Posted in: BARG Receivership Law Updates

Federal Bankruptcy is Not an Option for State Legal Cannabis Business so What Should They Do When They are Failing Financially? Appoint a Receiver

At this time, thirty-three states have legalized marijuana. (Esquire Link)  However, marijuana remains illegal federally.  21 U.S.C. §§ 801-890 (1970.)  As a result of marijuana’s status as a controlled substance federally, numerous bankruptcy courts have flatly banned state legal marijuana growers from seeking federal bankruptcy protection.  In re Rent-Rite Super Kegs W. Ltd. (Bankr.D.Colo. 2012) 484 B.R. 799, 809.  There was some hope that In re Rent-Rite Super Kegs W. Ltd would lose momentum, but it was reaffirmed in 2018.  In re Way to Grow, Inc. (Bankr.D.Colo. 2018) 597 B.R. 111, 120.)

It is well known the current state of cannabis law in the United States is a quagmire that nobody can make sense of.  California and ten other states have legalized recreational marijuana, and thirty-three states have legalized medical marijuana. (Esquire Link).  However, marijuana remains illegally federally, and further muddying the issue is the fact that the Federal Government cannot criminally prosecute an individual or company that has a valid state cannabis license.  (McIntosh v. United States, 833 F.3d 1163, 1171 (9th Cir. 2016).

In an effort to shed some light on this puzzle the University of Massachusetts Law Review will be publishing an interesting Law Review Article on the topic of states using Article V of the Constitution to utilize a Convention of the States to amend the Constitution to federally legalize marijuana.  The University of Massachusetts Law Review Article on the topic of states overriding the Federal Government will be released in May 2021.  However, any legislative change coming from a law review article is unlikely.

Therefore, what is a cannabis company that is licensed in California supposed to do if it is falling on difficult times?  Most companies when facing financial hardships can file for Chapter 11 bankruptcy and seek financial rehabilitation.  (SEC v. American Trailer Rentals Co.,  (1964) 379 U.S. 594, 607.)  In 2019, there were 38,944 commercial bankruptcy filings, including from major California companies like PG & E. (Jones Day Article)  All these companies were entitled to a chance at financial rehabilitation, which state licensed cannabis companies do not have access to.  While many will disagree with the state of the law, it is how the law is currently set.  Therefore, what can a cannabis business do when it needs to financially rehabilitate itself?  The answer that many cannabis companies are finding is to appoint a receiver.

A receiver is a creature of state law and not subject to federal restrictions.  California has numerous receivership statutes for certain situations.  These include appointing a receiver over nuisance properties for building code violations (see California Health and Safety Code § 17980.6 & 17980.7), appointing a receiver to unwind a criminal enterprise (California Penal Code § 186.6), or appointing a receiver to overtake an unlawful business (California Business and Professions Code § 17204).  However, the general receivership statute that applies to all receiverships is found at California Code of Civil Procedure 564 et seq.  There is also a California Rule of Court Scheme found at California Rule of Court 3.1175-3.1184 that governs what a receiver must do during the pendency of a receivership action.

With that introduction, most readers are likely wondering what exactly a receiver is.  The answer is not San Francisco 49er legend and NFL Hall of Famer Jerry Rice.  Instead, a state court can appoint a receiver to resolve difficult situations such as the insolvency of a corporation, to carry a judgment into effect, or for any reason to preserve the property rights of a party.  CCP 564 et seq.

Receiverships date back to old English Chancery Courts and were a way to resolve a situation where a property or estate was out of control.  A common occurrence would be a king dying without an heir.  If that occurred, all the king’s subjects would wonder who is going to manage the farmers, the knights, the treasury and so on.  To answer these questions, the English Chancery Court would appoint a receiver to temporary control the castle until a permanent plan was formed. Ancient Petitions of the Chancery and the Exchequer at Page 51.  This is still the practice today, a receiver can be appointed over a business, a property, or an estate to take temporary control of a problem asset until a permanent plan is in place, or the asset is sold. (Misita v. Distillers Corp. (1942) 54 Cal. App. 2d 244, 252.)

It is worth noting that a receiver is an agent of the court and is a fiduciary to all parties with an interest in the property.  (California Rule of Court 3.1179; see also Shannon v. Superior Court (1990) 217 Cal. App. 3d 986, 992.) Therefore, a business is often wise to appoint a receiver if it is facing a financial hardship.  This is because a receiver can resolve disputes between parties that it cannot resolve or handle itself.  Once a receiver is appointed, they are cloaked with tremendous power, but to be appointed a receiver must prove their expertise and develop a plan that the court approves.  Therefore, a receiver is often an expert that comes in temporarily under court supervision and fixes difficult problems that a company is facing.

As it relates to cannabis, receivers have recently been appointed to resolve business disputes for cannabis companies.  (In re Cwnevda LLC, (2019) 602 B.R. 717, 726.)  Furthermore, a Colorado court even authorized a receiver to obtain state cannabis licenses for an unlicensed cannabis company. (Yates v. Hartman, 2018 COA 31 (Colo. App. 2018).  These cases show the numerous ways receiver can be utilized to help a cannabis company, which is locked out of bankruptcy court, financially rehabilitate.

However, while receivership is an ancient remedy, its utilization to financially rehabilitate state legal, but federally illegal cannabis businesses is a new innovation.  With that being said, the most recent receivership development in California law was that of the Health and Safety Receivership, which cities and counties utilize to abate nuisance properties.  (California Health and Safety Code 17980.6 & 17980.7.)   The Health and Safety Receivership remedy has been a tremendous success that cities and counties use throughout the State.  See Daily Journal Article on H & S Receivership from April 1, 2020. 

Based on the success of the Health and Safety Receivership remedy and other receiverships throughout the country, the application of receiverships to the cannabis industry is likely to be another resounding success.  Therefore, until the federal law is resolved, receivership is an excellent alternative for cannabis businesses facing financial difficulty that cannot seek bankruptcy protection.