“With rescheduling, it is possible that medical cannabis operations might have similar success filing a chapter 11 in the near future.”
By Michael Brandess and Steve Levine, Husch Blackwell LLP
The cannabis business can be challenging. Margins are often pretty thin. Customers are fickle. And taxes are pretty high. While other industries have similar problems, until the recent rescheduling of medical marijuana, the industry had been completely frozen out of U.S. bankruptcy courts because it was federally illegal, and bankruptcy law is federal law.
To some extent, however, that recently changed.
On March 24, The Cannabist Company Holdings (Canada) Inc. and its U.S. subsidiaries commenced proceedings under the Companies’ Creditors Arrangement Act (CCAA) in Canada, which has similarities to Chapter 11 under U.S. bankruptcy law. The next day, Cannabist initiated a Chapter 15 bankruptcy proceeding in the District of Delaware.
The Cannabist Chapter 15 is the first instance of an operating U.S. cannabis business successfully availing itself of U.S. bankruptcy protections, albeit indirectly through the Canadian proceeding and without the full menu of benefits typically available to companies undergoing Chapter 11.
Chapter 15 of the U.S. bankruptcy code allows for “recognition” of cross-border insolvency proceedings. Recognition occurs when a company undergoing an insolvency proceeding in a foreign country (e.g., Canada) has assets in the U.S. Chapter 15 allows that company to open an ancillary proceeding in which U.S. bankruptcy courts can grant judicial comity to the reorganization or liquidation ongoing in the foreign country.
There was a meaningful question at the onset of Cannabist’s filing as to whether Bankruptcy Judge Brendan Shannon would “recognize” the chapter 15, as U.S. bankruptcy law grants him authority to refuse recognition of the foreign proceeding. That would have left Cannabist’s U.S. subsidiaries exposed to considerable and near-immediate creditor collection activity.
But with minimal creditor pushback, the judge quickly granted provisional relief, previewing his inclination to allow the proceeding to move forward. On May, he entered a final order granting recognition and implementing a sweeping stay against creditor collection activity.
Although a cannabis business utilizing a complicated restructuring process inclusive of U.S. bankruptcy law is exciting for a particularly narrow subset of people, the business implications are far-reaching.
Over the past few years, numerous U.S. cannabis businesses have suffered considerable financial distress. Companies like Schwazze, MedMen, PharmaCann, AYR Wellness and others have undergone receiverships, foreclosures or comprehensive restructurings with their lenders. Many of those businesses had Canadian affiliates or parent companies, and it’s likely that Cannabist will provide a roadmap for similarly situated entities in the future.
To appreciate the implications of the Cannabist Chapter 15, it’s important to understand what cannabis companies have been missing.
Business bankruptcy often carries a negative connotation. It is psychologically correlated with financial ruin and business failure. And while financial distress is often attendant to bankruptcy, it is only part of the story.
U.S. bankruptcy law is intended to provide troubled companies with a breathing spell from their creditors to allow for reorganization or an organized wind down. This breathing spell comes in the form of an “automatic stay,” which is effectively an injunction preventing creditors from seeking collection of their debts or landlords and contract counterparties from terminating their leases and contracts during the bankruptcy proceeding.
But U.S. bankruptcy cases are federal proceedings. The cases are overseen by federal judges rather than those elected or appointed in the individual states. U.S. bankruptcy law is federal law, although it incorporates state law in certain instances.
But there is good reason to think that the federal government is taking a different approach to cannabis than it has in the past. In December 18, President Donald Trump signed an executive order directing federal agencies to expedite the reclassification of marijuana. The resulting rescheduling move undertaking by the Department of Justice immediately pertains to medical, not recreational, cannabis; and accordingly, not all facets of the industry will enjoy the benefits of this regulatory change for now.
Even after rescheduling of medical marijuana, adult-use marijuana is still federally illegal as a Schedule I substance. Accordingly, cannabis businesses in the U.S. have previously been precluded from obtaining bankruptcy relief. When they have tried in the past, DOJ’s bankruptcy watchdog, the U.S. Trustee, has zealously, and in most cases successfully, opposed cannabis businesses from obtaining U.S. bankruptcy protection.
In addition to being deprived of U.S. bankruptcy relief, cannabis businesses have also largely been restricted from obtaining standard bank loans.
Many U.S. banks won’t risk lending to federally illegal businesses. As such, the cost of capital for most cannabis businesses (e.g., interest rates and other fees) has been higher than for non-cannabis businesses. And despite continued market growth, profit margins are squeezed by operational challenges, significant regulatory compliance costs and heightened tax burdens at the state and federal levels.
Compressed profit margins for certain operators mean low margins for error without the risk of loan defaults and liquidity problems.
And so, when cannabis businesses have had trouble in the past, unlike most U.S. businesses, they have had to seek alternative means of reorganizing their businesses or liquidating their assets.
For instance, MedMen had operations across the country. A non-cannabis company with a footprint similar to MedMen would typically have sought chapter 11 bankruptcy relief because a federal court in one state could oversee the reorganization or liquidation of assets across the country. But MedMen, like many before and after, filed a receivership in California, necessitating a more complicated winddown process.
The U.S. cannabis industry enjoys more than $30 billion in annual revenues and maintains tens of thousands of jobs. From a corporate insolvency perspective, businesses in this industry deserve the same opportunity afforded to non-cannabis businesses to turnaround and restructure their companies.
Patchwork regulations between states and federal half-measures, such as rescheduling for a subset of the industry, create considerable confusion for multistate and cross-border operators. Companies in distress need as much certainty as possible.
While the Cannabist development does not provide complete access to U.S. bankruptcy law, it is a meaningful step forward. Following Cannabist, there is now a backdoor to U.S. bankruptcy courts for companies with foreign parent companies or affiliates. It is another potential lifeline for businesses with similar corporate and financial structures as Cannabist.
Additionally, with rescheduling, it is possible that medical cannabis operations might have similar success filing a chapter 11 in the near future. But alas, these attorneys can only hope for so much excitement at one time.
Steve Levine is a partner and leader of the Financial Services & Capital Markets industry group and co-leads the national Cannabis practice at Husch Blackwell LLP, focused on guiding MSOs, investors and entrepreneurs through complex transactions and strategic growth initiatives in the cannabis industry. Michael Brandess is a corporate restructuring partner at Husch Blackwell LLP, helping businesses, their owners and their creditors manage the complexities associated with financial distress and bankruptcy law.
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