Sowing the Seeds of Marijuana Bankruptcy: a Look at Garvin v. Cook

In a post last week, we discussed the ongoing personal bankruptcy case In Re Adair, in which a United States Trustee is seeking to have the court dismiss a Chapter 13 plan of an individual that is employed by a “non-plant-touching” ancillary marijuana business. The Trustee argued that, as the debtor’s salary is paid by an employer that derives income from the sale of cannabis, which remains federally illegal, approval of the bankruptcy plan would “improperly involve a federal court in administering the fruits and instrumentalities of federal criminal activity”. This argument has also been made in other bankruptcy cases in which the debtors engage in activities related to the marijuana industry, resulting in a seemingly blanket refusal by the bankruptcy courts to confirm any plans involving state-sanctioned marijuana operations.

However, a significant chink in the armor occurred last week when the Ninth Circuit Court of Appeals issued a ruling in Garvin v. Cook, which affirmed a bankruptcy court’s confirmation of a Chapter 11 plan involving income derived from the sale of marijuana. The Trustee in Garvin objected to the plan in question based, in part, upon 11 U.S.C.A. § 1129(a)(3), which provides that “[t]he court shall confirm a plan only if all of the following requirements are met… [t]he plan has been proposed in good faith and not by any means forbidden by law”. The Ninth Circuit rejected the expansive reading of this section by the Trustee, opting to instead take a much more plain text view of the code. In their opinion, § 1129(a)(3) does not mean a plan can be rejected if its underlying components are be unlawful, but rather only if the proposal itself was made in an illegal manner (e.g. fraud, undue inducement, etc.). The opinion of Garvin explains that § 1129(a)(3) “directs bankruptcy courts to police the means of a reorganization plan’s proposal, not its substantive provisions”.

In addition to its nonconformity with other similar Chapter 11 cases, the Garvin decision is further intriguing when compared to a Tenth Circuit case involving a Chapter 13 plan, In Re Arenas. In that 2015 case, the court held that a bankruptcy court did not abuse its discretion in dismissing a debtor’s Chapter 13 plan, because the underlying marijuana business was illegal under federal law and would therefore be in violation of 11 U.S.C.A. § 1325(a)(3). Section 1325(a)(3) of the Bankruptcy Code has similar language to § 1129(a)(3) and states that “a court shall confirm a plan if… the plan has been proposed in good faith and not by any means forbidden by law”. The expansive view taken by the In Re Arenas court, was based on the fact that the debtors in question would receive income from federally illegal marijuana activities and the Trustee’s administration and distribution of those funds, under the plan, would be in contravention of federal law. The court held that, since the debtors knew their income was derived from marijuana, which the Trustee could not lawfully receive and distribute, the debtors’ submission of a plan involving such funds was deemed to be not proposed in “good faith” and therefore not in compliance with the first prong of § 1325(a)(3).

It is striking that, although the language of the two counterpart sections applicable in Garvin and In Re Arenas (§ 1129(a)(3) and § 1325(a)(3), respectively) are quite similar, the Ninth and Tenth Circuits based each of their decisions on different prongs of the respective sections of the Code. The decision of Garvin noted that “[o]nly the second prong is at issue here”, centering their focus on the “unlawful means” test for plan approval. Conversely, the In Re Arenas court only considered the “good faith” portion and, in finding no such good faith, indicated that they “need not address whether the debtors’ plan was proposed by any means forbidden by law”.

While it is unclear when – or even if – this matter might be taken up to the U.S. Supreme Court, it is clear that, as the marijuana industry matures and more ancillary companies generate revenue from plant-touching operators, the ability of those companies operating in the marijuana industry to obtain bankruptcy relief is an issue that will not go away anytime soon and one that we will continue to monitor closely.