Member Blog: How Risk Management Can Heal Medical Marijuana Businesses

by Steve Schain, Esq., Senior Attorney at Hoban Law Group

Envision managing the risk of a volatile, staggeringly lucrative, 100 percent federally illegal enterprise. Toss in ridiculously inconsistent federal, state and local regulations, insanely evolving technologies and efficiencies, and an industry-wide disinclination to “play by the rules.” Remember to remove the safety net, because neither cannabis businesses, nor their owners, are entitled to bankruptcy law protection.

However, when armed with decent risk management fundamentals, a marijuana-related business (“MRB”) can diminish most horrible outcomes, fortify the enterprise’s sustained growth, and maybe even get rich along the way.

Risk management is the identification, evaluation, and prioritization of risks followed by coordinated and economical resources application which minimize, monitor, and control unfortunate events’ probability or impact. 

Identifying Marijuana-Related Businesses’ Loss Exposure

The Comprehensive Drug Abuse Prevention and Control Act of 1970 prohibits marijuana’s manufacture, distribution, dispensation and possession and lists it next to heroin as a Schedule I controlled substance having “a high potential for abuse”.  21 U.S.C. §§ 801, Et. Seq (1970). Because of marijuana’s one hundred percent (100%) federal illegality, MRB’s are denied many standard “risk management tools” (like credit cards, bankruptcy law protection, and federal patents and trademarks), assembling a “risk management insurance, accounting, and legal advisory team” could prevent an insufficiently prepared MRB from foundering. 

Risk management is the process of anticipating losses and developing a plan to survive them through: (1) identify each loss exposure (ex., being sued for a defective product); (2) evaluating each loss exposure’s frequency and severity; (3) weighing, then selecting, each exposure-managing-technique; (4) deploying exposure managing techniques; and (5) reviewing evaluating and improving risk-management plan.  

An MRB’ “loss-causing-events universe” encompasses: (1) people (owners, investors, employees, customers and vendors); (2) property (buildings, equipment, crops, inventory, vehicles, data, cash, intellectual property); and (3) profits. 

Although people are a MRB’ most valuable asset, and their welfare is the first priority, even the most safety-conscious businesses experience job-related injuries costing thousands in medical expenses and lost productivity. Through enacting safety plans and rigorous employee training, accidents’ frequency and severity can be minimized, employee health and welfare can be protected, and workers’ compensation insurance coverage premiums can be stabilized. Similarly, to prevent a dying investor’s ownership transferring to a less than cooperative relative, MRBs could obligate owners to execute buy-sell agreements requiring their survivors to sell decedent’s portion to the surviving partners. 

Unlike people, damaged or destroyed property can be repaired and replaced and its “useful life” can be accurately anticipated and amortized. Unfortunately, due to federal prohibition, MRBs are denied many standard insurances (like crop or cash exceeding $25,000), federal trademark and patent protection, and banking and credit card services. 

MRBs’ profits and valuation create the greatest vulnerability and regulatory fines and penalties, business interruption, and lawsuits impose the most perilous risk. Because they endure federal, state and local regulations, MRBs are vulnerable to fines and penalties from federal agencies, state agencies, and each municipality and borough in which they operate.

“Business interruption loss” is where an event halts an MRB’ operations like a wildfire’s soot and ash wiping out a grower’s crops immediately prior to harvest. Before the ensuing revenue-generating-grow-cycle is completed, employees, utilities and rent still require payment and, unless it has 6 months of cash to survive a revenue-less 180 day period, an MRB could get crushed. 

Lawsuits range from a single plaintiff seeking damages to class actions in which an entire group of claimants seek compensation. Each year defective, faulty or misused products cause serious injuries and property damage. Although primarily seeking remuneration for personal injury, property damage, or economic harm, product liability claims may also seek punitive relief to punish the defendant and redress harms allegedly done to society. Defending litigation or settling claims can materially drain a company’s resources requiring additional regulatory requirement compliance, developing/ disseminating product warnings, instituting a product recall, deploying employee time to investigate/mitigate claims, investigating/testing products and assessing risk, and hiring expert consultants. 

Bankruptcy’s Unattainable Protections

Because of marijuana’s one hundred percent (100%) federal illegality, and because bankruptcy can’t be used to facilitate federally illegal activity or administer assets that can’t be possessed or sold under federal law, bankruptcy protection is denied to both marijuana growers, processors, sellers, and transporters and the parties that own them.

Generally governed by federal law, called the “Bankruptcy Code” (“Code”), the bankruptcy system allows debtors to either dismiss or partially satisfy debts they are incapable of fully paying, and, upon filing, creates an “automatic stay” period during which creditors are prohibited from attempting to collect. Bankruptcy petitions are filed in a federal bankruptcy court governed by federal law, although state laws may determine how debtors’ property rights are affected (ex., validity of liens or exempting property from creditors). 

Bankruptcy’s most common form is a Chapter 7 “liquidation” in which the court appoints a trustee to collect and sell debtors’ non-exempt property and distribute proceeds to creditors. Because most state allows debtors to keep essential property, Chapter 7s are usually “no asset” in which there are zero saleable assets to fund a distribution to creditors. 

Bankruptcies allowing debtors to keep some or all of their property, reorganize and use future earnings to pay off creditors fall under Code Chapters 11, 12 or 13. Individual debtors usually file Chapter 13s, business entities file Chapter 11s, and Chapter 12 filings mirror Chapter 13 but are only available to “family farmers” and “family fisherman” and provide more debtor favorable terms.

Because the bankruptcy system cannot be used to facilitate illegal activity and the Code provide no mechanism to administer assets that cannot be legally possessed or sold under federal law, bankruptcy protection is unavailable to both Plant Touching MRBs and the parties that own them.

First, because the United States Trustee Program prohibits debtors with marijuana-derived-income-or-assets from proceeding, Plant Touching MRB’s Chapter 7 petitions are usually dismissed upon filing. April 26, 2017 Letter from Clifford J. White, Director, Executive Office for the United States Trustee to Chapter 7 and Chapter 13.

Second, even if a compliant state-licensed MRB debtor is involved, most bankruptcy courts dismiss cases involving marijuana-derived-income-or-assets. In re Arenas, 535 B.R. 845 (B.A.P. 10th Cir. 2015) (denial of marijuana grower/seller and legal dispensary landlord’s motion to convert to Chapter 13 and Chapter 7 dismissal because debtor is unable to propose feasible plan without violating federal law and trustee’s estate administration duties by selling debtors’ assets); In re Medpoint Management, LLC, 528 B.R. 178 (Bankr. Az. 2015) (dismissing “owner of intellectual property leased to marijuana products seller” due to “dual risk” of assets’ potential forfeiture and trustee’s CSA violation in administering estate).  

This “bankruptcy protection denial” also may extend to Non Plant Touching MRBs. In re Way to Grow, Inc., (Bankr. D. Col., Dec. 14, 20l8 No. 18-14330)(because hydroponics equipment seller knew or had reason to believe that customers would use equipment to grow marijuana, bankruptcy dismissed because business deemed illegal under 21 U.S.C. §843(a)(7)).

2019 National Law Journal “Finance, Banking, & Capital Markets Trailblazer” award winner, Steve Schain chairs global cannabis law firm Hoban Law Group’s PA and New Jersey practice and chairs its Financial Services Group. With 17 offices and 52 lawyers, Hoban Law Group is the only practice 100% devoted to cannabis and hemp law. Admitted to practice in PA and New Jersey, Steve represents entities, governments, and individuals in litigation, regulation, compliance, preparing and submitting license applications, entity formation, and drafting legislation. A nationally recognized consumer finance litigation, banking law, and cannabis law expert, Steve is a The Legal Intelligencer, New Jersey Law Journal, and Cannabis Business Executive columnist, frequent Pennsylvania Bar Institute, and National Bar Institute author and lecturer and serves as a court-appointed judge pro tempore and arbitrator.