As discussed in our earlier blog post, In re The Hacienda Company, LLC – a Flicker of Hope for Distressed Cannabis Companies: Bankruptcy May be Available to Liquidate Assets of Non-Operating Cannabis Companies | In Solvency (foxrothschild.com), Judge Neil Bason of the United States Bankruptcy Court for the Central District of California held that The Hacienda Company LLC (“Hacienda”), a “former” cannabis company that terminated its wholesale manufacturing and packaging business prior to filing its chapter 11 bankruptcy petition, could sell its ownership interests in the Canadian acquiring entity to pay creditors. See In re The Hacienda Company LLC, Case No. 2:22-bk-15163-NB, 674 B.R. 748, 756 (Bankr. C.D. Cal. 2023). Judge Bason denied the Office of the United States Trustee’s (“UST’s”) first motion to dismiss Hacienda’s bankruptcy case, which was filed in response to the debtor’s status report stating its intent “to propose a plan of reorganization that provides for Debtor to sell off the shares of [Lowell Farms that] it owns in an orderly fashion and use the proceeds from the stock to pay creditors ….” Judge Bason surveyed the cases in which the Bankruptcy Code was used to restructure a business or liquidate assets that may have involved criminal activity under applicable non-bankruptcy law, concluding that there was nothing in the Bankruptcy Code that per se prohibited a debtor from selling assets of a business that may have violated non-bankruptcy law to pay creditors.
After Judge Bason denied the UST’s first motion to dismiss the bankruptcy case, Hacienda made good on its promise to file a chapter 11 liquidating plan, which proposed to sell Hacienda’s shares of Lowell Farms on the Canadian Securities Exchange or in any other orderly manner, and to distribute the funds received from the sale to Hacienda’s creditors on a pro rata basis, with any excess funds after payment of creditors to be distributed to Hacienda’s equity holders. And once again, the UST filed a motion to dismiss, arguing that Hacienda continued to violate the federal Controlled Substances Act (“CSA”) by holding stock worth about $35 million in a Canadian cannabis company to which it transferred assets after ceasing operations in February 2021, and asserting that Hacienda’s intention to sell such stock to pay creditor claims violated federal criminal and money laundering statutes. The UST also cited authority “that debtor has not taken sufficient steps to withdraw from an ongoing conspiracy to violate the CSA.”
On September 20, 2023, Judge Bason doubled down on his prior ruling, and entered an order denying the UST’s second motion to dismiss. Although Judge Bason agreed with the UST that he mistakenly overlooked the evidence in granting the first motion to dismiss that Hacienda sold more than intellectual property, which could have conceivably changed his views, Judge Bason agreed to take a discretionary fresh look at the situation even though the UST had not met the standard for reconsideration under Federal Rule of Civil Procedure 60(b). Judge Bason found that unlike the first motion to dismiss, the UST satisfied its burden in the second motion to dismiss “to establish that, more likely than not, Debtor is engaged in a postpetition violation of the CSA by not withdrawing from a prepetition conspiracy with Lowell Farms to profit from its business involving controlled substances.” However, Judge Bason concluded that even assuming that there was any postpetition violation of criminal law, that does not necessarily mean the appropriate remedy is to dismiss the bankruptcy case. Judge Bason held that federal bankruptcy law does not restrict companies engaged in illegal activity from making payments to legitimate creditors: “It would be odd to read the Bankruptcy Code as implicitly barring any payments to legitimate creditors when that is what federal criminal law itself provides.” Judge Bason, relying on his prior analysis in his first order denying the UST’s motion to dismiss, noted that Congress did not adopt a “zero tolerance” policy that automatically requires dismissal of any bankruptcy case involving violation of any criminal law. Rather, “Congress has shown a willingness to avoid punishing a debtor that may have violated law when ‘the real victims would be innocent creditors.’”
Indeed, Judge Bason presumed for purposes of his opinion that Hacienda’s ownership and proposed liquidation of “Lowell Farms’ shares would violate the Money Laundering Statutes outside of a federal court-supervised liquidation to pay creditors.” Id. (citing United States v. Manarite, 44 F.3d 1407, 1416 (9th Cir. 1995) (concluding that cashing in chips from a chip-skimming scheme constituted promotional money laundering because “[t]he chip-skimming scheme could not benefit its participants unless the chips were cashed”); United States v. Montoya, 945 F.2d 1068, 1076 (9th Cir. 1991)(concluding that depositing a bribe check constituted promotional money laundering because “Montoya could not have made use of the funds without depositing the check”)). However, he noted that Hacienda “is proposing a liquidation under a federal court’s supervision – this Bankruptcy Court – pursuant to Congress’ statute that carefully regulates any such liquidation: namely, the Bankruptcy Code:
The UST’s argument for dismissal of this bankruptcy case would interpret the Bankruptcy Code (§ 1112) implicitly to prohibit what the Money Laundering Statutes expressly endorse: namely the liquidation of assets obtained from criminal activity and distribution of funds to creditors, including any victims of the unlawful activity. Specifically, the Money Laundering Statutes contemplate, as one remedy, the appointment of a “Federal Receiver” to “collect, unlawful activity or, more broadly, to satisfy any “civil judgment.” 18 U.S.C. § 1956(a)(1), (b)(4)(A), & (c)(9).
Id. Judge Bason was “not persuaded that, in the circumstances of this case, any federal court policy of not condoning illegality should override Congress’ mandates to administer bankruptcy cases, with all of the resulting benefits to innocent creditors and other parties in interest.” Accordingly, Judge Bason denied the UST’s second motion to dismiss and held that he would approve Hacienda’s Chapter 11 plan of liquidation.
Recognizing the potential for abuse, Judge Bason took pains to note that his decision should not be interpreted as condoning illegal activity. He also noted that his decision should not be construed as preventing prosecutors in the future “from pursuing any remedies against the Canadian company for any sales of cannabis in the United States that are illegal under federal law” and potentially against the Debtor’s equity owners for a recovery of profits based on the Money Laundering Statutes or any other remedies that “do not contravene this Court’s order confirming the Plan or violate the releases set forth in the Debtor’s liquidating plan” in the unlikely event that Hacienda’s “liquidation of its stock in the Canadian company were to generate surplus proceeds for distribution to Debtor’s equity owners . . . .” Although Judge Bason refused to certify a direct appeal at this time, it is likely that the UST will ultimately appeal Judge Bason’s ruling to the Ninth Circuit Bankruptcy Appellate Panel or District Court. Until then, Hacienda may be cited by other bankruptcy courts to permit debtors to use the Bankruptcy Code to liquidate assets of a non-operating cannabis business.
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