How U.S. Bankruptcy Law Leaves Legal Cannabis Companies High and Dry
December 1, 2024In October, the Zicklin School’s William (Billy) Organek, an assistant professor in the Department of Law, published “Up in Smoke: Bankruptcy by Contract in the Legal Cannabis Industry,” in the American Bankruptcy Law Journal. He sat down for an interview with Zicklin News. (This interview was edited and condensed for clarity.)
Zicklin News: Tell us about your research.
Billy Organek: In this paper, I look at federal bankruptcy law vis-à-vis the legal cannabis industry. Cannabis, or marijuana, is now legal in most states, including here in New York. However, many people aren’t aware that marijuana is still illegal on the federal level. In effect, this means that if a marijuana business becomes insolvent, it can’t declare bankruptcy, because U.S. bankruptcy law is federal and federally, marijuana is still illegal. To offer an imperfect analogy, it’s kind of like the idea of the Mafia declaring bankruptcy. It wouldn’t make sense because it’s a criminal enterprise.
ZN: There seems to be a lot of demand for marijuana, especially now that it’s legal. How likely is it that a cannabis business would fail?
BO: Cannabis businesses are like any other business. They have to deal with competition, increasing costs, the consolidation of the industry, and so on. They need to continuously innovate to stay competitive. Moreover, because their products are not universally legal, they face high costs and a high regulatory burden—no pun intended.
ZN: OK, so maybe some weed shops are going out of business. Why should the average person care? In other words, why does your research matter?
BO: Number one, marijuana is big business, and it’s growing. Last year alone, cannabis companies made more than $33 billion in sales nationwide. That’s more than Americans spent on eggs, chocolate, or craft beer.
Number two, the business world typically likes certainty, but here you have a type of business that operates in a system where federal and state laws compete with each other. If a business is legal at the state level but illegal federally, that makes it challenging to operate, and any businessperson interested in it should be aware of this reality.
Number three, people think of bankruptcy as the final stage—a company declares bankruptcy, that’s it, kaput. But just about every airline you’ve flown recently has filed for bankruptcy, reorganized, and come back stronger. In reality, the U.S. bankruptcy system is part of the entrepreneurial lifecycle of a company. The idea is that companies that are economically viable but financially stressed can have a fresh start. Maybe they took on too much debt or their employment costs were too high, but they’re still a good company selling products people want. However, if you’re excluding a whole class of companies from bankruptcy protection, that makes things difficult for other businesses that depend on the investments those companies make, for example. it’s also very hard on people who work for those companies—without bankruptcy, companies might need to shut operations completely, but with bankruptcy they can often retain a large part of their workforce. So, it has a broad ripple effect.
ZN: “Ripple” is one of my favorite Grateful Dead songs! But back to your research: What else would you like us to know?
BO: One way around the disconnect between federal and state cannabis laws is through contractual modifications—in other words, a cannabis business could negotiate individual contracts with the different parties it does business with, contracts that have been modified to include terms and provisions allowing for some bankruptcy protection. However, my research showed that very few companies actually do this. I theorize that this is because it’s very expensive to create these sorts of customized contracts. But is that true? For the second part of my research, I plan to interview people in the cannabis industry, show them my data, and ask them why they don’t use contractual modifications to protect themselves if they go bankrupt. Is it because it’s too expensive, they’re not aware of the issue, or some other reason? Stay tuned.