An Identifiable Risk to Collateral Property That Is Used In The Marijuana Business

by Sherman & Howard L.L.C.

The legalization under state law of the marijuana business in Colorado through Amendment 20 (medical marijuana) and Amendment 64 (recreational marijuana) (Amendment 20 and Amendment 64 shall be referred to collectively as the "Colorado Amendments") raises serious issues for banks whose customers or borrowers are involved in the marijuana business in Colorado.  The Colorado Amendments do not affect federal law that defines marijuana as a Class 1 controlled substance.  Because involvement in the marijuana business remains a federal crime, real property subject to the lender's security interest that is used in the marijuana business may be subject to forfeiture to the federal government.

Under federal law, marijuana is a Schedule I controlled substance.  See U.S.C. § 812 Schedule I(c)(10).  Under federal law, it is a crime to "manage or control any place . . . as an owner . . . and knowingly and intentionally rent, lease, profit from, or make available for use, with or without compensation, the place for the purpose of unlawfully manufacturing, storing, distributing, or using a controlled substance."  21 U.S.C. § 856(a)(2).  Also under federal law, all real property used in any manner to commit a violation of the Controlled Substances Act is subject to forfeiture.  21 U.S.C. § 881(a)(7).[1]

In a recent case, the United States Bankruptcy Court for the District of Colorado held that cause exists to dismiss a chapter 11 bankruptcy case where a debtor derived a substantial portion of its revenue from leasing warehouse space to tenants who were engaged in growing marijuana.  See In re Rent-Rite Super Kegs West Ltd, 484 B.R. 799 (Bankr. D. Colo. 2012).<[2]  In Rent-Rite, the secured creditor held a security interest in the warehouse, rents, and certain personal property of the borrower.  The borrower had leased portions of its warehouse to tenants engaged in the business of growing marijuana.  Although, the borrower had entered into those leases before its bankruptcy filing, it continued to lease the property and receive the marijuana tenants' rent after its bankruptcy filing. [3]

After analyzing the applicable sections of the federal Controlled Substances Act, the bankruptcy court concluded that the Debtor's activities in leasing space to tenants engaged in growing marijuana was an ongoing federal crime and placed the collateral at risk of total loss.  The bankruptcy court rejected the Debtor's argument that the Colorado Amendments legalizing marijuana under State law somehow ameliorated the ongoing violation of federal law:  "[T]hat marijuana cultivation may not be criminally prosecuted under the laws of the state of Colorado is simply of no consequence and has no bearing on the Court's finding that debtor's business operation constitutes a continuing criminal violation of the federal Controlled Substances Act."  Id., 484 B.R. at 805.  Even though the federal authorities might exercise prosecutorial discretion and not prosecute the federal crime, the bankruptcy court concluded that a federal bankruptcy court could not assist a debtor whose activities are a continuing federal crime:  "under no circumstance can the Court place itself in the position of condoning the Debtor's criminal activity by allowing it to utilize the shelter of the Bankruptcy Code while continuing its unlawful practice of leasing space to those who are engaged in the business of cultivating a Schedule I controlled substance."  Id., 484 B.R. at 809.  Based upon the risk of forfeiture of the warehouse, however speculative, the Court concluded that the secured creditor should not bear the risk of loss of its collateral.

When a secured creditor learns that a borrower is involved in the marijuana business, it must be proactive in order to protect the collateral subject to its security interest.  While the borrower may not be eligible for bankruptcy protection, the secured creditor will still need to protect the collateral through appropriate action in the state courts.  This diligence is necessary even though the borrower may not have been involved in the marijuana business at the commencement of the loan.

[1] Secured creditors may be able to protect from forfeiture their interest in the real property by demonstrating that the secured creditor is an innocent owner.

[2] Attorneys in Sherman & Howard's Banking and Finance Group represented the secured creditor in the Rent-Rite bankruptcy case.

[3] Although it was not pertinent to the bankruptcy court's ruling, the secured creditor had obtained the appointment of a receiver for the property prior to the bankruptcy filing.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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