DUE TO the COVID-19 pandemic, more and more businesses are filing bankruptcy. And while many cannabis operators may be thriving during this time, others have been affected like other businesses during the economic downturn.
But while businesses in other industries can file under the U.S. Bankruptcy Code, cannabis companies do not have that option.
Although legal cannabis operations operate under state law, cannabis itself remains illegal under federal law. And because bankruptcy cases are all handled in Federal Bankruptcy Court, that means the courts would have to administer assets that are illegal under federal law.
As a result, cannabis operators have to look at other options if they are in financial trouble.
The legal website JDSupra.com notes in a recent article that there are three alternatives:
Assignment for benefit of creditors
One option is an Assignment for Benefit of Creditors (ABC), which would be regulated under state law, as opposed to federal law.
There is no Chapter 11 reorganization available under an ABC arrangement, only liquidation.
Under this arrangement, the cannabis firm would assign its assets to a trust administered by an assignee that it appoints. The assignee would operate like a trustee in a bankruptcy and would sell the firm’s assets and pay off creditors with the proceeds.
Due to the complexity of the cannabis industry, JDSupra recommends appointing an assignee who is familiar with laws and regulations governing the industry.
The assignee, much like a trustee in a typical bankruptcy, will liquidate the business’s assets and distribute the proceeds to the company’s creditors.
But be warned, an ABC does not provide an automatic stay prohibiting creditors from taking adverse action against the business, as is the case in a bankruptcy filing.
Also, “Depending on the jurisdiction, existing state law may not be clear as to whether an assignee has the authority to resolve the businesses’ assets, especially considering regulatory requirements associated with marijuana inventory. In those instances, the assignee may need court authorization to administer the company’s asset,” JDSupra writes.
During an ABC liquidation, the company is separated from its assets, after which unsecured creditors would be unable to pursue claims against the operator. That said, creditors could still collect from third parties such as guarantors.
Secured creditors, however, have the same rights as in a bankruptcy.
If investors are responsible for debts, creditors could pursue them to recoup funds.
The second option is to put a cannabis operation into receivership, where receivers are appointed to run the company.
Receiverships can only be initiated by a state court order, which would arise from a dispute with a shareholder, creditor or partner. But be warned: If this is the chosen route, the receivers take full control of the company and current owners and management will have limited say in what happens next.
California laws and regulations allow receivers to operate cannabis businesses and dispose of their assets.
The final option, which is likely the most palatable if the owners hope to reorganize and continue operations, is what is known as a “debt workout.”
In such an arrangement, the company and creditor(s) would work out a plan to change the terms of the debt repayment.
One way to do that is through a composition agreement, which allows a debtor to pay its creditors pro-rata payments from a pool of funds which is similar to how companies may restructure their debts in a traditional bankruptcy.
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