Marijuana Grower's Bankruptcy Hopes Go Up in Smoke

Bloomberg Law’s® Bankruptcy Law News publishes case summaries of the most recent important bankruptcy law decisions, tracks major commercial bankruptcies, and reports on developments in bankruptcy...

By Stephanie Cumings
Aug. 26 — If your income is derived from marijuana sales then you might not be entitled to bankruptcy protection, even in states where the sale of marijuana has been legalized (Arenas v. U.S. Tr. (In re Arenas), 2015 BL 270646, B.A.P. 10th Cir., No. CO-14-046, 8/21/15).
The U.S. Bankruptcy Appellate Panel for the Tenth Circuit has now become the highest court to weigh in on this issue, according to research conducted by Bloomberg BNA. The court said that debtors whose income stems from marijuana sales can't fund a bankruptcy plan without breaking federal law.
“In this case, the debtors are unfortunately caught between pursuing a business that the people of Colorado have declared to be legal and beneficial, but which the laws of the United States—laws that every United States Judge swears to uphold—proscribe and subject to criminal sanction,” the court said.
“Mr. and Mrs. Arenas operate and own marijuana-assets within the bounds of Colorado law, and the Department of Justice has determined that there is no reason to prosecute them under federal law,” Daniel J. Garfield of Foster Graham Milstein & Calisher, LLP, Denver, who represented the debtors, told Bloomberg BNA Aug. 25. “Yet, the DOJ, through the [U.S. Trustee], sees fit to oppose allowing the Arenas the protections of the Bankruptcy Code that any other person or business operating within the bounds of the law would unquestionably have.”
“We don't use notions of ‘justice' and ‘fairness' very often in the bankruptcy bar, but those notions are clearly lacking when people such as the Arenas cannot obtain the fresh start that anyone else would be entitled to,” Garfield added. “When it comes to marijuana, the War on Drugs continues in insidious ways.”
The Executive Office for U.S. Trustees declined to comment on this case.

Case Dismissed

Frank Arenas grows and dispenses medical marijuana legally under Colorado law. Along with his wife Sarah, the couple also leases a commercial property to a marijuana dispensary. When Frank and Sarah filed for bankruptcy, the U.S. Trustee moved to have their case dismissed. The U.S. Trustee Program oversees certain bankruptcy matters for the Department of Justice.
The debtors tried to have their case converted from a Chapter 7 liquidation to a Chapter 13 reorganization, but the bankruptcy court said it wouldn't make a difference. The bankruptcy court held that the debtors weren't entitled to bankruptcy relief and granted the UST's motion to dismiss.
Not ‘Intrinsically Evil,' Still Criminal

On appeal, the bankruptcy appellate panel said that the “pivotal issue” was “whether engaging in the marijuana trade, which is legal under Colorado law but a crime under federal law, amounts to ‘cause' including a ‘lack of good faith' that effectively disqualifies these otherwise eligible debtors from bankruptcy relief.”
“We agree with the bankruptcy court that while the debtors have not engaged in intrinsically evil conduct, the debtors cannot obtain bankruptcy relief because their marijuana business activities are federal crimes,” the court said.
‘Nothing Could Be More Burdensome.'

A Chapter 13 case can be dismissed for “cause,” which the court said includes “lack of good faith.” One of the factors the court looked to in evaluating good faith was “the burden the plan's administration would place on the trustee.”
“[S]hort of exposing him to physical harm, nothing could be more burdensome to the [t]rustee's administration than requiring him to take possession, sell and distribute marijuana [a]ssets in violation of federal criminal law,” the court said. “There is no way the [t]rustee could administer the plan without committing one or more federal crimes.”
The court also factored in the debtors' “motivation and sincerity” in seeking Chapter 13 relief. The court agreed with the bankruptcy court's view that “[i]f the debtors are incapable of proposing a confirmable plan, it is objectively unreasonable for them to seek Chapter 13 relief whether their intentions are kindly or not.”
‘Epitome of Prejudicial Delay.'

The court similarly found dismissal appropriate under Chapter 7, pursuant to which “cause” for dismissal can include “unreasonable delay by the debtor that is prejudicial to creditors.” The debtors argued that the trustee could simply abandon the marijuana assets in this case to avoid selling and distributing the proceeds of those assets in violation of federal law.
“If the [t]rustee abandoned the [a]ssets, the debtors would retain their business after exposing the [t]rustee to grave risk, provide the creditors with little or no recovery, and receive a discharge, protected all the while from their creditors’ collection efforts by the automatic stay and then the discharge injunction,” the court said. “That is the epitome of prejudicial delay.”
The court added that it isn't clear a bankruptcy court can simply order a trustee to abandon assets and, furthermore, the debtors never raised this argument in the bankruptcy court. The court therefore affirmed the order dismissing the case.
Garfield added that the debtors “have not yet decided whether to appeal to the Tenth Circuit.”
Prior Decisions

The bankruptcy court in Colorado previously made a similar ruling in 2012 in In re Rent-Rite Super Kegs West Ltd., 2012 BL 343750, 484 B.R. 799 (Bankr. D. Colo. 2012). In Rent-Rite, the debtor acknowledged that roughly 25 percent of its revenue came from leasing warehouse space to tenants that grew marijuana. The Colorado bankruptcy court found that “the [d]ebtor's continued criminal activity satisfie[d] the requirement of ‘cause' under Section 1112(b) and require[d] dismissal or conversion of [the] [C]hapter 11 bankruptcy case.”
In In re Medpoint Mgmt., LLC, 2015 BL 97197, 528 B.R. 178 (Bankr. D. Ariz. 2015), the Arizona bankruptcy court also refused to “enter an order for relief which would then result in the appointed [C]hapter 7 trustee necessarily violating federal law (the [Controlled Substances Act]) in carrying out his or her duties under the [Bankruptcy] Code.”
Precedential Effect Unclear

According to the National Organization for the Reform of Marijuana Laws, 24 states and the District of Columbia currently allow the use of medical marijuana, and four states (Alaska, Colorado, Oregon, and Washington) have legalized the recreational use of marijuana. In addition to Colorado, the bankruptcy appellate panel's ruling could impact New Mexico, which has legalized medical marijuana and also resides in the Tenth Circuit.
However, the U.S. Court of Appeals for the Tenth Circuit hasn't weighed in on whether or not bankruptcy appellate panel decisions are binding on bankruptcy courts, so New Mexico may not be bound to follow Colorado's lead. Courts are split on whether or not bankruptcy and district courts should be bound by bankruptcy appellate panel decisions, according to research conducted by Bloomberg BNA.
Judges Tom R. Cornish, Robert E. Nugent, and Dale L. Somers sat on the three-judge panel in this case.
Daniel J. Garfield of Foster Graham Milstein & Calisher, LLP, Denver, represented the debtors.
Ramona D. Elliott, P. Matthew Sutko, and Noah M. Schottenstein of the U.S. Department of Justice, Washington, and Patrick S. Layng, Alan K. Motes, and Greg Garvin of the Office of the U.S. Trustee, Denver, represented the U.S. Trustee.
To contact the reporter on this story: Stephanie Cumings in Washington at
To contact the editor responsible for this story: Jay Horowitz at

Request Bankruptcy Law News on Bloomberg Law