding that the Bankruptcy Court was correct in not converting the Chapter 7 bankruptcy to one under Chapter 13, the Appellate Panel of the Tenth Circuit noted that pursuant to 11 U.S.C. § 1307(c), a bankruptcy court may dismiss a Chapter 13 case for “cause,” including the debtors’ “lack of good faith.” The Appellate Panel further reasoned that for any repayment plan to meet the good faith requirement, the plan must provide for the repayment of debt by means which are not forbidden by law. Here, however, the Chapter 13 repayment plan proposed by the debtors would have been funded primarily from marijuana-related business activity. Thus, because funding under the plan could not be obtained from income sources which did not violate federal law, the Tenth Circuit ruled that the Bankruptcy Court was correct in denying the request for conversion. However, the Appellate Panel did not entirely foreclose bankruptcy relief to debtors who engage in marijuana-related businesses. Instead, the Appellate Panel emphasized that any Chapter 13 repayment plan must be funded from income sources which are not illegal under federal law.

  1. Analysis

In denying bankruptcy relief under Chapter 7 and Chapter 13 to the debtor in this case, the Appellate Panel noted that “[b]ankruptcy relief is merely a privilege.” This statement, while otherwise passing dicta, is in line with how other “privileges” under federal law, such as business deductions on income taxes, and banking, are also denied to marijuana-related businesses. (More information on these other areas can be found in our previous reports here, here, here, and here.) Moreover, the impact of this decision is far reaching, and leaves marijuana-related businesses – even in states where marijuana is legal – with few, if any, options comparable to bankruptcy protection. (Our recent blog on the preemption issues Puerto Rico faced in attempting to create state level bankruptcy protection can be read here.)

However, while federal courts and the federal government are quick to revoke “privileges” which are derived from federal law, the federal government continues to enforce obligations which derive from federal law on marijuana-related businesses, such as requiring the payment of federal income tax. Moreover, it would difficult to imagine that the Americans with Disabilities Act, the Fair Labor Standards Act, the Civil Rights Act, and OSHA and Department of Labor standards would not apply to marijuana-related businesses. Thus, due to the continued classification of marijuana as a Schedule I drug under the Controlled Substances Act, marijuana-related businesses are saddled with the burdens of federal regulation but cannot derive the benefits of any of its “privileges.”

The attorneys at Fuerst Ittleman David & Joseph, PL have extensive experience in the areas of administrative law, anti-money laundering, food & drug law, tax law and litigation, constitutional law, regulatory compliance, white collar criminal defense and litigating against the U.S. Department of Justice. If you are a marijuana-related business, or if you seek further information regarding the steps which your business must take to remain compliant, you can reach an attorney by emailing us at contact@fidjlaw.com or by calling us at 305.350.5690.