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CANABIS LAW 2019

Presented By: Hanan B. Kolko, Esq. Cohen, Weiss And Simon 900 Third Avenue, Suite 2100New York, New York [email protected](212) 356 0214

CANABIS LAW 2019

The Federal Controlled Substances Act (the "CSA") applies nationwide, and, under the CSA, the cultivation, processing, distribution, and sale of cannabis is a felony and can subject a convicted defendant to punishment up to life in prison. 21 USC § 841(b). This is so regardless of applicable state law. Under the CSA, cannabis is a "Schedule I' substance. 21 USC § 812. As a Schedule I substance, it is deemed to have a high potential for abuse and no currently accepted medical use. 21 USC §812(b)(1). Thus, it is critical to understand that, whatever any state law does, anyone who grows, processes, sells, and/or possesses cannabis pursuant to state law is violating the federal CSA.

Federal Law: The Controlled Substances Act

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The Federal Response to the explosion of state laws legalizing cannabis — The August 29, 2013 Cole Memorandum

• What is it? in 2013, speaking on behalf of the U.S. Department Of Justice, Deputy Attorney General James Cole issued a memorandum entitled "Guidance Regarding Marijuana Enforcement.“

• What does the Cole Memorandum tell us?• It is "guidance" for "federal [CSA] enforcement activity" involving cannabis in states that have

legalized cannabis as a matter of state law. It is not a statute, it is not a regulation, and it is not binding. It could be revised or ended at any time.

• It is an acknowledgement that the vast majority of law enforcement activity related to cannabis is done by state and local authorities.

• As a matter of prosecutorial discretion, and in order for the DOJ to use its limited resources in "the most effective, consistent, and rational way," DOJ will look to eight "enforcement priorities" in determining whether to prosecute those operating in compliance with state cannabis laws.

• Where cannabis businesses operate in strict compliance with state law and in a manner consistent with the federal enforcement priorities, federal law enforcement, as a matter of discretion, will be unlikely to prosecute those businesses for a CSA violation.

The Cole Memo

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a. Preventing distribution of cannabis to minors;

b. Preventing cannabis revenues from going to support criminal enterprises;

c. Preventing diversion of cannabis to states where it is not legal;

d. Preventing "state-authorized marijuana activity from being used as a cover...for trafficking of other illegal drugs or other illegal activity";

e. Preventing violence and the use of firearms in the production and distribution of cannabis;

f. Preventing drugged driving and other adverse health effects;

g. Preventing the growth of cannabis on public land; and

h. Preventing cannabis use or possession on federal property.

The Cole Memorandum Enforcement Priorities:

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January 4, 2018: The Department of Justice Rescinds The Cole Memo. Now what?

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• Precludes Congress from commanding state legislatures and executives "to enact or enforce a federal policy or program," but that Congress can subject the states to regulation by "generally applicable laws."

Printz v. United States, 521 U.S. 898, 917(1997); accord New York v. United States, 505 U.S. 144, 188 (1992)

ANTI-COMMANDEERING DOCTRINE

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• The Controlled Substances Act "does not require the [state legislatures] to enact any laws or regulations, and it does not require state officials to assist in the enforcement of federal statutes regulating private individuals."

• Reno v. Condon, 528 U.S. 141, 151 (2000).

CSA DOES NOT IMPLICATE PROHIBITION ON FEDERAL "COMMANDEERING"

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• The CSA's preemption section: 21 U.S.C. §903. It states that the CSA preempts state laws only where there is a "positive conflict" between state law and the CSA so that "the two cannot consistently stand together."

• How have courts treated claims that the CSA preempts state law?

• What impact would such a ruling have?

PREEMPTION

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• Willis v Winters, 253 P.3d 1058 (Or. 2011)

• Emerald Steel Fabricators v Bureau of Labor and Industries, 230 P. 3d 518 (Or. 2010)

• County of San Diego v San Diego NORML, 81 Cal. Rptr. 3d 461 ( Cal. Ct. App. 2008), cert. denied 556 U.S. 1235 (2009)

• Ter Beek v City of Wyoming, 846 N.W. 2d 531 (Mich. 2014)

What Does the Preemption Language Mean? Some earlier decisions.

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241 Ariz. 230 (Ariz. Ct. App. 2016)

• Plaintiff sought county zoning approval for dispensary pursuant to Arizona Medical Marijuana Act ("AMMA"). Defendant Maricopa County refused to issue the required documents. Plaintiff sued.

• In the Superior Court, the County moved for summary judgement, arguing that the AMMA was preempted by federal law. It asserted both "impossibility preemption" and "obstacle preemption." The State intervened and joined the "obstacle preemption" argument.

• Think about the political impact of a state and its largest county arguing that the state's medical cannabis law is preempted.

White Mountain Health Center v. Maricopa County

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• The Superior Court rejected these arguments and both the State and County appealed.

• The preemption issue on appeal was relatively narrow: were the state and county actions at issue — approving zoning for dispensaries in specific areas and processing applications under the AMMA — preempted?

• Note what the appellate court did not do: it did not address claims raised by Amicus that the AMMA is in direct conflict with the CSA and "unidentified treaty obligations of the United States."

• Citing to the CSA preemption language, 21 U.S.0 §903, the appellate court noted that there is no express preemption in the CSA, and no field preemption.

White Mountain Health Center v. Maricopa County (con’t)

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• The Appellate Court rejected the State and County's obstacle preemption argument.

• In reaching this conclusion, the court cited to a 2015 Arizona Supreme Court decision, Reed-Kaliher v Hoggat, 347 P.3d 136 (Ariz. 2015). There, the Court citing Ter Beek, ruled that because the AMMA did not prevent the U.S. from enforcing federal law — but instead provided immunity from state law prosecution — the AMMA did not "stand as an obstacle to the CSA."

• Rejecting attempts to distinguish or narrowly construe Reed-Kahiler, the court concluded this:

• the AMMA did not bar the federal government from enforcing the CSA in Arizona;

• the federal government cannot compel Arizona to enforce the CSA;

• there is no obstacle preemption


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• Note that the court also cited to County of San Diego to bolster this ruling.

• The county also argued that it was impossible to comply with both the CSA and the AMMA, and thus asserted impossibility preemption. It argued that by issuing the zoning documents at issue, County officials might face prosecution for aiding and abetting CSA violations.

• The Court rejected this argument. Citing to Reed-Kaliher, it ruled that by issuing a zoning document, a county official would not be "authorizing or sanctioning a violation of federal law." The court also held that because the CSA did not "expressly prohibit a county official from abiding by the AMMA issuing zoning documents," the impossibility argument failed.


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• Nebraska v Colorado, 136 S. Ct. 1034 (2016). The Court declines to allow Nebraska and Oklahoma to file a complaint against Colorado, following its long practice of exercising discretion in deciding whether to allow a claim by one state against another to proceed.

• Nebraska and Oklahoma sought to sue Colorado. They asserted that Amendment 64 (which amended the Colorado constitution to legalize and regulate adult use of cannabis) "increased trafficking and transportation of Colorado-sourced marijuana" into their states and forced those states to expend "law enforcement, judicial system, and penal system resources" to address that heightened flow of out-of-state cannabis. They sought a declaratory judgment that parts of Amendment 64 were preempted by the CSA.

• What is the impact of the Court declining to hear the case?

The U.S. Supreme Court Dodges The Issue

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• What do we make of the dissent by Justice Thomas, joined by Justice Alito?

• Note the Amicus brief filed on behalf of all nine former DEA administrators. It argued:

• the "President's refusal to deploy DEA agents [to Colorado] violates his constitutional duty to 'take care that the laws be faithfully executed'. U.S. Const. Art. II §3, c1.5."

• "the dangers of marijuana are irrefutable."

• "Marijuana sold in Colorado does not stay in Colorado." Leakage!!

• Colorado Amendment 64 is preempted by the CSA.

• How will the addition of two new Justices affect the Court's approach to this?

U.S. Supreme Court Dodges the Issue (con’t)

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• United States v McIntosh, 833 F.3d 1163 (9th Cir. 2016)

• The issue: What impact does Rohrabacher-Blumenauer have on federal CSA prosecutions?

• Language of the rider: "None of the funds made available in this Act to the Department of Justice may be used, with respect to the States . . . to prevent such States from implementing their own state laws that authorize . . . medical marijuana."

The Rider And The DOJ — Rohrabacher-Blumenauer

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• By August 2016, when the Ninth Circuit issued its McIntosh ruling, statutory language like that had been in effect since the 2014 — 2015 budget. The rider remains in place through September 30, 2018.

• Who were the McIntosh parties? The United States and various CSA prosecution defendants.

United States v. McIntosh

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• Relying on the Rider language, the McIntosh defendants asked the District Courts hearing their cases to enjoin DOJ from spending any further money on the prosecutions.

• The Ninth Circuit first ruled that the language of the Rider gave defendants the ability to enjoin DOJ from spending money from the relevant appropriations acts, agreeing that they had Article III standing to seek such relief.

United States v. McIntosh (con’t)

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• Based on the Rider and the Constitution's Appropriations Clause, Article I §9 cl. 7, the Ninth Circuit ruled for the McIntosh defendants.

• The court concluded that if DOJ spent funds in violation of the Rider, it would violate the Appropriations Clause and give rise to a separation of powers issue.

• The Ninth Circuit agreed with defendants that the Rider barred DOJ from spending appropriated money to prosecute people operating in compliance with state law.

United States v. McIntosh (con’t)

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• How do courts react to illegality defenses raised by parties to a cannabis-related contract?

Recent Litigation in Which a Party Asserts an Illegality Defense

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Mann v. Gullickson, 2016 WL 6473215 (N.D. Cal. November 2, 2016)

• Plaintiff Mann sold two cannabis-related businesses to defendant Gullickson. Under the stock purchase agreement, defendant agreed to pay $400,000 in three installments.

• Plaintiff sued alleging that defendant breached the obligation to make payments under the contract and associated promissory note. Defendant removed and filed a counterclaim for, inter alia, breach of contract.

• Defendant then moved for summary judgment, arguing that the contract was void "because it relates to medical marijuana, which is still a prohibited substance" under the CSA.

Illegality Defense

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• The court analyzed case law and concluded that "even where contracts concern illegal objects, where it is possible for a court to enforce a contract in a way that does not require illegal conduct, the court is not barred from according such relief . . . If . . . the enforcement . . . would require the court to order illegal conduct, such contracts are unenforceable. This Court must . . . assess whether a remedy exists that would not require it to order a violation of the CSA."

• The court ruled that it could require defendant to pay what it owed under the sale agreements without requiring defendant "to possess, cultivate, or distribute marijuana, or to in any other way require her to violate the CSA."

• Court rejects defendants claim that ordering her to pay under the sale agreement would be "condoning and encouraging" conduct in violation of the CSA, citing to a desire to avoid unjust enrichment, noting defendant's continued investment in the

• business, and pointing to California law allowing for medical cannabis and "the federal government's waivering policy on medical marijuana."

Illegality Defense: Mann v. Gullickson

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• Hammer v. Today's Health Care II, CV 2011-051310 (Ariz. Superior Ct. Apr. 17, 2012)

• Takes the opposite approach, and refuses to enforce a contract where funds were loaned to a cannabis business.

• Which approach is more likely to be followed?

Illegality Defense

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• Don't rely on boilerplate language.

• Think about using detailed recitals.

• Think about explicit waivers of an illegality defense.

• Think about binding arbitration.

• Make a record to show that all parties knew the nature of the enterprise.

• Forum selection clause.

• Problem of obtaining an injunction for specific performance.

• NOTE: Section 136 of Proposed New York State Statute

Practice Pointers

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Green Earth Wellness Center v. Atain Specialty Insurance, 163 F. Supp. 3d 821 (D. Col. 2016)

• Plaintiff operated a dispensary and a grow. Defendant, an insurer, provided it with a commercial property and general liability policy, effective June 29, 2012.

• As a result of a June 23, 2012 fire, smoke and ash infiltrated the grow and damaged plants. Plaintiff made a claim under the policy for plant damage. Defendant denied the claim.

• In 2013, thieves entered the grow and stole plants, and, in the process, damaged the roof and ventilation system. Plaintiff made a claim under the policy and defendant denied that claim.

Insurance Coverage Disputes

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• Plaintiff sued, alleging breach of contract, bad faith refusal to pay claims, and unreasonable delay in payment of claims.

• After discovery, the parties cross-moved for summary judgment. Defendant also filed two motions for "Determination[s] of Question[s] of Law" — whether it could lawfully pay a claim for damages to plants and whether the court could order it to make such a payment, and whether the policy's "Contraband Exclusion" removed the plants from coverage.

Green Earth Wellness Center v. Atain Specialty Insurance

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• The court rejected both arguments.

• The policy's "Contraband" exclusion applied to "Contraband, or property in the course of illegal transportation or trade." While acknowledging that cannabis is unlawful under the CSA, the court stated that "the nominal federal prohibition . . . conceals a far more nuanced (and perhaps even erratic) expression of federal Policy." Based on this, the court found that the Contraband clause was ambiguous, and thus considered extrinsic evidence to ascertain whether the parties intended for the clause to apply to cannabis.

Green Earth Wellness Center v. Atain Specialty Insurance (con’t)

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• In finding for the insured on this point, the Court pointed to three pieces of extrinsic evidence:

1. The insurer's pre-policy statements refusing to cover "growing plants" and the negative implication that thus harvested plants were covered;

2. The insurer's detailed pre-policy inquiries into the extent to which the insured kept inventory;

3. The insurer's pre-policy knowledge of the insurer's business.

• In finding for the insured on the public policy argument, the Court relied on these points, and also cited to "a continued erosion of any clear and consistent federal public policy in this area."


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• The Court explicitly rejected the contrary holding in Tracy v. USAA Cas. Ins. Co., No. 11-00487 LEK-KSC, 2012 WL 928186 (D. Haw. Mar. 16, 2012).

• Bottom line of Tracy: "the cultivation of marijuana, even for the state authorized medical use, violates federal law and the enforcement of an insurance policy under the particular circumstances of this case is contrary to public policy."

• Practice pointers: • Don't rely on boilerplate.

• Look carefully at the rider.

• Be explicit


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The federal/state conundrum affects attorneys' ability to represent clients in the cannabis industry. Let's look at some recent developments.

Recent Ethics Developments

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• Cannabis businesses exist. They have legal needs. They will hire lawyers. Can a lawyer represent a client whose business violates the CSA?

• Different states have taken different approaches. We will examine some of them today.

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• Model Rule 1.2(d): "A lawyer shall not counsel a client to engage, or assist a client, in conduct that the lawyer knows is criminal or fraudulent, but a lawyer may discuss the legal consequences of any proposed course of conduct with a client and may counsel or assist a client to make a good faith effort to determine the validity, scope, meaning or application of the law." The language in bold is not in the New York version of 1.2(d). How have states applied their version of 1.2(d) to attorneys who ask whether they can represent clients in the cannabis business?

The Applicable Model Rule

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• Maine Professional Ethics Commission Opinion #199 (July 7, 2010). Maine's version of 1.2(d) was almost identical to the model rule.

• How the opinion framed the issue? "Whether and how an attorney might act in regards to a client whose intention is to engage in conduct which is permitted by state law and which might not, currently, be prosecuted under federal laws, but which is nonetheless a federal crime."

• What does the Maine opinion tell us? "While attorneys may counsel or assist a client in making good faith efforts to determine the validity, scope, meaning, or application of the law, [Rule 1.2] forbids attorneys from counseling a client to engage in the business or assist a client in doing so." The Maine Commission continues by citing to Comment 9 to Maine Rule 1.2(e), which states: "[t]here is a critical distinction between presenting an analysis of legal aspects of questionable conduct and recommending the means by which a crime or fraud might be committed with impunity." It explains that "the Rule which governs attorney conduct does not make a distinction between crimes which are enforced and those which are not."

The Maine Approach

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"So long as both the federal law and the language of the Rule each remain the same, an attorney needs to perform the analysis required by the Rule and determine whether the particular legal service being requested rises to the level of assistance in violating federal law....Where the line is drawn between permitted and forbidden activities needs to be evaluated on a case by case basis....We cannot determine which specific actions would run afoul of the ethical rules. We can, however, state that participation in this endeavor by an attorney involves a significant degree of risk which needs to be carefully evaluated."

Where did the Maine opinion leave an attorney? With very little guidance.

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• Professional Ethics Commission Opinion #214 (May 4, 2016)

• Commission revisits Opinion #199 (July 7, 2010).

• Opinion #214 cites to "consensus . . . that lawyers should be permitted to advise clients on how to conform their conduct to the law and that the provision of legal advice to clients involved in the medical marijuana trade falls squarely within that exception [to 1.2]."

• Opinion #214 recommends that Maine Rule 1.2(e) be amended to add the following: That a lawyer be allowed to "counsel or assist a client regarding conduct expressly permitted by Maine Law provided the lawyer counsels the client about the legal consequences, under other applicable law, of the client's proposed course of conduct."

Maine Tries to Make Progress

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• In Informal Opinion 2013-02 (2013), the Connecticut Bar Association ("CBA") addressed this issue.

• Citing to Connecticut Rule 1.2(d) — which is almost identical to the model rule — the CBA opines that "[alt some point, perhaps, but not necessarily after the planning and licensing are complete, some clients may expect their lawyers to assist them by providing advice and services in aid of functioning marijuana enterprises that may violate federal law." The CBA continues, citing to Comments to Rule 1.2(d) which provide that a lawyer "must end his or her assistance" "once a lawyer discovers that client conduct the lawyer considered legally proper is criminal or fraudulent." The CBA then points to Connecticut Rule 1.4(a)(5), which "encourages lawyers to inform clients of the limits of the lawyer's ability to assist clients in these circumstances." Finally, the CBA quotes the official comment to Connecticut Rule 1.2, that there is "a critical distinction between presenting an analysis of legal aspects of questionable conduct and recommending the means by which a crime or fraud might be committed."

The Connecticut Approach

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After a paragraph that reiterates that continued status of marijuana under the CSA, the CBA makes the following points:

• Citing to the Maine Commission, it "decline[s] to categorize particular factual circumstances that may raise issues of culpability because the circumstances may be so various as to make the effort valueless."

• The CBA quotes the Maine Commission for the proposition that "the Rule ... does not make a distinction between crimes which are enforced and those which are not" and that "an attorney needs to perform the analysis required by the Rule and determine whether the particular legal service being requested rises to the level of assistance in violating federal law."

• An attorney must, "at minimum ... inform the client of the conflict between the state and federal statutes, and that the conflict exists regardless of whether federal authorities in Connecticut are or are not actively enforcing the federal statutes."

The CBA then concludes by stating that "it is our opinion that lawyers may advise clients of the requirement of the [Connecticut statute] [but] ... may not assist clients in conduct that violates federal criminal law. Lawyers should carefully asses where the line is between those functions and not cross it." 37

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On June 13, 2014, the Judges of the Connecticut Superior Court amended the Connecticut Rules of Professional Conduct to address this issue. Rule 1.2(d) was amended to add the following language: "...but a lawyer may... (3) counsel or assist a client regarding conduct expressly permitted by Connecticut law, provided that the lawyer counsels the client about the legal consequences, under other applicable law, of the client's proposed course of conduct." The comments to section 1.2(d) were amended to add the following language: “(s)ubsection (d)(3) is intended to permit counsel to provide legal services to clients without being subject to discipline under these Rules notwithstanding that the services concern conduct prohibited under federal or other law but expressly permitted under Connecticut law, e.g. conduct under An Act Concerning the Palliative Use of Marijuana...." The comment to Rule 8.4 was amended to add the following language: "[c]ounselling or assisting a client with regard to conduct expressly permitted under Connecticut law is not conduct that reflects adversely on a lawyer's fitness notwithstanding any conflict with federal law."

This raises a critical point: any lawyer representing a client in the cannabis business must be explicit about the fact that the cultivation, processing, distribution, sale, and possession of cannabis violates the CSA regardless of whether those activities are lawful under state law. Any lawyer representing a client in the cannabis industry must also be explicit about the fact that the Cole memo is not a statute or a regulation, and can be revoked at any time.

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• State Bar of Arizona Ethics Opinion 11-01 addressed whether a lawyer "may ethically advise and assist a client with respect to activities that comply with the [Arizona Medical Marijuana] Act, including such matters as advising clients about the requirements of the Act, assisting clients in establishing and licensing non-profit business entities that meet the requirements of the Act, and representing clients in proceedings before state agencies regarding licensing and certification issues." Arizona Rule 1.2(d) is almost identical to the model rule. The opinion concluded that "[I]awyers may ethically advise clients about complying with the Arizona Medical Marijuana Act, including advising them about compliance with Arizona law, assisting them to establish business entities, and formally representing clients before a governmental agency regarding licensing and certification issues, but only in the narrow circumstances set forth in this opinion and only if lawyers strictly adhere to those requirements."

The Arizona Approach

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In reaching this decision, Arizona first discussed prior ethics decisions. One held that lawyers could, consistent with 1.2(d), ethically advise clients to refuse to undergo blood/breath/urine tests upon being arrested for DUI, and another held that lawyers could not, consistent with 1.2(d), advise clients to tape telephone conversations when doing so was unlawful. This discussion concluded that 1.2(d) "has been applied to sanction lawyers who affirmatively counseled their clients to engage in conduct that was knowingly... in violation of state law, but not in conflict-of-law circumstances." Arizona then noted that Maine's version of 1.2(d) was nearly identical to the Arizona version, and quoted, without otherwise discussing, the Maine decision.

In the section of its ruling entitled "Analysis," the Arizona opinion started by stating that "no prior Arizona ethics opinions or cases have addressed the novel issue presented by the adoption of the Act - whether a lawyer may ethically 'counsel' or 'assist' a client under the following conditions: (1) the client's conduct complies with a state statute expressly authorizing the conduct at issue; (2) the conduct may nonetheless violate federal law; (3) the federal government has issued a formal 'memorandum' that essentially carves out a safe harbor for conduct that is in 'clear and unambiguous compliance' with state law, at least so long as other factors are not present... and (4) no court opinion has held that the state law in invalid or unenforceable on federal preemption grounds." Under those circumstances, the Arizona opinion concluded that lawyers could advise clients, whose proposed conduct is in "clear and unambiguous compliance" with state law.

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In reaching this conclusion, the Arizona opinion relied on the following factors:

▪ to interpret 1.2(d) otherwise would "deprive[ ] clients of the very legal advice and assistance that is needed to engage in the conduct that the state law expressly permits";

▪ state law now permits certain conduct, and "legal services are necessary or desirable to implement...that conduct expressly permitted under state law";

▪ "In any potential conflict between federal and state authority, such as may be presented by the interplay between the Act and federal law, lawyers have a critical role to perform in the activities that will lead to a proper resolution of the controversy";

▪ the Arizona Act has not been found to be preempted or otherwise invalid.

The Arizona opinion went on to make it clear that a lawyer may represent a client in connection with the Arizona Act only if (a) the client asks the lawyer's "assistance to undertake the specific actions that the Act expressly permits," (b) the lawyer "advises the client with respect to the potential federal law implications and consequences"; (c) the client, "having received full disclosure of the risks...wishes to proceed with a course of action specifically authorized by the Act." Under those circumstances, the lawyer "may perform such legal acts as are necessary or desirable to assist the client in the conduct that is expressly permissible under the Act." Arizona went on to explicitly provide that lawyers may advise clients about compliance with the Act, help them form business entities, and represent them before government agencies regarding licensing and certification. It also noted that any change in the law, "or in the federal government's enforcement policies" could affect its conclusion.

Again, the Arizona approach requires the lawyer to clearly tell the client about the serious federal risks.

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• Despite this opinion, recent events have called into question.

• Petition R-16-0027, filed on January 11, 2016, asked the Arizona Supreme Court to amend Arizona Rule 1.2(d) to adopt the Connecticut language.

• In making this request, the petitioner noted — correctly — that although Arizona Ethics Op. 11-01 "has provided much needed guidance to lawyers," the opinion is "advisory only . . . not binding on the discipline system," and, quoting an Illinois ethics opinion, notes that it does not "immunize any lawyer from disciplinary action."

• The State Bar General Counsel and its Senior Ethics Counsel submitted a supportive comment.

• The Maricopa County attorney submitted a comment in opposition.

• This past September, the Court rejected the petition without comment.

• Where does this all leave Arizona attorneys? 42

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• Effective 3/24/14, the Colorado Supreme Court adopted a new comment 14 to Rule 1.2. Comment 14 states: "[a] lawyer may counsel a client regarding the validity, scope, and meaning of Colorado constitution [provisions regarding marijuana], and may assist a client in conduct that the lawyer reasonably believes is permitted by these constitutional provisions and the statutes, regulations, orders, and other state or local provisions implementing them. In these circumstances, the lawyer shall also advise the client regarding related federal law and policy."

• There are three interesting points about new Colorado comment 14. First, the Supreme Courts adoption of it was not unanimous. The comment notes that two of the justices "would not approve Comment [14]." Second, it takes the form of a comment, rather than a rule. While a majority of a state bar committee had recommended that Rule 8.6 be modified to "clarify that, notwithstanding any other rule, a lawyer will not be subject to discipline for...advising clients concerning activity that may violate federal law, but which is permitted under a specific provision of the state constitution," the Supreme Court's action took the form of a comment, and not an amendment to a rule. Finally, the U.S. District Court for Colorado declined to adopt this comment.

The Colorado Approach

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• Nevada — adds comment [1] to its Rule 1.2, effective 5/7/14;

• Washington — adds comment [18] to its rule 1.2, effective 12/9/14;

• Oregon — ads the following language: • (d) Notwithstanding paragraph (c), a lawyer may counsel and assist a client

regarding Oregon's marijuana-related laws. In the event Oregon law conflicts with federal or tribal law, the lawyer shall also advise the client regarding related federal and tribal law and policy. Effective 2/19/15.

• Alaska — Adds new section (f) to its 1.2: • (f) A lawyer may counsel a client regarding Alaska's marijuana laws and

assist the client to engage in conduct that the lawyer reasonably believes is authorized by those laws. If Alaska law conflicts with federal law, the lawyer shall advise the client regarding federal law and policy. Effective 6/23/15.

Other States Following the Colorado Approach

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• New York State Bar Association — Committee On Professional Ethics: Opinion 1024 (9/29/14). Issued less than three months after the New York Compassionate Care Act was signed.

• How did the opinion frame the issue? • "Under these unusual circumstances, do the New York rules of Professional

Conduct permit a lawyer to provide legal advice...to doctors, patients, public officials, hospital administrators, and others engaged in the cultivation, distribution, prescribing, dispensing, regulation, possession, or use of marijuana...to help them act in compliance with state regulation ... and consistently with federal enforcement policy?"

• Some points about this framing: (a) it encompasses a wide variety of potential clients, (b) it encompasses a wide variety of potential legal services, and (c) it refers to helping clients act "consistently with federal enforcement policy."

The New York Approach

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In answering the question, the opinion makes a number of points: • "Mlle question presented by the state's medical marijuana law is highly unusual if not

unique: Although participating in the production, delivery, or use of medical marijuana violates federal criminal law as written, the federal government has publicly announced that it is limiting its enforcement of this law, and has acted accordingly, insofar as individuals act consistently with state laws that legalize and extensively regulate medical marijuana."

• State law and "publicly announced federal enforcement policy presuppose that individuals and entities will comply with new and intricate state regulatory law and, thus, presuppose that lawyers will provide legal advice... to an array of public and private actors... to promote their compliance with state law and current federal policy."

• There are a wide range of potential clients, including public officials, state agencies (DOH), health care providers, Registered Organizations and applicants, physicians, and patients. Providing these clients with legal assistance "would be entirely consistent with lawyers' conventional role in helping clients comply with the law. Indeed it seems fair to say that state law would not only permit but affirmatively expect lawyers to provide such assistance."

• Notwithstanding the Cole memo, all of the conduct regulated by the New York statute violates federal law, so providing legal assistance to people seeking to operate under that law "might involve assistance in conduct the lawyer knows to be illegal."

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The opinion concludes that: • "The New York Rules... permit lawyers to give legal assistance regarding the

[statute] beyond a mere discussion of the legality of the client's proposed conduct."

• "Implicitly, the state law authorizes lawyers to provide traditional legal services to clients seeking to act in accordance with state law."

• "In this situation, the federal enforcement policy also depends on the availability of lawyers to establish and promote compliance with the 'strong and effective regulatory systems' that are said to justify federal forbearance from enforcement of narcotics laws that are technically applicable."

• "Nothing in the history and tradition of the profession, in court opinions or elsewhere, suggests that Rule 1.2(d) was intended to prevent lawyers in a situation like this from providing assistance that is necessary to implement state law and to effectuate current federal policy. If federal enforcement policy were to change materially, this Opinion might need to be reconsidered." (emphasis added)

• NOTE: Section 127 of proposed New York law.

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• Maryland State Bar Association Committee on Ethics Docket 2016-10 (Feb. 29, 2016)

• Attorneys not barred from advising clients or providing services to clients.

• Notes that it is not a binding opinion and suggests that the Maryland Court of Appeals amends the Maryland Rules of Professional Conduct.

• No safeguard suggestions.

Maryland

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Minn. Stat. Ann. § 152.32(i) (May 29, 2014)

"An attorney may not be subject to disciplinary action by the Minnesota Supreme Court or professional responsibility board for providing legal assistance to prospective or registered manufacturers or others related to activity that is no longer subject to criminal penalties under state law."

MINNESOTA

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• The Florida Bar Board of Governors adopted a policy not to prosecute Bar members for misconduct if they advise clients about the new state law — as long as they also remind clients about federal law.

• The committee considered a rule amendment or an ethics opinion, but decided a board policy was best

• Policy: "The Florida Bar will not prosecute a Florida Bar member solely for advising a client regarding the validity, scope, and meaning of Florida statutes regarding medical marijuana or for assisting a client in conduct the lawyer reasonably believes is permitted by Florida statutes, regulations, orders, and other state or local provisions implementing them, as long as the lawyer also advises the client regarding related federal law and policy."

• The policy does not address whether a lawyer can personally run a medical marijuana business.

FLORIDA

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CANABIS LAW 2019

Illinois State Bar Ass'n Prof. Conduct Advisory Op. 14-07 (Oct. 2014)

Notes the complexity of the state's statutory and regulatory medical marijuana scheme, and remarks that this is "a classic example of a business in serious need of legal advice and counsel," and that "the provision of legal advice to those engaged in nascent medical marijuana businesses is far better than forcing such businesses to proceed by guesswork."

ILLINOIS

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Makes reference to the "safe harbor" identified in the Cole Memo:

"[A]n Illinois lawyer who represents and counsels medical marijuana clients should tread carefully over the legal terrain. When advising a client concerning conduct governed by the new Illinois law, the importance of the client's conformity with the law and regulations should be stressed. The safe harbor provided by the DOJ Memorandum depends, in part, on 'whether the operation is demonstrably in compliance with a strong and effective state regulatory system."

ILLINOIS

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Opinion is conditioned on current federal policy remaining in place:

"The guidance on prosecutorial discretion provided by the DOJ Memorandum is subject to change, so lawyers providing advice in this field should be up to date on federal enforcement policy, as well as any modifications of federal and state law and regulations. Under the present state of affairs, it is the opinion of the Committee that the provision of legal services to clients involved in the medical marijuana business is consistent with the Rules of Professional Conduct."

ILLINOIS

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At the same time as it issued the opinion, the ISBA recommended to the Illinois Supreme Court Rules Committee to amend Rule 1.2(d):

"In the judgment of the ISBA, the ethical conundrum faced by Illinois lawyers who represent medical marijuana businesses is sufficiently grave to merit a change in Rule 1.2(d) along the lines of the Connecticut amendment. Contemporaneously with the publication of this opinion, the ISBA is recommending to the Illinois Supreme Court Rules Committee that just such an amendment be promulgated."

ILLINOIS

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Illinois Supreme Court Changes Illinois Rule 1.2(d)

In October 2015, the Illinois Supreme Court amended its RPC 1.2(d) to allow attorneys to advise medical marijuana businesses. Amendment became effective January 1, 2016.

Under the new Rule 1.2, lawyers may "counsel or assist a client in conduct expressly permitted by Illinois law that may violate or conflict with federal or other law, as long as the lawyer advises the client about that federal or other law and its potential consequences."

ILLINOIS

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CANABIS LAW 2019

State Bar of New Mexico, Ethics Advisory Panel, Formal Opinion 201 rejecting the Arizona approach and adopting the Maine approach. Note that, in issuing this opinion, the panel pointed to the fact that the New Mexico Supreme Court declined to adopt an amendment to its 1.2 that would have allowed attorneys to "counsel or assist a client regarding conduct expressly permitted by the" state's medical cannabis statute.

NEW MEXICO

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• Supreme Court Of Ohio, Board Of Professional Conduct, Opinion 2016-6 (August 5, 2016).

• Citing to Ohio Rule 1.2(d), the decision stated that "until federal law is amended . . . a lawyer may only advise a client as to the legality of conduct either permitted under state law or prohibited under federal law," but "cannot provide the types of legal services necessary for a client to establish and operate a medical marijuana enterprise or to transact with a medical marijuana business."

OHIO

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• What are the implications of that?

• What did the Ohio Supreme Court do? In September 2016, it adopted an amended Rule 1.2(d), which provided, in relevant part, that a lawyer "may counsel or assist a client regarding conduct expressly permitted under [the Ohio statute] . . . . In these circumstances, the lawyer shall advise the client regarding federal law.

• As a practical matter, what duties does this impose on the lawyer?

OHIO

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Spring 2016: Pennsylvania passes House Bill SB3, which legalizes medical cannabis.

May 2016: Proposed amendment to Rule 1.2(d)

October 26, 2016: Pennsylvania Supreme Court amends 1.2 to add a new (e), which states: "[a] lawyer may counsel or assist a client regarding conduct expressly permitted by Pennsylvania law, provided that the lawyer counsels the client about the legal consequences, under other applicable law, of the client's proposed course of conduct."

PENNSYLVANIA

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• Language regarding the CSA?

• Language regarding cash payments?

• Language regarding unique risks associated with the cannabis business?

• Ethical issues when speaking with attorneys for other parties in transactions: how should you characterize the risks?

Considerations for drafting retainer agreements

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• Cannabinoids are chemical compounds that act on cannabinoid receptors in the body. Different cannabinoids cause different reactions in the body, from feelings of euphoria to nausea relief.

• Cannabinoids are produced by plants other than cannabis and are also produced synthetically.

• There are 113 different cannabinoids that have been isolated from cannabis, including THC and Ct'D.

• THC is shorthand for Tetrahydrocannabinol and is the principal psychoactive agent in marijuana

• CBD is shorthand for Cannabidiol and has medical benefits and is used in in cosmetics and dietary supplements.

• THC and CBD are both cannabinoids.

CBD v. THC

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• Same Genus and Species: Cannabis Sativa

• Different Subspecies or Cultivars (like different types of roses that are produced by careful breeding and selection for color and form).

• Hemp refers to the subspecies that has been bred specifically to produce fiber used in clothing and other materials, oils and seeds and contains low levels of THC.

• Marijuana is the subspecies that has been bred specifically for its medical or psychoactive effects and contains relatively high levels of THC.

• Both hemp and marijuana contain CBD.

HEMP V. MARIJUANA

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• On December 20, 2018, industrial hemp was removed from the Controlled Substances Act. Hemp is defined as follows:

• 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 .3 percent on a dry weight basis.

• The Farm Bill requires the United States Department of Agriculture to formulate national hemp regulations as expeditiously as practicable.

• The Farm Bill allows states, territories and Indian tribes to submit hemp-growing regulations plans to the United States Department of Agriculture. The plans must include:

• THC testing procedures, including inspections done at least annually

• Bookkeeping procedures to track land approved for hemp cultivation

• Plans for "effective disposal" of hemp plants with too much THC.

HEMP AND THE FARM BILL

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• The USDA has the ability to approve or reject those cultivation regulations within 60 days

• The Farm Bill bans hemp cultivation by people with drug felonies in the past 10 years.

• The Farm Bill guarantees that hemp and hemp products can be moved from state to state and imported and exported the same as any other crop.

• The Agricultural Marketing Act of 1946,7 U.S.C. § 1621 et seq., as amended.

• The Farm Bill does NOT guarantee interstate commerce for products containing CBD.

• The Farm Bill does not limit the FDA's authority to ban CBD from foods, drugs and cosmetics.

HEMP AND THE FARM BILL (con’t)

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THE IMPACT OF OTHER FEDERAL LAW ON MARIJUANA BUSINESSES

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• The Financial Crimes Enforcement Network (FinCEN) is a bureau of the U.S. Department of the Treasury. It oversees and implements policies to prevent and detect money laundering. https://www.treasury.gov/abouthistory/Pages/fincen.aspx

• The Currency and Foreign Transactions Reporting Act of 1970 (which legislative framework is commonly referred to as the "Bank Secrecy Act" or "BSA") requires U.S. financial institutions to assist U.S. government agencies to detect and prevent money laundering. Specifically, the act requires financial institutions to keep records of cash purchases of negotiable instruments, file reports of cash transactions exceeding $10,000 (daily aggregate amount), and to report suspicious activity that might signify money laundering, tax evasion, or other criminal activities. It was passed by the Congress of the United States in 1970. The BSA is sometimes referred to as an "anti-money laundering" law ("AML") or jointly as "BSA/AML." Several AML acts, including provisions in Title III of the USA PATRIOT Act of 2001, have been enacted up to the present to amend the BSA. (See 31 USC 5311-5330 and 31 CFR Chapter X [formerly 31 CFR Part 103] ). https://www.fincen.gov/resources/fincens-mandate-congress

BANKING AND CANNABIS

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• While medical marijuana is legal in many U.S. states (at least for medical purposes), it remains illegal under federal law, and is currently labeled a Schedule 1 drug under the Controlled Substances Act. Any bank that provides services to a legal marijuana business faces possible criminal prosecution for "aiding and abetting" a federal crime and money laundering. Id.

• Inability for marijuana related businesses to avail themselves of banking services results in all transactions being conducted in cash:

• Creates security issues for business owners, workers and the surrounding community

• Increases the cost of doing business as business owners must pay more for security and cash transport services

• Diminishes the ability of law enforcement to identify illegal activity because financial institutions are not reporting suspect transactions.

BANKING AND CANNABIS (con’t)

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• On February 14, 2014, FinCEN issued guidance to clarify expectations for financial institutions seeking to provide service to marijuana-related businesses.

• The FinCEN guidance was a response to the relative widespread legalization, on a state wide level, of certain marijuana related activity and the serious problems associated with such a large industry operating on a cash only business.

• Predicated on the Cole Memo

• Designed to provide some level of comfort to financial institutions that they will not be prosecuted for providing services to legal marijuana related businesses.

BSA Expectations Regarding Marijuana-Related Businesses, FIN-2014-G001• Under the BSA, a financial institution is required to file a suspicious activity report

("SAR") if the financial institution knows, suspects, or has reason to suspect that a transaction conducted or attempted by, at or through the financial institution: (i) involves funds derived from illegal activity or is an attempt to disguise funds derived from illegal activity; (ii) is designed to evade regulations promulgated under the BSA, or (iii) lacks a business or apparent lawful purpose. 31 C.F.R. § 1020.320.

THE FINCEN RESPONSE

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• The business is unable to produce satisfactory documentation or evidence to demonstrate that it is duly licensed and operating consistently with state law.

• The business is unable to demonstrate the legitimate source of significant outside investments.

• A customer seeks to conceal or disguise involvement in marijuana-related business activity. For example, the customer may be using a business with a non-descript name (e.g., a "consulting," "holding," or "management" company) that purports to engage in commercial activity unrelated to marijuana, but is depositing cash that smells like marijuana.

• Review of publicly available sources and databases about the business, its owner(s), manager(s), or other related parties, reveal negative information, such as a criminal record, involvement in the illegal purchase or sale of drugs, violence, or other potential connections to illicit activity.

• The business, its owner(s), manager(s), or other related parties are, or have been, subject to an enforcement action by the state or local authorities responsible for administering or enforcing marijuana-related laws or regulations.

• A marijuana-related business engages in international or interstate activity, including by receiving cash deposits from locations outside the state in which the business operates, making or receiving frequent or large interstate transfers, or otherwise transacting with persons or entities located in different states or countries.

• The owner(s) or manager(s) of a marijuana-related business reside outside the state in which the business is located.

• A marijuana-related business is located on federal property or the marijuana sold by the business was grown on federal property.

• A marijuana-related business's proximity to a school is not compliant with state law.

• A marijuana-related business purporting to be a "non-profit" is engaged in commercial activity inconsistent with that classification, or is making excessive payments to its manager(s) or employee(s).

THE FINCEN RESPONSE

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• On February 14, 2014, FinCEN issued guidance to clarify expectations for financial institutions seeking to provide service to marijuana-related businesses.

• The FinCEN guidance was a response to the relative widespread legalization, on a state wide level, of certain marijuana related activity and the serious problems associated with such a large industry operating on a cash only business.

• Predicated on the Cole Memo

• Designed to provide some level of comfort to financial institutions that they will not be prosecuted for providing services to legal marijuana related businesses.

BSA Expectations Regarding Marijuana-Related Businesses, FIN-2014-G001• Under the BSA, a financial institution is required to file a suspicious activity report

("SAR") if the financial institution knows, suspects, or has reason to suspect that a transaction conducted or attempted by, at or through the financial institution: (i) involves funds derived from illegal activity or is an attempt to disguise funds derived from illegal activity; (ii) is designed to evade regulations promulgated under the BSA, or (iii) lacks a business or apparent lawful purpose. 31 C.F.R. § 1020.320.

THE FINCEN RESPONSE

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• As of September, 2018, the legal marijuana business had $9 billion in sales — equivalent to the entire snack market— but only 30% of business had a bank account. Kevin Murphy, Legal Marijuana: the $9 Billion Industry that Most Banks Won't Touch, Forbes, September 6, 2018 https://www.forbes.comisites/kevinmurphvf2018/09/06/1eqal-mariivana-the-9-billion-industrv-that-most-banks-wont-touch/#783f943f3c68

• On January 4, 2018, Attorney General Jeff Sessions rescinded the Cole Memo. Notwithstanding such revocation, by the end of March, 2018, 411 banks and credit unions in the U.S. were "actively" operating accounts for marijuana businesses, according to a report from the Treasury Department's Financial Crimes Enforcement Network (FinCEN). That's up more than 20% from when President Trump took office in January, 2018. Tom Angell, More Banks Working with Marijuana business, Despite Federal Moves, Forbes June 14, 2018 https://www.forbes.comisites/tomangell/2018/06/14/more-banks-workinq-with-marquana-businesses-despite-federal-moves/#3b496c581bib

• Legal marijuana businesses can expect to pay $3,000 to $5,000 a month in bank fees for checking account services alone. Justin Rohrlich, Cannabis Companies are Paying Federal Taxes in Cash and it's Giving the IRS a Headache, Quartz November 14, 2018 https://qz.com/1461947/the-irs-cant-handle-cannabis-companies-all-cash-tax-payments/

THE RECENT STATE OF THE BANKING INDUSTRY

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26 U.S. Code §280E states:

• No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of Schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.

• IRC 280E is the congressional response to Jeffrey Edmondson v. Commissioner, T.C. Memo. 19891-623 (1981). In that case, Edmondson, a drug dealer, received 1.1 million amphetamine pills, 100 pounds of marijuana, and 13 ounces of cocaine from a supplier on consignment. Edmondson reported on his 1974 return that his cost of goods sold for these products was $105,300, itemizing deductions, which included a couple thousand miles he put on his automobile, the cost of a scale to weigh his product, packaging costs, a couple hundred dollars in long-distance and local business calls and a portion of his rent for his home office. The Tax Court allowed the illegal business to recover the costs of the controlled substances and to claim the business expenses.

INTERNAL REVENUE CODE SECTION 280E

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• In Californians Helping to Alleviate Medical Problems, Inc. v. Commissioner, 128 T.C. 173 (2007), the Tax Court held that the taxpayer trafficked in medical marijuana, which is a Schedule I controlled substance, 280E disallows all deductions attributable to that trade or business but that 280E does not disallow the deductions attributable to the taxpayer's separate and lawful trade or business. In that case, taxpayer contended that it was engaged in two separate "trades or businesses," caregiving services and supplying medical marijuana, and that only expenses allocable to the medical marijuana segment were subject to limitation under Section 280E. The court agreed with the taxpayer, finding two separate trades or businesses, with the caregiving services business being the taxpayer's primary business. In so doing, the court analyzed Section 280E's legislative history and determined that Congress' intent was to disallow only expense deductions associated with a trade or business of trafficking in controlled substances.

• In Patients Mutual Assistance Collective Corp v. Commissioner, 151 T.C. 11 (2018), the Tax Court again held that a medical-marijuana dispensary cannot take deductions for ordinary and necessary business expenses. In addition, the Tax Court placed substantial limitations on the ability to capitalize and deduct indirect expenses for the cost of goods sold

• Historically, the IRS assessed a 10% penalty to legal marijuana businesses that paid their taxes in cash. In 2015, the IRS revised its policy and indicated that it would no longer apply the 10% penalty to businesses that had tried in good faith to open bank accounts. Justin Rohrlich, Cannabis Companies are Paying Federal Taxes in Cash and it's Giving the IRS a Headache, Quartz November 14, 2018 https://qz.com7f461947/the-irs-cant-hardle-cannabis-companies-0-cash-tax-payments/

INTERNAL REVENUE CODE SECTION 280E

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BANKRUPTCY OVERVIEW

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In re Arenas, 535 BR 845 (10th Cir. BAP 2015) Facts: Debtors owned nonresidential real property. Debtors used one portion of property to grow and wholesales marijuana pursuant to Colorado license. Debtors leased remaining property to marijuana dispensary. Debtors sued to evict tenant and tent interposed a $120,000 counterclaim. Debtors incurred $40,000 in legal fees in connection with eviction action. Debtors filed for chapter 7 bankruptcy to discharge claims for attorneys' fees and counterclaim. Former tenant made offer to purchase debtors' real property from chapter 7 trustee. Debtors then moved to convert case from chapter 7 to chapter 13. Office of United States Trustee moved to dismiss chapter 7 case on grounds that chapter 7 Trustee could not administer estate assets without violating federal law.

Holding: United States Bankruptcy denied motion to convert case and granted United States Trustee's motion to dismiss case. Bankruptcy Appellate Panel for Tenth Circuit affirmed.

Rationale: The bankruptcy court denied the Arenases' motion to convert their Chapter 7 case to Chapter 13 based on bankruptcy code section 1307 which requires that debtors act in good faith in seeking to convert their case from chapter 7 to chapter 13. The court concluded that the debtors' reorganization would be funded from profits of an ongoing criminal activity under federal law. Even assuming the debtors rented their real property, the chapter 13 plan would be barely feasible because the debtors would have surplus income of less than $8 a month, yielding at best, a nominal dividend. Although the bankruptcy court found the debtors to be sincere and credible and took pains to emphasize that their motives in seeking bankruptcy relief were not improper, the court also recognized that lack of good faith carries an objective rather than a subjective meaning. If the debtors were incapable of proposing a confirmable plan, it is objectively unreasonable for them to seek Chapter 13 relief whether their intentions are kindly or not. In addition, the Chapter 13 trustee would be at risk because the trustee would be administering and distributing funds derived from the Debtors' violation of the Controlled Substances Act.

Bankruptcy and Cannabis

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The bankruptcy court dismissed the case for "cause" under bankruptcy code section 707. Cause is not defined in the bankruptcy code. The court concluded there was cause to dismiss the case because it would be impossible for the chapter 7 trustee to administer the Arenases' estate because selling and distributing the proceeds of the marijuana assets would constitute federal offenses. Although the Chapter 7 trustee could have abandoned the plants, without the marijuana assets, creditors had no expectation of receiving any dividend while the debtors would receive a discharge and would have the benefit of retaining and reaping the benefits of the plants. The court emphasized that the debtors created the situation by acting in violation of federal law.

Takeaway: Individuals or entities involved in the marijuana business are ineligible for bankruptcy relief.

Bankruptcy and Cannabis (con’t)

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In re Johnson, 532 BR 53 (Bankr. W.D. Michigan 2015)

Facts: Debtor filed for relief under chapter 13 after falling behind on his house payments, his utility payments, and at least one payment on his truck. Debtor's income consists of social security and $1,000.00 per month from cultivating and selling marijuana to three patients and a regulated dispensary, pursuant to a valid caregiver license under the Michigan Medical Marihuana Program. Debtor's chapter 13 plan proposed a repayment plan that only used the debtor's social security income to fund such plan.

Office of United States Trustee moved to dismiss case.

Holding: The bankruptcy court gave the Debtor a choice to cease cultivating, distributing or transferring or doing anything with marijuana and destroying the plants or case would be dismissed.

Rationale: The Debtor's marijuana business, though presumably authorized as a matter of state law, violated federal criminal law. The Debtor's financial life is inextricably bound up with his federal criminal activity through the chapter 13 plan, even if he segregated proceeds of that activity. Both chapter 13 trustee and debtor must abide by federal law.

Takeaway: Individual debtors that find themselves in financial distress for reasons unrelated to the marijuana business may be unable to use bankruptcy to obtain a fresh start.


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In re Medpoint Management LLC, 528 B.R. 178 (Bankr. D. Az. 2015)

Facts: Medpoint manged Arizona Nature's Wellness ("ANW"), an Arizona nonprofit entity that held an Arizona Department of Health Services-issued Dispensary Certificate. ANW terminated the Medpoint Service Agreement on May 27, 2014, alleging dissatisfaction with Medpoint's performance under the Medpoint Service Agreement.

Medpoint owned the "Bloom" name and trademark ("IP") under which ANW sold its marijuana products. As of the date of the involuntary bankruptcy petition, Medpoint licensed the IP to Bloom IP Industries, LLC ("Bloom Industries") for $8,000 per month, which was Medpoint's only source of revenue. In addition to the IP and the revenue it generated, Medpoint's other assets included: (1) its 100% membership interest in Tier Management, LLC, which in turn had entered into a Cultivation and Dispensary Services Agreement with ANW (2) its causes of action relating to ANW's alleged wrongful termination of the Medpoint Service Agreement.

The four petitioning creditors were (a) the former owner of Tier that was owed money for his LLC interests: (b) an individual that was owed money for consulting services; and (c) two lenders Each of the petitioning creditors was aware that Medpoint was in the marijuana business.

Medpoint filed a motion to dismiss the involuntary bankruptcy contending that a bankruptcy trustee could not lawfully administer a bankruptcy estate's marijuana-related assets without violating the controlled substances act (citing In re Arenas). Alternatively, Medpoint argued that the Court must dismiss the case because Petitioning Creditors' hands were unclean due to their involvement in a medical marijuana enterprise.


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The petitioning creditors denied that Medpoint was currently engaged in any illegal activity and denied that either the IP or the IP licensing revenues were forfeitable under the CSA. Petitioning Creditors distinguished Medpoint from In re Arenas and other similar cases noting that those cases involved operating dispensaries or growers. Petitioning Creditors denied they had unclean hands, arguing that nothing in the record or Motion indicated that their claims were related to the actual proceeds of the sale of marijuana or ongoing illegal activity and denied that Medpoint used their funds to purchase marijuana or any other illegal substance. Petitioning Creditors observed that Medpoint applied for and received a Federal Tax ID number, and that Medpoint banked at Wells Fargo, an FDIC-insured bank. Lastly, Petitioning Creditors argued that even though medical marijuana may be technically illegal, with the passage of the Consolidated and Further Continuing Appropriations Act ("Cromnibus Act"), there could be no federal enforcement actions against Arizona medical marijuana businesses.

Holding: Bankruptcy court granted motion to dismiss case.

Rationale: The court was strongly persuaded by In re Arenas and other similar cases and the arguments presented by the United States Trustee that appointing a chapter 7 trustee was untenable and placed the trustee at risk of potentially violating the CSA. The court also rejected Petitioning Creditors' argument that the Cromnibus Act essentially eliminated the risk of federal enforcement actions against medical marijuana operations. The court noted that although the Cromnibus Act prohibits the Department of Justice ("DOJ") from using that funding for enforcement against medical marijuana operations, the Attorney General could spend money from the DOJ's Asset Forfeiture Fund to seize property pursuant to any law enforced or administered by the Department of Justice, or for any other necessary expense incident to the seizure of such property.

The bankruptcy court held that the Petitioning Creditors were barred from seeking bankruptcy relief because they knew or should have known that Medpoint's activities were illegal under federal law. Petitioning Creditors nonetheless decided to contract with Medpoint to pursue potentially lucrative investments or lending profits, and/or consulting fees, none of which could be realized but for Medpoint's marijuana-related business affairs. The unclean hands defense arises from and applies to Petitioning Creditors' medical marijuana-related claims against Medpoint.

Takeaway: Creditors doing business with marijuana related business may be precluded from filing an involuntary bankruptcy petition against a debtor.


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Rent-Rite Super Kegs West Ltd., 484 BR. 799 (Bankr. D. Colo. 2012)

Facts: Debtor derived roughly 25% of its revenues from leasing warehouse space to tenants who were engaged in the business of growing marijuana. Debtor filed chapter 11 case to stay the foreclosure action. VFC, the mortgagee, moved to dismiss the debtor's case under the "clean hands doctrine."

Holding: Debtor's conduct provided "cause" to dismiss or convert case based on its gross mismanagement of the estate, but court could not determine, based on record before it, whether it was in best interests of creditors and estate to dismiss or convert. On the one hand, the debtor's real property had substantial equity that could be used by a trustee to pay creditors. On the other hand, the chapter 7 trustee would be taking over an asset that was being used in connection with a criminal activity.

Rationale: The bankruptcy court's application of the clean hands doctrine was justified. Any willful act concerning the cause of action which rightfully can be said to transgress equitable standards of conduct is sufficient cause for the invocation of the clean hands doctrine." Even if the debtor held a good faith —albeit misguided—belief that Colorado state law would prevail over the federal law or that the federal law was unlikely to be enforced, the debtor has knowingly and intentionally engaged in conduct that constituted a violation of federal criminal law and did so with respect to its sole income producing asset.

Takeaway: Entity that derives substantial revenue by doing business with marijuana businesses may be precluded from filing for bankruptcy.


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