A California court recently confirmed a plan for a cannabis-related business to sell its equity assets in a Canadian cannabis company and distribute the proceeds to creditors, a milestone ruling that may open a new path for cannabis-related businesses to utilize the U.S. Bankruptcy Courts.

The U.S. Bankruptcy Court for the Central District of California rejected a request for dismissal – based on the drug being illegal at the federal level -- by the United States Trustee, a quasi-judicial entity charged with overseeing the bankruptcy system. In confirming the plan submitted by The Hacienda Company to sell its shares of Canadian-based Lowell Farms, the Court broke from the standard of bankruptcy courts routinely dismissing cannabis-related business filings because due to the illegality of cannabis on the federal level.

The Court found the bankruptcy plan was unrelated to any possible illegal activity that preceded it. "Debtor's passive ownership of stock, with intent to liquidate that stock to pay creditors, will terminate any connection with cannabis.” In re The Hacienda Co., LLC, 647 B.R. 748, 753 (Bankr. C.D. Cal. 2023).

Furthermore, the Court ruled, “Debtor's temporary retention of [Lowell Farm] stock, while divesting itself of that connection to cannabis, does not foster a single sale of any cannabis products, nor does it add a single dollar to any cannabis-related enterprise. Although Debtor's payments to creditors may include distribution of ‘ill gotten gains’ (to the extent that proceeds from U.S. operations violate federal law), such distribution to creditors is what criminal law itself provides.” In re The Hacienda Co., LLC, Case No. 2:22-bk-15163-NB, 2023 Bankr. LEXIS 2359, *8-9 (Sept. 20, 2023).

The ruling could allow more distressed cannabis-related businesses to file to restructure debts and obtain breathing room from creditors’ litigation and collection efforts. This could be especially helpful to New York’s struggling cannabis-related businesses that only now are seeing the state open up licensing to all cultivator, processor, distributor, microbusiness and retail dispensary applicants, nearly three years after the state voted to legalize cannabis.

Up to now, cannabis companies and related businesses have not been afforded the protections provided by the U.S. Bankruptcy Code because cannabis is still classified as a Schedule I drug under the Controlled Substances Act. HHS recently recommended to the U.S. Drug Enforcement Agency that cannabis be moved to Schedule III of the Controlled Substances Act. As a Schedule III drug, cannabis would still be illegal under federal law, but the change would ease some restrictions presently imposed on the cannabis industry and represent an important step toward full legalization. The DEA is reviewing the HHS request.

Meanwhile, dozens of states have legalized marijuana in in one way or another, with some, including New York, offering alternatives to bankruptcy for cannabis and cannabis-related companies. The most common forms of relief are an assignment for the benefit of creditors and a state receivership. Both allow for the structured liquidation of assets, as well as the restructuring of a business, but neither are governed by the Bankruptcy Code. Instead, each state has its own statute allowing for the liquidation of a debtor’s assets through assigning the assets to an “assignee” who oversees the distribution to creditors.

In May, New York's Office of Cannabis Management introduced a receivership to adult-use cannabis regulations. Under the cannabis receivership program, the receiver will manage a company's finances, inventory, licensing compliance and other business operations to maximize value. This expert guidance hopefully helps the business manage through financial struggles.

Receiverships – and now, possibly, bankruptcy, are extremely important tools for struggling cannabis businesses, many of which have been hurt economically by the nearly three years of delays in rolling out New York’s legal cannabis market. These paths allow for a safety net for the company and protection for lenders.