In a recent Chapter 11 case filed by a real estate holding company, the United States Trustee appealed confirmation of the Debtor’s Chapter 11 Plan because one of the tenants at the Debtor’s properties used the property to grow marijuana. The United States Trustee made two arguments during the case:

 

1.    Early in the case the U.S. Trustee filed a motion to dismiss the bankruptcy case on the grounds that leasing to a marijuana establishment "constituted gross mismanagement" and was thus cause to dismiss under Bankruptcy Code Section 1112(b). The motion to dismiss was denied with leave to renew the motion at  plan confirmation. The U.S. Trustee never renewed this motion, and as a result the Ninth Circuit did not rule on whether the case should have been dismissed. As a result, the issue of whether businesses who lease to marijuana enterprises should have their cases dismissed remains an open issue in the Ninth Circuit. The Ninth Circuit's quote at the end of this article notes this.

 

2.    The U.S. Trustee argue at plan confirmation that the lease violates federal drug laws and that therefore the Amended Plan was "proposed ... by ... means forbidden by law" and should not be confirmed under Bankruptcy Code Section 1129(a)(3). It is important to note that the lease at issue specifically provided that the tenant would use the property "exclusively as a marijuana establishment." While this complied with Washington state law, it violated the Federal Controlled Substances Act 21 U.S.C. §§801-971, which prohibits knowingly leasing any place for the purpose of manufacturing, distributing or using any controlled substance.  Section 856(a)(1).

 

The Amended Plan provided for payments of 100% of creditors’ claims. In what appears to be an obvious attempt to structure the Plan so it does not run afoul of federal law, the lease with the marijuana tenant (“Green Haven”) was rejected. The plan was structured so that even without revenue from Green Haven it was feasible, and all monthly rent payments from all of the other tenants would be paid directly to the Landlord’s only secured creditor - - the bank that held a lien on the property at issue. Green Haven would continue to rent the property, presumably on a month-to-month basis, and pay rents directly to the property owner. No creditors objected to the plan. The only objector was the United States Trustee, which argued that a Plan must be "proposed in good faith and not by any means forbidden by law." Section 1129(a)(3).

 

As noted above, because the United States Trustee failed to renew its motion to dismiss at plan confirmation, the District Court affirmed denial of the motion to dismiss. The U.S. Trustee’s motion for a stay (of Plan Confirmation) was denied. The debtor made payments pursuant to the Amended Plan during the pendency of the appeal, and unsecured creditors were repaid (presumably in full) while the secured creditor was still in the process of being repaid when this case was considered by the Ninth Circuit Court of Appeals.

 

The Ninth Circuit ruled that the phrase "not by any means forbidden by law" modified the phrase "the plan has been proposed." For this reason the Ninth Circuit concluded that Section 1129(a)(3) directs courts to look only to the way a plan has been proposed, and not to the contents nor terms of a Plan.  The Ninth Circuit specifically stated:

“We do not believe that the interpretation compelled by the text will result in bankruptcy proceedings being used to facilitate legal violations. To begin, absent waiver, as in this case, courts may consider gross mismanagement issues under § 1112(b). And confirmation of a plan does not insulate debtors from prosecution for criminal activity, even if that activity is part of the plan itself. In re Food City, Inc., 110 B.R. 808, 812 (Bankr. W.D. Tex. 1990). There is thus no need to ‘convert the bankruptcy judge into an ombudsman without portfolio, gratuitously seeking out possible ‘illegalities’ in every plan,’ a result that would be ‘inimical to the basic function of bankruptcy judges in bankruptcy proceedings.’”

 

Gavin v. Cook Investments Ninth Circuit Court of Appeals, 5/2/19, Case No. 18-35119.