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Bankruptcy Court Addresses Conflict Between State and Federal Marijuana Laws

In 2018, California joined a small group of states that have legalized the production, distribution, and possession of small amounts of marijuana for recreational use. Marijuana remains a Schedule I controlled substance under the federal Controlled Substances Act (CSA) of 1970. As more companies move into the legal marijuana business, conflicts between state and federal law will become more pronounced. A recent decision by a U.S. Bankruptcy Court offers an idea of what California business owners might expect. In re Way to Grow, Inc., et al (“WTG”), No. 18-bk-14330, order (Bankr. D. Colo., Dec. 14, 2018). If you have questions about any related matter, reach out to a California business lawyer.

Bankruptcy offers relief to individuals and businesses whose income is not sufficient to continue paying their debts. Businesses commonly use the liquidation procedures defined by Chapter 7 of the Bankruptcy Code, or the reorganization procedures of Chapter 11. A court-appointed trustee manages the debtor’s assets and makes payments on outstanding debts. At the end of a bankruptcy case, the court discharges some or all of the debtor’s remaining debts.

The bankruptcy code allows interested parties to move to dismiss a Chapter 7 or Chapter 11 case “for cause.” 11 U.S.C. §§ 707(a), 1112(b). All parties must receive notice of the motion, and the court must conduct a hearing. The statutes do not provide an exhaustive list of grounds for dismissal. The question before the court in WTG was essentially whether the trustee could lawfully administer the bankruptcy estate.

California has allowed medical marijuana since voters passed Proposition 215, also known as the Compassionate Use Act of 1996. Twenty years later, California voters approved Proposition 64, the Adult Use of Marijuana Act. Adults may legally possess up to one ounce of cannabis for personal recreational use. They may grow up to six plants without obtaining a license. State regulators began issuing commercial licenses to grow and distribute marijuana in 2018.

Federal law places marijuana on Schedule I, the highest level of restriction under the CSA. Schedule I controlled substances are defined as having “high potential for abuse” and “no currently accepted medical use.” 21 U.S.C. § 812(b)(1). The fact that more than half of all U.S. states now allow medical marijuana to some extent suggests that the substance is misclassified by the CSA. Nevertheless, the U.S. Supreme Court has ruled that Congress’ classification of marijuana supersedes state laws. Gonzales v. Raich, 545 U.S. 1 (2005).

The debtors in WTG sold “equipment for indoor hydroponic and gardening-related supplies.” WTG, order at 2. Colorado’s legal cannabis industry comprised a substantial amount of their customer base, but the court notes that they also had customers in other industries. A secured creditor moved to dismiss their bankruptcy case on the ground that they were involved in illegal activity, and therefore ineligible for bankruptcy relief under 11 U.S.C. § 1112(b).

The court granted the motion to dismiss, finding that the debtors’ business likely violates a provision of the CSA that makes it an offense to knowingly “manufacture…any equipment…which may be used to manufacture a controlled substance.” 21 U.S.C. § 843(a)(7). The court noted that “[b]ut for the marijuana issue, this would be a relatively run-of-the-mill Chapter 11 proceeding.” WTG, order at 27-28.

Business attorney James G. Schwartz has advocated on behalf of businesses and business owners in the Bay Area for more than forty years in both litigation and transactional matters. Please contact us online or at (925) 463-1073 today to schedule an initial confidential consultation with a member of our knowledgeable and skilled team.

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Ninth Circuit Rules on Default Interest Rates in Chapter 11 Bankruptcy, Pleasanton Business & Commercial Law Blog, March 15, 2017

Ninth Circuit Rules in Business Bankruptcy Case on Liability of Corporate Insider Who Personally Guaranteed Loan, Pleasanton Business & Commercial Law Blog, September 15, 2015

Court Denies Discharge in Personal Bankruptcy Case, Finding that Transfer of Cash from Bank Account to Safe Deposit Box Had Fraudulent Intent, Pleasanton Business & Commercial Law Blog, November 14, 2014