Marijuana CEOs Face Invalidation of Contracts Until Congress Acts

NEW YORK (MainStreet) — When Rent Rite Super Kegs West Limited filed for bankruptcy in Denver in 2012, the supplier of production materials and nutrients was denied protection by Federal Judge Howard Tallman because it was a marijuana-related business.

“Federal law trumps state law,” said Bob Hoban, a cannabis attorney in Denver. “In any federal court, involving marijuana, the judge is bound to invalidate contracts or the party’s right to bankruptcy protection, because marijuana is still federally illegal.”

Without bankruptcy protection, marijuana businesses are not allowed to dissolve or disappear without paying back debt obligations and instead face debt collection by judgment enforcement, which includes placing liens on real estate, garnishing wages, seizing property and freezing bank accounts.

“It indicates that federal courts believe they are bound to strictly apply federal law to the detriment of marijuana businesses unless and until Congress acts or a federal appellate court finds that state law trumps federal law on marijuana issues,” Hoban told MainStreet.

Although there are medicinal uses, both recreational and medical marijuana are classified under the Controlled Substances Act and are thus illegal federally. Even having licenses and permits to grow and sell marijuana does not protect business owners from their creditors. For example, the Arenas case involving a Denver building that housed a dispensary and grow was dismissed in August after owners sought a reorganization plan.

“These cases need to be appealed to set a precedent reversing them,” saidMatthew Abel, a marijuana attorney in Detroit. Courts have a history of voiding promissory notes, employment contracts, leases and other business contracts when the subject matter involves marijuana cultivation or distribution. Vulnerable contracts include agreements regarding growing, harvesting, trimming, curing, packaging and selling.

“There are limited options to guarantee enforceability of contracts across state lines since multi-state contracts involving controversies in excess of $75,000.00 are usually litigated through the federal courts,” said Leo Shalit, marijuana attorney in New York. Yet almost any contract relating to themarijuana business is at risk for being challenged due to current conflict with Federal law regardless of a state’s position on legalization.

“A state judge could still find that a contract is void due to federal preemption and public policy violations because federal law trumps any direct conflict with state law,” said Shalit. “This concept is known as Federal Preemption.”

One option to enforce marijuana related contracts is to include a choice of law provision in the contract at origination.

Under choice of law, all parties agree that contract disputes will be litigated in a particular state court applying that state’s law because pot CEOs may find leniency from state judges.

“In territories where marijuana is legal, where the matter is heard in state court and the other requirements for contract enforceability are met, a judge could find that the contract is valid,” Shalit told MainStreet. “This could be so because state law would be applied to the analysis.”

But once a marijuana company’s dispute exceeds $75,000 and involves more than one state, CEOs may have no choice but to litigate in federal court.

“In the event of an unfavorable outcome at the state level, the marijuana business will have the option to appeal the judge’s decision to a higher state court,” said Shalit.