An increasing number of states are moving forward with legalizing cannabis in some fashion. In Michigan, and in many other states, it is legal for most adults over the age of 21 to partake in medical and recreational marijuana.
As such, an entire cannabis industry in Michigan has popped up over the last few years to meet the immense demand of consumers. The state has created an in-depth licensing system to ensure that all direct and ancillary businesses in the industry are up to the proper standards and operating legally.
While cannabis is a growing industry that has just begun to realize its full potential, not all cannabis-related businesses are going to be successful. Unfortunately, due to clashing laws, cannabis companies don’t enjoy the same federal protections as other industries in times of need.
One of the main areas where cannabis businesses don’t enjoy protections from the law are when they are struggling financially. Cannabis companies don’t enjoy the same bankruptcy protections as businesses in other industries.
So, what are the options for cannabis companies if they are facing financial hardship? We’ll detail those options — as well as how this could change in the future.
Why Cannabis Companies Can’t File for Bankruptcy
If cannabis companies are legally allowed to operate in Michigan and some other states, why are they not allowed to file for bankruptcy? The reason is quite simple, really: Marijuana is illegal in all forms at the federal level, and bankruptcy protection is provided by the federal government.
When a company files for bankruptcy, they will do so under the rules set forth by the United States Bankruptcy Code in a U.S. bankruptcy court. These protections are only provided to companies that are operating legally.
Since cannabis is illegal in all forms federally, any company in the cannabis industry is not afforded typical protections under U.S. Bankruptcy Code — since they are technically operating illegally according to federal law. This goes not just for companies directly in the industry, but could also apply to ancillary companies that provide some services to cannabis companies.
This doesn’t mean that these companies are going to be prosecuted by the federal government, and it is highly unlikely that the federal government is going to shut down a cannabis company’s operations as long as they are abiding by their state’s rules and aren’t doing any interstate commerce. But, it also means the federal government isn’t going to go out of its way to provide these companies with federal protections such as bankruptcy.
Bankruptcy Alternatives to Cannabis Companies
Typical business bankruptcy proceedings would include a reorganization or official action to sell off the company’s assets to meet the business’ debt obligations. This would be done under a direct order from the bankruptcy court, which would lead the process so there is no concern about which creditors are prioritized over others, and which assets must be sold.
Some businesses are even able to use bankruptcy protection to restructure their debt so that they can emerge from bankruptcy as a solvent company that can continue to operate.
Without this official and straightforward process available to them, though, cannabis companies must seek out alternatives if they are in a tough financial position.
There are two main options cannabis companies will have in these situations.
The first option is called an ABC, or assignment for the benefit of creditors. This is available to cannabis companies in many instances, because ABC is a process that operates under state law. As such, each state will have its own rules and regulations for how this can be used.
The process is very similar to how Chapter 7 bankruptcy works. State law will dictate how the cannabis company’s assets will be liquidated. All of these assets will be assigned to a person known as an assignee. This person will then oversee the entire liquidation of all the assets as well as how the proceeds from this liquidation are distributed to the company’s various creditors.
The positive to ABC is that it can actually be completed much quicker and for far less money than a typical bankruptcy proceeding.
If the ABC effort doesn’t work, or if there are hiccups in the process, then another option would be for the cannabis company to directly negotiate with their creditors. This is referred to as a “workout agreement,” since the two sides will “work out” the conditions or terms of settling the outstanding debt.
While some creditors may be willing to work with the cannabis company to work out repayment arrangements, others may not. One of the main reasons for this is that the cannabis company doesn’t have a lot of leverage in this case, since they can’t use the threat of bankruptcy.
That being said, a creditor may be willing to negotiate arrangements with a failing cannabis company because the alternative might be to file a civil suit. Those lawsuits can be time-consuming and expensive, and might not lead to much in the end.
Could Bankruptcy Law Change?
With more and more cannabis businesses popping up throughout the country, it’s possible that bankruptcy laws could ultimately change so that cannabis companies could receive some protection.
In fact, a Michigan-based cannabis company tried to challenge its Chapter 7 bankruptcy filing, which was dismissed in part because federal law considered the business to be illegal.
The company appealed the decision to federal district court, but they were not successful in their arguments. In making its ruling in the case, the federal court said that bankruptcy isn’t available for any company that has assets “that are used for, or generated by, a business prohibited under the CSA [Controlled Substances Act].”
Since marijuana is prohibited under the CSA, then, any business dealing in marijuana is ruled to be ineligible for bankruptcy protections.
There is a possibility that this could change in the future, though. Some members of Congress have considered proposing legislation that would at least decriminalize recreational marijuana, while others have suggested making recreational use legal — as many states have.
Until this happens, though, it’s very likely that cannabis companies that are in financial trouble will have to seek alternatives to bankruptcy.