AKalamazoo cannabis company’s recent Chapter 11 bankruptcy filing will test some particularly murky legal waters and could potentially set a legal precedent for other cannabis-related businesses facing insolvency.
Master Equity Group LLC on April 20 filed with the U.S. Bankruptcy Court in 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 to mid-sized companies.
In court filings, Master Equity CEO Adam Tucker described Master Equity as a “holding and management company for several related-entity businesses operating in the cannabis industry.” In this role, Master Equity Group buys or leases property to sublease to cannabis businesses along with providing accounting, payroll and other centralized functions. Kalamazoo-based Cannamazoo Recreational Weed Dispensary is one such brand.
Represented by Mark Shapiro of Southfield-based Steinberg Shapiro & Clark, Master Equity Group faces between $100,001 and $500,000 in total liabilities. The company owes its top 18 creditors a total of $176,255, per the filing.
Some of the largest unsecured claims are from Angola, Ind.-based Northern Industrial Flooring for $26,109, Portage-based internet law firm Revision Legal for $23,268, and Chicago-based Adams Outdoor Advertising for $21,340.
Shapiro and Tucker did not respond to requests for comment.
Federal, state laws collide
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 illegal at the federal level.
As part of 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 use under medical supervision, and a high potential for abuse.
United States Trustees, which are a party to all bankruptcy cases and serve as a watchdog for the system, generally do not allow businesses affiliated with cannabis to seek protection under the bankruptcy process, leaving the fate of the Master Equity Group case hanging in the balance.
“The U.S. Trustee’s office has taken the position for several years now that it is illegal for the bankruptcy courts to administer cases that involve marijuana companies even if they’re legal under state laws,” said Robert Hendricks, senior counsel for Warner Norcross+Judd LLP, who also is co-chair of the firm’s Cannabis Industry Group.
The scant legal precedent, paired with the U.S. Trustee’s vocal stance on the matter, would suggest that trustees in the Western District of Michigan will likely file to dismiss the case, Hendricks said.
“They might have said, ‘We’re going to try to file bankruptcy and argue that, because we don’t touch the plant, we’re entitled to propose a plan,’” Hendricks said. “Maybe they can convince a bankruptcy court to rule that way, maybe they can’t — who knows. A lot of other people have tried that and most of them have not been successful. But every court is different.”
However, the case could potentially break new legal ground if it’s permitted to move forward.
“It could be the first case in the nation, of which I am aware, to allow an entity that is legally licensed under state law to cultivate, process, or distribute cannabis to receive the same federal right to liquidate or reorganize as corporate entities in other industries,” said Steve Bylenga, co-founder of Grand Rapids-based CBH Attorneys & Counselors, who specializes in bankruptcy cases.
A U.S. Trustee Program spokesperson wrote in a statement to MiBiz: “U.S. Trustee Program enforcement actions are based on the well-established legal principle that the provisions of the Bankruptcy Code cannot be used to aid in the violation of federal criminal law. That said, enforcement action decisions are based upon the particular facts of a case, including whether the assets involved are held in violation of federal law.”
While legal precedent for cannabis bankruptcies in Michigan may be limited, petitioners have requested courts to consider their cases. Local attorneys pointed to a couple of previous cases in which cannabis-related businesses were shut out of the bankruptcy process.
One case dates back to 2015 and involved West 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. Because roughly half of his income was generated through the cultivation and sale of marijuana, he was in direct violation of federal law.
The bankruptcy court did not throw out the case, but it allowed Johnson to move through the bankruptcy process if he abandoned his marijuana activity, which he did.
Another case played out in the Eastern District of Michigan involving Basrah Custom Design Inc., which in 2018 filed for Chapter 11 bankruptcy protection. The cabinetry business operated out of two conjoined buildings, which it leased to a cannabis dispensary. Because of its entanglement with the dispensary, its Chapter 11 case was thrown out by a bankruptcy judge.
With bankruptcy essentially off the table, cannabis companies must seek alternate routes when faced with financial insolvency.
Working with creditors outside of court is one avenue, allowing the cannabis company to try and strike a deal without bankruptcy’s legal shield that prohibits creditors from taking individual legal action.
“You can try that, but usually that doesn’t work, especially the bigger the case gets and the more creditors are involved,” Hendricks said. “Every creditor wants to get just a little bit more than their neighbor.”
Michigan also allows for state court receiverships in which a state circuit judge appoints a receiver, equipping them with the powers to take control and liquidate the debtor’s assets before distributing money to creditors. These state court receiverships are permissible under both Michigan law and under the rules of the state’s Cannabis Regulatory Agency.
The fact that cannabis companies can’t benefit from the structure or protection of bankruptcy 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 and cost-efficient process to liquidate or reorganize distressed corporate entities. Investors like predictability. They like to know in advance how their claim will be treated if a company fails.”
While Hendricks echoed that sentiment, he also said that some creditors are optimistic that, if finances go south for a cannabis company, they could potentially strike an even better settlement deal.
“In my experience, investors and lenders and those who sell on credit to businesses in the cannabis space have already built into their pricing and terms the understanding that bankruptcy is probably not available and other means will have to be taken if the debtor doesn’t make it,” Hendricks said.