Despite commodity prices and growing demand that are the envy of every other industry, cannabis companies still occasionally go bankrupt. Why? This is an other story. But despite a series of high-profile failures, there is still no clear path to winding up a company that sells cannabis.
This puts potential lenders at risk, which tends to increase the interest rates that remaining lenders can charge.
As stated previously in Cannabis time, the debt raised by private placement is increasing as companies in the sector seek capital. However, it is not because investors can have a document allowing them to be reimbursed from a sale of assets in the event of default that they will be able to perceive.
“There are no guarantees,” according to court-appointed receiver Ted Lanes, whose California-based company works to help creditors and failing businesses find solutions. “Licences generally cannot be used as collateral, and inventory has its own problems. Lenders may be able to obtain loans with direct ownership of shares or partnership interests, but these values obviously decrease in a distressed situation.If there is value in the mark, or [intellectual property]this can mitigate the risk.
Cannabis and bankruptcy
There are two types of investors: shareholders and creditors.
Equity holders are willing to bear higher risk for higher reward; there are unlimited benefits, but if the company goes bankrupt, the shareholders get nothing.
Debt holders are not interested in the upside; they are willing to lend the company money, but demand that the note be repaid on time, in full and with interest. If the company goes bankrupt, its assets are sold and the lenders are the first to be paid.
In the cannabis-free world, this is handled by bankruptcy, a court-ordered process that creates a protective legal shield around the debtor, allowing them to do any or all of a number of things to satisfy lenders. Bankruptcy allows the company to liquidate its assets – essentially sell everything it owns. More often than not, this allows the company to restructure its finances and operations, allowing the business to remain in operation while its management reaches an agreement with creditors. This often involves special dispensation to withdraw from leases or other contracts and to repay those creditors less than what is owed to them.
Where this solution fails is that, like many other financial remedies, bankruptcy protection is not available for cannabis or even cannabis-adjacent businesses. This is because we are at a time when the industry is sandwiched between its classification as a Schedule 1 drug by the Drug Enforcement Agency and the relief that would be brought by the SAFE Banking Act, which has again blocked by the US Senate in June.
The language provided by a memo from the United States Department of Justice Administrator Program (USTP), which represents the federal government in bankruptcy courts, is one example.
“The USTP’s response to marijuana-related bankruptcy filings is guided by two simple, uncontroversial principles. First, the bankruptcy system cannot be used as an instrument in the commission of an ongoing crime and the reorganization plans that permit or require the continuation of illegal activities may not be upheld,” according to the 2017 memo. “Second, trustees in bankruptcy and other estate trustees should not be required to administer assets if doing so would cause them to violate federal criminal law.”
In the meantime, cannabis operators’ need for some sort of creditor relief is dire.
That’s not to say there’s no way for creditors to collect. These include:
- Off-court training;
- Assignment for the benefit of creditors (ABC);
- State court receivership; and
- State-regulated remedies under the Uniform Commercial Code.
Dallas-based cannabis consultancy UnitedCMC provided Cannabis time with a comparison grid (see above).
Off-court training ticks the most boxes and does so at a moderate price. It is based on the existence of a certain feeling of good faith between the debtor and the creditors, because it does not involve hiring a third party to arbitrate.
“A workout is [a] a non-judicial process by which a company in financial difficulty can negotiate with its creditors to restructure the amount or terms of debt repayment,” according to the website of the US law firm Fox Rothschild, which practices cannabis. “Successful training can allow a business to continue operating with the same direction.”
Receivership can accomplish everything a workout can do, but it’s also the most expensive option, according to UnitedCMC, which acts as a receiver for companies in difficulty. Generally, the court appoints a receiver at the request of creditors.
“Receivership is an old, tried and tested legal tool to collect, protect and preserve assets,” according to UnitedCMC President Dotan Y. Melech. “In the current environment, this may include revocable privileged cannabis licenses as well as cannabis products.”
The biggest hurdle, however, is that the rules governing receiverships vary from state to state, so actions that might be legal in one jurisdiction might be precluded in a neighboring jurisdiction.
They could also change in the middle of the procedure.
In the case of dispensary operator CWNevada, “The regulatory regime brought about a dramatic change in how marijuana would be regulated in Nevada. This took place in the middle of the receivership process,” according to Melech. The Cannabis Compliance Board was created, replacing the Department of Taxation as the regulatory authority.Additionally, there were no laws governing cannabis receivership in Nevada until 2021, leading to the promulgation of receivership regulations.
An ABC is a voluntary alternative to bankruptcy that transfers the debtor’s assets to a trust for liquidation and distribution, according to Cornell Law School. The trustee will manage the assets to repay the debt to the creditors, and if any assets remain, they will be transferred back to the debtor. The advantages for the company are that the management can choose the trustee and the process is quite fast compared to that of a bankruptcy. The ABCs, however, are not without their critics.
“Personally, I’m not an ABC fan,” Lanes says. “In a receivership, there is a court order that both defines roles and protects the receiver and its staff from litigation by the parties. This does not exist in an ABC. The assignment of assets takes place under the alleged default of the loan agreements, and creditors can, and do, sue if they believe they will get no recovery of their funds. In short, it is certainly faster, and cheaper, but risky.
If there is no suggestion of reorganization and liquidation is the only goal, there is some protection for creditors under the Uniform Commercial Code, which governs contracts. Specifically, they fall under section 9, which deals with debt. Creditors whose interests are secured by company assets can claim those assets and sell them, essentially doing what a bankruptcy court would do if it could. Without the blessing of the court, however, this course of action is fraught with pitfalls.
“This is a limited option for security holders,” according to Melech. “However, revocable privileged licenses are not considered personal property and cannabis inventory is not subject to seizure. Any sale or transfer of cannabis products requires a state-approved license.