Business Law

In re Christopher Michael Callaway

A Bankruptcy Court in the Northern District of California (the Court) recently denied the United States Trustee’s (“UST”) motion to dismiss a chapter 7 case for cause under 11 U.S. C. § 707(a) because the debtor owned interests in LLCs which were engaged in the cannabis business.  In re Christopher Michael Callaway, 2024 WL 3191673 (Bankr. N.D. CA. June 26, 2024).  To view the opinion, click here.

Facts

Debtor Chrstopher Michael Callaway (the debtor) filed a chapter 7 case in February 2024.  His schedules and statement of financial affairs indicated that he owned and operated 100% of Caliverde, LLC, a retail cannabis dispensary in San Francisco, and owned a 40% interest in Grassy Castro, LLC, another retail cannabis store in San Francisco.  The debtor also owned interests in other LLCs, some operating, some not, and some related to cannabis.  The schedules showed that the debtor had no tangible assets that bore any connection with marijuana plants or equipment. They also showed that though he might have a right to receive distributions from Grassy Castro LLC, he had never received any.  Finally, Schedule I reflected his monthly income was from Caliverde, an insignificant fact since his post-petition income was not property of the bankruptcy estate.

Motions to dismiss by a creditor, M. Dattani Credit Trust, and the UST, referencing generally the debtor’s relationship to the cannabis business through the LLC interests, argued that the chapter 7 trustee could not lawfully administer assets in violation of the Controlled Substances Act, 21 U.S.C. §§ 801-904 (“CSA”), and continuation of the case would force the chapter 7 trustee into such a position.  The chapter 7 trustee joined in the motions, arguing that he believed he would be subject to prosecution in any attempt to administer the assets of the estate.

In response to these arguments, the Court held that administering the ownership interest of LLCS that engage in the marijuana business is not necessarily equivalent to administering marijuana assets and that the trustee’s own personal belief that he could not lawfully administer the estate was not sufficient cause to dismiss the chapter 7 case.  The Court suggested the trustee had other options.

Reasoning

The CSA regulates the manufacture, distribution and dispensing of controlled substances, which are listed in schedules to the Act.  Marijuana is a Schedule 1 controlled substance, the most tightly regulated classification of controlled substances.  The Court noted that in addition to regulation, the CSA prohibits “direct acts or benefits as they relate to engaging in marijuana business.”  None of the restrictions includes a direct prohibition on owning or disposing of an interest in an entity that engages in marijuana business. The Court recognized that the Ninth Circuit had a “stated reluctance to adopt per se bright-line rules requiring the immediate disposition of bankruptcy cases in which marijuana activity is present.”  Burton v Maney (In re Burton), 610 B.R. 633 (9th Cir. BAP 2020).  The preferred approach is to address the specific facts of each case which relate to marijuana to see whether that link causes some violation of the CSA.  That focus is narrow in this case, since the only cause asserted is the debtor’s ownership interests in LLCs involved in the marijuana business when he filed his petition.

The Court compared the inquiry in a chapter 7 to a like inquiry in a chapter 11 or 13 where post petition conduct of the debtor was expected.  A chapter 7 differs because what the debtor does and the source of his income are not at issue.  In addition, for the trustee to administer the estate, he is not required to receive distributions from the LLCs.  The estate’s interest is only an ownership interest in the businesses, not ownership of the business’s assets or operating funds.  A shareholder only has an “expectancy interest” in a corporation and only becomes an owner of assets upon liquidation, which is not foreseen here.

The chapter 7 trustee has several options for administering the estate which don’t compel him to violate the CSA.  The Court finds that the potential sale of a membership interest in an LLC is only a sale of a bundle of rights.  The sale proceeds are not necessarily the proceeds of a marijuana business just because the LLC is itself engaged in that business.  In sum the Court holds that “possible sale of interests in LLCs, enforcement of LLCs’ contractual rights and sale of other intangibles related to marijuana are not sufficient for the Court to find cause to dismiss” the case.

The Court concludes with a policy statement: “[t]here is no clear basis to disqualify a debtor from the benefits of chapter 7 because of perceived but unanalyzed difficulties the chapter 7 trustee might face when administering the bankruptcy estate.  To somehow equate the trustee’s dilemma with cause to deny this debtor’s right to file and stay in chapter 7 has not been explained by the Dismissal Motions, and the court would be abusing its discretion under section 707(a) to grant them for the reasons argued in those motions.”

Author’s Comments

The UST offices around the country have taken a scorched earth approach to eliminate any bankruptcy case which has even the most remote link to a cannabis business.  The argument is usually the same in chapter 7s: it is impossible for the trustee to administer the estate without violating the CSA.  This case takes on that one-size-fits-all approach, pointing out its short-comings, particularly in a chapter 7 where the debtor’s post petition income and conduct are not in play.  As the bankruptcy court notes, nothing in the CSA directly prevents the sale of interests in the LLCs or proclaims that the monetary value paid for those interests is so closely derived from marijuana that the CSA is violated.  If the debtor was the managing member and those rights come into the estate – something that is hotly litigated in many bankruptcy cases where the debtor is a member of an LLC – the trustee may cease managing immediately.  Other options to monetize value may exist on a case-by-case basis.  The takeaway is there is no blanket cause for dismissal; a detailed factual inquiry and evidentiary showing must happen before the court may dismiss a chapter 7.

[The Commercial Financial Newsletter is written by an ad hoc group of the California Lawyers Association (CLA) Business Law Section.  This article was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, CD CA, ret.), a member of the ad hoc group.  The opinions contained herein are strictly those of the author.].           


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