After the Green Rush: Bankruptcy Alternatives for Restructuring Cannabis Businesses
One of these challenges that has come into focus in recent years is the inability of cannabis businesses to access the US bankruptcy system to restructure their debts or liquidate their assets. As the industry faces growing pains from increased supply and depressed pricing, it is more important than ever for entrepreneurs, investors, managers, and other market participants to understand the strategic options and alternative solutions for restructuring or winding down a financially distressed cannabis business.
Overview of Receiverships
The cannabis wind-down model most similar to a bankruptcy proceeding is the state-court receivership. A receivership is a court-supervised process in which a fiduciary (the receiver) is appointed to manage and typically liquidate an insolvent company (the debtor), typically at the request of creditors. Although the process differs from state-to-state, it is generally commenced with a petition filed by a creditor or shareholder in the court of the state (or states) where the debtor and its assets are located. The court enters an order appointing the receiver and describing his or her rights, powers and responsibilities, which typically include selling assets, retaining and terminating staff, and making distributions to creditors. At the conclusion of the receivership, the company is dissolved and the receiver is discharged.
Placing a cannabis business into receivership involves special considerations to account for its highly regulated environment. A receiver needs to qualify to operate the cannabis business not only in the eyes of the court, but also under the regulations of the state in which he or she is appointed. Whether a receiver qualifies under the company’s cannabis license may vary from state-to-state and, as a result, the decision to place a cannabis company into receivership requires careful diligence of the process and ramifications.
States Expressly Authorizing Cannabis Receiverships
Several states have specifically addressed the ability of a cannabis company to wind down in receivership. In Massachusetts, for example, the Cannabis Control Commission enacted detailed regulations outlining the qualifications to be appointed as a receiver of a cannabis company, including satisfaction of suitability requirements and control limitations. In addition, the Massachusetts regulator implemented a form of mandatory advanced insolvency planning by requiring any cannabis company to obtain a surety bond prior to commencing operations that ensures payment of the receiver’s costs and compensation in the event of an insolvency proceeding.
Oregon and Washington have also created regulatory frameworks for the appointment of cannabis receivers. Others states have enacted more limited regulations clarifying that cannabis companies can qualify for receivership through rules permitting cannabis operating licenses to be transferred temporarily or be granted to a receiver. Illinois, Maine, and Rhode Island statutes include receivers and trustees as “persons” who may be licensed to cultivate and sell cannabis. California law provides that, upon the receivership of the person or entity holding the marijuana license, the receiver has fourteen calendar days to submit a request to modify the license. Michigan law permits court-appointed receivers to operate a cannabis facility upon approval by the state’s Marijuana Regulatory Agency. The upshot is that placing a cannabis company into receivership must comply with the detailed requirements of the state to ensure that the receiver is vested with proper authority to accomplish the objectives of a structured wind-down and payment of creditors, with an understanding of the potential exposure of operators and investors.
States Without Clear Guidance on Cannabis Receiverships
The majority of states and territories that have legalized cannabis — including Alabama, Arkansas, Connecticut, Delaware, Florida, Hawaii, Kansas, Louisiana, Maryland, Minnesota, Mississippi, Missouri, Montana, New Jersey, New York, North Dakota, Utah, Vermont, Virginia, West Virginia, DC, and Guam — have not clarified the rules regarding receivership for cannabis companies. Companies in those states that are considering a receivership may look to the general receivership laws, but it is unclear whether courts or regulators will approve the receivership or recognize the receiver’s authority. As a result, the use of a receivership in these states should be undertaken with additional care and thought towards other alternatives.
Limitations and Alternatives
As important as it is to understand the potential of a receivership, it is equally important to understand its limitations. While one key advantage of a receivership is the appointment of a professional fiduciary who understands how to wind down an insolvent company, a corresponding disadvantage is the loss of control over a process in which insiders have a vested interest. In addition, unlike a bankruptcy court, which has nationwide jurisdiction over the debtor’s assets and imposes an automatic stay (or injunction) against creditors’ attempts to seize those assets, a receivership court’s jurisdiction is limited to the state in which the court is located and may not include an injunction unless specifically requested and justified to the court. As a result, multi-state operators have additional complications that may require coordination among different states and courts, with increased costs to effectuate the restructuring or wind-down. More fundamentally, a receivership is typically intended to liquidate a company rather than reorganize it to facilitate continued operations. There are exceptions, such as Rhode Island’s Non-Liquidating Receivership Program, but in general an attempt by existing ownership to retain or regain control of the business post-receivership is uncertain and will require careful coordination with the applicable cannabis regulatory regime.
In light of these drawbacks, it is also important to consider the circumstances and options for an out-of-court process that may be more desirable for company’s ownership, management, or investors. A company may attempt a self-managed wind-down with the assistance of legal and accounting professionals, or alternatively, make an assignment for the benefit of creditors (or ABC) through a contract that assigns all of its assets to a professional fiduciary (the assignee). The assignee will then liquidate the assets and distributes the proceeds to creditors. As with receiverships, the laws governing ABCs vary from state-to-state and may be addressed by the state’s cannabis regulations (as they are in Massachusetts). An ABC may be an attractive option if the debtor has amicable relations with its core creditors and can convince them that a less expensive out-of-court process will provide a superior value proposition over a court-supervised receivership. Ultimately, as with any other distressed business, selecting a path requires a careful analysis of the circumstances and desired objectives from the point of view of the company, shareholder, or creditor considering its strategic alternatives.
Winding down a cannabis business through a state law receivership involves unique challenges in light of inconsistent regulatory treatment, jurisdictional limitations, and in most circumstances, the unavailability of a uniform restructuring law. Although there have been outliers granted access to bankruptcy court after taking creative steps to cleave off their cannabis-centric operations (consider for example, The Hacienda Co., which sold its assets to Lowell Farms in exchange for stock), most cannabis businesses have been unable to access the federal bankruptcy system’s nationwide reach, efficiency, and effectiveness. Nonetheless, cannabis businesses have options for liquidating or reorganizing that may still be highly effective with the right level of planning and preparation to select and execute the best strategy under the circumstances.