Hoban Law: Cannabis INDUSTRY’S “COVID-19 DISASTER RECOVERY Playbook”

Hoban Law: Cannabis INDUSTRY’S “COVID-19 DISASTER RECOVERY Playbook”

For legalized marijuana, the coronavirus (“COVID-19”) pandemic has been the worst of times and the best of times.

Despite being deemed “ineligible” for much of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) benefits, nearly derailed by commercial-contract-voiding “force majeure” provisions, and denied federal bankruptcy protection, COVID-19 has resulted in extraordinary Marijuana Related Business (“MRB”) advancements including online patient certification and ordering, curb-side pick-up, tripling the maximum purchasable amount, and home delivery via caregivers.

Written by Steve Schain

 

While unclear how this will impact achieving legalized marijuana’s $11.3 billion 2019 sales level, learning how to access CARES Act benefits, invoke and dodge “force majeure” claims and deploy “financial distress tools” will distinguish pandemic victors from the vanquished.

State Medical Programs’ Great Leap Forward

Administered by its Department of Health (“DOH”), in less than two years Pennsylvania’s Medical Marijuana Program (“Program”) generated half a billion dollars of revenue from 180,000 registered patients suffering from 23 “serious medical conditions” including anxiety.

Despite halting all “non-life-sustaining” business, on March 19, 2020 Governor Tom Wolf declared legalized marijuana an “essential business” and on March 21, 2020, the DOH massively expanded the Program’s breadth including:

  • suspending “in person qualification requirements” enabling doctors to certify medical-marijuana patients online or over the phone;
  • an on line medical marijuana ordering system;
  • increasing cannabis purchasing limits from a 30-day to 90-day supply;
  • allowing curbside cannabis pick-up from dispensaries;
  • eliminating limit on the number of patients for whom a “caregiver” could obtain cannabis
  • via caregiver expansion, creating a “patient home delivery service”.

Beyond dispelling lingering prejudice, and confirming its “crucial” status, the state’s “essential business validation” raises legalized marijuana’s stature, encourages further and deeper investment and signals receptivity to expanded medical and adult use programs.

Disaster Loan Eligibility

Although “Plant Touching MRBs” are disqualified for any CARES Act loan, “Non Plant Touching MRBs” may receive relief including Economic Injury Disaster Loans and Loan Advances (“EIDL”).

Licensed and regulated by the state, Plant Touching MRB’s include those planting, cultivating, harvesting, processing/extracting, testing, packaging, disposing, transporting, and dispensing marijuana and any entity having a financial or controlling interest in them.  “FIN-2014-G001: BSA Expectations Regarding Marijuana-Related Businesses,” FinCEN, February 14, 2014.  Businesses providing products and services to Plant Touching MRB’s, but not directly manufacturing, processing, transporting, distributing, or dispensing marijuana, are “Non Plant Touching” MRB’s.  Id.

In conjunction with the Small Business Administration (“SBA”), the CARES Act offers Paycheck Protection Program and the EIDL, which provide $10,000 advances and up to $2 million of working capital loans.  Comprising commercial loans structured pursuant to SBA requirements through an SBA authorized lender, the SBA guarantees to repay a portion of the loan proceeds to the lender if the borrower defaults.  Prior to the CARES Act, SBA programs included: “7(a)” (up to $5,000,000 for eligible small businesses); “Express” (up to $350,000 for up to 7 years); “Community Advantage” (targeting mission-based lenders assisting under-served markets); “504” (economic development and job creation/retention through fixed assets acquisition/refinance); and “Microloan” (through nonprofit lending organizations to under-served markets).

Barred from all SBA loan eligibility are specific industries (including gambling, non profits, lenders, life insurance, pyramid sales, private clubs, and prurient sexual nature) and those engaged in any “illegal activity”. 13 CFR §120.110(h).  For “7(a) program” eligibility, “legality” hinges on “nature of the business’s specific operations” disqualifying “Direct Marijuana Business”, i.e., a plant touching MRB, and an “Indirect Marijuana Business” deriving any gross revenue from “products or services” sales to Direct Marijuana Businesses “reasonably determined to aid in marijuana “use, growth, enhancement or other development”.  Lender and Development Company Loan Programs’ Small Business Administration Standard Operating Procedures, April 1, 2019.

“Indirect Marijuana Businesses” comprise those providing “testing services”, “grow lights, hydroponic or other specialized equipment”, or “advise or counsel” on “specific legal, financial/accounting, policy, regulatory or other issues associated with establishing, promoting, or operating a Direct Marijuana Business”.  Id.  Conversely, the SBA expressly excludes a “plumber who fixes a sink” or “tech support company repairing a laptop” from aiding in marijuana’s “use, growth, enhancement or other development”. Id.

While closed to Plant Touching MRBs, a Non Plant Touching MRB not “aiding marijuana’s use, growth, enhancement or development” is eligible for both CARES Act Paycheck Protection Program and EIDL benefits.  Further, because it does not fall into any prescribed 7(a) program limitations, all non Plant Touching MRB are eligible for EIDL benefits.

Invoking and Defending Against Force Majeure Claims

Following its rapid spread, the World Heath Organization’s March 11, 2020 “COVID-19 pandemic declaration” potentially voided every commercial contract via force majeure” provisions.

Force majeure” is the occurrence of an event which is outside of the parties’ reasonable control and prevents a party from performing its contractual obligations.  To qualify as a force majeure: (1) event must be beyond affected party’s reasonable control; (2) event must prevent, impede or hinder affected party’s ability to perform its contractual obligations; and (3) affected party must have taken all reasonable steps to avoid or mitigate event or its consequences.

Force majeure events take two forms: (1) “natural” involving physical risks that might impact a business or a project; and (2) political involving risks created by political or legal environment changes.  Each category provides different remedies like agreement termination following a natural force majeure versus time extension and increased costs for a political force majeure.

Force majeure provisions relieve a party from what would otherwise be a breach of contract, i.e., failure to fulfill contractual duty, and critical to triggering protection is degree of impairment to party’s ability to perform contractual obligations.  The party must establish the causal link between the event and its inability to perform, and a provision requiring a party to be “prevented” by the force majeure will more difficult to demonstrate than merely requiring being “impeded” or “hindered” in obligations’ performance.

COVID-19’s initial “force majeure impact” was an “inability to perform contractual duties due to workplace self-isolation.  Under most clauses, and subject to affected party having taken all reasonable measures, this forms sufficient impact and causal link to qualify as a force majeure event.  Conversely, a disruption merely impacting a contract’s profitability, economic downturn, other general adverse business conditions is insufficient so support a force majeure claim even if COVID-19 triggered.

A party seeking to rely upon a force majeure provision must demonstrate that: (1) it has taken reasonable steps to avoid or mitigate event and event’s consequence; and (2) there are no alternate means for performing under the contract.  What constitutes a reasonable mitigation measure is fact-specific and depends upon both contract’s subject matter and language and force majeure event’s context.

Triggering a force majeure provision’s relief also requires providing the other party with evidence-supported-notice (including anticipated consequences and event’s duration) within a specified time period from when affected party first became aware of event’s occurrence.  A force majeure clause’s invocation hinges on affected party’s contractual obligations, and the provision’s consequences and remedies range from extension of time to perform, contractual performance suspension for event’s duration, and contract termination.

Financial Distress Solutions

Although federal bankruptcy protection is presently unavailable, MRBs may obtain financial distress relief via “workouts” or state law receivership’s or assignments for the benefit of creditors (“Creditors’ Assignment”).

Generally governed by federal law, called the “Bankruptcy Code” (“Code”), the bankruptcy system allows debtors to either dismiss or partially satisfy debts they are incapable of fully paying, and, upon filing, creates an “automatic stay” period during which creditors are prohibited from attempting to collect.  Bankruptcy petitions are filed in a federal bankruptcy court governed by federal law, although state laws may determine how debtors’ property rights are affected (ex., validity of liens or exempting property from creditors).

Bankruptcy’s most common form is a Chapter 7 “liquidation” in which the court appoints a trustee to collect and sell debtors’ non-exempt property and distribute proceeds to creditors.  Because most states allow debtors to keep essential property, Chapter 7s are usually “no asset” in which there are zero saleable assets to fund a distribution to creditors.

Bankruptcies allowing debtors to keep some or all of their property, reorganize and use future earnings to pay off creditors fall under Code Chapters 11, 12 or 13.  Individual debtors usually file Chapter 13s, business entities file Chapter 11s, and Chapter 12 filings mirror Chapter 13 but are only available to “family farmers” and “family fisherman” and provide more debtor favorable terms.

Because of marijuana’s one hundred percent (100%) federal illegality, and because bankruptcy can’t be used to facilitate federally illegal activity or administer assets that can’t be possessed or sold under federal law, bankruptcy protection is denied to both “Plant Touching” and “Non-Plant Touching” MRBs.  Comprehensive Drug Abuse Prevention and Control Act of 1970, 21 U.S.C. §§ 801, Et. Seq (1970).  April 26, 2017 Letter from Clifford J. White, Director, Executive Office for the United States Trustee to Chapter 7 and Chapter 13; In re Arenas, 535 B.R. 845 (B.A.P. 10th Cir. 2015) (denial of marijuana grower/seller and legal dispensary landlord’s motion to convert to Chapter 13 and Chapter 7 dismissal because debtor unable to propose feasible plan without violating federal law and trustee’s estate administration duties by selling debtors’ assets); In re Medpoint Management, LLC, 528 B.R. 178 (Bankr. Az. 2015) (dismissing “owner of intellectual property leased to marijuana products seller” due to “dual risk” of assets’ potential forfeiture and trustee’s CSA violation in administering estate).

1 – Workouts

A non-judicial process through which a financially distressed business negotiates with creditors individually or en masse to restructure debt’s amount and establish repayment terms, workouts are the first and most powerful line of defense.  Similar to a Chapter 11 bankruptcy, workouts allow a debtor to propose terms in a “composition agreement” defining exactly what is owed, proposing a restructuring of debtor’s “universe of debt”, providing a pro rata payment schedule of both arrearage and to-be-incurred debt payments, and listing defined source of funds from which payment will be made.  Beyond reassuring creditors of debtor’s universe of debt, financial viability and commitment to repay, workouts cost effectively and swiftly resolve a dispute, enable a debtor to confidently resume or fortify operations, and trigger repayment streams into creditors hands.

2 – Receivership’s

Often initiated by disgruntled owners or concerned creditors, “receivership’s” mirror

Chapter 11 bankruptcy in being a non-liquidating judicial process and require a state court filing following which a court appointed receiver guides a financially troubled MRB through its insolvency.  The receiver’s efforts span from operating troubled company “as is”, restructuring entity’s operations (ex., hiring/firing, debt payment hierarchy and workouts, winding-down or eliminating operational components), and selling business either in whole or in pieces.  Unlike a workout, which usually leaves leadership intact and presumes “pre-workout operations resumption” at its conclusion, a company in receivership’s stakeholders generally are unable to either select the receiver or run the company following the proceeding’s close.

3 – Creditors’ Assignment

Mirroring a Chapter 7 bankruptcy liquidation proceeding, 38 states have Creditors’ Assignment statutes in which the debtor MRB transfer its assets to a trust administered by an “assignee” selected by the MRB, which, in turn, liquidates the assets and distributes the proceeds to the MRB’s creditors.  Because the MRB has divested itself all of its assets and is, essentially, judgement proof, barring rights to collect against third parties like guarantors, unsecured creditor claims against the asset-less MRB are rendered worthless.  Parties rights that are secured by the MRB’s assets travel with the assets and any secured party like a mortgage or Uniform Commercial Code lien holder can proceed directly against the transferred asset.

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