BAP rules “mere presence” of marijuana near bankruptcy case not sufficient for dismissal

The following is a case update analyzing a recent decision of interest:

Summary

In a relatively short period of time, the United States Court of Appeals for the Ninth Circuit decided two reorganization cases involving the growing and sales of marijuana in very different manners, and for very different reasons. 

Most recently, the U.S. Bankruptcy Appellate Panel for the Ninth Circuit (“BAP”) affirmed a bankruptcy court’s dismissal of a chapter 13 case filed by Brigham and Carly Rae Burton (the “Burtons”).  The Burtons owned the majority interest in Agricann, LLC (“Agricann”), an entity that was engaged in cultivating and selling marijuana – an action that is illegal under the federal Controlled Substances Act, 21 U.S.C. sections 801 et seq., in particular, section 841(a).  A copy of the decision is available here.

Facts

In In re Burton, 610 B.R. 633 (9th Cir. BAP Jan. 14, 2020), the bankruptcy court issued an order to show cause why the case should not be dismissed due to the Burtons’ majority ownership interest in Agricann, a marijuana-related business.^[1]  The Burtons had scheduled a potential gross recovery of $31 million from state court lawsuits in which Agricann was the plaintiff, but asserted that recovery from those lawsuits was “unlikely.”  The bankruptcy court rejected this assertion as not credible, and concluded that any recovery from those lawsuits would be derived from conduct that is illegal under federal law.  The bankruptcy court reasoned that if the case were allowed to continue, the bankruptcy court and the trustee would be required to become involved in such illegal conduct.  As a result, the bankruptcy court found dismissal was proper.  The debtors appealed the order dismissing the case to the BAP.

Reasoning

In affirming the dismissal, the BAP considered the recent Ninth Circuit decision Garvin vs. Cook, 922 F.3d 1031 (9th Cir. 2019).  There, the court affirmed the bankruptcy court’s order confirming a chapter 11 plan, over the objection of the United States Trustee, even though one of the chapter 11 debtors had a tenant who leased property from the debtor for use in a marijuana growing operation.  Specifically, the chapter 11 debtor planned to use income from that lease to fund the plan.  The United States Trustee objected that the lease violated federal drug law – namely, the Controlled Substances Act – and the plan was therefore unconfirmable under Section 1129(a)(3) because it was proposed by means forbidden by law. 

The bankruptcy court overruled the objection and confirmed the chapter 11 plan.  The Ninth Circuit affirmed, concluding that Section 1129(a)(3) directs bankruptcy courts to police the means of a reorganization plan’s proposal, not its substantive provisions.  The panel specifically found that the plan was not proposed by any means forbidden by law, despite the alleged violations of federal law. 

In finding that the Garvin case did not support a reversal of the dismissal of the Burton’s case, the BAP in Burton noted:

The sole issue before the Ninth Circuit in Garvin was whether the plan at issue violated § 1129(a)(3)’s requirement that a chapter 11 plan be proposed “not by any means forbidden by law.”  The Circuit held that § 1129(a)(3) directs courts to look only to the proposal of a plan, not its terms.  The Circuit specifically rejected the notion that § 1129(a)(3) forecloses confirmation of a plan that relies on income from criminal activity, as held by some bankruptcy courts considering whether to dismiss a case based on a debtor’s involvement in the marijuana business.  The court acknowledged that there may be consequences arising from a debtor’s connections with criminal activity, but denial of confirmation under § 1129(a)(3) is not one of them.

Burton, at 640, n. 8. (citations omitted).

The BAP in Burton recognized that there seemed to be a split in authority among courts from other circuits, and stated that it appeared to the BAP that the Ninth Circuit was reluctant “to adopt per-se bright line rules requiring the immediate disposition of bankruptcy cases in which marijuana activity is present . . .”  Id. at 641.  The BAP concluded that the Burtons had failed to demonstrate that the proceeds derived from activity illegal under federal law – the selling of marijuana – would not become part of the estate, nor that the court and the trustee would be absolved of the duty to administer those assets. 

Author’s Commentary

The Burton court stated at the beginning of its discussion that “the mere presence of marijuana near a bankruptcy case does not automatically prohibit a debtor from bankruptcy relief.”  Burton, at 637.  It cited the Garvin case (among others) as support for this proposition.  The fact that the Burton case was filed under chapter 13, and the Garvin case was filed under chapter 11, did not seem to factor into the decision.  Query: if the Burton debtors appealed further to the Ninth Circuit, would they stand a chance of reversing the BAP?  Section 1325(a)(3), governing confirmation of plans in chapter 13 cases, contains the identical language as Section 1129(a)(3) upon which the Garvin court rested: a requirement for plan confirmation in a chapter 13 is that the “plan has been proposed in good faith and not by any means forbidden by law; . . .”  Or would further review distinguish the two cases based upon the facts and circumstances, namely, that the Burtons failed to meet the burden placed upon them by the court’s issuance of the order to show case? 

These materials were prepared by Kathleen Cashman-Kramer of Sullivan Hill Rez & Engel in San Diego (cashman-kramer@sullivanhill.com), with editorial contributions from Gary Rudolph of Sullivan Hill Rez & Engel in San Diego (rudolph@sullivanhill.com) and Maggie E. Schroedter, Partner at Higgs Fletcher & Mack, LLP in San Diego (schroedterm@higgslaw.com).

[1] The order to show cause was issued by the court after a creditor of the Burtons filed a motion to convert the case to chapter 7 on the basis that the Burtons were not eligible under Section 109(e) because their debts exceeded those allowable for a chapter 13 case.  The creditor also asserted the case was filed in bad faith, and that the Burtons had failed to disclose their projected recovery from the state court action which was based upon their marijuana business.