Strategies for Distressed Cannabis Businesses

It’s pretty easy to write about everything that’s going wrong in today’s cannabis industry. Today, I want to change gears and talk about some of the strategies we’ve seen work for distressed cannabis businesses in the past. Yes, some of these strategies may seem obvious at first. But pulling them off correctly – especially in a highly regulated market – may be a challenge.

What I’m about to talk about might not work for every cannabis business and certainly not for every problem they face. And this is certainly not legal advice. The point I’m trying to make is that despite being in an over-taxed, over-regulated, industry on the edge of (if not in) a recession, there may be ways out. So without further ado, here goes:

1. Negotiating with tax authorities

Hands down, the worst problem facing cannabis businesses today is taxation. If you’re not as familiar with that issue, I suggest you delve into my recent post, “Cannabis Taxation is Theft” to see how dire the situation is. At the end of last year, cannabis businesses owed the California Department of Tax and Fee Administration (CDTFA) hundreds of millions of dollars in unpaid taxes. This number is going to keep growing until the state figures out a way to deal with it.

As the CDTFA’s unpaid tax balance balloons, we have seen the agency become increasingly aggressive. It can assess 60% penalties plus interest and other fees for late payments! It can levy assets, report cannabis businesses to the Department of Cannabis Control (DCC) to suspend licenses, and can even go after individual officers or managers of cannabis businesses in some cases. And this is just the state – the IRS has much more power and local tax agencies can be as aggressive as their state and federal counterparts.

As the CDTFA and other agencies have become more aggressive, we’ve developed a practice of  negotiating payment plans for a number of clients. CDTFA typically won’t budge on waiving penalties until underlying tax principal has been paid. But that’s the state. Local jurisdictions may operate on completely different wavelengths, and may even agree to a waiver up front. It really just depends on the circumstances of the taxpayer, the tax agency, and the ways they negotiate.

2. Resolving costly disputes in court and before court

I don’t think I’ve ever seen a distressed cannabis business that wasn’t mired in at least one, usually nasty, dispute. In a lot of cases, a company hasn’t paid vendor X, and hasn’t been paid by vendor Y, so the company has to fight on both ends. Sometimes employees sue. Sometimes competitors sue. Sometimes the government files an administrative action. Sometimes they have to sue someone. You get the idea.

It almost seems too obvious to say, but it is key for distressed cannabis businesses to resolve disputes as quickly as possible and as cost-effectively as possible, while avoiding a bad settlement. Going to court, or even taking precursor actions to going to court, are not easy things for people to do. It’s costly, stressful, and has no guaranty of success. A lot of businesses are understandably hesitant to reach out to counsel “until things get too late,” and for a lot of them, things got too late weeks before they did that.

Sometimes, it may seem like an issue will never be resolved, but a simple demand letter gets the other side to pay. Or a cease and desist letter gets the other side to cut its shenanigans out. When things need to be escalated, pre-filing mediation or even early mediation can be an effective tool to avoid costly litigation. Our dispute resolution team has seen plenty of cases resolved out of court or at least early on that could easily have turned into 2-3 years in court. But sometimes that doesn’t work. Sometimes, filing and moving forward with litigation is the only way out. And sometimes a hard-fought dispute leads a business to a massive judgment and recovery of attorneys’ fees.

Again, all of this may seem obvious, because it is – conceptually at least. But navigating difficult disputes to achieve a cost-effective, reasonable outcome is incredibly complicated.

3. Other third-party remedies (both in and out of court)

Sometimes cannabis businesses have specific options that they can use in connection with a dispute or potential dispute in addition to just sending demands or litigating. Those might include:

Taking secured property. Lenders often insist on collateralizing assets as part of a loan. This is called a “security interest” and is governed by Article 9 of the Uniform Commercial Code. Sometimes, even landlords do this. If the debtor defaults and fails to cure its default, the creditor will have the right to take the secured property. Think about repossessing a car. Depending on the state and type of asset, this may require filing an action, but that’s not always the case. And depending on the terms of the security agreement, the creditor may be able to auction the asset or even keep the asset for its own use. So collateral interests can be a huge benefit to cannabis creditors.

Landlord self-help remedies. Some states allow commercial landlords to engage in self-help remedies. This includes changing locks, evicting tenants, etc. If a state (and also a lease!) allows this, it can be a powerful tool for landlords to evict non-paying tenants. But many states expressly bar self-help remedies, and landlords that engage in self-help in these states can find themselves in a worse situation than before.

Appointing a receiver. I wrote about receiverships just the other day, so I won’t belabor the point in this post. A receiver can help get a business back on track, or, if things fail, sell off business assets. This can be an immensely powerful tool for creditors.

Writs of attachment. Let’s say a cannabis business fails to pay money to a creditor. The creditor can take them to court (see point 2 above) but by the time a case is resolved, the cannabis business may be insolvent. If the creditor has good reason to believe that the debtor has assets and will get rid of them, it can file a writ of attachment and have the court “freeze” the assets of the debtor pending resolution of the action. Procedures for getting a writ of attachment vary from state to state, sometimes significantly. But once a bank account is frozen, that money’s not going anywhere and the creditor can rest easy for the duration of the suit. Moreover, once a debtor’s assets are attached, there’s a huge incentive for that debtor to start settlement talks in good faith.

These are just a few of what I think of as the “extra” remedies beyond just filing a lawsuit and waiting for the suit to make its way through the court system. Again, some of these things can be done out of court depending on the contract at issue and depending on state law. Attorneys versed in cannabis dispute resolution can guide creditors and debtors alike through prosecuting and defending against these remedies.

4. Business restructuring

When a state opens up cannabis licensing, there’s usually a mad dash to acquire as many licenses and locations as possible. Over the following years, cannabis business owners begin to realize that some aspects of their supply chain aren’t profitable or don’t make sense for other reasons. Combine this with all of the other costs of being in the industry and the dwindling cannabis economy, those businesses often have to figure out ways to restructure.

One of the most common things we’ve seen over the years is a shedding of assets. Here are some common examples:

Selling an operating subsidiary (a business sale) an operating subsidiary’s assets (an asset sale). This will allow a parent company to sell off one or more “branches” or locations and net some capital that it can use to fund other branches. The problem is this only really works for productive assets. If a company’s subsidiary has no business or very poor sales history, it’s going to be hard to find an interested buyer.

Sale-leaseback deals. In my experience, probably 90+% of all cannabis real estate deals are leases, as opposed to acquisitions, because it’s a lot easier and takes up a lot less up-front capital to lease a parcel of land. Businesses that nevertheless bought real estate and become cash-strapped often try to sell the real estate off and lease it back. Like with a business sale, it means that the seller will have a capital infusion that it can reinvest in its business.

Shedding licenses. If a location is not producing revenue, and there’s nothing else special about it, no buyer will want it. For those assets, cannabis businesses may just opt to get rid of them. I’ve seen this quite a bit over the years with distribution licenses in California. Many cannabis businesses thought a distro license would be a nice addition and help them stay vertically integrated. But for those businesses that never intended to offer distribution as a service to third parties, having a license doesn’t usually mean a whole lot. The ability to do self-transport may end up costing more in licensing, vehicle, employee, and insurance per year than simply paying someone else. So in many cases, businesses may just drop these licenses altogether.

Refinancing past-due debt. As the market for cannabis matures, we’re seeing more established lenders jump into the game. This can mean interest rates and other debt service costs that are lower than a few years ago. We’ve helped plenty of cannabis businesses refinance and secure better loan terms, whether that means lower interest, longer payment terms, or completely different loan structures. Refinancing can be an essential tool for cannabis debtors.

These kinds of restructuring opportunities can shed costly assets and gain money, or better manage mountains of debt– sometimes all at once. But cannabis businesses need to be aware that there are tons of pitfalls if this is not done the right way. For example, restructuring often requires explicit permission from regulators, secured creditors, or even landlords of the property where assets are being sold. And in my experience, these third-party approvals tend to be the hardest, longest, and most complicated parts about a business restructuring. This is especially true for cannabis landlords who, from time to time, can be the worst part of any business restructuring. Failure to consider these types of gating issues at the beginning can not only kill a deal, but it can also lead to license revocation or other penalties.

It’s hard to be a cannabis business owner in 2023. But when things get tough, it doesn’t necessarily have to mean insolvency or dissolution – if a business thinks ahead and picks remedies that make sense given its situation. As 2023 continues to unfold and we continue to see the distressed market under pressure, we’ll be sure to keep writing about all of these topics. So stay tuned to the Canna Law Blog.

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