Addressing Financial Hurdles for Michigan's Cannabis Companies: Looking Beyond Bankruptcy

For many in Michigan and across the U.S., the challenges faced by the cannabis industry are well-known. Despite being an emerging market, the industry confronts numerous federal hurdles including stringent tax rules, limited banking options, challenges accessing capital markets, varied intellectual property rights, and restrictions on interstate trade. Michiganders closely following the industry are well-versed with these hurdles that hinder the growth of our state's promising cannabis sector.

Recently, a new obstacle has emerged in mature cannabis markets, including Michigan: the lack of federal bankruptcy protections for cannabis ventures. This poses significant challenges for these businesses and their stakeholders, particularly during economic downturns.

Yet, it's not a completely bleak scenario. Although federal bankruptcy protections might not be accessible, Michigan's cannabis businesses have alternative contractual and state law mechanisms to counteract insolvency and financial distress. It's vital for Michiganders to stay informed and back our local businesses as they navigate this intricate path, ensuring the sustained growth of our state's cannabis industry.

Deciphering Bankruptcy Laws for Michigan's Budding Cannabis Sector

If you're an aspiring entrepreneur in Michigan, grasping the nuances of U.S. bankruptcy laws is essential. Unlike many countries, the U.S. is known for its relatively accommodating and lenient bankruptcy regulations. These provisions, believed to foster American entrepreneurship, offer individuals and businesses a valuable safety net, providing a pathway to either liquidate assets or reorganize debt.

Tracing back the roots, the authority for Congress to frame bankruptcy laws is enshrined in the U.S. Constitution itself. Initially, states individually managed bankruptcy until the late 18th century when the need for a unified approach became apparent. This epiphany gave rise to the inaugural federal bankruptcy law in 1800, setting the stage for federal control over bankruptcy, culminating in the present-day U.S. Bankruptcy Code.

For Michigan's cannabis entrepreneurs, however, there's a twist. Due to the federal criminalization of cannabis, the U.S. Trustee Program, an arm of the Department of Justice supervising bankruptcy proceedings, views aiding a cannabis venture as endorsing an ongoing criminal activity, albeit one legalized at the state level. As a result, even businesses compliant with Michigan's cannabis regulations are left without the safety net of federal bankruptcy protections.

To truly gauge the magnitude of this, consider financial negotiations. They always hover under the potential shadow of bankruptcy. The pivotal difference between debt and equity, particularly the favored status of debt holders during bankruptcy, significantly influences the dynamics of lender-borrower interactions. For our state's cannabis enterprises, the ramifications are significant. When these businesses, hit by financial adversities, seek concessions from their lenders, they lack the typical bankruptcy fallback. This absence places them at a marked disadvantage, an ongoing challenge for our local cannabis domain.

Financial Solutions Beyond Bankruptcy for Michigan's Cannabis Sector

In the face of financial distress, many companies across the U.S., including those in the cannabis industry, often gravitate towards out-of-court resolutions. Drawing a parallel to the legal realm where parties might choose a structured settlement over a jury's unpredictability, numerous debtors and creditors opt for extra-judicial strategies for financial woes.

1. Contractual Solutions for Cannabis Businesses:

a. Renegotiating Debt, Exchange Proposals, and Composition Deals

At its core, the bond between debtors and creditors is contractual. Thus, both sides have the flexibility to amend their agreement upon finding mutual interests. Debt renegotiation allows businesses facing financial hardships to revise their financial commitments. Such discussions can culminate in:

• Postponing payments (either interest or principal).
• Pushing back maturity dates.
• Easing off on covenants, like altering a lender's financial conditions to avoid default activation.
• Opting for debt-to-equity swaps, a strategy gaining momentum in Michigan's cannabis sector given its distinct banking obstacles.

Exchange proposals come into play for businesses nearing default. Here, they present new securities (either debt or equity) in lieu of existing ones, but with terms that are more appealing to sidestep imminent fiscal challenges.

On the other hand, composition deals involve creditors consenting to less favorable conditions, allowing the debtor breathing room to reorient its operations. The overarching objective is bolstering the debtor's financial stability to avert a total business collapse. Typically, committees supervise these deals, ensuring creditors' rights are activated only when a specified criterion is met.

2. Statutory Alternatives:

a. UCC Article 9 Sales

For those in Michigan's cannabis industry, mastering the UCC (Uniform Commercial Code) is imperative. UCC's Article 9 outlines procedures for collateral disposal under a security interest post-debtor default. Dubbed "friendly foreclosure", these sales mandate "commercial reasonability". Court-validated or creditor committee-approved sales gain a presumptive commercial reasonability status under the UCC.

b. Assignments Benefiting Creditors (ABCs)

ABCs, while less prevalent and varying across states, entail a debtor allocating its assets to an external entity. This entity then liquidates these assets in a role akin to a bankruptcy trustee. But here's the catch for cannabis businesses: this intermediary cannot possess or manage a cannabis enterprise sans a legitimate license. This constraint equally pertains to UCC Article 9 sales. Only those already possessing a license or those prepared for the extensive licensing journey can procure these assets, narrowing the pool of prospective buyers and diminishing asset valuation.

In Michigan's cannabis landscape, any contractual arrangements, like management service contracts, should be crafted with precision. It's crucial they don't inadvertently transfer business ownership to the assignee or buyer prematurely, aligning with state guidelines.

Receivership: A Middle-Ground Solution for Financially Troubled Cannabis Companies

When navigating the muddy waters of financial distress, cannabis companies often find themselves caught between the devil and the deep blue sea. Contractual remedies, though immediate and accessible, might lack robustness due to their voluntary and narrow nature. Meanwhile, statutory remedies may seem too unwieldy, focusing more on piecemeal liquidation rather than preserving the business as an ongoing entity. Enter the concept of receivership – a judicious blend of flexibility and power that can be a lifeline for ailing cannabis firms.

1. Receivership: An Overview

Originating from English and Welsh equitable principles, receiverships function as quasi-judicial remedies where courts can intervene to ensure fairness in situations where conventional legal remedies may be insufficient. Contrary to the structured, rule-bound bankruptcy process, receivership thrives on its fluidity, offering remedies tailored to specific situations.

In the context of the cannabis industry, some US states have crafted unique receivership statutes that acknowledge the industry's regulatory nuances. These statutes typically mandate the receiver to secure appropriate licensing akin to regular cannabis operators.

2. The Receivership Process

Generalizing the receivership process can be challenging due to the multifaceted nature of state regulations. However, a standard pathway often involves:

• Initiation: A complaint is lodged against the entity in question in a state court. This could be initiated by a varied set of stakeholders – creditors, regulators, or even co-owners of the business.
• Receiver Appointment: A motion is filed to nominate a receiver, preferably a neutral third party. Although the consent of the opposing party isn't a necessity, securing it can ease the process.
• Establishing Grounds: The plaintiff must demonstrate their standing and highlight pertinent events warranting the receivership. This could range from evidencing insolvency, mismanagement, or even contractual breaches.
• Role Definition: The court-issued order for the receiver defines their scope, delineating specific powers to manage or liquidate the "receivership estate" to benefit creditors.

3. Diversity in Receivership Laws

State-specific variations in receivership laws add layers of complexity. These variations typically manifest in:

• Nature of Statutes: While some states lay out a broad general statute, possibly supported by industry-specific guidelines, others root their receivership powers within civil procedure rules.
• Type of Remedy: For certain states, receivership is an independent remedy, while others treat it as an ancillary action supporting primary claims.
• Extent of Control: General receiverships can engulf an entire business, while limited ones might only encompass specific segments, leaving other parts under the original owner's control.

For cannabis businesses, some states with legal frameworks have tailored receivership laws, addressing licensing needs to ensure receivers can operate within the ambit of the law.

Michigan's Approach to Receivership in the Cannabis Industry

Michigan's legal framework provides a comprehensive and flexible approach to the appointment and regulation of receivers, especially for the cannabis industry. This guide offers an overview of Michigan's receivership provisions relevant to the cannabis industry.

1. Broad General Receivership Statute

Michigan's general receivership statute is encompassing and grants courts the discretion to appoint receivers based on their equitable powers. This appointment is valid as long as it aligns with existing legal provisions.

2. Incorporation of Cannabis-specific Provisions

Recognizing the burgeoning cannabis industry's unique needs, Michigan amended its laws in 2020 to explicitly allow for the appointment of receivers over cannabis businesses. This adjustment ensures the state's legal framework is responsive to the industry's evolving landscape.

3. Regulatory Oversight and Compliance

Post the appointment of a receiver for a cannabis company, Michigan's cannabis regulatory rules necessitate the notifying of the state regulatory agency within a 10-day window. Furthermore, the state has stipulated that any receiver must procure the state regulator's approval before operating a cannabis facility. This tight regulatory oversight ensures adherence to state guidelines and preserves the integrity of the cannabis market.

4. Eligibility to Seek Receivership

Interestingly, Michigan's legal provisions are inclusive in terms of who can petition for the appointment of a receiver. This includes entities or individuals with ties to the property or business in question. Nevertheless, the state mandates that receivership cannot be the primary or sole objective of an action. Instead, it should be a subsequent request following an initial claim.

5. Criteria for Receiver Appointment

When appointing a receiver, Michigan courts prioritize the individual's capability and expertise. The chosen receiver should possess:

• Relevant competence
• Necessary qualifications
• Proven experience in administering a receivership estate

6. Powers Granted to the Receiver

Receivers in Michigan enjoy substantial authority under the general commercial receivership statute. When appointed over cannabis entities, they operate within the bounds of the court's equitable discretion. Their powers are extensive, enabling them to:

• Operate the business effectively
• Undertake restructuring initiatives, if necessary
• Liquidate assets, if deemed appropriate
• Facilitate the sale of the business

Assignment for the Benefit of Creditors (ABC)

ABCs offer a unique solution for struggling businesses in situations where a balance between debtors and creditors needs to be found. Here's a breakdown of what ABC entails and how it can be beneficial for cannabis businesses:

1. Nature of ABCs:

• Voluntary Negotiations: Typically suited when a business's underlying value surpasses its liabilities.
• Receivership: Used when creditors want the court to restructure or liquidate a business, even if the business is against it.
• ABC: Ideal when the creditor and debtor relationship is relatively friendly but the business's value indicates minimal remaining value for equity holders.

2. ABC vs. Bankruptcy and Receivership:

• An ABC resembles a Chapter 7 or liquidating Chapter 11 bankruptcy.
• Unlike receivership, where a court appoints a receiver, the debtor initiates the ABC to methodically liquidate its assets.
• Court involvement in ABC is minimal, reserved for specific disputes.

3. ABC Process:

• The debtor picks the assignee to acquire its assets.
• The assignee essentially holds the assets in a trust for the benefit of the creditors.
• Post-assignment, the assignee examines the debtor's assets and liabilities and informs relevant parties about the assignment.
• The assignee manages the business (if operational) and sets up an asset sale process.

4. Pros and Cons of ABCs:

Advantages:

• Typically more cost-effective than receiverships.
• Flexibility in picking the assignee.
• Generally swifter and simpler route to asset liquidation.

Limitations:

• Assets in an ABC aren't automatically devoid of underlying liens.
• Risk of a creditor's petition to shift the ABC to a bankruptcy or receivership.
• Limited ability to sell assets "free and clear" of liens and interests.

5. Benefits for the Cannabis Industry

In the constantly evolving landscape of the cannabis industry, businesses face numerous challenges, from regulatory hurdles to fierce competition. ABCs can offer a lifeline for struggling cannabis entities:

• Regulatory Compliance: As the cannabis industry is heavily regulated, businesses undergoing ABC can ensure they remain compliant, even during restructuring or liquidation.
• Maintaining Reputation: The quieter, less public nature of an ABC versus a bankruptcy can help businesses maintain their reputation during challenging times.
• Swift Resolution: Time is often of the essence, especially with perishable cannabis products. ABCs allow for faster asset disposition compared to prolonged court procedures.

6. Choosing Between ABC, Receivership, and Bankruptcy

For cannabis businesses, the decision between opting for ABC, receivership, or bankruptcy depends on various factors:

• Debt Structure: Businesses with more secured debt might favor ABC or receivership, while those with significant unsecured debt might lean towards bankruptcy.
• Stakeholder Relations: Friendly creditor relationships are conducive to ABCs, while contentious situations might necessitate receivership.
• Future Plans: Entities looking to continue operations post-restructuring may prefer receivership, while those looking to wind down might choose ABCs.

Key Takeaways

Michigan's nuanced approach to receivership in the cannabis sector demonstrates its commitment to a sustainable and responsible industry. By understanding the mechanisms of receivership, ABCs, and bankruptcy, cannabis businesses can navigate financial challenges effectively, ensuring the industry's long-term success in the state.

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