Court: United States Bankruptcy Court, D. Arizona; April 6, 2015; Us Bankruptcy; United States Bankruptcy Court
The Court has granted Medpoint Management’s Motion to Dismiss the involuntary Chapter 7 petition filed against it by Petitioning Creditors on October 7, 2014. Medpoint filed its Motion to Dismiss on December 31, 2014, which prompted a series of responses and hearings, including additional briefing on the potential forfeitability of Medpoint's assets under the Controlled Substance Act. The Court conducted oral arguments on multiple occasions, ultimately taking the Motion under advisement before issuing its ruling.
Background information reveals that Arizona Nature’s Wellness (ANW) is a nonprofit entity operating a medical marijuana dispensary under the Arizona Medical Marijuana Act, which mandates dispensaries be not-for-profit. Medpoint, an Arizona limited liability company, was involved in managing ANW's operations and held a management agreement through its acquisition of Tier Management, LLC from one of the Petitioning Creditors. This acquisition was intended to facilitate ANW's operational needs, as it lacked its own employees. Medpoint continued to service ANW under the terms of the initial agreement until it entered into a new service agreement with ANW on December 11, 2013, which replaced the previous agreement.
ANW terminated the Medpoint Service Agreement on May 27, 2014, citing dissatisfaction with Medpoint’s performance, despite ANW being a captive entity under the agreement, which permitted Medpoint to appoint ANW’s board. Currently, Medpoint provides no management services to ANW or others, as ANW has engaged Bloom Master Fund I, LLC for these functions.
Medpoint owns the "Bloom" trademark, under which ANW markets its marijuana products, and licenses this intellectual property to Bloom IP Industries, LLC for $8,000 monthly, which is Medpoint's sole revenue source. Medpoint's assets include a 100% membership interest in Tier and causes of action against ANW for alleged wrongful termination of the Service Agreement.
The Petitioning Creditors—Danzer, 7511 IRA Investments, LLC, Jason Jensen, and Robert Brown—have claims against Medpoint. Danzer's claims stem from a sale agreement where Medpoint defaulted on payments for acquiring his interest in Tier and failed to pay $5,000 monthly under a consulting agreement for construction management services. Jensen also has an unpaid consulting agreement for project management services. Additionally, Robert Brown loaned Medpoint $100,000 and 7511 loaned $400,000, both of which remain unpaid, with their agreements acknowledging Medpoint's involvement in the medical marijuana industry.
The court is tasked with determining whether to issue an involuntary order for relief against Medpoint, despite the potential illegality of its business operations under federal law. The court concludes there is cause under section 707(a) to dismiss the Petition.
Medpoint contends that a bankruptcy trustee cannot legally manage marijuana-related assets due to potential violations of the Controlled Substances Act (CSA), referencing the case In re Arenas, which indicated that administering illegal assets could justify case dismissal under section 707(a). Medpoint argues that the involvement of the trustee in controlling Debtors’ Property would implicate him in federal crimes. Additionally, Medpoint cites Northbay to assert that the case should be dismissed due to the Petitioning Creditors' alleged unclean hands from their involvement in the medical marijuana industry, and suggests the court alternatively suspend proceedings under section 305(a) due to inefficiencies arising from state-federal law conflicts.
In response, the Petitioning Creditors deny any illegal activity by Medpoint and assert that their claims are not tied to marijuana sales or illegal actions. They differentiate their case from those cited by Medpoint, emphasizing that they do not engage in the sale of marijuana. The Creditors also highlight that Medpoint has obtained a Federal Tax ID and banked with an FDIC-insured institution, indicating lawful operations. Regarding Medpoint's section 305(a) argument, they argue that suspending proceedings would not serve creditors' best interests, citing legal precedent that emphasizes the need for both debtors and creditors to benefit from dismissal. Furthermore, they reference the Cromnibus Act, which prohibits federal enforcement actions against Arizona medical marijuana businesses, thereby asserting that federal resources cannot impede the implementation of state laws regarding medical marijuana.
The United States Trustee expressed doubts about the viability of a trustee managing Medpoint’s bankruptcy estate, questioning the feasibility of overseeing contracts for illegal activities and expressing skepticism about Medpoint's possession of legal, non-marijuana assets, confirming that all of Medpoint's assets are marijuana-related.
The Court evaluates three key arguments regarding the Motion: 1) the basis for dismissing the Petition; 2) whether the Petitioning Creditors possess unclean hands, and if so, whether the Court should grant relief; and 3) whether the Petitioning Creditors acted in bad faith.
Under Section 707(a), the Court can dismiss a chapter 7 case for cause after providing notice and a hearing. The case of In re Arenas established that a bankruptcy case can be dismissed due to the debtor's assets being marijuana-related, as the trustee's inability to lawfully administer these assets under the Controlled Substances Act (CSA) rendered the case futile. Similarly, in In re Vel Rey, the court denied a trustee's request for immunity related to noncompliance with housing regulations, asserting that concerns about personal liability could lead to dismissal for cause under Section 707. In another case, In re Rent-Rite Super Kegs W. Ltd., the court found that a landlord's lease with a marijuana entity constituted gross mismanagement, warranting dismissal.
The Court aligns with these precedents, emphasizing that a chapter 7 trustee would face significant risks in managing a marijuana-related estate. The Bankruptcy Code grants the trustee special powers, but these must yield to government interests in public health and safety as outlined in the CSA. As marijuana is classified as a schedule-I controlled substance, the trustee's responsibilities must be balanced against these governmental interests, which prioritize the health and welfare of the public.
The Court notes the potential for seizure or forfeiture of Medpoint's intellectual property (IP) and licensing revenues, along with the possibility that Medpoint may have facilitated a crime under the Controlled Substances Act (CSA). Individuals involved in marijuana cultivation, sales, or distribution, as well as those who knowingly assist such activities, violate the CSA irrespective of state laws. Both Medpoint and ANW could be implicated under an accomplice theory of liability as per 18 U.S.C. § 2(a). The Court expresses concern that the risk of asset forfeiture poses an unacceptable threat to a Chapter 7 estate and its trustee. Citing precedent, the Court references a prior case where similar risks led to case dismissal.
Petitioning Creditors claim that the Cromnibus Act mitigates the risk of federal enforcement against medical marijuana operations; however, the Court finds this argument unconvincing. The Act limits DOJ funding for enforcement actions but does not eliminate the potential for enforcement altogether. The Court highlights past DOJ asset forfeiture activities to illustrate this risk, noting that the Attorney General may use the Asset Forfeiture Fund for seizures under any law administered by the DOJ, including the CSA. The Cromnibus Act's provisions are temporary, expiring on September 30, 2015, which raises the possibility that future funding could allow for enforcement against Arizona’s medical marijuana businesses.
Ultimately, the Court declines to issue an order that would compel the appointed Chapter 7 trustee to violate federal law while administering the estate, determining that the dual risks of asset forfeiture and the trustee’s potential CSA violations justify the dismissal of the Petitioning Creditors’ involuntary petition under section 707(a). The Court grants Medpoint’s motion.
The unclean hands doctrine asserts that a party seeking equitable relief must come to court with clean hands, meaning they must not have engaged in unethical or illegal conduct related to the matter at hand. The bankruptcy court, as a court of equity, is guided by this principle, which prevents it from aiding a plaintiff involved in actions contrary to law. In this case, Medpoint, while managing a medical marijuana business, engaged in practices that siphoned off cash from ANW, a not-for-profit organization, through various agreements. These actions included employing a subsidiary, Infinite Bloom, LLC, and hiring consultants for facility construction, all while branding products under the Bloom trademark. The Petitioning Creditors, aware of the illegal nature of Medpoint's operations under federal law, chose to enter into contracts with Medpoint, seeking financial gains from its marijuana-related activities. Given their knowledge of the potential criminal implications, the Petitioning Creditors' hands are deemed unclean, thus barring them from seeking relief from the court regarding their claims against Medpoint.
The Court may award Medpoint fees or costs for a successful Motion, or actual and/or punitive damages related to a bad faith involuntary petition under sub-sections 303(i)(1) and (2). Determining bad faith involves factual findings compared to reasonable person standards, considering the totality of circumstances. Medpoint claims that the Petitioning Creditors filed the Petition to gain control of a medical marijuana license for a business violating federal law. They attached a draft settlement offer letter from the creditors' counsel to ANW's board, which is unsigned and denied by the creditors as being sent. The Court views the letter as indicative of the creditors’ involvement in the medical marijuana business but not as evidence of bad faith. The Court finds no unreasonable actions by the Petitioning Creditors in filing the Petition, noting Medpoint's inability to meet financial obligations sufficient to justify an involuntary petition under section 303(b). There are no facts supporting a finding of bad faith, as unclean hands do not equate to bad faith. Consequently, the Court concludes there is no need for a damages hearing since no bad faith was found.
The Court has denied the Petitioning Creditors’ requested relief but acknowledges that they have alternative avenues for recourse against Medpoint, potentially through state-law claims enforceable in state court. Evidence from Downing’s deposition suggests that Medpoint may have defaulted on various agreements, and there are facts that could support claims of fraudulent transfer under Arizona law. The Court emphasizes that granting Medpoint’s Motion does not absolve it of responsibility, as the Petitioning Creditors retain the ability to pursue their claims in state court. It notes a conflict between Arizona law and the Controlled Substances Act (CSA), stating that Arizona does not enforce the CSA against businesses like Medpoint. However, as a federal court, it must adhere to federal law, which prohibits marijuana-related business activities. The Court points out that the Petitioning Creditors might themselves have violated the CSA, entering the proceedings with unclean hands. Consequently, the Court lacks the authority to provide relief or jeopardize a trustee managing drug-tainted assets. The Court grants Medpoint’s Motion, dismisses the Petition, and denies Medpoint’s request for a hearing on damages, fees, or costs.
The document outlines several entities involved in a legal matter, including ANW Arizona Nature Wellness, Medpoint Management, and others, with varying organizational structures and profit statuses. The Court asserts jurisdiction under 11 U.S.C. §§ 157 and 1334 and references the Controlled Substances Act (CSA) as codified in 21 U.S.C. 801, et seq. Medpoint's request for a damages hearing is denied, as no provisions for such a hearing were found in the Medpoint Service Agreement or the Tier Service Agreement. There is no written contract between ANW and BMF provided in the pleadings, and Downing is identified as both a current employee and former member of BMF. A diagram is attached illustrating the relationships between the entities following ANW's termination of the Medpoint Service Agreement.
Bloom Industries is a subsidiary of BMF, which currently manages ANW, while Infinite Bloom, a former Medpoint subsidiary, was sold to BMF for $11,100 in 2014 to avoid employee contract complications. The Court refrains from determining the forfeitableness of Medpoint’s assets under the CSA, noting that such issues could influence future bankruptcy proceedings in states permitting medical marijuana operations. It further discusses the legality of contracts and negotiable instruments related to federal law, citing a similar case (Northbay) that highlights the conflict between state legalization of marijuana and its federal illegality.
