In re Arenas

• Decision Date: 28 August 2014
• Docket Number: Case No. 14–11406 HRT
• Citation: 514 B.R. 887
• Parties: In re: Frank Anthony Arenas and Sarah Eve Arenas, Debtors.
• Court: U.S. Bankruptcy Court — District of Colorado

514 B.R. 887

In re: Frank Anthony Arenas and Sarah Eve Arenas, Debtors.

Case No. 14–11406 HRT

United States Bankruptcy Court, D. Colorado.

Signed August 28, 2014

George Dimitrov, David M. Serafin, Denver, CO, for Debtors.

Alan K. Motes, United States Trustee Program, Denver, CO, for U.S. Trustee.

Chapter 7

ORDER ON THE UNITED STATES TRUSTEE'S MOTION TO DISMISS AND THE DEBTORS' MOTION TO CONVERT

Howard R. Tallman, Judge, United States Bankruptcy Court

This case comes before the Court on United States Trustee's Motion to Dismiss Debtors' Case under 11 U.S.C. § 707(a) (docket # 17); and Debtor's Motion to Convert Chapter 7 Case to One under Chapter 13 Pursuant to 11 U.S.C. § 348(a) and Fed. R. Bankr. P. 1017(f)(2) (docket # 23).

I. FACTUAL BACKGROUND

Mr. Arenas is engaged in the business of producing and distributing marijuana ¹ on the wholesale level in the state of Colorado. According to his uncontradicted testimony, he possesses all of the required licenses and permits necessary to legally engage in his business under the laws of the state of Colorado. Mr. Arenas does not possess, and has not applied for, any type of license or permit from the Drug Enforcement Administration to allow him to lawfully operate his business of producing and distributing marijuana under the federal Controlled Substances Act, 21 U.S.C. § 801 et seq. (the “CSA”). ²

The Debtors jointly own a commercial building located at 2863 Larimer Street, Denver, Colorado (the “Property”). The building consists of two units. Mr. Arenas carries on his business operations in one of the units and the Debtors lease the other unit to a marijuana dispensary that operates under the name of Denver Patients Group, LLC (“DPG”).

Mrs. Arenas suffered a stroke in 2011 and is disabled. Her income consists of a Social Security Disability benefit and a pension benefit. Those sources total approximately $3,000.00 per month. The remainder of the family's monthly income—$4,265.16 according to the Debtors' Schedule I—is derived from the lease with DPG and from the operation of Mr. Arenas' growing business. ³ There is no evidence that Mrs. Arenas participates in the growing business.

II. DISCUSSION

The Court finds Mr. Arenas to be a candid and credible witness. In accordance with Mr. Arenas' uncontradicted testimony, the Court finds the Debtors' business operations and ownership and operation of their Property are not illegal under the laws of the state of Colorado and that the Debtors are in compliance with applicable state regulations. Mr. Arenas' testimony also establishes that his business operations and the Debtors' control over their Property are unlawful under the CSA. Both the Debtors' activity of leasing space to a marijuana dispensary and Mr. Arenas' cultivation of marijuana on the property makes the Debtors liable for criminal penalties under the CSA.

The United States Trustee (the “UST”) moves to dismiss the Debtors' case for cause under 11 U.S.C. § 707(a). The UST bases his position largely on the analysis contained in the Court's prior case of In re Rent–Rite Super Kegs West Ltd., 484 B.R. 799 (Bankr.D.Colo.2012). The Debtor invites the Court to reexamine it's decision in the Rent–Rite case.

InRent–Rite, the Court addressed issues concerning a chapter 11 debtor's activities with respect to medical marijuana—activities that are legal under Colorado law but that constitute criminal violations of the CSA. The case came before the Court on a creditor's motion to dismiss the debtor's chapter 11 reorganization case under § 1112(b) of the Bankruptcy Code. The Court held:

Unless and until Congress changes [federal drug] law, the Debtor's operations constitute a continuing criminal violation of the CSA and a federal court cannot be asked to enforce the protections of the Bankruptcy Code in aid of a Debtor whose activities constitute a continuing federal crime.

Rent–Rite, 484 B.R. at 805. The legal principles discussed in Rent–Rite apply with equal force to this case.

InRent–Rite the Court found that the Debtor's operation of a warehouse that was partially rented to a tenant engaged in the cultivation of marijuana was a violation of the CSA. Specifically, the debtor violated 21 U.S.C. § 856(a)(2). That provision makes it unlawful to own or control premises that are knowingly used for the manufactureor distribution of a controlled substance.⁴ Marijuana is classified as a Schedule I controlled substance under the CSA. In addition to the Debtors' ownership of premises that are used in the production and distribution of a controlled substance, Mr. Arenas' growing operation violates the CSA. See21 U.S.C. § 841(a)(1) ( “Except as authorized by this subchapter, it shall be unlawful for any person knowingly or intentionally ... to manufacture, distribute, or dispense, or possess with intent to manufacture, distribute, or dispense, a controlled substance....”). See, also,U.S. v. Oakland Cannabis Buyers' Cooperative, 532 U.S. 483, 121 S.Ct. 1711, 149 L.Ed.2d 722 (2001).

Cases like this case and Rent–Rite arise because of the conflict between the marijuana policies reflected in state law and the federal marijuana prohibition. The Debtor has provided the Court with a law review article that speaks to some of the ramifications of those conflicting policies. Robert A. Mikos, On the Limits of Supremacy: Medical Marijuana and the States' Overlooked Power to Legalize Federal Crime, 62 Vand. L.Rev. 1421 (2009). The Court has read Professor Mikos' article with some interest. The article was written in 2009, prior to any state legalizing recreational marijuana. At the time, 13 states had legalized medical marijuana.

Professor Mikos recognizes that, even though many courts and commentators frequently view the conflict in terms of Constitutional preemption of state law by the federal law, there is no such preemption and the states are perfectly free to legalize and regulate the use of medical marijuana. See alsoRent–Rite, 484 B.R. at 804–805.

Professor Mikos' analysis “suggests that as long as states go no further [than passive legalization]—and do not actively assist marijuana users, growers, and so on—they may continue to look the other way when their citizens defy federal law.” Mikos at 1424. As a result, “[t]he federal ban may be strict—and its penalties severe—but without the wholehearted cooperation of state law enforcement authorities, its impact on private behavior will remain limited. Most medical marijuana users and suppliers can feel confident they will never be caught by the federal government.” Id.

The point that Professor Mikos makes goes to the heart of the Debtors' dilemma. He does not suggest that state legalization somehow nullifies federal law and prevents federal enforcement of the CSA within state borders. To the contrary, he frankly recognizes that marijuana production and distribution continue to be federal crimes even in those states that have legalized those activities. State legalization works, in his view, only because it is the states that have been on the forefront of enforcement of marijuana laws. Once the states decriminalize marijuana and stop enforcing a prohibition on its distribution and use, the federal government lacks the resources to fill that void. Id.

Nothing in Professor Mikos' article supports the notion that the Debtors are not involved in an activity that is a federal crime. It may be extremely unlikely that they will ever be arrested and prosecuted for their violations of the CSA.⁵ Nonetheless,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.

Under our federal system of government, a state is perfectly free to, as Professor Mikos puts it, “continue to look the other way when their citizens defy federal law.” Id. By the same token, the states have no power to require any branch of the federal government to do the same. A state citizen that chooses to defy one federal law puts himself in an awkward position when he seeks relief under another federal statute—especially when granting that relief directly involves a federal court in administering the fruits and instrumentalities of federal criminal activity.

Here the United States Trustee seeks dismissal of the Debtors' case under § 707(a). Both § 1112(b)—relied upon by the creditor in Rent–Rite—and § 707(a) provide that a case may be dismissed “for cause.” The Debtors have also filed a motion under § 706(a) to convert their case to a case under chapter 13.

A. Motion to Dismiss

The fundamental bargain underpinning a chapter 7 consumer liquidation case is that a debtor turns over his non-exempt assets to a chapter 7 trustee so those assets may be liquidated for the benefit of creditors. In return, the debtor receives a discharge of his dischargeable debts. Here, the Debtors' chapter 7 trustee (the “Trustee”) cannot take control of the Debtors' Property without himself violating § 856(a)(2) of the CSA. Nor can he liquidate the inventory of marijuana plants Mr. Arenas possessed on the petition date ⁶ because that would involve him in the distribution of a Schedule I controlled substance in violation of § 841(a) of the CSA. The Court finds that administration of this case under chapter 7 is impossible without inextricably involving the Court and the Trustee in the Debtors' ongoing criminal violation of the CSA.

There is some indication that the Debtors' Property represents an asset of value for the bankruptcy estate.⁷ But it is an asset that cannot be administered for the benefit of creditors. For the Trustee to take possession and control of the Debtors' Property and marijuana inventory would directly involve him in the commission of federal crimes. To allow the Debtors to remain in a chapter 7 bankruptcy case under circumstances where their Trustee is unable to administer valuable assets for the benefit of creditors would allow them to receive...