COMMENTARY: Hashing out state marijuana laws and the bankruptcy code

By Jacob Kahn

In 1996, the State of California declared open rebellion on the federal Controlled Substances Act when it legalized marijuana for the limited purpose of medical usage within its borders. Since then, the number of states in which medical marijuana is legal has risen to 33, plus the District of Columbia. As well, 11 states (plus D.C.) have passed laws legalizing marijuana for recreational purposes.

However, despite such developments, marijuana remains illegal at the federal level, and is designated as a Schedule 1 controlled substance, along with heroin, MDMA, and others (CSA, 21 U.S.C. §§ 801-904).

The divergence between state and federal laws regarding marijuana has given rise to an endless number of legal quandaries. In its earliest days, the nascent marijuana industry struggled with practical concerns such as where to store cash and liquid assets. Following the legalization of recreational marijuana in Colorado, for example, the budding industry found itself contracting private security firms and armed guards to protect warehouses of pot and cash. The concern was that cash deposited in a bank from the sale of marijuana, as permitted by the various states, might be subject to immediate seizure by the federal government. Various presidents have taken conflicting positions on the degree to which their administrations would enforce federal statutes criminalizing the manufacture, distribution, and possession of marijuana. To further complicate matters, individual municipalities within legalized states have passed their own various ordinances restricting marijuana, in conjunction with, or opposition to, state and federal laws. The ensuing legal conflict has led to many predictable, yet difficult questions regarding financial penalties, incarceration, and in general how to approach an endlessly lucrative business that thumbs its nose at federal authority.

A recent case out of the Ninth Circuit raises a more unique question of law stemming from Arizona’s dissonant marijuana laws. In November of 2010, Arizonans approved a ballot initiative legalizing medical marijuana. Shortly thereafter, many entrepreneurs flocked to the industry, which is worth tens of billions of dollars on the national level. Two such individuals, Brigham and Carly Burton, recently had cause to file for Chapter 13 bankruptcy protection in the U.S. Bankruptcy Court for the District of Arizona (Bk. No. 2:18-bk-04571-BMW). The couple maintained a 65 percent interest in Agricann, a limited liability company engaged in Arizona’s marijuana industry. Although the Burtons claimed that Agricann was no longer a going concern, it was still seeking damages through a number of civil suits at the time the Burtons sought to have their Chapter 13 plan confirmed. Here is where the petitioners’ attempt to secure relief through the cramdown went off into the weeds. If, at some future date during the plan, the Burtons were to realize a windfall from their interest in Agricann’s ongoing litigation, such funds would invariably become part of the bankruptcy estate. What choice, then, would the trustee be left with besides dispersing funds earned by federally criminalized activity to creditors?

Of course, a United States trustee is forbidden from becoming involved in illegal conduct in the settling of a bankruptcy estate. While it is doubtful that the Burtons’ creditors have any particular care over where the funds originated, the trustee cannot collect and distribute funds which are, technically, the proceeds of a crime as set forth in federal law. As a result, the District Court dismissed the Burtons’ case, and on January 14, the U.S. Bankruptcy Appellate Panel of the Ninth Circuit affirmed the dismissal (BAP No. AZ-19-1126-LTaF). 

In its opinion and order, the Appellate Panel provides a comprehensive review of the dynamic case law and ever-evolving questions surrounding the relationship between bankruptcy and the marijuana industry. While the Panel reiterated that mere involvement with some aspect of the marijuana industry does not necessarily serve as an automatic bar to the relief and protection granted by the bankruptcy code, it does point to a near-bright-line rule showing that a bankruptcy case cannot survive if the trustee would be forced to administer assets that are either illegal under the CSA, or are the proceeds of illegal activity under the CSA. However, this rule raises about as many questions as it answers. Most of the cases exploring the interplay between the marijuana industry and the bankruptcy code involve formalized, state-sanctioned business operations standing in conflict with federal law. But what of the individual consumer who may be engaged in a personal operation?

Imagine a scenario in which a creditor – for example, a local B-lot car dealership – is seeking to recover $12,000 in a breach of contract claim against Mary Jane, a debtor in the State of Michigan. The dealership secures a judgment against Jane, and subsequently garnishes her personal bank account, locking up the full amount of the judgment. Jane immediately files for bankruptcy. On her schedule, she states that her only income is derived from her job as a cashier. Suppose her creditors can show that she also derives income from the sale of marijuana, (either as a state-sanctioned caregiver, or as an outright illegal distributor. Is Jane barred from relief otherwise afforded by the bankruptcy code, because the court or trustee might have to dirty their hands with the garnished funds from her bank account, in which the proceeds of her marijuana sales are commingled? Practically speaking, could the plaintiff ever make such a showing? Would the debtor’s subsequent promise to forego such activity for the duration of the plan impact the court’s decision? There are a litany of unanswered questions, some of which have not even been breached.

Back to the Appellate Panel of the Ninth Circuit. A second question arose for the Burtons – could their petition, even provided that they had accurately and honestly listed all of their marijuana-related interests in the schedule, ever be considered “good faith” if they are (or were) engaged in for-profit activity criminalized at the federal level? According to the Panel, certain courts have held that a debtor so situated comes into the court with unclean hands and is not entitled to bankruptcy protection.

Ultimately, as stated, the Panel affirmed the District Court’s dismissal of the case, primarily on the grounds that it was entirely possible the Burtons would realize a windfall from Agricann’s pending litigation, thereby creating a risk that the trustee would be forced to administer ill-gotten gains. To put it in perspective, the bankruptcy court was worried that an order from a state court might produce funds that would then see the bankruptcy court engaged in criminal activity. Now, the Burtons’ creditors must seek remedies through state court, including possible liens and levies of funds that the federal court could not touch. In a word, the situation is ridiculous. To top it all off, various circuits have articulated differing approaches to bankruptcy petitions involving marijuana-related funds, squaring off against one another in the type of stalemate normally broken by the Supreme Court. One can hardly imagine how SCOTUS would be possessed of the authority to reinterpret the federal bankruptcy code to treat funds created by the manufacture or distribution of marijuana as anything other than criminal proceeds, a finding which would obviously be at odds with the current reality of 33 states plus D.C.

I wouldn’t expect any legislative solution to the problem soon – relative to the other conundrums this country faces at the moment, confusion in bankruptcy court over marijuana laws has to take a spot on the back burner. However, this problem does serve to add to the ever-growing list of difficulties faced by both consumers and businesses as a result of having to live and operate in a country with contradictory state and federal laws.

Once again, it appears that the courts, whose charter is to interpret existing law, not create it, will have to pick up legislative slack and provide some directive for aggrieved parties who find statutory law falling short.
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Jacob Kahn is a student at Wayne State University Law School. He works as a process server and law clerk at the Law Office of Anthony Wayne Kahn.