The adult-use marijuana market in Michigan has seen a plunge in the price of marijuana. According to the Cannabis Regulatory Agency, the average price of one ounce of marijuana in December 2020 was $350.88. In contrast, the average price fell to $109.22 in September 2022. This rapid price compression puts tremendous pressure on many marijuana businesses as they face greater competition with ever-slimming margins. For some, these market forces may present a financial or existential crisis.
Often, financially-distressed companies seek the protection afforded by federal bankruptcy courts to restructure their finances. There are several benefits to an overwhelmed debtor going through the bankruptcy process. As just one example, once a debtor files for bankruptcy, an automatic stay on actions prevents creditors from collecting against a debtor until the bankruptcy case is resolved or the Court allows the stay to be lifted. In addition, bankruptcy provides an orderly process that provides the debtor with the means of resolving creditor claims simultaneously.
However, the doors to the bankruptcy courts are currently closed to marijuana businesses because marijuana is still illegal at the federal level. Since marijuana is still classified as a schedule 1 drug under the federal Controlled Substances Act, bankruptcy courts will not administer the assets of marijuana businesses since the business and proceeds are derived from a federally illegal criminal enterprise. Reform would be necessary to address this issue, but some financially struggling marijuana businesses may not have the luxury of waiting for reform and, consequently, will have to consider alternatives to bankruptcy to resolve their distress. Each alternative has associated positives and negatives, and the availability of each is highly fact-intensive. The following is a short overview of some of the aspects of each alternative.
Creditor Composition Agreement
From a practical standpoint, unless the entity is seeking to wind down or sell assets, which can be a risk for creditors and equity alike, an out-of-court workout agreement, oftentimes referred to as a composition, workout, or restructuring agreement (collectively a “Plan”), is often the best course of action for all parties involved. A Plan is a contractual agreement amongst the main stakeholders, which usually contains operational and financial requirements, milestones for key events, and the amounts that will be distributed to creditors, with creditors agreeing to stand down in collection efforts and reduce debt obligations if the terms and conditions of the Plan are met. Oftentimes out of court Plans provide the basis upon which owners can retain equity interests, whereas many in court options would result in a complete loss of owner’s equity interests.
Plans are usually the most achievable when there is a relatively simple debt structure (for example, a single lender/secured creditor), a relatively small number of creditors with similar interests, and the primary reason for the financial distress arising from market conditions rather than mismanagement. Both secured and unsecured creditors will be more supportive of this approach when there is a high risk of an inability to sell the company and low recovery on claims in a liquidation (i.e., liquidation values are low). Because of the high regulatory aspects of a cannabis business and the difficulties in selling the entities without equity owner support, an out of court Plan is sometimes the only good viable option for these companies. Benefits of this approach include providing a path for the owners to maintain control of the business, potentially lower legal fees since it is out-of-court, and quicker resolution if there is little dispute among the parties. The downsides to this approach are it is difficult to get creditors organized and on the same page. Instead, creditors are prone to trying to hold out and litigate as a strategy to attempt to obtain better treatment than other similarly situated creditors, which often causes the prospect of a Plan to fail and results in the company’s liquidation. In addition, by its nature, a Plan requires coordination of creditors. As a result, owners can find themselves dealing with an organized, recalcitrant group that can be even more difficult to deal with if a Plan agreement is not reached. Lastly, during this process, a creditor could seek the appointment of a receiver or take other action, rendering the deal a nullity and, in hindsight, a potential waste of time and effort.
A receivership is a court proceeding provided by federal or state statutes in which a person acting as an officer of the Court takes possession, custody, and control of a company’s assets. Since the federal court system is not available to a marijuana company, the appointment of a receiver would have to be through state statutes that permit a receivership process for a marijuana-based company. In Michigan, for example, a receiver may receive approval from the Cannabis Regulatory Agency to manage a marijuana establishment, which helps resolve any licensing issues. MCL 333.27959a. Whereas licensing issues have prevented receiverships in certain other states because the receiver is not licensed to operate the marijuana business. See e.g. Yates v Hartman, 488 P3d 348, (Colo 2018). Because state receiverships limit the legal reach of receivers, which can only take control of assets located in the applicable state, practically speaking, the appointment of a receiver is only a viable option for smaller operating businesses with operations located in one state. Otherwise, multiple receivership proceedings would be required to take over control of the assets and thus is not ideal for multi-state operators. See Emmons v Emmons, 136 Mich App 157, 355 NW2d 898 (1984).
Owners of companies that want to retain control of a company’s operations typically will not support a receivership proceeding since receivers usually act as court officers that take over the business operations, replacing management and operating or liquidating assets for the benefit of the creditors. A Receivership proceeding provides a means for the preservation of, and either a restructuring or sale of, the company’s assets for the benefit of the creditors. Generally, the creditor recommends the receiver they would like the Court to appoint and nominates that person to the Court for approval. Since courts often appoint receivers upon the request of a creditor and after a judgment has been awarded, it can be an effective means for a creditor to remove management and have an independent party take control over the debtor’s assets. See MCL 600.6104. It can also provide a means for shareholders themselves to “walk away” from the business by seeking to dissolve the company through the appointment of a receivership. See MCL 600.3505. In contrast to bankruptcy proceedings, in Michigan, receivers are only guided by Michigan Court Rule 2.622 and an order of the Court appointing the receiver (“Order Appointing Receiver” or “OAR”). OARs often mirror many of the basic provisions provided by Bankruptcy Code processes, including providing injunctions against third-party actions to repossess the property. This injunction preserves the assets for the creditors and creates a more streamlined process through one proceeding.
A downside of a receivership proceeding is that it can be expensive for the entity seeking the appointment of a receiver. Indeed, in Michigan, the Court may order a creditor to pay the fees. See MCL 554.1031. In addition, a receiver may have to hire outside professionals to advise on the management of the business and may hire its own counsel, which all can become part of the cost of seeking the receivership proceeding. While these fees may eventually become the debtor’s obligation, if the debtor’s assets are insufficient to satisfy the receiver’s fees, the creditor seeking the appointment is likely liable for the fees.
Hence, a receivership could be a good creditor remedy against a marijuana business if a receivership statute is in place that authorizes a receiver’s continued operation. Without such a statute, a court may decline to authorize the receivership, or the receiver may face state regulatory issues in administering the estate, creating, at best, uncertainty of a receivership as a viable option for debtors or creditors of cannabis-based businesses.
Assignment for the Benefit of Creditors
An assignment for the benefit of creditors (“ABC”) is again a state law-determined process. Consequently, the law from one state to another can be quite different, with some making ABCs part of a court process and others governed by statute. The ABC creates a means for transferring an entity’s assets to a trust or third party that acts as a trustee over the assets. This third party must oversee the sale of these assets and distribute the proceeds from the transferred assets. Michigan ABCs are statutory and involve a court process in which the debtor enters into an agreement with an assignee, assigning the property to the assignee. See MCL 600.5201. After receiving the assigned assets, the assignment agreement is filed in state Circuit Court, and the assignee is then obligated to inventory and value the assets. The assignee has a duty to pay as much of the assignor’s debts as possible from the assets after the property is sold at a public or private sale. The limit on this approach is that, at this time, the Cannabis Regulatory Agency does not expressly have the authority to approve of an assignee taking over the assets of a marijuana business or transferring these assets, and, thus, it is unlikely that a debtor company can legally transfer its marijuana products to an assignee. See MCL 333.27959a. In addition, this process calls for liquidating the company’s assets. While some have interpreted this to allow “liquidation” to be a quick sale of an operating entity as the means for liquidation, it is rarely used for an operating entity that intends to remain in business.
In summary, struggling marijuana businesses and their creditors currently have limited tools available for addressing financial distress. Since both the insolvent company and creditors have limited options, it puts both at high risk that the only outcome would be the limited prospect for selling the entity’s assets resulting in liquidation. Exceptionally high-risk factors for all sides are often the best cases for developing out of court Plans that brings parties together to reach a fair settlement to restructure the debts, resulting in a relative “win” for all parties within the context of no perfect outcome for anyone when dealing with financial distress. The art of pulling multiple parties together and getting them to agree on the goal and how to achieve it requires skills beyond just the legal knowledge. Consequently, creating the right team to approach creditors is as important, if not more, as the structure of the deal sought to be achieved.
Dykema will continue to monitor the legal market and offer updated options for any struggling marijuana company. Stay tuned for more updates from Dykema.