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How close can you get to a cannabis business before the doors of bankruptcy close?
If you work for a cannabis business, bankruptcy relief may not be available to you, depending on the In re Blumsack decision of the United States Bankruptcy Court for the District of Massachusetts1. If an employee works for the Sinaloa Cartel or Bud’s Buds2, that employment involves the cultivation, manufacture, possession, and/or distribution of a controlled substance in violation of federal law. Therefore, according to this ruling, the employee’s W-2 income is tainted with this illegality and cannot be used to fund payments under a bankruptcy plan.
Numerous widely known bankruptcy court decisions prevent cannabis businesses and related entities from availing themselves of the reorganization provisions under Chapter 11 of the Bankruptcy Code3. The results of these cases left cannabis and ancillary companies in uncertain legal territory, having no clear rules about “how far you can go” from a state-legal marijuana business and still having access to bankruptcy protection. But, unlike the debtor in In re Blumsackcompanies have alternatives under state law that, while not as attractive as Chapter 11, are usable in many cases.4
What is new in the recent decision of In re Blumsack is that the door to bankruptcy court was closed to an individual who derives income from a cannabis business. In Backpackthe court found that the debtor, a manager of a marijuana dispensary legal under Massachusetts law with no stake in the business, engaged in activities that violated federal criminal laws.5 The court found that his use included: distribution and possession of cannabis with intent to distribute; possession of a controlled substance without a prescription; aiding and abetting his employer to illegally distribute and possess cannabis with intent to distribute; and conspiracy to commit the crimes of distribution and possession of cannabis with intent to distribute.
Chapter 13 bankruptcies and Chapter 11 cases for high income/wealthy individuals are most often used by people who want to save their home from foreclosure. If they are in financial difficulty, they file Chapter 13 or Chapter 11 reorganization cases rather than Chapter 7 liquidation cases. In this case, the court decided that these foreclosure protections were not available. for the debtor – in essence, which could result in the debtor losing his home. If he had been employed by another legal company, he would not have run this risk.
The debtor in Backpack argued that denying him the right to stay in his Chapter 13 case defeats the purpose of consumer bankruptcy: to allow individuals to reorganize their financial affairs and get a “fresh start” in their financial lives . He pointed out that any company employee involved in marijuana — even including a warehouse worker who stacks boxes or a web designer — is committing a crime. Further, the debtor argued that, given the marijuana industry’s contribution to a wide swath of the Massachusetts economy, an unfavorable ruling in his case would render much of the community – including the janitorial agency that cleans a dispensary, a pizza place where dispensary employees get their lunch, Federal Express that delivers packages for a dispensary, the power company, public schools, and maybe even 2.3 million employees of Walmart – ineligible for bankruptcy relief because they derive economic benefit from marijuana-related businesses.
The court was not convinced by the debtor’s arguments. The court disregarded the debtor’s “slippery slope” and political arguments by noting that it was ruling on only one case before it.
The United States Supreme Court has urged bankruptcy courts to apply the text of the Bankruptcy Code in accordance with its ordinary meaning.6 Chapter 13 of the Bankruptcy Code requires that the debtor’s plan be offered “in good faith and not by any means prohibited by law.”7 The court found that the debtor’s plan in this case would be funded by, and require the Chapter 13 trustee to administer, wages earned from illegal activities. Therefore, the court found that the plan failed to meet the requirement of § 1325(a)(3) and confirmation was denied.
Going further, the court also found that the debtor could not seek the benefits and protections of federal bankruptcy laws while undertaking and deriving continuous and concurrent income from actions that violate federal criminal laws. The court therefore granted the United States Trustee’s motion to dismiss the bankruptcy case for cause.8
Finally, the court concluded that it would be an abuse of process to allow the debtor to obtain the protections and benefits of federal bankruptcy laws while continuing to commit federal crimes. Because this constitutes an abuse of the bankruptcy process, the court ruled that this was additional grounds for dismissal.9
The political arguments put forward by the debtor may be very well founded. However, it will be up to future cases outside of Massachusetts whether or not they agree with the Backpack court and settle the fundamental question of “how far can we go? to a cannabis company before the doors of bankruptcy court are closed to you. We suspect there will be many more such cases decided in the immediate future, which will begin to answer that question. Should future courts answer this question using the reasoning employed by the court in In re Blumsackhowever, even a small amount of dollars received by an individual through legitimate dealings with a state-legal cannabis business could taint that person’s entire income with illegality and bar the door to bankruptcy court. .
[1] In re Blumsack, 2023 WL 214293, 2023 Bankr. LEXIS 108 (Bankr.D.Mass. Jan. 17, 2023).
[2] Bud’s Buds was a fictional marijuana dispensary on the TV show “Last Man Standing”. See https://lastmanstanding.fandom.com/wiki/Bud%27s_Buds
[3] See, for example, In re Burton, 610 BR 633, 637-38(9e Cir. BAP 2020); In re Basrah Custom Design, Inc., 600 BR 368, 382-83 (Bankr. ED Mich. 2019; see Garvin v Cook Investments NW, SPNWY, LLC, 922 F.3d 1031 (9e. Cir. 2019)..
[4] Heidi Urness and Timothy Byrd, Pot Cos. Can Rely on State Law for Bankruptcy Safeguards (available at https://www.law360.com/articles/1531461/pot-cos-can-rely-on-state-law-for-bankruptcy-safeguards)
[5] 2023 WL 214293 at *5-7.
[6] See, for example, Hartford Underwriters Ins. Co. v. Union Planters Bank, NA, 530 US 1, 6 (2000); United States v Ron Pair Enterprises, Inc., 489 US, 235, 242 (1989).
[7] 11 USC § 1325(a)(3).
[8] 11 USC § 1307(c).
[9] 11 USC § 105(a). These holdings imply that Chapter 7 cases would also be denied. The matter will be left to future cases to decide.
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