Tag Archives: marijuana

September 29, 2015

Another Marijuana Bankruptcy Case Bites the Dust as the Arizona Bankruptcy Court Dismisses an Involuntary Case Filed Against a Medical Marijuana Dispensary

Following its sister court in Colorado[1] the United States Bankruptcy Court for the District of Arizona recently held that the debtor’s operation of a business that it illegal under federal law mandates dismissal of an involuntary bankruptcy petition filed against the debtor.  In re Medpoint Management, LLC, 528 B.R. 178 (Bankr. D. Az. 2015).  Medpoint Management managed the operations of Arizona Nature’s Wellness (“ANW”), which held an Arizona Department of Health Services-issued Dispensary Certificate allowing it to operate a branded medical marijuana dispensary under the Arizona Medical Marijuana Act.  In its capacity as manager, Medpoint owned ANW’s name and trademark under which ANW sold its marijuana products.  When several of its creditors filed an involuntary bankruptcy petition against it Medpoint filed a motion to dismiss the petition.  In the context of the motion to dismiss, the court analyzed the issue as “whether [the court] can or should enter an involuntary order for relief against Medpoint despite the fact that Medpoint’s current and former business affairs are illegal under applicable federal criminal statutes.”

Medpoint argued that the case should be dismissed because the trustee could not lawfully administer the bankruptcy estate’s marijuana-related assets without violating the Controlled Substance Act, 21 U.S.C. § 801 et seq.  The petitioning creditors argued that an order for relief was not precluded under federal law because their claims against Medpoint were not related to it’s the actual proceeds of its marijuana sales, that Medpoint had received a federal tax identification number and maintained a bank account at an FDIC-insured bank, and that Consolidated and Further Continuing Appropriations Act (“Cromnibus Act”) prohibited the use of appropriated funds to “prevent Arizona from implementing its own law that authorizes the use, distribution, possession or cultivation of medical marijuana.”

The court decided to dismiss the case for cause.  It was persuaded by the opinions from the Colorado bankruptcy court dismisses two marijuana related cases.  The first, In re Arenas, held dismissal proper because the chapter 7 trustee could not take control of or administer the debtor’s assets without violating the Controlled Substance Act.  The court in In re Rent-Rite Super Kegs held that dismissal was proper in a case where the debtor owned real property that was rented to a marijuana entity and that the debtor’s continuing lease with that entity constituted gross mismanagement of the estate.  The Arizona court was persuaded by these decisions.  The court determined that the bankruptcy trustee would be placed in an untenable position, with the debtor’s assets subject to the prospect of possible forfeiture or seizure by the federal government under the Controlled Substance Act.  The fact that the Cromnibus Act prohibited the use of appropriations by the government under it to enforce the Controlled Substance Act did not persuade the court, as it noted the Department of Justice had other sources of funds from which it could prosecute violations of the Controlled Substance Act.  In short, the court held that entering an order for relief would result in the trustee necessarily violating federal law in carrying out his or her duties under the Code.  As a result, the court found cause existed to dismiss the involuntary petition.



[1] In re Arenas, 514 B.R. 887 (Bankr. D. Colo. 2014); In re Rent-Rite Super Kegs W. Ltd., 484 B.R. 799 (Bankr. D. Colo. 2012)

July 21, 2015

Ninth Circuit Holds Public Policy Prevents Attorney from Defending Client’s Fraud Claim Under the Unclean Hands Doctrine

Client, with the assistance of its attorney, engages in illegal conduct.  Client places money received from its illegal conduct in the attorney’s trust account.  Attorney absconds with these illegal funds.  When the client brings a non-dischargeability action in the attorney’s bankruptcy case, may the attorney defend the action under the unclean hands doctrine because the funds he stole were gained by the client through its own illegal conduct?  As a matter of public policy, the Ninth Circuit has answered this question in the negative.  In Northbay Wellness Group, Inc. v. Beyries (In re Beyries), 2015 WL 3529634 (9th Cir. 2015), the attorney, Michael Beyries, served on Northbay Welness’ board of directors and acted as its counsel.  Northbay engaged in business in California as a medical marijuana dispensary, a business illegal under federal law.  Northbay deposited $25,000 into Beyries’ trust account to hold for use as a legal defense fund for Northbay and its employees.  Beyries stole the money, resigned from Northbay’s board, and absconded. 

Eventually Beyries filed bankruptcy, and Northbay filed a non-dischargeability action for the theft of its trust funds.  Although it found that such conduct would result in a judgment of non-dischargeability, the bankruptcy court dismissed the adversary proceeding because the funds held by Beyries in trust were the proceeds of Northbay’s own illegal conduct.  The U.S. District Court affirmed the dismissal, but the Ninth Circuit reverse. 

The Ninth Circuit’s opinion was based on public policy grounds.  The court noted that a plaintiff seeking a denial of the discharge of his debt must come to the court “with clean hands,”  and a plaintiff who does not cannot obtain a judgment of non-dischargeability.  However, the court noted that a defendant wrongdoer cannot always “retain the profits of his wrongdoing merely because the plaintiff himself is possibly guilty of transgressing the law.”  In addition, the court held that the unclean hands doctrine should not be strictly enforced when doing so would frustrate an important public policy.  Consequently, courts are required to balance the plaintiff’s wrongdoing against that of the defendant.  In the present case, Beyries was on Northbay’s board of directors and, in the court’s opinion, therefore as guilty of the illegal conduct as was Northbay.  Significantly, Beyries was Northbay’s attorney, owing it a fiduciary duty to maintain the funds placed with him in trust by his client:  “A lawyer’s ‘[m]isappropriation of a client’s prop is a gross violation of general morality likely to undermine public confidence in the legal profession and therefore merits severe punishment.’”  (citing Greenbaum v. State Bar, 544 P.2d 921, 928 (Cal. 1976). 

Weighing the relative wrongdoing, the court determined that the doctrine of unclean hands cannot prevent recovery of funds stolen from a client.  As a result, the Ninth Circuit held the bankruptcy court abused its discretion in dismissing Northbay’s complaint for non-dischargeability.

September 25, 2014

Nowhere to Turn for Insolvent Marijuana Businesses

Recreational marijuana is legal in two states—Washington and Colorado—and medical marijuana is legal in another twenty-one states.  Colorado alone has over 500 marijuana dispensaries and that number is on the rise.  However, as the marijuana industry continues to grow, federal law still prohibits the use of marijuana.  So what happens when a marijuana business becomes insolvent? Does it have the right to avail itself of the protections of the Bankruptcy Code?

The United States Bankruptcy Court for the District of Colorado (the “Court”) says no.  In In re Arenas, 2014 Bankr. LEXIS 3642 (Bankr. D. Colo. Aug. 28, 2014), a husband and wife filed for chapter 7 bankruptcy.  The husband engaged in the business of producing and distributing marijuana on the wholesale level in Colorado. The husband carried on his business operations in one unit of a commercial building owned by the debtors.  The debtors also leased another unit in the building to another marijuana dispensary.  The wife was not involved in the business and her income derived solely from disability payments. 

About one month after the debtors filed for bankruptcy, the United States Trustee (“Trustee”) moved to dismiss their case.  The Trustee argued that the Court should dismiss the case because it should not enforce the protections of the Bankruptcy Code to aid violations of the federal Controlled Substances Act (“CSA”).  Moreover, the Trustee argued that the Court should not place him in the position of administering assets used in connection with marijuana-related businesses.  The debtors filed a pro se opposition to the motion as their counsel previously withdrew from the case because it and the debtors disagreed as to whether bankruptcy relief was available to the debtors.

The Court agreed with the Trustee and debtors’ counsel and held that the debtors could not receive bankruptcy protection while operating the marijuana business.  Specifically, while the Court found that the husband’s activities were legal under Colorado law, they still violated the CSA.  These violations of federal law created significant impediments to the debtors’ ability to seek relief under the federal bankruptcy laws in a federal bankruptcy court. 

In its decision, the Court referred back to its prior ruling in In re Rent-Rite Super Kegs West Ltd., 484 B.R. 799  (Bankr. D. Colo. 2012).  In that case, the Court addressed issues concerning a chapter 11 debtor’s activities with respect to medical marijuana.  It held: “Unless and until Congress changes [federal drug] law, the Debtor’s operations constitute a continuing criminal violation of the CSA and a federal court cannot be asked to enforce the protections of the Bankruptcy Code in aid of a Debtor whose activities constitute a continuing federal crime.”  Id. at 805.

The debtors in Arenas invited the Court to reexamine its decision in the Rent-Rite case, but it declined to do so.  The Court explained that the “fundamental bargain underpinning a chapter 7 consumer liquidation case is that a debtor turns over his non-exempt assets to a chapter 7 trustee so those assets may be liquidated for the benefit of creditors….  Here, the…Trustee cannot take control of the Debtors’ property without himself violating…the CSA.  Nor can he liquidate the inventory of marijuana plants…because that would involve him in the distribution of a…controlled substance in violation…of the CSA.”  In re Arenas, 2014 Bankr. LEXIS 3642 at *10.  Therefore, the Court found that administration of the case under chapter 7 was impossible without involving the Court and the Trustee in ongoing criminal violations, and that impossibility constituted “cause” for dismissal under 11 U.S.C. § 707(a).

Moreover, the Court denied the debtors request to convert the case to a case under chapter 13 because any reorganization would be funded from ongoing criminal activity and would necessarily involve the chapter 13 trustee in administering and distributing funds derived from such activity.  The Court found that such circumstances would violate Section 1325(a)(3)’s requirement that a chapter 13 plan be “proposed in good faith and not by any means forbidden by law.”  Therefore, the Court denied the debtors’ request to convert and dismissed the case. 

In dismissing the debtors’ case, the Court noted that it recognized that dismissal would be devastating for the debtors, but that the legal analysis necessary for the resolution of the case was “relatively straight-forward.”  In re Arenas, 2014 Bankr. LEXIS 3642 at *19.  The debtors have appealed the decision to the United States Court of Appeals for the Tenth Circuit.

The marijuana industry continues to grow and legalization efforts are ongoing throughout the nation.  However, the Colorado cases make clear that unless federal law changes, there may be nowhere to turn for insolvent marijuana-related businesses.