Bankruptcy and Medical Marijuana: Are There Any Special Rules or Exceptions? - Westgate Law

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Bankruptcy and Medical Marijuana: Are There Any Special Rules or Exceptions?

In a recent bankruptcy filed by Mr. and Mrs. Arenas, the question of whether or not income from medical marijuana makes a difference in the consumer’s ability to benefit from bankruptcy discharge.

Mrs. Arenas was disabled. Her disability and pension benefits of about $3,000/month combined with her husband’s income to generate their family’s monthly average income of about $4,000. The interesting element in this case is that Mr. Arenas’ income was derived from the operation of a medical marijuana production and distribution business. He also leased a portion of their property out to a marijuana dispensary to supplement their income.

Activities in question were compliant with state law, but as Mr. Arenas didn’t have a license or permit issued by the federal Drug Enforcement Administration allowing him to operate a business legally according to the federal Controlled Substances Act (CSA), the debtors were liable for criminal penalties according to federal law.

Precedents set by previous rulings on different cases in different courts made it clear that a federal court cannot offer bankruptcy protection to any debtor who has operations that fall into the category of a continuing federal crime. The debtors argued the conflict between state and federal law and asked the court to reconsider their stance. The conflict between state and federal law often involves the preemption of state law by federal law. In the case of medical marijuana, Congress has not chosen to preempt state law. This means that states are allowed to legalize and regulate the use of medical marijuana. The only stipulation is that the states legalizing marijuana must not offer any active assistance to marijuana users or growers.

Marijuana users and suppliers are often very confident that there will be no prosecution or repercussions even though they are technically breaking federal law. They are often right. It’s not that the activities themselves are not illegal under federal law, but that the federal government does not have the type and amount of resources that would be necessary to get it done. So while states are allowed to look the other way regarding this federal law, states can’t require that the federal government behave in the same manner.

The crux of the matter was that the “assets” of these particular debtors were in themselves, a violation of federal law. The bankruptcy trustee, in order to sell the debtors’ assets, would have to involve himself in their criminal acts (according to federal law). This prevented him from selling the debtor’s assets. The fundamental requirement of a Chapter 7 consumer liquidation case is for the debtor to turn over any and all non-exempt assets to the bankruptcy trustee so they can be liquidated in order to pay creditors listed in the case. In exchange, the debtors remaining debts are discharged. The trustee in this particular bankruptcy case could not take control of the debtors’ property or liquidate the inventory. Doing so would make him a criminal according to federal law. Since the trustee couldn’t perform the necessary function of administering the debtors’ assets, to allow the case to proceed would mean the debtors received the benefit of discharge without the required sale of their available assets. The court decided this was cause for dismissal.

The U.S. trustee attempted to have the chapter 7 case dismissed “for cause.” The debtors countered by converting their chapter 7 to a chapter 13 filing and it was left dependent upon interpretation of the federal Controlled Substances Act. As to propose an appropriate repayment plan meant the Arenas’ would need to include income from their illegal profits, the court found there was cause to dismiss the chapter 13 case as well; as such the couple was found “ineligible” to convert to chapter 13 bankruptcy.

The ruling was devastating for the debtors, but the court’s decisions were based upon legal analysis that is very straightforward.

If you have questions about possible ineligibility to file for chapter 7 or chapter 13 bankruptcies due to your specific circumstances, contact the southern California bankruptcy experts at Westgate Law.

About the Author

Justin Harelik

Justin has a singular goal: to get people out of financial distress and move them to financial stability and prosperity. He does this by combining 15 years of in-depth experience in bankruptcy, credit management, debt negotiation and student loan modifications, and he does it with both English and Spanish-speaking clients.

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