ACannabis company Kalamazoo’s recent Chapter 11 bankruptcy filing will test particularly murky legal waters and could potentially set a legal precedent for other cannabis-related businesses facing insolvency.
Master Equity Group LLC filed April 20 with the U.S. Bankruptcy Court for the Western District of Michigan under Subchapter V of the federal bankruptcy code, a relatively new but frequently used measure designed to expedite the bankruptcy process for small and medium-sized businesses.
In court filings, Master Equity CEO Adam Tucker described Master Equity as a “holding and management company for several related businesses operating in the cannabis industry.” In this role, Master Equity Group purchases or leases properties for sublease to cannabis businesses while performing accounting, payroll, and other centralized functions. Kalamazoo-based Cannazoo Recreational Weed Dispensary is one such brand.
Portrayed by Mark Shapiro of Southfield Steinberg Shapiro & Clark, Master Equity Group faces total liabilities between $100,001 and $500,000. The company owes its 18 major creditors a total of $176,255, according to the filing.
Some of the largest unsecured claims come from Angola, Ind. Northern industrial floors for $26,109, Portage-based internet law firm Legal Review for $23,268, and based in Chicago Adams Outdoor Advertising for $21,340.
Shapiro and Tucker did not respond to requests for comment.
Federal and state laws conflict
However, the case is far from an ordinary bankruptcy filing. Master Equity Group profits from its involvement – albeit indirectly – in the production, marketing, sale and distribution of marijuana, which is still federally illegal.
Under the Controlled Substances Act, marijuana is listed as a Schedule I controlled substance, which is deemed to have no accepted medical use in the United States, a lack of accepted safety for supervised use medical and a high potential for abuse.
Administrators in the United States, who are parties to all bankruptcy cases and serve as a watchdog for the system, generally do not allow cannabis-affiliated businesses to seek protection through the bankruptcy process, leaving suspend the fate of the Master Equity Group case. in the balance.
“The U.S. Trustee’s Office has for several years taken the position that it is illegal for bankruptcy courts to administer cases involving marijuana companies, even if they are legal under state law,” said said Robert Hendricks, senior counsel for Warner Norcross+Judd LLP, who is also co-chairman of the company’s cannabis industry group.
The scant legal precedent, coupled with the U.S. administrator’s vocal stance on the issue, suggests administrators in the Western District of Michigan will likely file to dismiss the case, Hendricks said.
“They could have said, ‘We’re going to try to file for bankruptcy and argue that because we’re not touching the factory, we have the right to come up with a plan,'” Hendricks said. “Maybe they can convince a bankruptcy court to rule that way, maybe they can’t – who knows. Lots of other people have tried this and most of them don’t. have not succeeded. But every court is different.
However, the case could potentially open new legal horizons if allowed to go ahead.
“This may be the first instance in the country, of which I am aware, of allowing an entity legally authorized under state law to grow, process, or distribute cannabis to receive the same federal right of liquidation or of reorganization as corporate entities in other industries,” said Steve Bylenga, co-founder of the Grand Rapids-based company. CBH Lawyers and Advisorsspecializing in bankruptcy cases.
A spokesperson for the US Trustee Program wrote in a statement to MiBiz“The US Trustee Program enforcement actions are based on the well-established legal principle that the provisions of the Bankruptcy Code cannot be used to facilitate violations of federal criminal law. That said, enforcement action decisions are based on the particular facts of a case, including whether the affected assets are held in violation of federal law.
While legal precedents for cannabis-related bankruptcies in Michigan may be limited, the petitioners have asked the courts to review their cases. Local attorneys pointed to a few past cases in which cannabis-related businesses were excluded from the bankruptcy process.
One case dates back to 2015 and involved Western Michigan resident Jerry Johnson, who was a licensed grower and caregiver under the state’s medical marijuana law. Johnson filed for Chapter 13 bankruptcy in an attempt to avoid the foreclosure sale of his home. Since about half of his income came from growing and selling marijuana, he was in direct violation of federal law.
The bankruptcy court did not dismiss the case, but it did allow Johnson to go through the bankruptcy process if he exited his marijuana business, which he did.
Another case unfolded in the Eastern District of Michigan involving Basrah Custom Design Inc., which in 2018 filed for Chapter 11 bankruptcy protection. The cabinetmaking business operated out of two buildings spouses, which she rented from a cannabis dispensary. Due to her entanglement with the dispensary, her Chapter 11 case was thrown out by a bankruptcy judge.
With bankruptcy being essentially irrelevant, cannabis companies must seek alternative paths when faced with financial insolvency.
Working with creditors outside of court is one avenue, allowing the cannabis company to try to reach an agreement without the legal shield of bankruptcy that prohibits creditors from taking individual legal action.
“You can try that, but it usually doesn’t work, especially the bigger the case gets and the more creditors get involved,” Hendricks said. “Each creditor wants to get just a little more than his neighbor.”
Michigan also allows state court receiverships in which a state circuit judge appoints a receiver, giving it the power to take control and liquidate the debtor’s assets before distributing money to creditors. . These state court receiverships are permitted under Michigan law and the rules of the state’s Cannabis Regulatory Agency.
The fact that cannabis companies cannot benefit from bankruptcy structure or protection can be risky for parties looking to invest or work in the cannabis space.
“Bankruptcy doesn’t just protect debtors,” Bylenga said. “It also protects creditors and investors by providing a codified, cost-effective process to liquidate or reorganize distressed corporations. Investors like predictability. They like to know in advance how their claim will be handled if a business fails.
While Hendricks echoed that sentiment, he also said some creditors were optimistic that if a cannabis company’s finances deteriorated, they could potentially reach an even better settlement deal.
“In my experience, investors and lenders and those selling on credit to cannabis businesses have already built into their pricing and terms the understanding that bankruptcy is probably not available and that other means will have to be taken if the debtor fails to do so. do it,” Hendricks said.