In another decision that blocks cannabis businesses from bankruptcy relief, a Colorado district court affirmed the dismissal of Chapter 11 bankruptcy petitions filed by companies that sold machinery and equipment used not only by non-marijuana growers but state-licensed marijuana growers. In Way to Grow, Inc., et al., a secured creditor moved for dismissal based on the argument that the debtors’ business violated the Controlled Substances Act (CSA) and, therefore, it was not eligible for relief under the Bankruptcy Code.

The bankruptcy court found that the debtors were violating § 843(a)(7) of the CSA which makes it illegal under federal law to “manufacture” or “distribute” any “equipment, chemical, product or material which may be used to manufacture a controlled substance . . . knowing, intending, or having reasonable cause to believe, that it will be used to manufacture a controlled substance.”

Further, the court found substantial evidence that debtors had reasonable cause to believe that the equipment they sold would be used, by at least some of their customers, to manufacture marijuana. Here, the district court held that because the plan relied on profits generated by the cannabis business, the plan could not be proposed in good faith. Because of this, the court dismissed the cases “for cause” under § 1112(b) of Title 11.

Earlier in 2019, the Ninth Circuit, in Garvin v. Cook Invs. NW, 922 F.3d 1031 (2019), affirmed a district court’s decision affirming an order confirming a second amended Chapter 11 plan of five real estate holding companies. The trustee objected, arguing that a lease in the plan violated federal law because the underlying lessor used the property to (legally) grow marijuana.

The issue before the court was whether § 1129(a)(3) forbids confirmation of a plan that is proposed in an unlawful manner as opposed to a plan with substantive provisions that depend on illegality. The panel held that 11 U.S.C. 1129(a)(3) directs bankruptcy courts to police the means of a reorganization plan’s proposal, not its substantive provisions.

Therefore, the panel affirmed confirmation of the amended plan, ignoring the trustee’s objection. However, Garvin only looked only at the means by which the plan was proposed and not at the conduct of the reorganized business itself.

Section 1129(a)(3) requires that a plan be proposed in good faith and not by any means forbidden by law. The Ninth Circuit held that § 1129(a)(3) requires the bankruptcy court to examine only the means by which a plan was proposed and not whether the reorganized business will be compliant with non-bankruptcy laws such as the CSA.

Way to Grow demonstrates that, at least for the moment, motions to dismiss filed by the U.S. Trustee in cannabis cases will be successful more often than unsuccessful, thus preventing these businesses from obtaining bankruptcy relief.

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