California’s cannabis industry continues to struggle in this seemingly unending shake out period. Namely, hundreds of licensed cannabis companies are getting stiffed on A/R with an overwhelming inability to collect as those debtors go out of business. It’s gotten so bad that California considered passing a bill where cannabis companies that fail to pay their overdue invoices will suffer regulatory violations. And the Credit Management Association, at the request of a significant number of B2B California cannabis businesses, was set to compile a list of bad actor retailers that left wholesalers and distributors hanging. Such dire financial times require creditors to get both aggressive and creative. Their options in cannabis are limited since bankruptcy isn’t really available and because of the cannabis regulatory red tape. However, assignments for the benefit of creditors (“ABCs”) are definitely a (surprisingly) great way to deal with cannabis debtors in California (and potentially elsewhere). So, if you’re swimming upstream with a cannabis debtor, you may contemplate using a California cannabis ABC.
What is an ABC?
An ABC is a business liquidation mechanism that’s an alternative to bankruptcy (and state law receiverships). Bankruptcy isn’t available to cannabis-touching entities because of federal illegality. ABCs are great if the parties seek to transfer assets of the insolvent business to an acquirer free of unsecured debt incurred by the debtor prior to the ABC. ABCs are also relatively private agreements that help mitigate reputational risk for the debtor. The other beauty of ABCs is that, depending on the state, there’s actually not a lot of law or regulation involved, meaning the parties can move and shake a lot to meet their end goals.
How does an ABC work?
Pretty simply actually. Definitely get a hold of your solvency attorney for this one, but there are three parties involved: debtor/assignor, creditor(s), and assignee. Debtor/assignor is the distressed company looking to transfer its assets in order to give over any sale proceeds to its creditors. The assignee is a third party fiduciary that conducts the liquidation and eventual dissolution of the debtor/assignor entity. The main agreement in play is the assignment agreement in which the assignor assigns all of its assets (in trust) to the assignee. The assignee then liquidates those assets and pays the creditors of and on behalf of the assignor. Of course, creditors of the assignor have to submit claims to the assignee to try to collect.
California ABCs generally
ABCs in California are nonjudicial and they’re governed by common law with some statutory controls. Importantly, California assignees have to set deadlines for creditor claims as part of the ABC, and the assignee operates like a de facto bankruptcy trustee. California also has statutes that govern the sale proceed distribution process but not necessarily in any particular order of specific priority. Taxes, unpaid wages, other employee benefits, and customer deposits get paid first before any unsecured creditor claims, for instance. And secured creditors still get first dibs before unsecured creditors.
California cannabis ABCs
The legitimate assets of a cannabis company with real value are the licenses involved and the cannabis inventory. Typically, neither one of those is transferable without jumping through immense regulatory hoops. You certainly cannot acquire any cannabis inventory without a commercial cannabis license. And, specifically in California, cannabis licenses are not transferable–only changes of ownership of a licensed business are allowed by the Department of Cannabis Control (“DCC“). There is one lone bright spot though, and that is for California cannabis ABCs.
California cannabis ABCs can solve license transferability issues
With a standard California cannabis change of ownership, the DCC will require that at least one original “owner” remain with the cannabis company to be sold. That standard is met by either keeping an original owner in a “direction, management, or control” capacity (typically with a sale of 100% of the company’s equity), or by allowing an original owner to maintain at least 20% of the equity of the selling cannabis company. If you fail to follow the foregoing, the DCC will force the shutdown of the selling business and the buyer will simply have to apply for its own new license. Changes of ownership in California cannabis make for complicated and convoluted M&A, so you’d initially think that an ABC with a cannabis business is meaningless since you can’t liquidate the license or the inventory through an ABC without incurring a massive regulatory headache.
However, pursuant to 4 CCR 15024, assignors and assignees in a California cannabis ABC have a clear path to licensing and continued operation that isn’t your standard change of ownership nightmare. That section of the DCC regulations states that:
In the event of [an] . . . assignment for the benefit of creditors . . . the owner or owners’ successor in interest (e.g., appointed guardian, executor, administrator, receiver, trustee, or assignee) shall notify the [DCC] in writing, within 14 calendar days . . .
To continue operations or surrender the existing license, the successor in interest shall submit to the [DCC] the following:
(1) The name of the successor in interest.;
(2) The name of the owner(s) for which the successor in interest is succeeding and the license number;
(3) The phone number, mailing address, and email address of the successor in interest; and
(4) Documentation demonstrating that the owner(s) is incapable of performing the duties associated with the license such as a death certificate or a court order, and documentation demonstrating that the person making the request is the owner or owners’ successor in interest such as a court order appointing guardianship, receivership, or a will or trust agreement.
The above takes care of the California cannabis change of ownership issue–assignees (here the “successors in interest”) don’t have to go through the “owner retention” process in a California cannabis ABC in order to keep the distressed business afloat during the ABC. But what about a license transfer since California cannabis licenses are not transferable? The DCC has the following answer:
The [DCC] may give the successor in interest written approval to continue operations on the licensed business premises for a period of time specified by the [DCC]:
(1) If the successor in interest or another person has applied for a license from the [DCC] for the licensed premises and that application is under review;
(2) If the successor in interest needs additional time to destroy or sell cannabis or cannabis products; or
(3) At the discretion of the [DCC].
(d) The successor in interest is held subject to all terms and conditions under which a state cannabis license is held pursuant to the [Medicinal and Adult-Use Cannabis Regulation and Safety Act].
What the above means is that the assignee (or anyone else) can actually apply for its own license at the assignor’s licensed premises while the assignee still operates the assignor’s business. This is pretty much unheard of in other California cannabis circumstances, mainly because California only allows one licensee to operate at a single licensed premises at any given time. What I’ve seen to date are creditors not only taking advantage of the liquidation of the distressed cannabis businesses as assignees continue to run them but also applying for their own commercial cannabis licenses at the licensed premises of the assignor, too (or such opportunity is “for sale”).
With no bankruptcy on the table, California cannabis ABCs are not a bad way to negotiate continuing assignor operations while securing your own liability-free commercial cannabis license in a state that otherwise doesn’t allow license transfers. In the months and years to come, I think cannabis creditors will continue to explore this option in California when it comes to making themselves whole.
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Husch Blackwell’s Cannabis team has the experience to assist companies in navigating the complex and evolving federal legal landscape surrounding the cannabis industry. Contact Hilary Bricken or your Husch Blackwell attorney.