Despite achieving unprecedented growth, with sales reaching new highs in 2023, many Michigan cannabis businesses find themselves navigating a precarious path to profitability. This dichotomy between soaring demand and the financial struggle of retailers and growers underscores a complex challenge within the sector.
In this challenging environment, while cannabis businesses are increasingly confronted with the need to restructure, the option of bankruptcy remains off the table due to federal law. However, receivership under Michigan law is an effective mechanism through which cannabis businesses, investors and lenders, and state regulatory agencies can address financial and operational struggles in the industry in an organized fashion, and maximize value for creditors in the process.
The Profitability Paradox in Michigan’s Cannabis Industry
Michigan’s cannabis industry has witnessed a meteoric rise, with sales reaching unprecedented levels in recent years. The legalization of cannabis for both medical and recreational use has opened the floodgates to a burgeoning market, one that has rapidly become a significant economic force within the state. In 2023, the industry’s sales soared, a testament to the high demand and widespread acceptance of cannabis among consumers. Michigan’s cannabis industry sold $3 billion in both recreational and medical cannabis in 2023, making it the second biggest cannabis market in the U.S. behind California.
However, beneath the surface of these record sales figures lies a more complicated reality. Many cannabis businesses, especially retailers and growers, find themselves wrestling with profitability challenges. Despite the booming market, these entities face a plethora of pressures that threaten their financial stability. The cost of compliance with state regulations, competition from the black market, unavailability of certain federal tax exemptions, and a saturated marketplace have led to shrinking margins for many businesses.
As prices continue to fall due to market oversaturation and competition, the profitability for many of these businesses becomes increasingly elusive. This economic pressure has placed many businesses in a position where restructuring becomes not just an option but a necessity for survival. Yet, with bankruptcy not an option due to the federal classification of cannabis as an illegal drug, these businesses must look towards alternative solutions to navigate their financial difficulties.
The landscape of Michigan’s cannabis industry is thus one of contrast—high demand but also a need for financial sustainability. It is within this context that receivership has emerged as a critical tool for restructuring, offering a pathway for businesses to address their struggles.
Receivership as a Viable Alternative
As Michigan’s cannabis industry grapples with the complexities of growth amidst financial constraints, the concept of receivership stands out as a pivotal restructuring and liquidation tool. Unlike bankruptcy, which offers a broad spectrum of protections and relief under federal law, receivership operates within the state’s legal framework, providing a tailored solution for businesses that find themselves outside the reach of federal bankruptcy due to the federal illegality of cannabis.
Receivership involves the appointment of a receiver—a court-appointed individual or entity tasked with taking control of the financially distressed company’s assets and operations. This process is initiated through a legal action, often by a creditor seeking to recover debts owed. The receiver’s mandate is to manage the company’s assets in a manner that maximizes value for creditors, which may involve continuing business operations, liquidating assets, and/or negotiating with creditors and stakeholders to settle debts. The process culminates in the repayment of debts and, ultimately, the termination of the receivership, marking the conclusion of the receiver’s stewardship of the company’s assets.
In 2020, Michigan amended the Michigan Regulation and Taxation of Marihuana Act and the Medical Marihuana Facilities Licensing Act to pave the way for the Cannabis Regulatory Agency (CRA) to authorize the operation of a licensed cannabis business by a court-appointed receiver or trustee.
This legislative response acknowledges the critical gap left by the inaccessibility of federal bankruptcy protections for cannabis businesses. By allowing state court judges to appoint receivers or trustees, Michigan offers a structured alternative for the resolution of financial distress within the cannabis industry.
The Receivership Process
Receiverships for cannabis companies remain a fluid process in this nascent industry. Companies, courts, and regulatory agencies are all adapting in this environment. We have gained unique experience in this field by serving as counsel to the receiver in two major cannabis receivership cases, including the high-profile and challenging receivership of Skymint, one of Michigan’s largest cannabis brands, as well as retailer Comco.
In many respects, the receivership process for a cannabis business in Michigan is the same as it is for any other business. However, there are some important distinctions, as we address below.
Here are some of the key components of the receivership process:
1. Appointment of a receiver: A court selects a receiver, usually upon a secured creditor’s lawsuit, to take charge of the distressed company’s assets and oversee its operations. This crucial first step ensures that an experienced party guides the business through its financial turbulence.
2. Assuming control: Upon appointment, the receiver gains control of the company’s assets, from real estate to inventory. Their role may extend beyond mere asset management to include steering the company’s daily operations, setting the stage for stabilization or asset liquidation.
3. Asset management: The receiver’s key responsibility is to safeguard and strategically manage the company’s assets. Whether by sustaining business operations, selling off assets, or implementing other value-maximizing strategies, their goal is to serve the creditors’ best interests.
4. Repayment of debts: Receivers work diligently to address the company’s debts, giving priority to secured creditors but also engaging with unsecured creditors—like suppliers and employees—to negotiate debt settlements, striving for equitable solutions.
5. Litigation: Receivership can involve navigating complex legal challenges, from defending the company against claims to initiating litigation to recover assets.
6. Reporting: The receiver is obligated to keep the court informed, providing regular updates on the receivership’s progress and the status of asset disposition. This transparency is key to maintaining the process’s integrity and accountability.
7. Termination of receivership: The receivership process ends when the receiver has successfully discharged their duties—asset disposition and debt repayment—or when the court deems the process complete.
The receivership process in Michigan’s cannabis industry is significantly influenced by its regulatory environment, presenting challenges and considerations distinct from other sectors. Not only must the receiver keep the Court and other parties to the legal action informed of their status, but the receiver is also charged with reporting key updates to other third parties. Specifically, receivers must navigate stringent reporting requirements, including obligations to the CRA, and in some cases, the Michigan Department of Attorney General. These reporting duties underscore the heightened level of oversight and accountability expected in the cannabis industry.
The sale of cannabis-related assets adds another layer of regulatory complexity, requiring not just a willing buyer but one that has also secured the necessary licensing and approval from the CRA. This stipulation complicates what might otherwise be straightforward asset liquidation. Moreover, the receiver’s operational duties are further complicated by CRA guidelines, such as needing approval for the mere relocation of cannabis products, even absent a formal sale. Further, in the event the receiver seeks to change the business model or modify the structure of a cannabis business, the necessary approvals must be received.
These unique hurdles necessitate a nuanced approach to receivership in the cannabis sector, underscoring the importance of specialized knowledge and experience in navigating both legal and regulatory frameworks. As the industry continues to evolve, so too will the strategies for managing its financial distress, with each receivership case contributing to a growing body of precedent and practice in this dynamic field.
Conclusion
As the Michigan cannabis industry continues to navigate the delicate balance between booming sales and financial sustainability, the role of receivership as a restructuring tool has become increasingly critical. This process, distinctly shaped by the state’s regulatory environment, offers a viable path for businesses grappling with the constraints imposed by federal law. If you have any questions or require assistance, please contact Amanda Vintevoghel.
In an effort to keep you apprised of what’s happening in the realm of bankruptcy and restructuring, here are six legal and statutory developments from the month of January, 2024.
1. Commercial Chapter 11 bankruptcy filings surged in 2023 compared to the year prior. Chapter 11 filings increased 72% to 6,569 in 2023 from the previous year’s total of 3,819, according to data from Epiq Bankruptcy.
2. Bankruptcy filings by PE- and VC-backed companies in 2023 set records, according to S&P Global Market Intelligence data, climbing 174% from 2022. Healthcare and consumer goods portfolio companies led the way in terms of sector concentration.
3. There was also a big increase in repeat Chapter 11 bankruptcy filers—so-called “Chapter 22s.” The most Chapter 22 cases were filed since 2020 during the Covid-19 pandemic.
4. The cryptocurrency industry continues to be a boon for many bankruptcy lawyers. News outlets have recently reported on the hundreds of millions in legal fees generated in large crypto cases filed in the last couple of years, such as FTX. Add Terraform Labs to the mix, which filed for bankruptcy on January 21, listing liabilities ranging from $100 million to $500 million.
5. Airlines are among the most “frequent fliers” through the U.S. bankruptcy system. And recent reports suggest that two airlines, Spirit and Brazil’s Gol, may be on the brink. Following the U.S. government blocking Spirit’s merger with JetBlue, TD Cowen Aviation Analyst Helane Becker wrote: “We believe Spirit is likely to look for another buyer … but a more likely scenario is a Chapter 11 filing, followed by a liquidation.”
6. Having been heavily involved in two Michigan marijuana company receiverships over the past year (as counsel to the receiver), we expect to see more receivership cases in this space, given the financial/operational challenges faced by many in the industry, and the fact that such companies won’t have widespread access to U.S. bankruptcy courts unless and until marijuana’s status as an illegal Schedule 1 controlled substance under federal law changes.
In the recent legal case Fleming v. Bayou Steel BD Holdings II L.L.C., the United States Court of Appeals for the Fifth Circuit made a pivotal decision regarding the liability of private equity sponsors under the Worker Adjustment and Retraining Notification Act (WARN Act) for actions taken by a portfolio company. This decision underscores the potential risks for private equity firms when they exercise significant control over the operations of their portfolio companies, particularly in situations of financial distress.
BACKGROUND OF THE CASE
The case involves BD LaPlace, LLC, operating as Bayou Steel, a small steel producer in Louisiana. In 2016, the company was acquired by Black Diamond Opportunity Fund IV, LP (the Fund), managed by Black Diamond Capital Management (BDCM). Post-acquisition, BDCM installed a new management team and established a board of directors for Bayou Steel, comprising both BDCM and independent non-BDCM members.
Bayou Steel faced severe financial challenges towards the end of 2017 due to market fluctuations, requiring significant capital infusions and substantial third-party debt. By August 2019, the company defaulted on its loan covenants. The following month, the Fund decided against further capital support, leading Bayou Steel to notify employees of immediate termination and plant closure, followed by a bankruptcy filing.
WARN ACT AND ITS IMPLICATIONS
The WARN Act requires employers with 100 or more full-time employees to provide 60 days’ notice before a plant closing or mass layoff. Bayou Steel’s failure to provide this notice led to the legal action by the affected employees. They initially filed a class action in Delaware bankruptcy court, which was later moved to a Louisiana federal court against BDCM and BD Holdings II, the holding company within the Fund that owned Bayou Steel.
THE COURT’S ANALYSIS AND DECISION
The central question was whether BDCM, as a private equity sponsor, could be held liable for Bayou Steel’s WARN Act violations. The court considered five factors to determine if BDCM and Bayou Steel were a “single employer”: common ownership, common directors/officers, de facto control, unity of personnel policies, and dependency of operations.
Common Ownership: The Court found no common ownership between Bayou Steel and BDCM, noting that BDCM only held a 2.5% investment stake in the Fund.
Common Directors/Officers: Despite some shared directors between BDCM and Bayou Steel, the court concluded this was insufficient for liability, as they were never the majority and there were no common officers.
De Facto Control: This factor was pivotal. Evidence suggested BDCM’s significant involvement in Bayou Steel’s decisions, leading the court to infer that BDCM could have directed the plant closure.
Unity of Personnel Policies: The Court found no unity of personnel policies between the two entities.
Dependency of Operations: There was no financial commingling between Bayou Steel and BDCM, negating this factor.
Despite only one factor (de facto control) supporting the single employer status, the Fifth Circuit deemed it crucial enough to potentially warrant BDCM’s liability for Bayou Steel’s WARN Act violation, leaving the final decision to the district court.
IMPLICATIONS FOR PRIVATE EQUITY SPONSORS
This decision is significant for private equity firms. It highlights the risks associated with exerting substantial control over the employment-related decisions of portfolio companies. For private equity sponsors, it’s crucial to ensure compliance with employment laws and maintain clear, well-documented decision-making processes. This is especially important for companies in financial distress, as potential plaintiffs might seek alternate sources to satisfy legal liabilities. The ruling suggests that private equity firms should be cautious about their level of involvement in portfolio companies to avoid similar legal liabilities under the WARN Act.
In summary, the Fleming v. Bayou Steel decision by the Fifth Circuit has set a precedent where private equity firms could be held liable for their portfolio companies’ non-compliance with the WARN Act based on their level of control over the company’s decision-making. This ruling calls for careful consideration and diligence by private equity firms in their governance and oversight roles.
The Dragich Law Firm, located in Grosse Pointe, Michigan, is pleased to announce that Amanda Vintevoghel-Backer has been recognized by Michigan Super Lawyers in 2023.
Amanda received her recognition in the Business Bankruptcy category. Previously, Amanda was named a Super Lawyers—Rising Star from 2018-2022.
Amanda focuses her practice on business bankruptcy reorganization, business transactions, corporate restructuring, and commercial litigation She is a graduate of the University of Detroit Mercy School of Law, and is an active member of the Turnaround Management Association (“TMA”), and is past President of the TMA Detroit Chapter.
Each year, Super Lawyers recognizes the top lawyers in Michigan via a patented multiphase selection process that includes peer nomination and evaluation along independent research. The Michigan lawyers who receive the highest point totals during this selection process are named to this prestigious list. Learn more at www.superlawyers.com.
In 2019, a due diligence requirement was added to the Bankruptcy Code’s preference avoidance provision. There is often outcry by preference action defendants that demands are made and lawsuits are initiated to recover allegedly preferential payments without taking into account valid defenses a party may have to such claims. The due diligence requirement was presumably added to the Bankruptcy Code in order to address these issues. However, due to a lack of clarity in the statute about whether a preference plaintiff has the burden to satisfy the due diligence requirement as an element of a preference claim, courts have been left to consider the issue, and the results have been mixed.
As discussed below, in a recent case, In re Pinktoe Tarantula Ltd., the U.S. Bankruptcy Court for the District of Delaware ruled that the due diligence requirement in section 547(b) of the Bankruptcy Code is an element of a preference claim that must be proved by the preference plaintiff. The defendant does not have the burden to prove that the due diligence requirement wasn’t satisfied as an affirmative defense.
What is a Preference Action?
Section 547 of the Bankruptcy Code allows a debtor or bankruptcy trustee, subject to certain defenses, to recover payments made to creditors within 90 days of the filing of the petition. The look-back period for payments is increased to one year for “insiders.” The policy behind preference actions is that they prevent aggressive collection action against a debtor that might force a debtor into bankruptcy, and they also help ensure equal treatment of creditor claims.
The 2019 amendments to the Bankruptcy Code added the due diligence requirement that a preference action must be brought “based on reasonable due diligence in the circumstances of the case and taking into account a party’s known or reasonably knowable affirmative defenses under [section 547(c)].”
The Court’s Ruling in In re Pinktoe Tarantula Ltd.
In this case, the court ruled in favor of the defendant, and dismissed the preference complaint. The court reasoned that because the due diligence requirement appears in section 547(b) of the Bankruptcy Code, which sets forth the elements of a preference claim, and not in section 547(c), which sets forth affirmative defenses, then the due diligence requirement must be addressed in a preference plaintiff’s complaint—which it was not in this case. According to the court, “[b]ecause the due diligence requirement appears in subsection (b), not (c), I conclude that the due diligence requirement is an element of the claim, or something that must be proven by the [plaintiff].”
Since this was a bankruptcy court ruling, and not a court of appeals ruling, other courts are not bound by this decision. But the court’s analysis on this issue may prove influential, and at a minimum it’s helpful guidance for both preference plaintiffs and defendants moving forward.
The Dragich Law Firm is seeking a mid-level corporate restructuring associate with 2-5 years experience, ideally with some commercial litigation experience.
Our firm provides multifaceted services in restructuring and insolvency proceedings, including Chapter 11 bankruptcy proceedings, state and federal court receiverships, wind-down proceedings, and assignments for the benefit of creditors. Both as part of restructuring proceedings, and as discrete matters, we also provide commercial litigation services to our clients.
The right candidate will be an integral part of our talented team, gain significant experience in different aspects of restructuring and commercial litigation proceedings, and have the opportunity to work in a dynamic, entrepreneurial, and collegial boutique law firm environment.
While the Dragich Law Firm maintains a physical office in Grosse Pointe, Michigan (in metro Detroit), we welcome applications from candidates who wish to work remotely or prefer a flexible, hybrid work environment with partial time in the office. The ideal candidate will be licensed to practice in Michigan.
Benefits include competitive salary, performance and business origination bonuses, medical and dental benefits, and retirement savings account with employer match.
More companies are experiencing distress. Chapter 11 bankruptcy filings rose 105% in May compared to the previous year, according to data from Epiq’s Bankruptcy Analytics platform. When a company finds itself in financial distress, it’s important to remember that bankruptcy is not the only option. A viable and beneficial alternative for the right company can be an out-of-court, state-law wind-down proceeding.
In a recent article published by leading industry publication CFO.com, David Dragich compares and contrasts these two options, examining the relative advantages and disadvantages of bankruptcy versus a wind-down, to inform crucial decisions related to maximizing the value of a troubled company.
A federal receivership is a legal process in which a neutral third-party, called a receiver, is appointed by a federal court to take control of a business or individual’s assets.
A federal receivership can be an effective way to preserve, protect, or sell assets or property at issue. This article addresses many of the important issues that arise in connection with a federal receivership.
The Court’s Authority to Initiate a Receivership
The authority for a federal court to initiate a federal court receivership is derived from the Federal Rules of Civil Procedure, specifically Rule 66, and receiverships are governed by 28 U.S.C. § 3103 et seq.
Under this rule, a federal court may appoint a receiver to take possession of property or assets that are the subject of a lawsuit, in order to preserve or protect those assets pending resolution of the lawsuit. The authority to appoint a receiver is discretionary and may be granted only if the court finds that it is necessary to protect the interests of the parties involved.
Additionally, the court may also set forth specific guidelines and requirements for the receiver to follow, such as filing periodic reports with the court or obtaining court approval before taking certain actions related to the receivership.
Appointment of a Receiver
The process of appointing a federal receiver begins with a court order. A federal receiver may be appointed in a variety of cases, including securities fraud, breach of contract, and environmental violations, provided the federal court has jurisdiction. For example, the Dragich Law Firm has served as legal counsel to receivers in federal court receiverships involving many different businesses and business assets, such as ________. Typically, in the types of cases we are involved in, the process begins when a lender files a lawsuit against a borrower seeking the appointment of a receiver.
Duties and Responsibilities of a Receiver
Once a receiver is appointed, they are given specific duties and responsibilities. These duties may vary depending on the case, but typically involve taking control of the assets or property at issue, managing and preserving the assets, and distributing any proceeds from the sale of assets to creditors or stakeholders.
In addition to these core duties, a receiver may also have other responsibilities. For example, the receiver may be authorized to operate the business or asset during the receivership if it is in the best interest of the parties involved.
The receiver is accountable to the court and has the responsibility to update the court and parties involved on the status of the receivership.
The Receiver’s Rights to Sell Assets
One of the primary functions of a receiver is to sell assets or property at issue. The receiver is authorized to sell these assets, subject to court approval. The proceeds from the sale are then used to pay creditors or stakeholders, according to the priorities established by the court.
Litigation in a Receivership
A receivership may involve litigation, such as lawsuits or other legal proceedings. The receiver may be required to defend against claims made by creditors, stakeholders, or other parties. The receiver may also be required to bring lawsuits on behalf of the receivership estate, to recover assets or property at issue.
Avoidance Actions in a Receivership
A receivership may also involve avoidance actions, which are legal actions taken to recover property or assets that were wrongfully transferred or conveyed. Avoidance actions may be taken against parties who received assets or property from the entity at issue, and may involve complex legal issues and analysis.
Compensation for a Receiver
The receiver is compensated for their services, which may come from the proceeds of the sale of assets or from the entity at issue. The compensation for a receiver is typically approved by the court and is based on the receiver’s qualifications and experience in the relevant industry or field.
The compensation for a receiver may include a fee for their services, reimbursement for expenses, and payment for any staff or advisors hired to assist in the receivership.
Termination of a Receivership
A receivership may be terminated in a variety of ways. In some cases, the receiver may be able to complete their duties and responsibilities, and the receivership may be terminated. Alternatively, the court may terminate the receivership if it is no longer necessary or if it is not in the best interest of the parties involved.
Challenges to a Receivership
While a federal receivership can be an effective way to maximize the value of assets and resolve complex legal issues, it can be challenged by the parties involved. Challenges to a receivership may arise if there are disagreements about the appointment of the receiver, the scope of their duties and responsibilities, and actions taken, among other issues.
Conclusion
The federal receivership process can be complex. To learn more about the process, please contact David Dragich.
In an effort to keep you apprised of what’s happening in the realm of bankruptcy and restructuring, here are four significant legal and statutory developments from the month of January, 2023.
1. Chapter 11 business bankruptcy filings continue to tick up (albeit slightly). Filing increased 3 percent to 326 in December 2022 from the 315 filings recorded in December 2021, according to data from Epiq’s Bankruptcy Analytics platform.
2. On January 4, 2023, the United States Bankruptcy Court for the Southern District of New York issued a decision in the Celsius Network LLC chapter 11 cases regarding the ownership of cryptocurrency assets deposited by customers in the Celsius “Earn” rewards program accounts. The Court ruled that under the Celsius terms of use, customers transferred ownership of the deposits to Celsius and therefore such assets are presumed to be property of the bankruptcy estate. The Court did leave the door open for individual customers to rebut the presumption based on defenses or other circumstances.
3. In the past few weeks, it has been reported that retailers Party City and Bed Bath & Beyond are struggling and may need to seek bankruptcy protection. Since 2020, the retail sector has been one of the hardest hit, leading to a number of bankruptcy filings, including Neiman Marcus, J.C. Penney, Ascena Retail Group and Tailored Brands. One of the benefits of bankruptcy for a retailer with a large footprint of retail locations is that it gives retailers the ability to reject undesirable lease agreements.
4. One of the challenges of administering complex cryptocurrency company bankruptcy proceedings is the fact that many key parties to these proceedings seem to go “AWOL.” That’s requiring lawyers to think in novel ways about how to serve notices and subpoena people who go off the grid. For example, the Bankruptcy Court overseeing Three Arrows Capital Ltd.’s Chapter 15 Case pending in the Southern District of New York, recently authorized service via Twitter of a subpoena on one of the debtor’s founders.
To learn more about these issues, or if you have additional questions regarding bankruptcy and restructuring legal issues, please contact David Dragich.
In an effort to keep you apprised of what’s happening in the realm of bankruptcy and restructuring, here are five significant legal and statutory developments from the last month.
1. Chapter 11 business bankruptcy filings increased 74 percent to 345 in November 2022. That’s up from 198 filings recorded in November 2021, according to data from Epiq’s Bankruptcy Analytics platform. The next “restructuring wave” has been predicted (often inaccurately) for years now, but it seems to be upon us.
2. It looks like the anonymity that cryptocurrency owners/investors have come to expect may be coming to an end as a cascading number of crypto-related companies file for bankruptcy protection. The bankruptcy judge adjudicating the Celsius Network, LLC bankruptcy case in the Southern District of New York recently ordered the disclosure of customer names. This was a departure from the approach of judges in In re Altegrity, Inc. and In re Cred, Inc. in the District of Delaware. It will be interesting to see what happens in the FTX case, which is also in Delaware.
3. The U.S. Courts of Appeal for the Fifth and Eleventh Circuits recently ruled that the “solvent-debtor exception” is alive and well. The exception provides that a solvent debtor’s chapter 11 plan must pay postpetition, pre-effective date interest to unsecured creditors to render their claims unimpaired.
4. One of the most interesting issues to watch in the various pending bankruptcy cases involving cryptocurrency platforms such as FTX is whether customer withdrawals made in the 90 days before the filing will be “clawed back” as preferential payments. Many of these cases, if and when brought, will likely hinge on whether customer deposits are “interest of the debtor in property,” which is a key element of a preference claim. This will be a fact-driven argument in each case related to each platform’s terms of service and customer agreements.
5. A contract can be rejected, assumed or assigned in a bankruptcy case if it is an “executory” contract, which is, generally speaking, a contract pursuant to which performance is due to some extent on both sides. The U.S. Court of Appeals for the Fifth Circuit, in Matter of Falcon V, L.L.C., recently upheld lower-court rulings finding that a surety contract was not executory because the surety had already posted irrevocable surety bonds and, therefore, did not owe further performance to the debtors. In the process, the Fifth Circuit adopted a flexible approach to the “Countryman Test,” under which a contract is deemed executory only if both parties have unperformed obligations as of the petition date that would constitute a material breach if not performed. The Fifth Circuit explained that, when it comes to multiparty contracts, courts “should apply the Countryman test to multiparty contracts in a flexible manner that accounts for the various obligations owed to all of the parties, rather than focusing exclusively on the flow of obligations between the debtor and the creditor.”
To learn more about these issues, or if you have additional questions regarding bankruptcy and restructuring legal issues, please contact David Dragich.
