What is Cannabis Receivership? Here’s Everything You Need to Know.
Investing in a business is an inherently risky endeavor. Depending on the industry and type of investment, the chances that something might go wrong could be much higher than one expects.
Poor decision making, market fluctuations, a substandard product or running out of money are just a few reasons why companies might be in distress and in danger of failing.
Investing in a cannabis business poses all of those traditional investment risks—and more—in a unique regulatory environment. This is especially true when it comes to recovering an investment from a business in distress, attempting to work out disputes or initiating a turnaround to regain solvency.
In recent years, many new state cannabis markets have come online. But at the federal level, cannabis remains firmly rooted as a Schedule 1 drug with “no currently accepted medical use and a high potential for abuse.” Until the (inevitable) sea change arrives and federal legalization becomes a reality, cannabis investors and business owners will continue to face unique challenges and risks. And in order to recover capital in an industry where federal bankruptcy protection is not an option, cannabis receivership is the logical alternative.
Here’s a comprehensive overview of how receivership works, and considerations for any cannabis investor:
The federal illegality of cannabis means that federal bankruptcy courts typically cannot be used to facilitate the possession or sale of cannabis business assets. This extends to companies that are only tangentially involved in a state-legalized cannabis industry.
Some court briefs have hinted that bankruptcy may be appropriate for some cannabis-related companies in particular instances, but this option remains largely unavailable to those individuals and businesses that have any link—even if it is indirect—to the cannabis industry.
Even businesses operating in the federally legalized hemp sector have failed to receive requested bankruptcy protections. The Chapter 11 case of United Cannabis Corporation is a recent example of a business that deals solely in hemp failing to secure federal bankruptcy protection due to perceived indirect links to cannabis.
While federal bankruptcy protection and state-legal cannabis don’t mix, receivership is a solution that can look a lot like the bankruptcy process.
Cannabis receivership is a tool to restructure the debt, handle distressed assets and / or mitigate the losses of a company in dispute. The receiver is a court-appointed, neutral professional who is entrusted to manage not just the company’s operations, but also the finances and property of the business to protect assets and collateral.
Key goals of cannabis receivership include:
- Restructuring and prioritizing payment of debts to creditors;
- Creating a more efficient operations model;
- Monitoring business assets and collateral;
- Ensuring enforcement of government regulations, and;
- The ability for business owners to negotiate with creditors to lower interest rates.
A receivership can be initiated at the request of a creditor, a business partner or mortgagee to recover debts. Depending on the state, it can also be requested by a business owner or cannabis license holder if the business is in danger of insolvency. If a license holder initiates a receivership, it is usually with the goal of restructuring to get the business back on track to profitability.
Receivers must be state-approved and cannot be aware of technical or sensitive aspects of the business in question prior to being vetted by the state. The state agency can then protect its interests if it is a party to a receivership action and part of the process.
Ideally, the displaced cannabis licensee, the creditors and the receiver will work together to determine a strategy and plan for how the receivership will restructure debt, transfer or liquidate assets and facilitate the process in a way that will best benefit all involved.
After taking control of a cannabis business, the receiver will assess the business across its operations and decide whether to liquidate or restructure while working to protect the collateral of creditors. The receiver also administers the claims process that may or may not pay out to unsecured creditors. Depending on the state and the court, most companies under receivership will be protected from any new legal actions without court approval.
It’s important to know that receivership can be a costly process. A receiver bills time at an hourly rate and often retains counsel, accountants, outside financial services and other professionals to effectively complete the transactions. When a cannabis business is already distressed, complete liquidation of assets is a potential end result.
As you might imagine, there are several reasons why a cannabis business would reach the point of distress that would necessitate receivership. State laws usually specify the grounds for a receiver to be appointed, but ultimately, insolvency or failure to protect creditor interests and / or property rights are standard reasons for an appointment. If the debtor has defaulted on an obligation, the creditor can file a lawsuit against the debtor that may result in the appointment of a receiver.
When is a cannabis receivership needed? Here are three common reasons:
Increasing Debt: Creditors decide that their investment has been poor and want to get out as quickly as possible to recover what they can.
Investor Lawsuits: The investor thinks that the business is not being run properly or efficiently. Depending on the court, this might not be enough of a reason for a receivership. However, if the investor can prove negligence or misuse of funds or assets, the court will normally proceed.
Internal Disputes: The classic scenario of partners or owners fighting over how the business should be managed and who should have the most control.
Investments and loans are made with the expectation that the debtor will make the most of the loan and the creditor will be rewarded for the risk taken on the investment.
But even the best-laid plans do not always work out. If the debtor’s business becomes distressed, creditors need an effective tool to secure what is left of their investment and recover as much as possible.
A receivership allows for the rapid takeover of operational control of the business and provides a defined pathway to understanding what value might be recovered on the way to liquidation, or even turning around the fortunes of the distressed business through restructuring.
A lack of transparency and accountability can be detrimental to any business, and the cannabis industry is no different. To that end, receivership provides essential clarity.
For example: Cannabis ventures might be established by partners with disparate interests and backgrounds. One partner could represent the financial or marketing side of the company and another might handle the actual hands-on operational side of the business, be it an indoor cultivation facility, a manufacturing production line or a commercial kitchen. The internal disconnect between the two can potentially lead to disputes if the business revenue stream begins to suffer or fails to live up to expectations.
A court-appointed receiver has the power to access all financial and operational information about the company in order to make the process as transparent and secure as possible.
Once receivership is implemented, the receiver is the only individual who controls the assets of the business; the debtor cannot sell or transfer anything of value. Additionally, the receiver is subject to strict reporting requirements concerning budget, hours billed and work performed. Those reports are available to all involved parties, and any can object if it thinks that assets are not being properly valued.
This transparency across the business operations and finances allows the receiver to determine accountability that will either facilitate the distribution of assets, or provide the necessary monitoring access to complete a restructuring of the business. In extreme scenarios, receivership can also provide the transparency necessary to preserve threatened assets and stop fraud.
Financial disputes take many forms: They can arise over how revenue is managed (current federal banking restrictions mean that almost all cannabis businesses are primarily cash-based operations), how the company leadership is paid, or any number of minor disagreements that can quickly grow into more pronounced issues.
A cash-heavy business requires the implementation of unique and specific accounting and theft-prevention procedures.
Asset protection is a key objective of receivership. In a case where employees or stakeholders of the business might be intentionally committing fraud, legal action can be taken on behalf of one or multiple partners, and if the conflict is substantial and deemed justified, the court will appoint a receiver to take over the business operations and accounting until the dispute is resolved. Additionally, creditors who are concerned that a company or individual might damage or waste company assets can initiate receivership.
Receivership can also be used to avoid insolvency by bringing in a financial expert or forensic accountant who can manage assets while looking into the company’s structure.
If the receiver or financial expert can determine that all is not lost and changes can be made, he or she can initiate a restructuring process that can save the company from being dismantled.
State cannabis receivers are officers of the court who have broad power but have to navigate a varied and unpredictable landscape of state laws. State courts can appoint a receiver to run a failing cannabis business, and provide investors with some form of return through liquidating certain assets or selling the business itself.
The receiver essentially replaces the management team or business owner with the goal of preserving property and / or assets. The receiver can take possession of property, enter into contracts for lease or sale, execute deeds, collect rent, open accounts and perform any other task that is authorized by the court. The receiver can also force parties to renegotiate or restructure agreements that preserve a value or an asset.
Operational restructuring is an option if the receiver determines that a successful turnaround is probable after a thorough analysis of the company’s operations, but it is more likely that a court-approved sale of assets will be the outcome of most receiverships. Equity can be reinvested into the business, but the receiver must first stabilize the business and assure creditors of its solvency.
A receiver also has the ability to freeze certain creditor actions to ensure particular claims are honored before others. This is especially important if some creditors have a personal relationship with the cannabis business operator.
Not surprisingly, each state has its own set of rules and regulations regarding receivership.
Often, cannabis licenses aren’t revoked simply as a result of receivership. It is in the interest of the state to keep licensees operational, especially if the business is in the middle of a transparent compliance process like receivership.
In several states, court-appointed receivers are allowed to temporarily manage cannabis businesses, with a goal of keeping a company under receivership operational until assets can be redistributed to creditors.
Although current management will often be forced out when a receiver takes operational control, a receivership may nonetheless be an attractive option for business owners unable to reach an agreement with creditors. Depending on the circumstances, the receiver may be authorized to restructure the company’s debts or liquidate certain assets to generate funds for repaying creditors.
Although every receivership is unique, there is a traditional path that the process follows. First, the receiver tries to stabilize the business and achieve some type of profitability. Restructuring, lowering expenses and negotiating with creditors to lower interest rates are some tactics a receiver may utilize to achieve stability.
The receiver then assesses the longer-term prospects and why a receivership was needed in the first place. As mentioned above, the receiver does this by looking closely at the operations, logistics and finances to gain an understanding of the issues the company was facing that necessitated the courts to become involved. The receiver will then either initiate litigation or, if necessary, seek specific court authority to bring a lawsuit.
Because the receiver serves as a court-appointed objective and neutral party, he or she has the ability to ensure equitable debt resolution in an objective and efficient manner. A receivership provides the best structure to restructure for the cannabis industry. Creditors—secured and unsecured—have the opportunity and the platform to file and support their claims. The receiver is responsible for review and to make recommendations of allowed claims and their priorities subject to court approval.
The receivership ends upon court discharge or dismissal, and after all assets have been distributed to creditors.
A distressed business isn’t something anybody wants—not the investors, and certainly not the business owners and operators. At the end of the day, receivership provides a transparent roadmap to a final resolution, relief or even redemption. If you are looking for guidance, reach out to United CMC. Our expert team is here to help you.