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OP-ED: What Will Happen When Pot Businesses Go Up in Smoke?

January 2015

Published in the Daily Journal of Commerce

With the recent passage of Measure 91, the sale of marijuana for recreational use will soon be legal in Oregon under state law. As when any new market emerges, even businesses with no existing connection to the marijuana industry will be eager to identify new ways to make money. Some landlords, for example, will be interested in leasing property to marijuana producers or distributors, who may be attractive lessees with steady cash flow and few tenant improvement requirements.

Banks and private lenders may find marijuana growers and dispensaries, with high profit margins and a ready market for their product, to be worthwhile credit risks. However, doing business with marijuana producers or distributors necessarily involves unique risks and considerations, including the fact that marijuana remains an illegal controlled substance under federal law. As a result, certain creditors' remedies created by federal law – such as involuntary bankruptcy proceedings and federal court receiverships – are unlikely to be available to creditors of marijuana businesses. Landlords and lenders should seek competent counsel to fully understand these special risks involved, and others, before leasing or providing financing to a marijuana business.

As a general rule, when businesses experience financial difficulties, one of the first considerations for debtors and creditors alike is the possibility of bankruptcy. However, the emerging trend among bankruptcy courts (federal courts that apply federal bankruptcy laws) is to refuse to allow marijuana-related businesses (including those that lease property to marijuana operations) to avail themselves of bankruptcy protection on this basis.

For example, a federal bankruptcy court in Oregon recently refused to confirm a bankruptcy plan that would have relied on rental income from a medical marijuana business as well as profits from its own marijuana grow operation to pay creditors. In Colorado (which also has legalized recreational marijuana), a federal bankruptcy court took an even harder line, summarily dismissing both a business and an individual bankruptcy case because the debtors in each instance derived income from marijuana operations (one was a landlord, and the other was a grower).

Other federal remedies are also likely foreclosed.  For example, although no federal courts seem to have addressed the issue yet, creditors are unlikely to be able to place marijuana debtors into federal receiverships, for the same reasons that bankruptcy courts are unwilling to preside over such cases.

Landlords and lenders (and any other parties owed money by marijuana businesses) are therefore probably unable to force marijuana business debtors into involuntary bankruptcy proceedings or federal receiverships. Landlords whose tenants are engaged in marijuana businesses may also find themselves barred from seeking relief in federal bankruptcy courts. Thus, doing business with a marijuana producer may limit not only a landlord's remedies against that party, but may also have far-reaching consequences for a landlord's own ability to file for federal bankruptcy protection, should the creditor seek to do so.

Creditors will need to look to options in state courts and through self-help remedies available under state law with options in federal court limited. One option available to a secured creditor is to foreclose on the business' assets and liquidate them, or even operate the business itself. Oregon's new marijuana law explicitly provides for foreclosure of security interests in marijuana, and for the operation of a marijuana-related business for a secured party for a "reasonable period" after a debtor's default.

Most secured creditors are not likely to want to take possession of the marijuana-related business because of the numerous potential risks, including knowingly engaging in a business that is illegal under federal law. Alternatively, a creditor may seek to reorganize or liquidate an insolvent marijuana business by suing for appointment of a state court receiver.

Until the Oregon Liquor Control Commission (which will regulate marijuana businesses) provides specific rules for marijuana licenses, it is unclear what conditions would have to be satisfied to appoint a receiver for a marijuana-related business. Even after such rules are established, however, it still is not clear whether many receivers and turnaround managers will be willing to take the risks associated with operating marijuana businesses or if their insurance and bonding companies will permit them to do so. But it seems likely that if enough landlords and lenders need their services in this context, some receivers will find a way to serve those needs.

It is also not clear whether state court judges will be willing to oversee marijuana receiverships, notwithstanding the passage of Measure 91, but clear rules from the OLCC or amendment to the law could provide state court judges with the necessary guidance to do so.

Another strategy that may provide some measure of protection to a landlord is to create a special purpose entity to engage in marijuana-related business. However, doing so will not expand the remedies available to such an entity in the event of the lessee's default.

Finally, any secured creditor should keep in mind that civil forfeiture of the debtor's collateral under federal law is also a possibility. The Justice Department has provided guidance as to when it will pursue federal charges against businesses selling or distributing marijuana in ways that are otherwise legal in the laws of their states. But that guidance expressly states that it is subject to change at any time, and there is no guarantee that this administration, or any subsequent one, will continue the present policy.

In sum, lenders and landlords considering entering into business relationships with marijuana producers or distributors must understand that, in addition to the potential benefits of such business relationships, there are significant and unique risks in the event the marijuana business falters – especially in terms of available remedies. Based on the complexity and relatively untested-nature of this area of the law, and the likelihood for additional developments on both the state and federal levels, it is extremely important to consult with competent legal counsel before entering into any business relationship involving marijuana.

Related Practice Areas

Banking and Finance
Business Restructuring & Bankruptcy

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