Appellate Court Affirms Chapter 11 Bankruptcy Plan Leasing Property to Cannabis Business

The U.S. Court of Appeals for the Ninth Circuit recently held that a Chapter 11 Plan of Reorganization could be confirmed in a case where a landlord was receiving rent from someone involved in a state authorized cannabis business. 

In Garvin vs. Cook Investments, 922 F.3d 1031 (9th Cir., 2019), the office of the United States Trustee objected to confirmation of the Chapter 11 plan asserting that the lease with the state authorized cannabis business violated federal drug law which made the plan unconfirmable under the bankruptcy code. The Office of the United States Trustee (Trustee) had first moved to dismiss the case prior to confirmation asserting that the lease constituted gross mismanagement.  The bankruptcy court denied the motion to dismiss, but allowed the U.S. Trustee office to renew the motion at the plan confirmation hearing. 

The Trustee office however failed to move to dismiss the case at confirmation based upon gross mismanagement, but rather focused its attack on the plan itself, asserting that the plan was not confirmable.  The appellate court upheld the lower court’s decision, confirming the plan over the objection of the Trustee’s office. The Trustee asserted that the plan was not confirmable given that the plan failed to satisfy a requirement under the bankruptcy code, namely, 11 USC  §1129(a)(3), which requires a plan to be proposed in good faith and not by any means forbidden by law. 

The Trustee asserted that the plan was proposed by means forbidden by law.  The appellate court, however, found that the Bankruptcy Code provision only looks to the proposal of a plan, not the terms of the plan. Section 1129(a)(3) does not require that the contents of a plan comply in all respects with provisions of all non-bankruptcy laws and regulations. As a result, the appellate court confirmed the lower court’s decision which confirmed the confirmation of the debtor’s Chapter 11 plan. 

Importantly, however, the debtor had rejected the lease with the cannabis business and the revenue generated from the cannabis business was not being used to make payments under the plan. The plan was feasible without using the continuing lease payments from the cannabis tenant. (A tenant can remain in the leased premises after the lease is rejected as long as the tenant continues to pay rent pursuant to 11 USC §365(h)).

Going forward, if other courts follow the 9th Circuit decision, entities that file for bankruptcy that generate some of their revenue from state authorized cannabis businesses may be eligible for confirmation over the objection of the Office of the United States Trustee.  However, the Office of the United States Trustee could challenge a filing and move to dismiss the case asserting gross mismanagement. 

For whatever reason, the Office of the United States Trustee did not raise this objection to the case itself at confirmation.  In addition, the debtor may need to structure its plan in a way not to use the revenue generated from a lease of a cannabis tenant to fund its plan. There may now be a glimmer of hope that bankruptcy cases do not go up in smoke upon the filing of a Chapter 11 reorganization.

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