The Bankruptcy Court for the District of Colorado has issued another decision with ramifications for debtors in the cannabis industry by dismissing the chapter 11 cases of United Cannabis Corporation (UCANN) following assertions that UCANN was not merely a producer of hemp-CBD products but also involved in the marijuana industry. On January 12, 2021, Judge Joseph G. Rosiana, Jr. issued a one-page decision granting the Office of the United States Trustee’s (US Trustee) motion to dismiss for good cause without providing further explanation. Though short on explanation, the decision emphasizes that hemp-CBD producers maintaining marijuana-related assets are likely sacrificing bankruptcy protection.

The dismissal was not without warning. Just days after UCANN’s petition for chapter 11 relief (filed on April 20, 2020), the court issued an order to show cause why the bankruptcy case should not be dismissed since, the court observed, UCANN appears to be engaged in the marijuana industry. The order noted that business activities associated with marijuana may be legal under Colorado law but remain illegal under federal law.  A federal court cannot be asked to enforce the protections of the Bankruptcy Code in aid of a debtor whose activities constitute a federal crime.

The Controlled Substances Act (CSA) makes it illegal to manufacture, distribute, or dispense a controlled substance.[1] While cannabis that contains less than .3 percent tetrahydrocannabinol (THC), the principal psychoactive constituent, is classified as hemp and is legal, cannabis that contains greater than .3 percent THC is classified as “Marihuana” and remains an illegal Schedule 1 controlled substance under the CSA.

Multiple courts, among them the Bankruptcy Court for the District of Colorado, have held that debtors whose operations constitute or facilitate federal crimes are not entitled to bankruptcy relief.[2] But UCANN denied involvement in the marijuana industry, arguing that its revenues were from the sale of legal hemp-derived CBD and that none of its current or future revenue was, or would be, derived from illegal activity. Further, UCANN asserted that because no portion of its plan of reorganization would rely on income derived from activity in violation of the CSA, no cause existed to dismiss its case.

In contrast, the US Trustee responded that UCANN had indeed manufactured and sold products containing THC, citing UCANN’s plain representations regarding marijuana-related assets made on the debtors’ website and in publicly available filings with the US Securities and Exchange Commission. Additionally, the US Trustee noted that UCANN had licensed patents to medical and recreational marijuana businesses covering formulations involving THC. Accordingly, the US Trustee filed a motion to dismiss UCANN’s chapter 11 cases on the basis that UCANN “unequivocally violated the CSA prior to the bankruptcy filings by advertising and selling products containing THC and by aiding and abetting illegal CSA activities through their consulting business.”

UCANN continued to deny that its business violated the CSA. but did not object to the dismissal of its bankruptcy case.

The swift dismissal of this case leaves a number of open questions.  Foremost is whether a debtor that previously engaged in operations in violation of the CSA can reorganize under the Bankruptcy Code to emerge with a law-abiding business. Concerned debtors may opt for state law insolvency alternatives, but bankruptcy courts are likely to have further opportunity to weigh in as both the hemp/CBD and marijuana industries continue to grow.

[1] See 21 U.S.C. § 841(a)(1).

[2] See, eg, In re Way to Grow, Inc., 610 B.R. 338, 344 (D. Colo. 2019) (“as long as marijuana remains a Schedule I controlled substance, a Chapter 11 debtor cannot propose a good-faith reorganization plan that relies on knowingly profiting from the marijuana industry. And, in turn, inability to propose a good-faith reorganization plan is cause for dismissal under 11 U.S.C. § 1112(b)(1)”); Arenas v. United States Tr. (In re Arenas), 535 B.R. 845, 847 (B.A.P. 10th Cir. 2015); In re Rent-Rite Super Kegs West Ltd., 484 B.R. 799 (Bankr. D. Colo. 2012) (“[b]ecause a significant portion of the debtor’s income is derived from an illegal activity, § 1129(a)(3) forecloses any possibility of this debtor obtaining confirmation of a plan that relies in any part on income derived from criminal activity.”)