Patricia Heer

Will the Scope of US Trustee’s Policy on Cannabis-Related Bankruptcy Filings be Limited?

The Court of Appeals for the Ninth Circuit revived a chapter 13 debtor’s bankruptcy case holding that the bankruptcy court below made no specific finding that the debtor violated the Controlled Substance Act (“CSA”) to support dismissal of the case.

In In re Olson, 2018 WL 989263 (B.A.P. 9th Cir. Feb. 5, 2018), the debtor, a 92 year old landlord, rented a storefront to a cannabis dispensary. The landlord filed bankruptcy to stay a lawsuit that the tenant dispensary commenced against her. The bankruptcy court dismissed the bankruptcy case based on the ground that the landlord’s rental income constituted illegal proceeds and, thus, the landlord violated the CSA. On appeal, the Bankruptcy Appellate Panel overturned the dismissal holding that the bankruptcy court had not detailed sufficiently its findings with respect to the offending lease to support a conclusion that the landlord violated the CSA. The Panel held that the bankruptcy court could not rely just on the CSA itself to dismiss the case.

The Ninth Circuit’s holding is significant for cannabis businesses given the United States Trustee’s policy that debtors with assets or income derived from marijuana may not proceed through the bankruptcy system. That policy is rooted in the Trustee’s position that bankruptcy plans of debtors that permit continued illegal activity may not be confirmed and that bankruptcy estate fiduciaries should not be required to administer assets that would require violating federal law. Going forward, the Ninth Circuit Panel’s recent demand for more rigorous proof to establish a violation of the CSA, may require the Trustee in future cases to expend more resources to establish a violation before a cannabis-related case will be dismissed.

The Ninth Circuit’s more rigorous demand is actually not far off from a directive issued by the DOJ itself regarding the Department’s requirements to establish violations of federal laws.  Indeed, in Late January, Assistant Attorney General Brand issued a memorandum instructing DOJ that it cannot rely on, for instance, Department guidance documents on particular statutes and the compliance or noncompliance therewith, to establish that a party violated the underlying applicable statute in an active civil enforcement action. Instead, the DOJ must establish that the party violated the requirements specifically and only of the particular statute at issue.

In addition to the requirement of actually establishing a violation of the federal drug laws is the question of whether the US Trustee even has the authority to establish such a violation. Currently, an argument is being made before the US Supreme Court that the IRS, for example, oversteps its administrative authority when it carries out an investigation of a cannabis business and makes a determination whether the business violated the CSA.  In The Green Solution Retail Inc. v. U.S. case no. 17-663, the cannabis business posits that the IRS is not empowered to investigate and administratively rule that an entity has violated federal drug laws.  The IRS, on the other hand, defends its authority arguing that it is required to make such investigations and determinations in order to decide, pursuant to section 280E of the Tax Code, whether the entity is precluded from deducting certain expenses as a business engaging in drug trafficking.  That case is awaiting the Supreme Court’s decision on whether it will hear the case.

Cannabis-related debtors  facing dismissal may take an analogous position – that an investigation and finding of violation of a federal drug statute is beyond the scope of the US Trustee’s authority.   While the US Trustee Program is a component of the DOJ, when it comes to a debtor violating laws, such violations are supposed to be reported to the United States Attorney (USA).  The USA then determines whether an investigation should be commenced, and thereafter whether criminal proceedings should be commenced.  Cannabis-related debtors might argue that before their case can be dismissed for bad faith based on a violation of the CSA, a criminal investigation must first be conducted, which may not have been the process followed by the US Trustee thus far.  Given the recent Ninth Circuit Panel’s decision, and potential impact of the Green Solution case, the extent of the US Trustee’s policy on dismissal of cases involving marijuana may be starting to be curtailed.