FILED JAN 14 2020 ORDERED PUBLISHED SUSAN M. SPRAUL, CLERK U.S. BKCY. APP. PANEL OF THE NINTH CIRCUIT
UNITED STATES BANKRUPTCY APPELLATE PANEL OF THE NINTH CIRCUIT
In re: BAP No. AZ-19-1126-LTaF
BRIGHAM A. BURTON, a/k/a Kent Bk. No. 2:18-bk-04571-BMW Burton and CARLY RAE BURTON,
Debtors.
BRIGHAM A. BURTON, a/k/a Kent Burton; CARLY RAE BURTON,
Appellants,
v. OPINION
EDWARD JOHN MANEY, Chapter 13 Trustee; STRATTON RESTORATION, LLC,
Appellees.
Submitted Without Argument on November 21, 2019
Filed – January 14, 2020
Appeal from the United States Bankruptcy Court for the District of Arizona
Honorable Brenda Moody Whinery, Chief Bankruptcy Judge, Presiding Appearances: Appellants Brigham A. Burton, a/k/a Kent Burton, and Carly Rae Burton, pro se on brief; Ross M. Mumme, Esq. on brief for Appellee Edward J. Maney, Chapter 13 Trustee.
Before: LAFFERTY, TAYLOR, and FARIS, Bankruptcy Judges.
LAFFERY, Bankruptcy Judge:
INTRODUCTION
Brigham and Carly Rae Burton appeal the bankruptcy court’s
dismissal of their chapter 131 case. The Burtons own the majority interest in
Agricann, LLC (“Agricann”), an entity that was engaged in cultivating and
selling marijuana, which, while legal under Arizona law, violated federal
law. In response to the bankruptcy court’s order to show cause why the
case should not be dismissed based on the Burtons’ interest in Agricann,
the Burtons asserted that Agricann was no longer operating and was not
being relied upon to fund the Burtons’ chapter 13 plan. Agricann, however,
was a plaintiff in at least two state court lawsuits in which it sought
recovery of damages for breach of contracts related to growing and selling
marijuana. The Burtons asserted that recovery from those lawsuits was
1 Unless specified otherwise, all chapter and section references are to the Bankruptcy Code, 11 U.S.C. §§ 101-1532.
2 unlikely, but the bankruptcy court rejected this assertion as not credible
and concluded that any recovery from those lawsuits would be derived
from conduct that is illegal under federal law. Accordingly, allowing the
case to continue would likely require the court and the trustee to become
involved in such illegal conduct.
Because the Burtons did not provide sufficient evidence that the
potential litigation proceeds would not materialize, requiring the court and
the trustee to become involved in their administration, the bankruptcy
court did not abuse its discretion in dismissing the Burtons’ case.
We AFFIRM.
FACTUAL BACKGROUND
The Burtons filed a chapter 13 petition in April 2018. On their original
Schedule A/B, they disclosed interests in four limited liability companies,
all with unknown values, including a 65 % membership interest in
Agricann, of which Mr. Burton was a manager and its president. They also
listed a pending claim belonging to Agricann against Natural Remedy
Patient Center LLC, described as a breach of contract action, also with an
unknown value. They later amended Schedule A/B to disclose additional
ownership interests in other LLCs.2
2 The other LLC membership interests included on original and amended Schedule A/B were as follows: (1) a 70% interest in 363, LLC; (2) a 100% interest in 363 Business Alliance, LLC; (3) a 50% interest in Natural Agriculture, LLC; and (4) a 100% (continued...)
3 According to original and amended Schedule I, Mr. Burton was
unemployed during the pendency of the bankruptcy case. All Schedule I
income was attributed to Ms. Burton’s wages from her employment.
Schedule J showed a monthly net income of $458.80, with which the
Burtons proposed to fund their chapter 13 plan.3
Postpetition, Agricann sued Total Accountability Systems I, Inc. and
Cannabis Research Group in state court. Both lawsuits sought damages for
breach of contracts under which Agricann was to cultivate, grow, and sell
medical marijuana.
Although the Burtons proposed three different chapter 13 plans
during the approximately one year their case was pending, they were
unsuccessful in getting a plan confirmed.4
2 (...continued) interest in Carly Rae Burton, PLLC. The Burtons also listed entities that they had owned but which they contended were “inactive, insolvent and [had] no assets.” Those entities were: Zyrax, LLC, Burton Partners, LLC, Eleava, LLC, B&B Businesses, LLC, Nestaba, LLC. Finally, they disclosed a “de minimus” (less than 20%) interest in Twenty Sixth Ave Ventures, LLC. 3 We have exercised our discretion to review the bankruptcy court’s electronic docket and pleadings. See O'Rourke v. Seaboard Sur. Co. (In re E.R. Fegert, Inc.), 887 F.2d 955, 957–58 (9th Cir. 1989); Atwood v. Chase Manhattan Mortg. Co. (In re Atwood), 293 B.R. 227, 233 n.9 (9th Cir. BAP 2003). 4 The Burtons’ Second Amended Plan filed January 6, 2019, drew an objection from creditor Kevin Erdmann on grounds of: (1) lack of good faith; and (2) failure to pledge all disposable income (based on an allegation that Debtors had not disclosed income from their business entities). The chapter 13 trustee, John Maney (“Trustee”), (continued...)
4 On May 29, 2018, creditor Stratton Restoration filed a motion to
convert, in which it argued that there was cause to convert the bankruptcy
case to chapter 7. It contended that the Burtons were ineligible for chapter
13 relief because their debts exceeded the limitations under § 109(e), based
on Stratton’s $2.4 million unsecured claim arising from state court breach
of contract litigation, which the Burtons had not included on their
schedules. It also argued that the Burtons filed their case in bad faith
because, among other things, Mr. Burton derived income from a marijuana
business that was illegal under federal law.
At the preliminary hearing on the motion to convert held on March 5,
2019, the bankruptcy court raised its concerns regarding the Burtons’
alleged connections to the marijuana industry. After that hearing, the court
issued an order to show cause (“OSC”) requiring the Burtons to appear and
show cause why their case should not be dismissed due to their ownership
interest in, and deriving income from, an entity involved in the marijuana
industry.
4 (...continued) filed an Evaluation and Recommendation indicating that the plan was not ready for confirmation for numerous reasons, including the unresolved Erdmann objection and the fact that the Debtors’ general unsecured debts of $2.5 million reflected on the claims register were well over the chapter 13 debt limits. Trustee also required Debtors to provide documentation of a value for all of the Debtors’ businesses listed on amended Schedule B.
5 The Burtons filed a response to the OSC, verified by Mr. Burton’s
declaration, in which they disputed having an interest in an entity involved
in the marijuana industry. They stated that Agricann went out of business
in 2016 and had generated no income since then. As such, they claimed
they did not currently derive income from any entity involved in the
marijuana industry. Although they acknowledged that Agricann was a
party to litigation, they stated they did not expect to receive any proceeds
from such litigation due to a contingency fee agreement with the attorney
handling the litigation and a litigation financing lien on any recovery. The
Burtons also stated their intention to abandon from the estate their interest
in Agricann, after which they would divest themselves of their interest in
that entity. Finally, they asserted that the sole source of funding for the
chapter 13 plan would be Mrs. Burton’s employment income. The
following day, they filed a motion to compel abandonment of their interest
in Agricann.5
5 Attached to the motion to compel abandonment (but not included with the response to the OSC) was a spreadsheet entitled “Agricann, LLC Financial Information” that purported to show the expected recovery from the litigation. Although difficult to decipher, the spreadsheet does not seem to support the Burtons’ assertion that the litigation is worthless. The spreadsheet shows, as of March 2019, a potential gross recovery of $31,285,273.45, reduced to a net of $18,771,164.07 after deducting a 40 % contingency fee, with a litigation loan balance of $15,731,993.03. This leaves a final net figure of over $3 million. The spreadsheet then projects that the litigation loan balance would be nearly $21 million by June 2019, but there is no explanation or backup documentation regarding the source of these figures. In any event, the bankruptcy court (continued...)
6 Trustee and Stratton Restoration each filed responsive briefs in which
they argued that the case should be dismissed given the Burtons’
involvement in the medical marijuana industry.
The bankruptcy court held a preliminary hearing on the OSC on
April 3, 2019. The court stated that it did not expect to resolve the matter
without an evidentiary hearing.6 The court noted that there were other
entities owned by the Burtons and that there was no evidence regarding
whether those businesses were also involved in the marijuana business.7
The bankruptcy court heard argument from the Burtons’ counsel as well as
counsel for Trustee, Stratton Restoration, creditor Kevin Erdmann, creditor
5 (...continued) never ruled on the motion to compel abandonment. 6 On the eve of the hearing, Stratton Restoration had filed a 35-page (including exhibits) document entitled “Creditor Stratton Restoration, LLC’s Supplemental Evidence Regarding Debtors’ Bad Faith Filings,” to which it attached documents that it argued showed that (1) Mr. Burton has an interest in an entity called Green Tree Alliance, LLC (which had paid the Burtons’ chapter 13 counsel’s fees), which had been set up using other LLCs so as to hide the Burtons’ interest in that entity; and (2) the Burtons had set up a GoFundMe page during the bankruptcy case that explicitly told donors that due to their bankruptcy, the Burtons could not receive funds directly and so funds would go to a member of their church who had agreed to be the “Shepard [sic] of the funds.” 7 In fact, there was evidence that the Burtons held an interest in another entity that was involved in the marijuana business. Stratton Restoration attached to its response to the OSC a copy of a deposition transcript from a January 30, 2017, judgment debtor exam in state court litigation between Mr. Erdmann and the Burtons, in which Mr. Burton testified that Natural Agriculture, LLC, in which Debtors held a 50% membership interest, was engaged in the medical marijuana business.
7 Kerry Lechner, and the United States Trustee. The Burtons’ counsel
represented that the Debtors were not currently involved in the cannabis
industry and were “willing to get out of the Agricann business entirely.”
Counsel for Trustee noted that the Burtons had provided no evidence of
the value of the Agricann lawsuit other than a “one-page self-serving
spreadsheet” and no evidence regarding the litigation financing agreement.
Trustee’s counsel also pointed out that there were questions regarding
whether the Burtons had disclosed all their interests in business entities
and sources of income, which raised concerns about the Burtons’ good
faith.
At the May 6, 2019 final hearing on the OSC, the bankruptcy court
delivered its oral ruling. The court stated that it had determined it did not
need to hold an evidentiary hearing because the record before it was
sufficient for it to rule. It found that dismissal was appropriate under the
circumstances because, despite the assertion that Agricann was no longer
in the medical marijuana business, it was seeking recovery in the state
court litigation
of funds attributable to contracts under which it was to serve as a cultivator, grower, holder, deliverer, and/or seller of marijuana. Any recovery from the litigation would be derived from conduct that is illegal under federal law. Any distributions from Agricann to its members, specifically the Debtors, would also be derived from illegal conduct. The Debtors assert that the Agricann litigation has no value.
8 However, this assertion is not credible given that the litigation continues to be pursued. These cases are still active and pending.
Given the nature[] of Agricann’s business, which was clearly involvement in the marijuana industry, neither a case trustee, nor these Debtors, can sell or liquidate the 65 percent ownership interest in Agricann, which is property of this estate through the bankruptcy case. This would necessitate the Court and the Trustee’s involvement in condoning the illegal activity.
Hr’g Tr. (May 6, 2019) at 13:21-14:13.
The bankruptcy court entered an order dismissing the case, and the
Burtons timely appealed.
JURISDICTION
The bankruptcy court had jurisdiction under 28 U.S.C. §§ 1334 and
157(b)(1) and (b)(2)(A). We have jurisdiction under 28 U.S.C. § 158.
ISSUE
Whether the bankruptcy court abused its discretion in dismissing the
Burtons’ chapter 13 case.
STANDARD OF REVIEW
We review a bankruptcy court’s dismissal of a chapter 13 case for
abuse of discretion. Ellsworth v. Lifescape Med. Assoc., P.C. (In re Ellsworth),
455 B.R. 904, 914 (9th Cir. BAP 2011). A bankruptcy court abuses its
discretion if it applies the wrong legal standard, misapplies the correct
legal standard, or makes factual findings that are illogical, implausible, or
9 without support in inferences that may be drawn from the facts in the
record. See TrafficSchool.com, Inc. v. Edriver Inc., 653 F.3d 820, 832 (9th Cir.
2011) (citing United States v. Hinkson, 585 F.3d 1247, 1262 (9th Cir. 2009) (en
banc)).
DISCUSSION
In recent years, numerous states have legalized the medical and
recreational use of marijuana. Marijuana, however, remains a Schedule I
controlled substance under the federal Controlled Substances Act, 21 U.S.C.
§§ 801-904 (“CSA”). The CSA prohibits, among other things, the
manufacture, distribution, dispensing of, or possession with intent to
manufacture, distribute, or dispense, a controlled substance. 21 U.S.C.
§ 841(a). As a result, a bankruptcy filing by an individual or entity with ties
to a marijuana business raises difficult issues regarding how involved the
debtor may be in that business and still be permitted to seek relief under
the Code. The case law continues to evolve, and few bright line rules have
emerged from decisions published to date. One principle seems implicit in
the case law, however: the mere presence of marijuana near a bankruptcy
case does not automatically prohibit a debtor from bankruptcy relief. Olson
v. Van Meter (In re Olson), BAP No. NV-17-1168-LTiF, 2018 WL 989263, at *7
(9th Cir. BAP Feb. 5, 2018) (Tighe, J., concurring) (citing Northbay Wellness
Grp., Inc. v. Beyries, 789 F.3d 956, 960–61 (9th Cir. 2015)); cf. Garvin v. Cook
Inv. NW, SPNWY, LLC, 922 F.3d 1031 (9th Cir. 2019) (affirming bankruptcy
10 court’s confirmation of a chapter 11 plan where the plan derived indirect
support from rental income from a lessor engaged in a marijuana growing
business).8 Instead, a bankruptcy court must be explicit in articulating its
legal and factual bases for dismissal in cases involving marijuana. See In re
Olson, 2018 WL 989263 at *6 (remanding for the bankruptcy court to
“articulate the findings that led it to determine that Debtor was violating
the CSA and what legal standard it relied upon in dismissing the case.”).
Several courts have held that a bankruptcy case must be dismissed if
the continuation of the case would require the court, trustee, or debtor in
possession to administer assets that are illegal under the CSA or that
constitute proceeds of activity criminalized by the CSA. Arenas v. U.S. Tr.
(In re Arenas), 535 B.R. 845, 853 (10th Cir. BAP 2015); In re Way to Grow, Inc.,
597 B.R. 111, 120 (Bankr. D. Colo. 2018), aff’d, No. 18-cv-3245-WJM, 2019
WL 6332541 (D. Colo. Sept. 18, 2019); In re Medpoint Mgmt., LLC, 528 B.R.
178, 184-85 (Bankr. D. Ariz. 2015), vacated in part, Medpoint Mgmt., LLC v.
8 The sole issue before the Ninth Circuit in Garvin was whether the plan at issue violated § 1129(a)(3)’s requirement that a chapter 11 plan be proposed “not by any means forbidden by law.” The Circuit held that § 1129(a)(3) directs courts to look only to the proposal of a plan, not its terms. Garvin, 922 F.3d at 1035 (citing Irving Tanning Co. v. Me. Superintendent of Ins. (In re Irving Tanning Co.), 496 B.R. 644, 660 (1st Cir. BAP 2013)). The Circuit specifically rejected the notion that § 1129(a)(3) forecloses confirmation of a plan that relies on income from criminal activity, as held by some bankruptcy courts considering whether to dismiss a case based on a debtor’s involvement in the marijuana business. Id. The court acknowledged that there may be consequences arising from a debtor's connections with criminal activity, but denial of confirmation under § 1129(a)(3) is not one of them. See id. at 1036.
11 Jensen (In re Medpoint Mgmt., LLC), 2016 WL 3251581 (9th Cir. BAP June 3,
2016); In re Johnson, 532 B.R. 53, 56-57 (Bankr. W.D. Mich. 2015). Cf. In re
Rent-Rite Super Kegs W. Ltd., 484 B.R. 799, 810 (Bankr. D. Colo. 2012) (noting
that, where a chapter 11 debtor rented warehouse space to tenants who
were growing marijuana, conversion of the case would require the trustee
to be responsible for a site where continuing criminal conduct is taking
place, raising a question of feasibility of chapter 7 estate administration).
Additionally, some courts have held that a bankruptcy filing or a
plan of reorganization proposed by a debtor who is involved in an illegal
enterprise is not in good faith, even where the debtor does not have a
subjective bad motive, is in legitimate need of bankruptcy relief, and there
are no other indicia of an attempt to abuse the bankruptcy process. In re
Arenas, 535 B.R. at 852-53; see also In re Rent-Rite Super Kegs W. Ltd., 484 B.R.
at 809.9 Related to the good faith analysis, some courts have concluded that
a debtor engaged in an illegal business who seeks bankruptcy relief comes
into court with unclean hands and is not eligible for relief. In re Rent-Rite
Super Kegs W. Ltd., 484 B.R. at 807; cf. In re Medpoint Mgmt., LLC, 528 B.R. at
186-87 (petitioning creditors who knew the putative debtor was engaged in
9 The Ninth Circuit appears to have rejected this line of reasoning, at least as it pertains to plan confirmation. See Garvin, 922 F.3d at 1036 n.3 (noting that the good faith confirmation requirement pertains to a plan’s proposal, not its contents).
12 a federally prohibited medical marijuana business had unclean hands and
could not seek relief from the bankruptcy court).
The reported decisions also illustrate that the nature and extent of
debtors’ involvement in the marijuana business can vary widely. Compare
In re Arenas, 535 B.R. at 847 (where the debtor grew and sold marijuana and
leased premises to a marijuana dispensary), with In re Rent-Rite Super Kegs
W. Ltd., 484 B.R. at 803 (where the debtor derived about 25% of its income
from leasing space to a marijuana grower). The connection between the
debtors’ illegal business and the bankruptcy case can also vary: some
debtors attempt to reorganize and continue their marijuana-related
business, see In re Way to Grow, Inc., 597 B.R. at 115, while other debtors
wish to use the bankruptcy process to sever their connection to the
business, see In re Olson, 2018 WL 989263 at *3 (where the debtor declared,
“I wish only to terminate any dealings with [a marijuana dispensary
tenant] and to sell my property and pay my creditors in full.”).
We believe that the stated reluctance in this Circuit to adopt per se
bright-line rules requiring the immediate disposition of bankruptcy cases
in which marijuana activity is present, and the flexible cause standard
under § 1307(c), coupled with the abuse of discretion standard of review on
appeal, give bankruptcy courts appropriate latitude to deal with these
variations.
13 Against this backdrop, the bankruptcy court dismissed the Burtons’
chapter 13 case pursuant to §§ 105(a) and 1307(c), finding that their
ownership interest in Agricann constituted “cause” for dismissal10 because
the continuation of the case would likely require the trustee or the court to
become involved in administering the proceeds of the Agricann litigation,
which the court implicitly found would be tainted as proceeds of an illegal
business. The bankruptcy court did not err in this finding, nor did it abuse
its discretion in dismissing the case on those grounds.
Moreover, the court sufficiently articulated the legal and factual bases
for its ruling. It is undisputed that the Burtons own an interest in Agricann,
an entity that was engaged in a business that is illegal under federal law,
and that interest became property of the estate when they filed their
chapter 13 petition. Whether Agricann is currently actively engaged in
growing or selling marijuana is irrelevant, given that Agricann is a plaintiff
in litigation seeking to recover damages consisting at least in part of profits
lost as a result of breaches of contracts related to the growing and selling of
marijuana. As such, any proceeds received from the litigation would
represent profits from a business that is illegal under federal law.
10 Trustee assumes on appeal that the bankruptcy court dismissed the case for bad faith. To the contrary, the bankruptcy court made no bad faith finding, instead determining that the Burtons’ connection with the marijuana business in the circumstances presented here was itself “cause” for dismissal.
14 The Burtons contend that the bankruptcy court should have held an
evidentiary hearing to determine the true nature of Agricann’s operations
and the value of the Burtons’ interest in that entity, arguing that there was
no evidence that it was involved in any of the activities prohibited by the
CSA. But the bankruptcy court did not err in ruling on the evidence it had
before it. It based its ruling on the undisputed fact that Agricann, in which
the Burtons held a membership interest, was a plaintiff in litigation seeking
recovery for breaches of contract relating to growing and selling marijuana.
The Burtons point to no disputed material factual issue, nor do they
describe any evidence they would have presented to resolve any such
issue.
In response to the court’s OSC, the Burtons needed to produce
evidence to satisfy the court that its ownership interest in Agricann was not
cause for dismissal. The Burtons did not do so.11 With respect to the value
of the litigation, they provided only a foundationless, conclusory, and
equivocal statement that they did not expect to receive any proceeds from
the Agricann litigation after payment of a contingency fee and repayment
of a litigation loan. This statement was far from a categorical denial that the
11 We note that the bankruptcy court found not credible the Burtons’ assertion that Agricann’s litigation claims were worthless. Ordinarily, credibility determinations are not proper absent an evidentiary hearing. However, we interpret the bankruptcy court’s credibility determination (to which the Burtons do not assign error) as a finding that the Burtons did not meet their burden of proof.
15 claims had value, and the Burtons provided no details or documentary
evidence to support it. While we cannot agree with the bankruptcy court’s
blanket assertion that Agricann’s pursuit of these claims was indicative, per
se, that they had value, in light of Agricann’s undoubted legal obligation
under the litigation funding agreement fully to pursue the claims, we
discern no evidentiary support in the record for the Burtons’ assertions that
the litigation would not result in their receipt of any litigation proceeds.
The Burtons’ next arguments misconstrue the court’s ruling. They
argue that the bankruptcy court erred in concluding that they were
involved in any business activities that violated the CSA, such as
manufacturing, distributing, or dispensing marijuana. They also contend
that dismissal was not warranted because they did not propose to fund
their plan with proceeds generated by the illegal marijuana business. But
the court’s ruling was not based on those factors; its concern was that any
litigation recovery entering the bankruptcy estate would constitute
proceeds from a federally prohibited business, regardless of whether or not
the business was still engaged in activities prohibited by the CSA.
The Burtons also argue that the bankruptcy court was not required to
dismiss their case, citing In re Johnson and In re McGinnis, 453 B.R. 770
(Bankr. D. Or. 2011). In Johnson, the bankruptcy court permitted a debtor to
remain in chapter 13 on condition that he discontinue growing, selling, and
transferring marijuana and cease using property of the estate to further the
16 marijuana business. 523 B.R. at 58. And in McGinnis, the court stated that if
the debtor could propose a plan meeting the requirements of the
bankruptcy code, it was prepared to allow its confirmation. 453 B.R. at 773.
But the Burtons read too much into these cases. Although it is true
that a bankruptcy court has broad discretion in deciding whether to
dismiss a case, a particular court’s signal that it might permit a case to
continue under certain circumstances does not create a rule that all
bankruptcy courts must, in every instance, permit a debtor with ties to the
marijuana business to stay in bankruptcy. To the extent a court has
discretion to decline to dismiss such a case, that result would seem
appropriate only if the case were otherwise in compliance with the Code
and rules. Here, there were numerous unresolved issues that would have
supported dismissal but that did not arise out of the Burtons’ connections
with the marijuana business. For example, the Burtons’ eligibility for
chapter 13 was called into question when Stratton Restoration filed a proof
of claim for $2.4 million, and, although the case was pending over a year,
the Burtons had failed to propose a confirmable plan.
Finally, the Burtons argue that Congress deliberately chose not to
impose limitations on the ability of medical marijuana businesses to file for
bankruptcy. In support, they point to § 362(b)(23), which excepts from the
automatic stay an eviction action seeking possession of a residential
property where the tenant is engaging in the illegal use of controlled
17 substances. This argument was not raised before the bankruptcy court, and
in any event reflects a complete misreading of the cited statute. We need
not address it further. Roberts v. Erhard (In re Roberts), 331 B.R. 876, 881 (9th
Cir. BAP 2005).
CONCLUSION
The Burtons failed to demonstrate that their ties to Agricann would
not result in proceeds of an illegal business becoming part of the
bankruptcy estate, requiring the trustee and the court to administer assets
that constitute proceeds of activity criminalized by the CSA. Under the
facts presented, the bankruptcy court did not abuse its discretion in
dismissing the case for that reason. Accordingly, we AFFIRM.