Legalization of marijuana continues at the state level including in several new states this November, but it remains illegal at the federal level. Given this illegal status, businesses and individuals directly involved in the marijuana industry have often been unable to obtain relief in federal bankruptcy courts—with bankruptcy courts dismissing marijuana cases because the purported debtor’s conduct is unlawful under federal law. Three cases decided in 2020 highlight potential barriers to bankruptcy protection faced by debtors even when they are only indirectly involved in the marijuana industry.
As far back as April 2017, the Director of the Executive Office for United States Trustees, delivered a directive to all Chapter 7 and Chapter 13 trustees advising them that, among other things, “[i]t is the policy of the United States Trustee Program that United States Trustees shall move to dismiss or object in all cases involving marijuana assets on grounds that such assets may not be administered under the Bankruptcy Code.” Notably, the directive was not levelled solely at cases filed by debtors directly engaged in the marijuana industry, but was broad enough to encompass “all cases involving marijuana assets.” The result has often been the dismissal of bankruptcy cases even when the debtors are arguably indirectly involved in the marijuana industry.
Ninth Circuit Bankruptcy Appellate Panel
In Burton v. Maney (In re Burton), 610 B.R. 633 (B.A.P. 9th Cir. 2020), the bankruptcy court dismissed the bankruptcy case of individuals who owned an interest in an entity that was suing third parties for breach of contracts relating to growing and selling medical marijuana. On appeal, the Burton court affirmed and concluded that there was sufficient cause for dismissal because any proceeds recovered from the debtors’ litigation would necessarily represent profits from a marijuana business that is illegal under federal law. In doing so, the panel acknowledged that “the mere presence of marijuana near a bankruptcy case does not automatically prohibit a debtor from bankruptcy relief” and deliberately avoided any “bright-line rules requiring the immediate disposition of bankruptcy cases in which marijuana activity is present.”
District of Colorado
In March 2020, a Colorado district court addressed whether it was proper for a bankruptcy court to revoke an order reopening a Chapter 7 case because permitting the case to proceed could involve the Chapter 7 trustee’s administration of a marijuana asset in violation of federal law. See In re Malul, No. 11-21140 MER, 2020 WL 1486775 (D. Colo. March 24, 2020). In Malul, the debtor owned an equity interest in an entity that was formed to conduct business in the marijuana industry. The debtor sought to reopen her case and cause the Chapter 7 trustee to abandon the debtor’s claims against the marijuana entity’s former principal, whom the debtor accused of misappropriating the debtor’s investment. The court concluded that dismissal was proper because the debtor’s investment in the marijuana entity, in and of itself, was illegal and any proceeds recovered in connection with the failed investment would be proceeds derived from an illegal activity.
Nevada Bankruptcy Court
Most recently, in October 2020, a Nevada bankruptcy court dismissed the bankruptcy case of an entity that did not intend to operate in the domestic marijuana industry, but instead pursue a license in Canada to participate in that country’s legal marijuana industry following bankruptcy. See In re Pharmagreen Biotech, Inc., No. 20-50780-BTB (Bankr. D. Nev. Oct. 7, 2020). The bankruptcy court dismissed the case—holding that the debtor “does not qualify as a debtor based on its contemplated operations which include the cultivation and sale of marijuana.”
While states continue their tolerance for legalizing marijuana (see here), the federal government has yet to follow suit. Until it does, bankruptcy relief might remain unavailable not only to those debtors directly engaged in the marijuana industry, but also—as the recent Burton, Malul and Pharmagreen Biotech cases illustrate—those debtors who may be only tangentially involved in the industry.
 The United States Trustee Program is a component of the Department of Justice that is tasked with, among other things, overseeing the federal bankruptcy process, protecting the integrity of the bankruptcy system, monitoring the conduct of parties and private trustees and ensuring compliance with applicable bankruptcy laws and procedures. See https://www.justice.gov/ust/about-program.