In a noteworthy decision, the Bankruptcy Appellate Panel for the Ninth Circuit overturned a dismissal of a bankruptcy case, which the lower court had dismissed based on its belief that the landlord debtor was receiving rental income from a marijuana dispensary.  The decision is significant because it holds that a bankruptcy cannot be dismissed simply because of the mere presence of a marijuana business or related proceeds in the case.  Rather, under this decision, the dismissal of a bankruptcy must be supported by specific factual findings that demonstrate that the debtor violated federal law or that the bankruptcy trustee would be required to administer proceeds of a (federally) illegal business.

In In re Olson, 2018 WL 989263 (B.A.P. 9th Cir. Feb. 5, 2018), the debtor, a 92 year old, legally blind landlord, owned a small shopping center in which one of the tenants was a marijuana dispensary operating legally under California state law.  In an effort to stay a scheduled foreclosure sale of her property, as well as to halt ongoing litigation with the dispensary tenant, the debtor filed a chapter 13 bankruptcy case.  Following the commencement of the bankruptcy, the debtor continued to collect rent from the dispensary tenant, filed a motion to sell the shopping center for $3 million, and filed a proposed chapter 13 plan.  The plan, however, never reached confirmation.  Four months after commencing her bankruptcy, the Bankruptcy Court sua sponte dismissed the bankruptcy case based on its finding that the debtor “is leasing property for an unlawful purpose under federal law, although lawful under state law,” and, therefore, was receiving “illegal proceeds.”

On appeal, the Bankruptcy Appellate Panel overturned the dismissal, finding that the Bankruptcy Court had not articulated the legal basis for its ruling nor made any findings to support its conclusion that the debtor had violated federal law.  The decision is noteworthy in that it rejects a per se rule for the dismissal of a bankruptcy case where the debtor is receiving rental income from a marijuana business; however, the concurrence opinion by Judge Maureen A. Tighe may garner more attention.

Noting that over twenty-five states allow medical or recreational use of marijuana, Judge Tighe emphasized the need for bankruptcy courts to issue specific findings for how a debtor has violated federal law so as to “to avoid incorrectly deeming a debtor a criminal and denying both debtor and creditors the benefit of the bankruptcy laws.”  Focusing on section 856(a)(2) of Title 21, which prohibits a person from knowingly and intentionally allowing property to be used for the distribution of illegal drugs, Judge Tighe noted that the debtor could only be said to have violated that criminal statute upon a showing, “beyond a reasonable doubt,” that she knew the tenant was operating a marijuana dispensary and that she intended to allow that use.  In other words, “the presence of marijuana near the case should not cause mandatory dismissal.”

Ultimately, based on the holding in Olson, courts will need fully developed evidentiary records before dismissing a bankruptcy case for violating federal law due to, e.g., the debtor receiving rental income from a dispensary tenant.  Consequently, this may result in increased costs for the United States Trustee who, as reported here, has taken the position that a debtor’s participation in the marijuana industry – no matter how tangential – must result in the dismissal of the bankruptcy case.  Additionally, the requirement for factual findings opens the door for courts to create exceptions based on the facts and equities of individual cases.  The decision also suggests that a debtor may escape dismissal by refusing to accept rental payments from, e.g., a marijuana dispensary tenant and rejecting the lease under section 365 of the Bankruptcy Code.