Is a Bankruptcy Plan that Violates Federal Criminal Law Proposed in Bad Faith?

Although legal in many states, marijuana remains illegal under federal criminal law. See 21 U.S.C. § 856(a)(1). One would think that engaging in illegal activity under federal criminal law would preclude relief under federal bankruptcy law. And, in fact, several bankruptcy courts have reached that exact conclusion. See, e.g., In re Rent-Rite Super Kegs West, Ltd., 484 B.R. 799 (Bankr. D. Colo. 2012) (“[A] federal court cannot be asked to enforce the protections of the Bankruptcy Code in aid of a Debtor whose activities constitute a continuing federal crime.”). That bright-line rule, however, may now be subject to some debate.

In Garvin v. Cook Investments,[1] the Ninth Circuit affirmed the confirmation of a landlord’s bankruptcy plan that dealt, in part, with a marijuana operation. Given the narrow holding and peculiar procedural posture of Garvin, however, it is unclear exactly what impact the Ninth Circuit’s decision will ultimately have on marijuana-related businesses. Garvin could just be an aberration, but marijuana companies can now at least argue that the Ninth Circuit literally opened the bankruptcy court doors for them to seek and obtain bankruptcy relief.

The Facts

Aside from the marijuana angle, the facts of Garvin are rather mundane. Five real estate holding companies (the “Debtors”) filed for bankruptcy after falling on hard times. The Debtors leased properties to several commercial tenants, one of which—Green Haven—grew marijuana in compliance with Washington law. Because the Green Haven lease violated federal drug laws, however, the United States Trustee (the “UST”) moved to dismiss under 11 U.S.C. § 1112(b). The UST argued that the Debtors’ engaging in criminal activity constituted “gross mismanagement” of the estate and required dismissal. The bankruptcy court initially denied the motion, but allowed the UST to renew the argument at plan confirmation.

The Debtors proposed a plan that not only would repay all creditors in full, but also would reject the marijuana lease “so that all of [its] monthly obligations would be paid without revenue from Green Haven.” What happened next is what renders the Garvin holding so peculiar.

Rather than renew its argument under 11 U.S.C. § 1112(b), the UST only argued that the plan violated 11 U.S.C. § 1129(a)(3), which requires a plan to be “proposed in good faith and not by any means forbidden by law.” The bankruptcy court overruled this objection, and the UST appealed.

Legal Analysis

Although several bankruptcy courts have accepted the “gross mismanagement” argument to dismiss marijuana cases, the Ninth Circuit concluded that the UST waived this argument by failing to raise it in opposition to the plan. Specifically, the failure to re-urge the argument precluded the bankruptcy court from determining whether any such mismanagement had been cured. Accordingly, the Ninth Circuit did not address the merits of the prevalent “gross mismanagement” argument.

Instead, the Ninth Circuit focused only on whether the plan was “proposed in good faith and not by any means forbidden by law.” Based on the plain text of the statute, the Ninth Circuit concluded that although the substance of the plan might violate federal criminal statutes, it was not “proposed” in a manner that violated the law. Accordingly, the UST’s objection failed to invalidate the plan.

Conclusion

It remains to be seen how the Ninth Circuit’s decision will be interpreted by bankruptcy courts. It very-well may be interpreted rather narrowly since it only addresses one requirement of 11 U.S.C. § 1129(a)(3), and does not categorically hold that debtors that engage in federal crimes can obtain bankruptcy relief. In addition, it is also unclear what the outcome would have been had the UTS re-iterated its “gross mismanagement” argument at plan confirmation. Thus, Garvin could just be an outlier. Nevertheless, bankruptcy courts may ultimately conclude that Garvin perhaps implies that bankruptcy relief is not per se unavailable to companies in the marijuana space.

[1]           Garvin v. Cook Investments NW, SPNWY, LLC, No. 18-35119, 2019 WL 1945280 (9th Cir. May 2, 2019).