In a recent legal development that underscores the intricate interplay between federal bankruptcy law and the cannabis industry, a court case has emerged involving a bankruptcy filing by an employee of a cannabis company. It is well established that, because cannabis is generally considered a controlled substance under the federal Controlled Substances Act (CSA), certain cannabis related companies are precluded from obtaining debt relief through bankruptcy. Now, individuals employed by cannabis companies might find themselves in the same boat. In Blumsack v. Harrington, 2024 Bankr. LEXIS 560* (March 2024), the United States Bankruptcy Appellate Panel for the First Circuit (the “Bankruptcy Appeals Court”) upheld, albeit on different grounds, the United States Bankruptcy Court for the District of Massachusetts’ dismissal of the Chapter 13 bankruptcy filing of an individual employed by a cannabis company, because of the source of the individual’s income.

In April 2021, Scott H. Blumsack (“Blumsack”) initiated a chapter 13 bankruptcy filing while employed as a “budtender” at a Massachusetts cannabis dispensary. Blumsack’s financial disclosures included wages from the dispensary and his spouse’s income as an engineer, all commingled in a joint checking account. The United States Trustee (the “Trustee”) objected to the plan’s confirmation, citing the debtor’s employment in a cannabis-related business as a violation of the CSA, thus lacking good faith for bankruptcy relief. The Trustee also sought dismissal under § 1307(c) of the United States Bankruptcy Code (the “Bankruptcy Code”) due to the plan’s reliance on proceeds from illegal activity. Blumsack contested dismissal, arguing the lack of precedent denying individual bankruptcy relief solely based on marijuana-related employment, and sought a stipulation providing that, inter alia, if the bankruptcy court denied dismissal, Blumsack would propose a modified plan using alternative funding sources, including his spouse’s income and retirement funds. After testimony and arguments, the court denied plan confirmation and dismissed the case, citing lack of good faith and cause under § 1307(c) of the Bankruptcy Code and deeming continued employment in marijuana industry incompatible with bankruptcy relief and an abuse of federal bankruptcy laws.

On appeal,  Blumsack posited that the bankruptcy court erred in its good faith analysis by focusing solely on the nature of his employment rather than the totality of the circumstances and that in evaluating the Plan, the bankruptcy court should have focused its inquiry not on how the Plan was funded, but by the steps taken to propose the Plan. The Trustee argued that the bankruptcy court was not required to consider a specific set of factors in its good faith evaluation and that debtor’s illegal activities, i.e., employment with a cannabis company, demonstrated an absence of good faith.

The Bankruptcy Appeals Court reviewed the bankruptcy court’s (i) denial of confirmation of the debtor’s Plan, and (ii) the denial of the debtor’s request for additional time to submit a modified plan. While agreeing that Blumsack’s Plan was not proposed in good faith, it disagreed with the bankruptcy court’s finding that the debtor’s chapter 13 petition lacked good faith under § 1325(a)(7), instead basing its decision on lack of good faith under § 1325(a)(3).

Criticizing the bankruptcy court’s application of a bright-line rule regarding good faith under § 1325(a)(7), the Bankruptcy Appeals Court held that the rule was inconsistent with established legal precedent in the First Circuit, which emphasizes a “totality of the circumstances” approach. Further, the Bankruptcy Appeals Court found fault with the categorical rule established by the bankruptcy court regarding the bankruptcy eligibility of debtors employed in the cannabis industry, stating that such determinations should be based on individual circumstances rather than broad categorical parameters. Notwithstanding its criticism of the bankruptcy court’s reasoning, the Bankruptcy Appeals Court ultimately upheld the finding of lack of good faith in debtor proposing the Plan, holding that because the Plan would necessarily require the Trustee to administer funds derived from a federally illegal activity, the bankruptcy was properly dismissed.

Finally, the Bankruptcy Court of Appeals upheld the denial of the debtor’s request for additional time to submit a modified plan, finding that the debtor failed to provide sufficient evidence of alternative funding sources untainted by marijuana-related income.

While Blumsack does not hold that employees of cannabis companies are automatically foreclosed from seeking bankruptcy relief, it does underline the importance of those participating in the space engaging counsel knowledgeable in the complexities of the Bankruptcy Code and laws, as well as the cannabis space.