The Debtor argued that his cannabis-related investments required dismissal of the case because those assets could not be administered by a Chapter 7 trustee.

In In re Roberts, No. 22-10521, 2022 WL 4592086 (Bankr. D. Colo. Sept. 23, 2022), the Bankruptcy Court of the District of Colorado (the “Bankruptcy Court”) held that a Debtor’s alleged ownership interest in cannabis-related companies did not require a dismissal of the case and that a Chapter 7 trustee could administer the Debtor’s assets. This represents a significant change from prior decisions from this Court, which has usually dismissed any bankruptcy case involving cannabis.

Background

In Roberts, the Debtor, an individual investor, formed a limited liability company with two partners for the purpose of purchasing and developing real estate in Mexico. Together, the three investors purchased four beachfront properties through their jointly owned company and its Mexican subsidiary between 2006 and 2012. Two of the properties were purchased subject to an existing lien, and the investors negotiated a settlement agreement with the lienholder whereby the lienholder agreed to release the lien in exchange for $6.5 million. Rather than pay the lienholder on behalf of the investors’ shared company, the Debtor fraudulently purchased the lien for himself and attempted to foreclose on the property by hiring armed guards to take physical possession of all four of the jointly owned properties.

In 2018, the Debtor’s two investment partners and their jointly owned companies (collectively, the “Creditors”) filed cross claims as well as a third-party complaint against the Debtor in an ongoing lawsuit in the Denver District Court (the “District Court”). The District Court granted the Creditors’ request for a preliminary injunction enjoining the Debtor from taking any further action with respect to the four properties. In complete derogation of this injunction, the Debtor transferred his interest in the properties to two Mexican nationals.

During years of protracted litigation in the District Court, the Debtor repeatedly violated court orders and was held in contempt of court on two occasions. The District Court ultimately found that the Debtor had engaged in a fraudulent scheme to misappropriate the rights of his partners in the Mexican land venture and entered a default judgment in favor of the Creditors. In 2020—just four days before a hearing on damages was scheduled to occur in the District Court and while the Debtor was jailed for contempt of court—the Debtor filed for Chapter 11 bankruptcy in the Bankruptcy Court.

In the Bankruptcy Court, the Creditors argued, among other things, that the Debtor’s bankruptcy case was filed in bad faith and moved for the Bankruptcy Court to convert the Debtor’s Chapter 11 case to a Chapter 7. The Creditors also argued that, in light of the Debtor’s pre-petition litigation misconduct, the Bankruptcy Court should prohibit the Debtor from remaining in control of his assets as a debtor-in-possession and immediately appoint a Chapter 7 trustee to administer the estate’s assets.

The Debtor argued that his bankruptcy filing was proper, and that, in the event that cause existed to dismiss or convert his filing, his filing should be dismissed because his assets included an ownership interest in two cannabis companies that would become property of the estate in a Chapter 7 case. The Debtor argued that his cannabis-related investments required dismissal of the case because those assets could not be administered by a Chapter 7 trustee.

Ruling

Under Section 112(b)(1) of the Bankruptcy Code, a bankruptcy court may convert or dismiss a Chapter 11 case for “cause,” including, for example, when a bankruptcy filing is made in bad faith. The Bankruptcy Court analyzed a variety of factors—including the Debtor’s pre-petition conduct, the likelihood of success of the Debtor’s reorganization, and the timing of the filing in the context of the District Court action—and found that the present case presented a “textbook example” of a bad faith filing.

The Bankruptcy Court rejected the Debtor’s argument that his cannabis-related investments require that the case be dismissed, rather than converted to a Chapter 7, noting that the Debtor voluntarily sought relief under Chapter 11 with knowledge of his interests in these companies. Although the Debtor alleged that he had an ownership interest in two companies that are involved in the cannabis industry, the specific nature of those companies’ business and the extent of the Debtor’s ownership interest remained unclear. The Bankruptcy Court explained that, although the Debtor’s conduct may have violated the Controlled Substances Act, “a bankruptcy court must be explicit in articulating its legal and factual basis for dismissal for cases involving marijuana,” and the Bankruptcy Court found that it lacked adequate information on the record to explicitly articulate the factual basis for dismissal.

The Debtor relied, in part, on In re Arenas, 535 B.R. 845, 845 (10th Cir. BAP (Colo.) 2015), to support the argument that his cannabis-related investments compel dismissal. In Arenas, the bankruptcy court granted a U.S. trustee’s motion to dismiss a bankruptcy case due to the debtors’ involvement in the cannabis industry. Unlike the Roberts case, the Arenas debtors owned property that was being used for cannabis cultivation and leased space for use as a cannabis dispensary. The Bankruptcy Court found that the Debtor’s connection to the cannabis industry is “far more attenuated” than the debtors in Arenas, noting that “the mere presence of marijuana near a bankruptcy case does not automatically prohibit a debtor from bankruptcy relief.”

The Bankruptcy Court also noted that, unlike in Arenas, the U.S. trustee had not objected to the conversion of the Debtor’s case. However, the Bankruptcy Court left the door open for the case to be dismissed at a later date (presumably by motion by the Chapter 7 trustee) after more facts are developed about the nature of the Debtor’s involvement in the cannabis industry.

Conclusion and Commentary

The Bankruptcy Court granted the Creditors’ motion and ordered the swift appointment of a neutral third party to serve as the Chapter 7 trustee. The Roberts decision may be a signal that a debtor’s alleged investment in cannabis-related companies alone is not an automatic death knell to a debtor seeking bankruptcy relief or prevent a Chapter 7 trustee from administering estate assets, especially if the debtor’s connection to the cannabis industry is “attenuated.”

For More Information

If you have any questions about this Alert, please contact Lawrence J. Kotler, any of the attorneys in our Business Reorganization and Financial Restructuring Practice Group, any of the attorneys in our Cannabis Industry Group or the attorney in the firm with whom you are regularly in contact.

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