In re Way to Grow, Inc.

• Decision Date: 14 December 2018
• Docket Number: Case No. 18-14330 MER, Case No. 18-14333 MER, Case No. 18-14334 MER
• Citation: 597 B.R. 111
• Parties: IN RE: WAY TO GROW, INC., Pure Agrobusiness, Inc., Green Door Agro, Inc., Debtors.
• Court: U.S. Bankruptcy Court — District of Colorado

597 B.R. 111

IN RE: WAY TO GROW, INC., Pure Agrobusiness, Inc., Green Door Agro, Inc., Debtors.

Case No. 18-14330 MER

Case No. 18-14334 MER

Case No. 18-14333 MER

United States Bankruptcy Court, D. Colorado.

Signed December 14, 2018

Lee M. Kutner, Keri L. Riley, Denver, CO, for Debtors.

Jointly Administered Under Case No. 18-14330

ORDER

Michael E. Romero, Chief Judge

THIS MATTER comes before the Court upon the Motion to Dismiss or Abstain¹ filed by Secured Creditor Corey Inniss ("Inniss "); the Objection to the Motion to Dismiss² filed by Debtors Way to Grow, Inc., Pure Agrobusiness, Inc. and Green Door Agro, Inc. ("Debtors "); Inniss's Reply in support of the Motion to Dismiss;³ and the Debtors' Response to the Reply.⁴ The Court held a four day evidentiary hearing on the Motion to Dismiss on October 15-16, 2018, and November 8-9, 2018.

BACKGROUND

As of the Petition Date, Way to Grow, Inc. ("Way to Grow ") and Green Door Agro, Inc. ("Green Door ") owned and operated seven retail outlets in Colorado and an internet sales presence. Green Door has a sales facility in California. Way to Grow and Green Door are both subsidiaries of Pure Agrobusiness, Inc. ("Pure Agro "). Pure Agro also owns 100% of a non-debtor affiliate, Crop Supply, Inc., which caters to the Debtors' commercial clients, but is funded by Debtors.⁵ Richard Byrd ("Byrd ") is the owner and principal manager of the Debtors.

Debtors' business involves the sale of equipment for indoor hydroponic and gardening-related supplies. As to their customers' uses of their products, Debtors have represented "[w]hile the hydroponic gardening equipment may and is used for many types of crops, the Debtors' future business expansion plan is tied to the growing cannabis industry which is heavily reliant on hydroponic gardening."⁶

Byrd acquired ownership and control of the Debtors through a sale transaction with Inniss, who founded Way to Grow in Colorado in 2002. During Inniss's ownership, Way to Grow grew from a single store in Fort Collins to a chain of seven retail stores throughout Colorado's Front Range. Several of the Debtors' seven storefronts were in locations leased to the Debtors by Susan Inniss, the mother of Corey Inniss. James Blaha ("Blaha "), Susan Inniss's former husband, also leased a location to the Debtors through his wholly-owned entity, Blue Moose, LLC ("Blue Moose ").

The events leading to this bankruptcy case began on January 1, 2016, when Byrd and Inniss entered into an agreement for the sale of Way to Grow ("Purchase Agreement ").⁷ As set forth in Section 2.2 of the Purchase Agreement, the consideration for the sale consisted of: 1) a cash payment to Inniss of $ 2,500,000; 2) a secured promissory note to Inniss ("Note ") for the principal amount of $ 22,500,000; and 3) 12,500,00 shares of Byrd's common stock in Pure Agro, Debtors' holding company, with a par value of $0.001.⁸ According to Debtors' Amended Schedules and Statement of Financial Affairs, Inniss owns approximately 21.26% of the stock in Pure Agro.⁹ Pursuant to Section 3 of the Note, Debtors' pledged collateral securing its obligations to Inniss consists of "any and all property and assets" of the Debtors, including after-acquired property, accounts receivable and inventory.¹⁰

A short time after the sale closed, on April 6, 2018, Inniss, individually and derivatively on behalf of Pure Agro as a shareholder, filed a complaint against the Debtors and Byrd in the District Court for Larimer County, Colorado.¹¹ On April 9, 2018, Inniss moved to appoint a receiver over Pure Agro and its subsidiaries in the State Case, seeking to oust Byrd as the Debtors' manager. Debtors filed bankruptcy before a receiver was appointed.

Because Debtors filed this bankruptcy in the face of a receivership, Inniss argues this case is no more than a continuation of the two-party dispute between Inniss and Debtors arising from the pending receivership proceedings. Inniss asserts this Court should dismiss or abstain from these bankruptcy proceedings in favor of allowing the State Case to proceed through conclusion.

From the beginning of this case, Debtors represented an intent to reorganize by rejecting over-market leases and otherwise reducing expenses. Through August 2018, Debtors' Monthly Operating Reports disclosed cumulative net cash flow of $ 109,320 on revenues of $ 2,027,246 and expenses of $ 1,917,928.¹² Meanwhile, Debtors' profit and loss statements reveal a total net operating loss of $ 607,865 through August 2018.¹³

Inniss argues these net operating losses, together with other financial performance issues, constitute violations of this Court's orders on the Debtors' use of Inniss's cash collateral. In response, Debtors maintain their gradual progress towards reorganization, including rejecting over-market leases, will result in significant savings not yet reflected in its financial disclosures. It is true during the case, Debtors rejected four leases for its Colorado retail locations in Lakewood, Colorado Springs, Pueblo, and Fort Collins, and closed its location in Silverthorne.¹⁴ A motion to reject one of Debtors' Denver leases remains pending.¹⁵ One of Debtors' store managers also testified Debtors reduced their workforce as part of its cost-saving measures.

These first two issues — Debtors' alleged violations of the cash collateral order and the purported two-party nature of the dispute — are essentially secondary issues to the main event, namely, the Debtors' connections to the marijuana industry. As discussed extensively below, bankruptcy courts nationwide have wrestled with the issue whether companies connected to marijuana businesses legal under state law are eligible for bankruptcy protection, where those connections constitute continuing violations of federal law.

ANALYSIS

A. LEGAL FRAMEWORK FOR MARIJUANA RELATED BANKRUPTCY CASES

Pursuant to the Controlled Substances Act of 1970 ("CSA "),¹⁶ marijuana¹⁷ is designated a Schedule I controlled substance under federal law.¹⁸ Therefore, under the CSA, it is a federal crime to "manufacture, distribute, or dispense, or possess with intent to manufacture, distribute, or dispense, a controlled substance[.]"¹⁹ Further, the CSA prohibits any person from possessing or distributing "any equipment ... product or material which may be used to manufacture a controlled substance ... knowing, intending, or having reasonable cause to believe, that it will be used to manufacture a controlled substance" in violation of federal law.²⁰ The CSA also expressly provides any person who "conspires to commit any offense" under the CSA shall be subject to the same penalties as the principal.²¹

Notwithstanding the absolute federal prohibition on the use, sale or cultivation of marijuana, several states, including Colorado, have legalized marijuana for both medical and recreational use.²² In Gonzales v. Raich , the U.S. Supreme Court definitively held the federal government's designation of marijuana as a controlled substance supersedes contrary state law through application of the commerce clause.²³ As a result, there remains an ever-shifting landscape of federal enforcement of marijuana criminalization where the same activity is fully legal under state law.²⁴

Of course, bankruptcy laws and bankruptcy courts are purely creatures of federal law. Accordingly, bankruptcy courts have consistently dismissed cases where debtors engaged in ongoing CSA violations, or where a debtor's reorganization efforts depend on funds which can be considered proceeds of CSA violations.

The seminal case on the issue from this District is Judge Howard Tallman's (Ret.) decision in In re Rent-Rite Super Kegs West Ltd.²⁵ There, the court considered a motion to dismiss a Chapter 11 case in which the debtor derived 25% of its revenue from leasing warehouse space to marijuana businesses.²⁶ Finding this activity plainly prohibited under § 856(a), the court concluded the debtor was in continuing violation of federal law during its bankruptcy case.²⁷ Analyzing Colorado's legal framework for marijuana legalization, Judge Tallman noted Colorado law "make[s] it clear that their provisions apply to state law only. Absent from either enactment is any effort to impede the enforcement of federal law."²⁸ Accordingly, the court concluded:

[E]ven if the Debtor is never charged or prosecuted under the CSA, it is conducting operations in the normal course of its business that violate federal criminal law. Unless and until Congress changes that law ... 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.²⁹

As additional grounds for dismissal, Judge Tallman further concluded the debtor was barred from bankruptcy relief by the clean hands doctrine:

The Debtor freely admits that it leases space to those who are engaged in the cultivation of marijuana. Even if the Debtor's [sic ] holds a good faith — albeit misguided — belief that Colorado state law would prevail over the federal law or that the federal law is unlikely to be enforced, that is quite beside the point. The Debtor has knowingly and intentionally engaged in conduct that constitutes a violation of federal criminal law and it has done so with respect to its sole income producing asset."³⁰

Based on these conclusions, the Rent-Rite court found it necessary to dismiss the bankruptcy case pursuant to 11 U.S.C. § 1112(b).³¹

Two years later, in In re Arenas , Judge Tallman expanded the holding of Rent-Rite to dismiss a bankruptcy case where the bankruptcy trustee would be required to administer marijuana-related assets.³²

In Arenas , the debtors, who operated a marijuana grow facility, filed for relief under Chapter 7 of the Bankruptcy Code. A Chapter 7 trustee was appointed in the ordinary course.³³ The Office of the United States Trustee ("UST ") moved to dismiss. Assessing the ability of a Chapter 7 trustee to administer marijuana assets, Judge Tallman reasoned:

Here, the

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