Pot Shops in Colorado Face Another Federal Hurdle: Bankruptcy Filings Are Illegal, Rules Judge

Cannabis leaf
Although Colorado’s recreational marijuana shops are increasing in popularity, they’re still technically illegal under federal law. And this poses a serious problem for pot companies looking to purge their debts and pay what they can to creditors by declaring bankruptcy.Just recently, The Denver Post reported that a federal bankruptcy judge dismissed a Denver marijuana business owner’s bankruptcy petition on the grounds that the drug is still illegal under U.S. law. Judge Howard R. Tallman did recognize, however, that the implications of the dismissal would be “devastating for the debtor.”

Because federal courts have exclusive jurisdiction when it comes to bankruptcy cases, they can’t preside over illegal businesses, which is exactly what a recreational pot shop is — at least to the feds. Tallman pointed out to business owners Frank and Sarah Arenas, who had sought the initial filing, that their business had technically violated the Controlled Substances Act.

Tallman wrote that although it would be unlikely for the Arenas to be arrested for violating the CSA, “… those violations of federal law create significant impediments to the Debtors’ ability to seek relief from their debts under the federal bankruptcy laws in a federal bankruptcy court.”

The Arenas initially sought Chapter 7 bankruptcy, which would require them to turn over all of their assets to a trustee; the trustee would then liquidate the assets to pay off creditors. However, Tallman ruled that the trustee would be violating the law by selling marijuana to liquidate those assets.

The case could not be converted to a Chapter 13 bankruptcy, because the Arenas would still be operating their pot-selling business to pay off their creditors. That reorganization, Tallman noted, “would be funded from profits of an ongoing criminal activity.”

“What’s interesting about this case is that the state laws legalize the sale of the pot, but the federal laws say its still illegal. One of the requirements of a bankruptcy is that your federal income tax returns are filed, but it is difficult to do this when you own an illegal business,” explains Will Ridings, Principal of Ridings Law Firm. “It makes sense that a federal judge would say that you can’t take advantage of a Chapter 13 bankruptcy because they don’t try to prosecute or close their business. Instead, the creditors will get judgments against them in state court and pursue their legal remedies under state court laws. The state government could also seize their inventory.”

According to court records, the Arenas, who are wholesale marijuana producers and distributors, currently owe more than $556,000 to unsecured creditors. The Arenas have assets of $595,925, personal property worth $47,191, monthly income of $4,315.16 and about 25 marijuana plants valued at $250 each.

This is just one issue that pot businesses face. As noted in Forbes, many banks refuse to loan to pot companies — or deal with them at all — for fear of getting charged with money laundering, which can come with a sentence of up to 20 years in prison. Being charged with marijuana conspiracy can carry a life sentence.

These issues force most business owners to deal in cash only, which adds to the risk of robbery.

Marijuana businesses also pay larger federal tax bills because they are ineligible for the same tax incentives as other small businesses.

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