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Cannabis Businesses, Once in Trouble, Find No Good Way to Escape

Feb. 11, 2021, 11:00 AM

MedMen Enterprises Inc. thought it had found a niche in the exploding retail market for legalized marijuana. It invested heavily in brick-and-mortar space in high-income areas like Beverly Hills and New York where it believed upscale customers would want to shop.

The company soon learned that even well-heeled cannabis consumers would rather drive a few miles to get a lower price, and that controlling costs is integral to success.

Ordinarily, when a business finds itself in dire straits because of that kind of miscalculation, it can file for Chapter 11 to get breathing room from creditors while restructuring its debts. The bankruptcy code gives a company substantial powers to get out of leases and contracts, and to force creditors to accept less than they’re owed.

But with marijuana still illegal under U.S. law, cannabis companies are blocked from using federal bankruptcy court. Restructuring and insolvency professionals have to turn to other remedies—out-of-court workouts, assignments for the benefit of creditors, and receiverships.

But those approaches rarely allow owners to stay in control. The legal status of marijuana blocks access to commercial banks for financing, and liabilities from states’ rush to tax legal marijuana sales make it difficult to negotiate resolutions.

“No one can do anything—companies can’t file bankruptcy; investors can’t foreclose—it just creates a frozen market,” said Ted Lanes, a court-appointed receiver and restructuring consultant who previously directed operations for MedMen.

The block on cannabis companies using bankruptcy courts was evidenced again Jan. 13, when the U.S. Bankruptcy Court for the District of Colorado dismissed the Chapter 11 case of United Cannabis Corp. at the request of the U.S. Trustee, the Justice Department’s bankruptcy watchdog. United Cannabis had argued that it should be permitted to remain under bankruptcy protection because it deals with hemp products and CBD, distinguishable from marijuana’s high-inducing THC.

Bankruptcy could have helped MedMen escape overly expensive leases and stop a lot of litigation and collection efforts, Lanes said. “I’d have used bankruptcy to eliminate unwieldy horizontal growth and focus on key productive areas,” he said.

After getting new leadership last year, MedMen sought to turn around its fortunes by out-of-court negotiations with lenders, suppliers, vendors, and landlords, according to the company’s filings with the Securities and Exchange Commission. In July 2020, MedMen won rent deferrals and got concessions from its principal lender, Gotham Green Partners, according to the filings.

Out-of-court workouts may be the best option for struggling cannabis companies, said Tara Tedrow, chair of the Cannabis and Controlled Substances Group at Lowndes, Drosdick, Doster, Kantor & Reed PA and a professor at the University of Florida Levin College of Law.

The problem is that for them to work, all parties have to come to agreement, she said. That may not be possible with a large number of creditors.

Cash Only Limitations

Because pot companies are often forced to work cash only, many banks decline to take them on as customers, said Kevin Singer, the founder and president of Receivership Specialists, which serves various locations in southern California, Arizona, and Nevada.

It takes too much effort and expense to count the cash, while banks continue to pivot to more and more electronic services, said Singer, who regularly is appointed as a receiver in pot-related cases. On top of that, the banks are concerned with regulations and deposit insurance, he said.

Furthermore, being an all-cash business creates the potential for mischief, Singer said.

MedMen’s employees—those handling the product as well as the cash—were required to have their pockets sewn shut to reduce the chances for disappearing weed or money, Lanes said.

“You have to remember that before legalization, everyone in the industry was a criminal,” he said.

The inability to get insurance adds to business woes. In riots and looting around the nation last summer following the killing of George Floyd in Minneapolis, many companies lost millions of dollars worth of product, none of which was insured.

And cannabis companies are having a difficult time acquiring capital from new loans, with capital markets “drying up a year and a half ago,” Lanes said.

Institutional investors shy away from the industry, and individual investors are limited in how many licenses they can be associated with, he said. When a company is able to somehow get more investment, it often has to severely dilute the value held by earlier investors.

Meanwhile, law enforcement isn’t particularly motivated to curtail illegal growers and sellers, with marijuana widely decriminalized, Singer said. These sellers can undercut legitimate businesses by about 25%, he said.

State Court Receiverships

Those challenges have made state court receiverships the leading remedy for creditors seeking recovery from insolvent cannabis companies.

Receivership is traditionally used in real estate cases. The receiver, an independent fiduciary overseen by a court, collects rents and profits that have been pledged as collateral to a property owner’s lenders.

It’s a popular option for creditors trying to enforce judgments against cannabis companies, Singer said. Ordinarily a sheriff would execute on a judgment writ by attaching a bank account, but with cannabis businesses, there are no bank accounts to attach. Instead, the sheriff would have to go to the retail locations every day to sweep the till until the debt was paid, and sheriffs won’t do that, Singer said.

When a receiver is appointed, he or she typically takes over the business.

While receiverships sometimes result in a reorganized company—usually through a sale, acquisition by a creditor, or a settlement between partners—it’s primarily a collections remedy and not a restructuring procedure. Out-of-court workouts or restructuring are extremely rare for cannabis companies, Singer and Lanes both said.

More often the receiver will broker a settlement among the disputing parties, or arrange for a sale if that isn’t possible. A lot of these cases feature broken partnerships, many between a dealer-type and a businessman. Often one partner ends up buying out the other, Singer said.

If neither a settlement nor a sale can be reached, the receiver often oversees the company’s liquidation.

A problem with receiverships, however, is that there can be issues transferring licenses to an assignee who’s not properly licensed for the business, Tedrow said.

And because grow or sale licenses—a cannabis company’s most valuable assets—aren’t fungible and can’t be transmitted without the approval of each state’s cannabis control board or other agency regulating the industry, those assets end up having very little value, Lanes said.

State tax debts are also a big factor in many troubled cannabis businesses. In California, consumers are being taxed 25% to 30% for cannabis products, Singer said. Lanes called it a “breathtakingly expensive tax.”

Looking Ahead

In December 2020, the House passed a measure to legalize marijuana federally. The measure wasn’t taken up by the Senate.

But with a growing lobby and more states legalizing or at least decriminalizing weed, many are expecting the federal government eventually to join the 35 states and District of Columbia that have taken those steps.

“Sooner or later it’s going to happen,” Singer said.

MedMen last month managed to complete a $10 million convertible debt sale to investors led by Gotham Green Partners, according to SEC filings. To Lanes, staying afloat with debt sales is “just dodging bullets.”

Of course, not all companies have had success finding new investors or trying to get creditors, landlords, suppliers, and vendors to voluntarily reduce their claims. So companies have to scrape by however they can, for now.

“They’re just trying to hold on long enough for courts to give them some kind of protection, somewhere, somehow,” Lanes said.

To contact the reporter on this story: Daniel Gill in Washington at dgill@bloomberglaw.com

To contact the editor responsible for this story: Bernie Kohn at bkohn@bloomberglaw.com; Laura D. Francis at lfrancis@bloomberglaw.com

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