Despite Legalization of Recreational Marijuana, Uncertainty Remains for Businesses

Published in the Daily Journal of Commerce

Recreational marijuana use became legal in Oregon on July 1. Beginning in October, licensed medical marijuana dispensaries will be permitted to sell marijuana for recreational purposes. Next January, the state is expected to begin licensing recreational grow operations. Under the auspices of regulations to be promulgated by the Oregon Liquor Control Commission, sales to the public should begin through recreational dispensaries later in 2016. The legalization of marijuana presents exciting opportunities for prospective growers, sellers, and distributors, along with the lenders, landlords, and suppliers who hope to profit from doing business with such operations.

However, there is a major fly in the ointment: the use, possession, and sale of marijuana are still illegal under the Federal Controlled Substances Act. Not only those parties directly involved in the trade, but also those who lend, lease to, or supply such operations risk– at least in theory — hefty fines and lengthy prison sentences for violating federal law, or for aiding and abetting such violations. Aside from criminal concerns, the conflict between state and federal laws also creates difficulties for both debtors and creditors by limiting rights and remedies that might otherwise be available.

The federal government has tempered criminal risks to some degree by issuing guidance letters outlining enforcement priorities and stating that banks can offer deposit services to licensed marijuana businesses. Those guidance letters do not alter federal law, however. Nor do they specifically address lending, leasing or other service-providing activities.

Instead, the guidance letters merely set forth the federal government's current enforcement priorities, which are subject to change under this or subsequent federal administrations. In July 2015, a bipartisan group, including Oregon Sens. Ron Wyden and Jeff Merkley, introduced a bill that would make it easier to prevent federal bank regulators from penalizing banks for working with legal marijuana businesses. For now, though, the situation remains unsettled. As a result, few, if any, traditional banks are willing to risk lending to marijuana businesses.

From a debtor-creditor perspective, recent developments have brought more clarity, if not more comfort, concerning the sharp rift between federal and state law. In late August, the United States Bankruptcy Appellate Panel of the Tenth Circuit issued an opinion in the case In re Arenas, which held that a licensed marijuana business could not be a debtor in a federal bankruptcy court, either in a liquidation or a reorganization context. The court reasoned that a debtor cannot propose a plan in "good faith" if the plan involves ongoing violation of federal law, nor can it turn its assets over to a bankruptcy liquidating trustee who would then be forced to engage in illegal activities to administer those assets. Arenas is the latest, and most important, in a series of bankruptcy court decisions refusing to allow marijuana-related businesses, including those that lease property to marijuana operators, to avail themselves of bankruptcy protection on that basis. However, it is important to note that Arenas did not create a broad prohibition against marijuana-related businesses availing themselves of bankruptcy, and there may be situations in which a debtor that is less reliant on marijuana revenues could successfully seek protection under federal bankruptcy law.

Still, the uncertainty regarding the availability of bankruptcy for marijuana businesses creates wide-ranging implications for lenders, landlords, and others who are likely to be owed money by marijuana businesses. Such creditors are unlikely to be able to force marijuana business debtors into involuntary bankruptcy proceedings, particularly if they are set up as special purpose entities.

Even more significantly, a party whose business becomes intertwined with a marijuana operation, such as a landlord leasing space to a marijuana vendor or distributor, may find itself barred from seeking relief in bankruptcy court if its business is overly dependent on the income derived from marijuana operations, which are illegal under federal law. Although not tested to date, it is likely that other remedies that are exercised in federal court, such as federal receiverships, will similarly be unavailable to the extent they involve businesses that are illegal under federal law.

Based on Arenas and the reasoning that underlies the decision, the remedies available to both creditors and debtors under federal law are severely limited. For creditors, remedies may be limited to foreclosing on the marijuana crop and related assets (with the attendant risks associated with possessing that property) or seeking appointment of a state court receiver (and then hoping that a state court will be willing to supervise the administration of activities and assets that are illegal under federal law).

For marijuana business debtors seeking fresh starts, the situation is equally problematical. If unable to qualify as debtors in bankruptcy, such debtors will have to shut down their businesses and find ways to divest their assets before filing for bankruptcy, or else face having their bankruptcy cases dismissed without receiving discharges of their debts.

In conclusion, any entity wishing to enter the marijuana business, or to provide financing or services to such an entity, must proceed with caution. This is not to say that such risks outweigh the potential rewards. Like Oregon, other states are legalizing marijuana, and the burgeoning industry may yield substantial profits. But before doing business with marijuana growers, sellers, or distributors, lenders, landlords, and suppliers should carefully consider and evaluate the risks and potential obligations involved.

Timothy A. Solomon is an attorney in Sussman Shank's Business Restructuring & Bankruptcy Group.  Contact him at 503-227-1111 or tsolomon@sussmanshank.com.

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