A Chapter 11 plan cannot be denied confirmation because a tenant grows pot on property owned by the Bankruptcy Estate.

In a 2019 Ninth Circuit case, short-titled, Garvin v. Cook Investments NW, Gregory Garvin, the acting U.S. Trustee for Region 18 (Western District of Washington), objected to the confirmation of the Chapter 11 plan of Michael Cook (“Cook”), who managed five real estate holding companies, on the grounds that one of Cook's tenants was growing marijuana, which is illegal under federal law, on property of the Bankruptcy Estate. According to the US Trustee, the use of one the leased properties to grow marijuana in violation of federal drug laws violated 11 U.S.C. §1129(a)(3), which requires that a plan be “proposed in good faith and not by any means forbidden by law.”

The U.S. Trustee also moved to dismiss the Chapter 11 plan on the grounds of gross mismanagement of the bankruptcy estate. While the nature of the mismanagement was not spelled out in the opinion, presumably it had to do with the fact the Cook tolerated the use of one his properties for an activity (i.e., the growing of marijuana) that was illegal under federal law.

While the Bankruptcy Court denied the motion to dismiss, it indicated that the US Trustee could renew his motion to dismiss at the confirmation hearing. For whatever reason, however, the US Trustee failed to renew his dismissal motion at the confirmation hearing, and the plan was confirmed over his objection.

On appeal, however, the US Trustee tried to raise the gross mismanagement anew. The Ninth Circuit quickly dispatched that issue, finding that the US Trustee had waived the gross mismanagement argument by not raising and litigating the issue at the confirmation hearing.

However, the Ninth Circuit's ruling did not address the underlying issue of whether or not the act of leasing property to marijuana growers, manufacturers, or distributors may, in and of itself, constitute “gross mismanagement of the estate” pursuant to 11 U.S.C. §1112(b)(4)(B); the Ninth Circuit left that issue open for a future determination. 

On the issue of whether or not the plan was “proposed in good faith and not by any means forbidden by law[,]” the Ninth Circuit held that the clear meaning of the text limited the court's scrutiny to questions of process - that is, the process for obtaining plan confirmation - and not substantive terms of the plan. (See, Irving Tanning Co. v. Maine Superintendent of Insurance (In re Irving Tanning Co.), 496 B.R. 644, 660 (B.A.P. 1st Cir. 2013). The Ninth Circuit also cited, In re Gen. Dev. Corp., 135 B.R. 1002, 1007 (Bkrtcy. S.D. Fla. 1991), in which the court noted that the “[c]ourts [which have addressed] the issue have uniformly held that §1129(a)(3) does not require that the contents of a plan must comply in all respects with the provisions of all non-bankruptcy laws and regulations.” Also, noting that Cook’s confirmed plan was an unqualified success, and that all creditors were getting paid, the Ninth Circuit upheld the confirmation of Cook's Chapter 11 plan by affirming the decision of the District Court, sitting as a court of appeal.

Lastly, lest anyone be concerned that the Ninth Circuit’s decision might give license to bankruptcy debtors to confirm plans based on criminal conduct, as the US Trustee had argued, the Ninth Circuit acknowledged that a) debtors can be criminally prosecuted for illegal acts, and b) the confirmation of a bankruptcy plan does not provide cover or license to a debtor to commit criminal acts, or to engage in patterns of criminality, even if that criminal activity is an essential component of the plan (i.e., the criminal conduct is producing the income necessary for the plan’s consummation). [See, In re Food City, Inc., 110 B.R. 808, 812 (Bkrtcy. W.D. Tex. 1990)], in which the court noted that there is no requirement to “convert the bankruptcy judge into an ombudsman without portfolio, gratuitously seeking out possible ‘illegalities’ in every plan[;]” such a result, the court noted, would be “inimical to the basic function of bankruptcy judges in bankruptcy proceedings.”

Go grow in peace.