Cannabusiness Advisory

United Cannabis Chapter 11 Bankruptcy: Plant-Touching Litmus Test

April 24, 2020


United Cannabis Corporation (“United Cannabis”) and its wholly-owned subsidiary, UC Colorado Corporation, filed for Chapter 11 bankruptcy protection in the Bankruptcy Court for the District of Colorado on April 20, 2020. United Cannabis’ primary line of business is operating extraction facilities to convert compounds of industrial hemp flower into finished CBD products, while also deriving a limited amount of revenue from licensing its IP to plant touching businesses. The United Cannabis bankruptcy proceeding could be a unique test case for the cannabis industry.  Here is what you need to know:

Cannabis:  How Much is Too Much? What makes this case so fascinating is that, following the passage of the 2018 Farm Bill, certain hemp/CBD companies are now able to file for federal bankruptcy protection, which relief was denied to plant-touching and, for the most part, ancillary businesses.   United Cannabis’ business generates nearly all of its revenue from CBD product sales, with only (at most) a de minimis amount of revenue derived from IP licensing fees to medical and recreational marijuana businesses. According to the company’s recent SEC filings, the United Cannabis reported substantially all of its revenues – nearly $13 million – were derived from the sale of CBD products to customers. During that same period, the company generated less than $68,000 in revenues from licensing fees and consulting. Interestingly, United Cannabis owns a patent for concentrated liquid formulations of CBD, THC, and THCa, which the company licenses to medical and recreational marijuana businesses, per its SEC filings. While other bankruptcy judges have dismissed cases filed by ancillary companies, will the fact that less than 1% of its revenues were derived from MRBs make a difference?

Will United Cannabis’ Chapter 11 be Permitted to Proceed? The Colorado bankruptcy judge overseeing the Chapter 11 bankruptcy proceeding offered some insight when he entered an order to show cause this week. The judge asked the debtor and the U.S. Trustee to show cause why this case should not be dismissed since the debtor licenses a patent in the marijuana industry and therefore “appears to be engaged in the marijuana industry.” In its show cause order, the Court cites a number of cases, including holdings for the proposition that “[d]espite being legal under state law, activities associated with the marijuana industry are illegal under federal law and cannot be condoned by the bankruptcy courts.” A September 2019 Colorado district court decision may be instructive. In Way to Grow, the Chapter 11 debtors sold indoor hydroponic gardening-related equipment to customers growing various types of crops, including marijuana. On appeal, the Colorado district court reasoned that the debtors could not propose a good-faith plan of reorganization due to their reliance on profits generated from marijuana, and therefore the court affirmed the dismissal. We will be watching for a response to the show cause order from the United States Trustee – and perhaps the IRS, which holds an all asset federal tax lien. The U.S. Trustee Program generally has moved to dismiss all cannabis-related bankruptcy petitions, regardless of legality at the state level in which a debtor operates. Indeed, on April 22, 2020, the U.S. Trustee filed a motion to dismiss a Chapter 11 case filed in Colorado by an ancillary company, GrowCo., Inc.

Availability of DIP/Exit Financing?  If United Cannabis’ Chapter 11 case is not dismissed, and the Court permits the debtor’s reorganization to proceed, we will be curious to see who might provide debtor-in-possession (“DIP”) financing to fund the debtor’s post-petition operations during the Chapter 11 reorganization, as well as any exit facility upon the debtor’s emergence from Chapter 11. Query whether traditional sources of financing will be available, or will the debtor lean on existing secured creditors, or some other funding source, for DIP financing and any exit funding?

What about the Small Business Reorganization Act? At present, information about the debtor’s bankruptcy case is quite sparse, revealing few enlightening specifics.  United Cannabis’ skeletal bankruptcy petition indicates that United Cannabis has under $10 million in assets and under $10 million in liabilities. Given that United Cannabis owes $4.97 million to its 20 largest creditors, of which approximately $3.88 million of those claims is disputed, this raises the question of whether the debtors considered availing themselves of the Small Business Reorganization Act of 2019 (the “SBRA”) The SBRA, which went into effect on February 19, 2020, created new Subchapter V (“Subchapter V”) of Chapter 11 of the Bankruptcy Code.  Subchapter V was envisioned to make it easier for small business debtors to restructure their liabilities and successfully emerge from Chapter 11 through a streamlined and cost-efficient reorganization process.  Moreover, Subchapter V is intended to afford small business owners the ability to retain their equity and control of the company.  Originally, only small business debtors with non-contingent secured and unsecured debt under $2,725,625 could avail themselves of relief under Subchapter V, but with passage of the CARES Act, the maximum debt threshold was raised to $7.5 million.  However, this increased debt cap is only temporary and will sunset on March 27, 2021, unless further action is taken by Congress to extend. We anticipate that smaller hemp and CBD companies looking to reorganize rather than liquidate will seek protection under Subchapter V.

While one never knows how a court will rule, all of us in the industry will be watching how the Colorado bankruptcy court rules with respect to the availability of bankruptcy protection to ancillary companies and whether some de minimis threshold of revenues derived from THC will come into play.

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