By Bec Edelson and James Fazio

Claimed “illegality” of cannabusinesses continues to be a crucial difficulty for them in their means to implement their rights in the courts. The means to search judicial reduction could also be particularly essential to some cannabusinesses which are struggling as a outcome of the COVID-19 pandemic (e.g., to search chapter reduction, or to get hold of compensation from clients or suppliers that breach contracts).  In our December 2019 articles,[1]we noticed that a cannabusiness might discover it troublesome to pursue its Intellectual Property (IP) rights in sure jurisdictions the place hashish stays unlawful. Here, we offer an replace on the “illegality” difficulty, together with outdoors of the IP enviornment. We focus on some latest authorized rulings in the hashish house and a few potential ramifications to cannabusinesses’ means to search chapter and different reduction in the courts.

Can cannabusinesses can take benefit of federal chapter safety? It relies upon however probably is an uphill battle.  Historically, chapter courts have refused to enable debtors engaged in violating federal drug legal guidelines to take pleasure in the advantages of the chapter legal guidelines.  In In re Rent-Rite Super Kegs West Ltd., 484 B.R. 799 (Bankr. D. Colo. 2012), for instance, the debtor derived roughly 25% of its revenues from leasing warehouse house to tenants whom the debtor knew to be rising marijuana.  484 B.R. at 802.  Because a “significant portion of the debtor’s revenue [wa]s derived from an illegal activity,” the Court refused to verify the debtor’s chapter plan.  Id. at 809.[2]

 

However, the Agriculture Improvement Act of 2018 (generally generally known as the “2018 Farm Bill”) eliminated industrial hemp from the Controlled Substance Act’s (“CSA”) definition of marijuana and eliminated “tetrahydrocannabinols in hemp” from the definition of tetrahydrocannabinols, which, like marijuana, is classed as a Schedule I drug.[3] Additionally, the 2018 Farm Bill amended the definition of hemp to imply “the plant Cannabis sativa L. and any part of that plant, including the seeds thereof and all derivatives, extracts, cannabinoids, isomers, acids, salts, and salts of isomers, whether growing or not, with a delta-9 tetrahydrocannabinol concentration of not more than 0.3 percent on a dry weight basis.”[4]  This decriminalization of hemp made it attainable for sure (however not all) cannabusinesses to pursue federal chapter reduction.

For instance, in In re Royalty Properties, LLC, 604 B.R. 742 (Bankr. N.D. Ill. 2019), the Court acknowledged that the “2018 Farm Bill in effect legalized hemp and its derivative products.”[5]  Nevertheless, the Court refused to grant the debtor’s Chapter 11 petition for reorganization and as an alternative transformed its petition into a Chapter 7 petition as a result of the debtor “ha[d] no experience producing and selling hemp or hemp seeds” and the Court was not satisfied that the debtor’s plan for promoting hemp with none prior expertise would generate the “million of dollars” crucial for the proposed chapter plan to succeed.[6]  While the debtor in Royalty Properties was unsuccessful, the Court’s opinion might recommend that if a debtor can credibly set up that its chapter plan will probably be funded from the manufacture and sale of legalized industrial hemp or its derivatives, chapter reduction could also be accessible.

Recently, on April 20, 2020, United Cannabis Corporation (“UCann”) (a main producer of CBD merchandise) filed a Chapter 11 petition for chapter in Colorado.[7]  UCann owns a patent overlaying a extract containing 95% cannabinoids that are authorized underneath federal regulation.  The Court, nevertheless, issued an Order to Show Cause (OSC) why the chapter petition shouldn’t be dismissed as a result of UCann “appears to be engaged in the marijuana industry.”[8]  On May 4, 2020, UCann filed a response to the OSC in which it argued that as a result of all its revenues derived from the cultivation, processing and sale of legalized hemp, and never marijuana, UCann’s chapter petition needs to be granted.[9]  Citing and distinguishing a number of of the circumstances famous herein, UCann argued that the “Debtors are well established in the hemp and CBD industry” and had “no marijuana-related revenue.”[10]  The Court has not but dominated on the OSC.[11]

Further, the Justice Department continues to object to making chapter reduction accessible to members of the hashish business.  See“Justice Department Blocks ‘Essential’ Marijuana Workers From Bankruptcy Protection,” The Wall Street Journal, May 28, 2020 (“The department’s policy means the financial safety net that bankruptcy provides … is likely out of reach for those who work in the marijuana industry or businesses supporting state-regulated dispensaries or growers”; “Cannabis remains illegal under federal law, which includes the U.S. bankruptcy code” and the Justice Department is of the view is “based mostly on the authorized precept that the U.S. chapter code can’t be used to support in the violation of federal prison regulation.).

Takeaways: If a cannabusiness can credibly set up that its post-petition revenues will stem fully from the cultivation and sale of hemp and its derivatives (and never from the cultivation and sale of marijuana), it could have a affordable probability of acquiring chapter reduction however nonetheless might face hostility from the chapter decide arising from the “illegality” difficulty.  If a cannabusiness is engaged in a enterprise unlawful underneath federal regulation, then it probably is not going to be permitted to get hold of chapter reduction and may have think about different choices.  For instance, relying on the circumstances of the enterprise (together with the state(s) in which it operates), it could search sure reduction by way of a state court docket receivership or an project for the profit of collectors. 

Outside the chapter context, courts are divided as to whether or not cannabusinesses can search reduction from the courts if their companies are unlawful.  On April 22, 2020, a California Court of Appeal affirmed an order dismissing claims relating to a partnership that had been created for the manufacturing and distribution of edible hashish merchandise on the floor that the partnership’s cannabusiness was unlawful at the time of defendant’s alleged misconduct.[12]  Plaintiffs claimed that a former companion stole the partnership’s commerce secret recipes. The trial court docket, nevertheless, dismissed plaintiffs’ claims as a result of the “commercial cannabis operation” at the heart of the enterprise was unlawful at the time of the defendant’s alleged wrong-doing.  The Court of Appeal affirmed, reasoning that as a result of marijuana was a Schedule I managed substance prohibited by regulation in January 2014 when the alleged contract regarding the partnership’s possession of IP associated to the enterprise was made, the court docket couldn’t afford plaintiffs reduction.

On the different hand, different courts have rejected arguments that plaintiffs engaged in  cannabusinesses aren’t entitled to any judicial reduction as a result of their companies are unlawful.[13] In Siva Enters. v. Ott, 2018 U.S. Dist. LEXIS 223854, at *13 (C.D. Cal. 2018), for instance, plaintiff Siva Enterprises (a 10-year cannabusiness) filed go well with for commerce secret misappropriation and associated claims arising from defendants’ theft of Siva’s buyer lists and preferences, enterprise methods, and operation manuals associated to its cannabusiness.[14]  Defendant argued that Siva was not entitled to reduction as a result of it was facilitating drug trafficking in violation of the CSA.  However, the Court refused to dismiss the case as a result of the “case does not involve the actual production or sale of cannabis.  Rather, the [complaint] concerns the actions of defendants in allegedly misappropriating plaintiffs’ confidential business information.”[15]  The Court additionally refused to dismiss the Lanham Action claims on the identical grounds.  “Defendants contend that plaintiffs’ Lanham Act also fails because it involves ‘the aiding and abetting’ of the commission of a crime. …  This is a mischaracterization of plaintiffs’ allegations, which are predominantly focused on defendants’ alleged theft of plaintiffs’ client lists and client information.  Moreover, as explained earlier, the Court finds that the CSA’s prohibition on cannabis does not immunize defendants from federal laws.  Accordingly, the Court declines to dismiss plaintiffs’ federal claims based on the Controlled Substances Act.”[16]

Takeaways: Before submitting go well with, know the views on the illegality difficulty of the jurisdictions into consideration.  To the extent attainable, a cannabusiness searching for to implement commerce secret rights ought to try to file its grievance in a jurisdiction the place hashish is authorized (except there are extra important countervailing causes not to file there).  To the extent that a cannabusiness finds itself in a litigation in a jurisdiction the place hashish is unlawful (e.g., a federal court docket to pursue a patent infringement declare), it will behoove the cannabusiness to (i) emphasize the IP nature of its rights (to be distinguished from associated actions that could be thought-about unlawful)and (ii) argue that the jurisdiction’s prohibition on hashish mustn’t immunize defendant’s violations of different legal guidelines.

Also, to the extent attainable, enterprise ought to suppose proactively earlier than there’s a want for litigation.  For instance, a cannabusiness getting into into a contractual relationship with one other occasion ought to fastidiously think about with counsel whether or not there are any provisions that may be included to handle the potential illegality difficulty (e.g., favorable alternative of regulation and discussion board choice provisions).

About the co-author

James Fazio is particular counsel in Sheppard Mullin’s mental property follow group.

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This alert is supplied for data functions solely and doesn’t represent authorized recommendation and isn’t meant to kind an lawyer shopper relationship.

[1]For our prior articles, see Intellectual Property in the Cannabis Industry – Protecting Innovations And Products, Part I (Trade Secrets) and Intellectual Property In The Cannabis Industry – Protecting Innovations And Products, Part II (Patents).

[2]See additionally In re Arenas, 514 B.R. 887, 891 (Bankr. D. Colo. 2014) (dismissing the chapter petition as a result of administration of the case can be “impossible without inextricably involving the Court and the Trustee in [the debtor’s] ongoing criminal violations of the [Controlled Substance Act (‘CSA’)].”); In re Way to Grow, Inc., 2019 U.S. Dist. LEXIS 207846, at *28 (D. Colo. Sep. 18, 2019) (affirming the dismissal of a chapter petition on the floor that “for the debtors “at least had ‘reasonable cause to believe’ the [hydroponic] equipment [it] sells to at least some of [its] customers will be used to manufacture marijuana” in violation of the CSA).  But see Garvin v. Cook Investments, 922 F.3d 1031, 1035 (9thCir. 2019) (affirming affirmation of a chapter plan as a result of, whereas the debtors meant to lease property to a marijuana grower, §1129(a)(3) of the Bankruptcy Code “directs courts to look only to the proposalof a plan, not the [substantive] terms of the plan.”) (emphasis added); In re Basrah Custom Design, Inc., 600 B.R. 368, 382 (Bankr. E.D. Mich. 2019) (criticizing Garvinand dismissing a chapter petition as a result of the function of the proposed plan was to enable the debtor’s principal to both lease or promote industrial house to “some other marijuana dispensary” or “us[e] the property to operate a marijuana dispensary himself” in violation of the CSA).

[3] 7 U.S.C. § 1639o(1).

[4] Id.

[5] 604 B.R. at 744.

[6] Id. at 748-49.

[7] In re United Cannabis Corp., 20-br-12692, Dkt. 1 (D. Colo. Apr. 20, 2020).

[8] Id. at Dkt. 14.

[9] Id., Dkt. 53 at 3-4.

[10] Id., Dkt. 53 at 9.

[11]Unlike the United States, Canada presents chapter safety to failing cannabusinesses (a minimum of to these integrated in Canada).  See, e.g., Virus Pushes Green Growth To Insolvency Filing In Canada.

[12]Metsch v. Heinowitz, D074999 (Cal. 4thDiv. 1 Apr. 22, 2020), Order Affirming Judgment of San Diego Sup. Ct, 37-2017-28176.

[13]See https://www.cannabislawblog.com/2019/12/protecting-innovations-products-part-i-trade-secrets-protection/ (citingSiva Enters. v. Ott, 2018 U.S. Dist. LEXIS 223854, at *13 (C.D. Cal. 2018))and https://www.cannabislawblog.com/2020/01/protecting-innovations-products-part-ii-patent-protection/ (citingUnited Cannabis Corporation v. Pure Hemp Collective, Inc. No. 18-cv-1922 (D. Colo. 2019); Kenney v. Helix TCS, Inc., No. 18-1105 (10th Cir. 2019); Left Coast Ventures, Inc. v. Bill’s Nursery, Inc., No. C19-1297 MJP, 2019 U.S. Dist. LEXIS 189312 (W.D. Wash. Oct. 31, 2019).  InLeft Coast, the plaintiff had filed go well with to implement an possibility settlement to buy an possession curiosity in a marijuana distribution enterprise.  After briefing on defendant’s movement to dismiss, the District Court declined to train federal jurisdiction on abstention grounds, ruling that “the federal issues are not easily separable from complicated state law issues with which the state courts may have special competence and federal review might disrupt state efforts to establish a coherent policy” and thus remanded the case to state court docket for additional proceedings.  Id., Dkt. 23 [Order Remanding Case at 4].

[14]2018 U.S. Dist. LEXIS 223854, at *2.

[15] Id. at *5.

[16] Id. at *15-*16.



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