The Closed Doors of Bankruptcy Court for Cannabis-Related Businesses and Individuals Continue To Open Ever So Slightly
As we discussed in this previous post, cannabis businesses, as well as individuals who work in the industry, face unique hurdles and challenges if they attempt to avail themselves of bankruptcy protection. The ongoing failure of the federal government to reschedule cannabis under the Controlled Substances Act (CSA) and its continued illegality at that level has led bankruptcy judges, with rare exceptions, to take a “zero tolerance” approach to any bankruptcy proceeding or plan that involves funding from proceeds derived from cannabis sales. Fortunately, as a recent Massachusetts bankruptcy court decision illustrates, judges are attempting to navigate a course around this absolutist position to allow for bankruptcy relief in some matters that include cannabis-related income.
Blumsack v. Harrington (In re Blumsack) involved a Chapter 13 bankruptcy proceeding initiated by a “budtender” at a Massachusetts dispensary. The debtor proposed a plan that would have been funded with earnings from his employment at the dispensary. Citing the CSA, the United States Trustee asked the bankruptcy court to deny confirmation of the debtor’s plan and to dismiss his case.
Cannabis-Derived Income Alone Is Not a Bar to Bankruptcy Protection
As is often the case with such debtors, the Trustee asserted that, due to his violations of the CSA, the debtor could not satisfy the Bankruptcy Code’s requirements that (a) the Chapter 13 petition was filed in “good faith” under 11 U.S.C. § 1327(a)(3), and (b) the Chapter 13 plan was proposed in “good faith” under 11 U.S.C. § 1327(a)(7).
The court agreed and granted the Trustee’s request to dismiss the case, finding that “The Debtor’s Chapter 13 plan as currently proposed is to be funded by the wages derived from . . . illegal activities, which would require the Chapter 13 trustee to knowingly administer wages derived from an active participant in a criminal enterprise. . ..[T]he Court cannot find, under an objective standard, that the case was filed in good faith or that the plan was proposed in good faith as required by §§ 1325(a)(7) and (a)(3), since, from the inception of this case, the Debtor has engaged in and benefited from, and intends to continue [to] engage in and benefit from, activities that violate federal criminal law.
On appeal, the Bankruptcy Appellate Panel concluded that “the bankruptcy court erred in fashioning a rule of law that categorically prohibits an individual employed in the cannabis industry from seeking Chapter 13 relief.” It noted that a “good faith” analysis required consideration of the “totality of the circumstances” surrounding the filing of the petition and the proposed plan. In doing so, it wrote that:
“The good faith provisions of [Bankruptcy Code] § 1325 are not referenda on the debtor’s conduct generally; they are tethered to the debtor’s actions in filing a petition and proposing a plan. The bankruptcy court’s conclusion that ongoing violation of the CSA renders an individual categorically unable to file a Chapter 13 petition in good faith is, in our view, unmoored from the bankruptcy-specific context in which the good faith inquiry must occur.”
Beyond that, the court continued, “Broad categorical parameters regarding who is eligible to be a debtor are not the stuff of good faith, a fact-intensive inquiry specific to individual debtors and their particular financial circumstances.” It noted that “Congress has not articulated a ‘zero-tolerance’ policy that requires dismissal of any bankruptcy case involving violation of the CSA (or other activity that might be proven to be illegal). That type of policy choice to close the doors to the bankruptcy court categorically, without regard to individual circumstances, is one more appropriately left to the legislature” rather than bankruptcy judges.
Because of the CSA, Plans Funded by Cannabis Income Are Still Not Allowed
Even though “the nature of the debtor’s employment, by itself, does not render him ineligible to file a Chapter 13 petition in good faith,” the appellate court nevertheless agreed the debtor had not proposed his bankruptcy plan in good faith because it was to be funded by his cannabis-derived income. Bankruptcy trustees are not permitted to administer assets under a bankruptcy plan when those assets are illegal under the CSA or constitute proceeds of activity the statute criminalizes. If the debtor’s plan had instead relied on funds derived from sources other than his cannabis income, it would have been a different story, and his “budtending” job alone would not have seen his plan rejected and his case dismissed.
If followed by other courts, the rule articulated in Blumsack – a debtor’s cannabis-derived income is not a problem, but a cannabis-funded bankruptcy plan is – means those employed in the cannabis industry may be able to obtain relief that to date has been unfairly denied them. However, true clarity on the interaction between the Bankruptcy Code and the CSA won’t come until cannabis is de-scheduled at the federal level.