Distressed cannabis businesses can get temporary relief from a court-appointed receiver

Robert T. Hoban, Co-Chair, Clark Hill Cannabis Industry Group

When approaching a tough situation where a company in distress needs to either try to save itself or negotiate debt, lawyers might be inclined to recommend Chapter 11. 

This well-known reorganization plan, conducted through federal bankruptcy courts, offers a business the ability to stay afloat, borrow money, pay off creditors or dissolve in the most financially beneficial manner. In the immature but growing cannabis industry, though, federal law prohibits companies from declaring bankruptcy and the best way to find relief is often in the form of a cannabis receivership.

Although legal cannabis at the state level is still a fairly recent development, the industry has seen plenty of businesses fail, and an alarming percentage of cannabis companies claim to operate without making any profit. Gross revenues may be high, but there is a litany of debilitating issues, such as tax code restraints—specifically Section 280E of the Internal Revenue Code—lack of investment capital, market oversaturation, illegal products, severe compliance regulations and forbidden interstate commerce that create intense pressure on businesses. Through a receivership, some of that pressure can be relieved. 

The concerns listed above are not the only things that create roadblocks to success within the cannabis sector. Similar to other rapidly emerging industries, investors and creditors with little to no experience in the field are attracted with the hope of cashing in on the boom. Foreign investors working in international public markets can be disconnected from the actual day-to-day operations of the cannabis company and take money out of the business with relative impunity, to the detriment of the company’s interests. 

Additionally, operational inefficiencies due to inexperienced management and a lack of understanding of how the industry works can drag companies into the red. Infighting is often the result as parties blame each other for why the company is struggling.

In a nascent industry with compliance regulations that vary from state to state and can be frustratingly fluid, the individual in charge of the company’s compliance plays a critical role. They might be well-versed in government regulations, but without cannabis business experience and a deep knowledge of industry statutes, the company could receive substantial fines and penalties for not operating within the layered rules established by the state regulatory agency.

Preparing to Approach the Bench

Once it becomes apparent—or is determined by one or more of the stakeholders—that the company has reached a point where a receivership is the best option, the parties involved will go to court.

In the best-case scenario, issues that are destabilizing the business are identified, the mismanagement acknowledged and all of the problems understood. Any internal power plays or ulterior motives should be surfaced and addressed. The scope and goals of the receivership to be requested should also be agreed upon and fashioned by the lawyer presiding over saving or reorganizing the company. If the lawyer does as much as possible to present a united front to the court, it will be more inclined to order the receivership and appoint a receiver—giving the receivership the best chance for success. 

The court will not be pleased if it has to make any judgment regarding the business itself. Nor will it take sides or determine any right or wrong in the scenario. The receiver will be given the power to take advantage of the breathing room provided by the court’s order to attract investment, alter lines of credit, freeze tax or debt payments, and provide creditor protection.

Finding the Right Cannabis Lawyer 

The lawyer presiding over saving, reorganizing or liquidating the assets of the company should fully assess the cannabis business risk mitigation options and create a clear pathway that allows difficult situations to be properly addressed when they inevitably come up.

There typically are a litany of issues that follow once the hood of a company is peeled back in any industry, and many of those issues are exacerbated in the cannabis space. Most critically, that lawyer needs to have deep knowledge of the cannabis industry and how cannabis businesses operate within the jurisdiction in question. For example, can raw inventory be liquidated via wholesale channels? Would it perhaps be more lucrative to take the raw inventory and convert it into finished consumer goods? In some jurisdictions, the answer to each question is yes. In other jurisdictions, the answer is no. The lawyer needs to understand such nuances to be truly effective.

There are plenty of people who jump into the cannabis space with no expertise and do not have the knowledge of the business or the legal tactics available to work effectively or to be bailed out of a bad situation. Even in the federally legal hemp and CBD industries, many owners and operators are not aware that there are lawyers who are cannabis specialists who can facilitate receiverships in order to avoid outright bankruptcy, and such operators face the same challenges as their THC-producing cousins when it comes to Chapter 11.

To learn more about the role of cannabis lawyers in receivership scenarios, reach out to Bob Hoban at Clark Hill PLC. For more information about cannabis business risk mitigation, contact United CMC today.