Turning a new leaf: First going concern sale of an insolvent cannabis producer

This article was originally published in National Insolvency Review.

Introduction

On August 28, 2020, James E. Wagner Cultivation Corporation (together with its corporate group, JWC) and Trichome Financial Corp. (together with its purchaser designee, Trichome) closed a transaction for the “going concern” sale of substantially all of JWC’s assets to Trichome in court-supervised proceedings under the Companies’ Creditors Arrangement Act (CCAA)¹. This marked a significant event for both the cannabis industry and Canadian law: it was the first time that regulated cannabis assets were monetized by way of an asset sale within insolvency proceedings.

By establishing an insolvency and regulatory practice allowing for such going concern asset sales, the JWC-Trichome transaction addresses a gap in the Cannabis Act² and its regulations and contributes to the development of a more mature financial and legal framework for cannabis businesses and their lenders, ultimately facilitating the orderly development of the legal cannabis industry.

Unique challenges

The cannabis industry operates in a challenging regulatory environment. Distressed cannabis businesses and their creditors must contend with the Cannabis Act, which does not contemplate procedures for secured creditors or others—in an insolvency context or otherwise—to take possession of a debtor’s regulated cannabis assets. Contrast this to other regulated industries such as telecommunications, alcohol, oil and gas and pharmaceuticals where such mechanisms exist. In this regard, there is a legislative gap in the Cannabis Act.

This challenge stems from the requirement that cannabis businesses obtain and maintain a valid licence (or licences) from Health Canada in order to engage in the activities required to operate³. In the context of an insolvency-driven asset sale, this means a purchaser company must first become licensed in order to acquire a vendor’s cannabis assets, and both the vendor and the purchaser must hold valid licences at the time of closing to effect a transfer of regulated cannabis assets. This presents two obstacles that typically preclude a purchaser from acquiring a vendor’s cannabis business as a going concern in an insolvency context.

First, as a precondition to obtaining a Health Canada licence, certain individuals associated with the licensee corporation, including its directors, officers and key personnel, must obtain security clearances⁴. These security clearances include criminal record checks conducted by the RCMP, which can take anywhere from a few months to over a year to complete. The purchase and sale of cannabis assets cannot be completed unless and until each of the purchaser company’s directors and officers have obtained the requisite security clearance.

Second, the Cannabis Act does not contemplate or permit the transfer or assignment of Health Canada licences. This becomes problematic in the context of an asset sale, as licences are issued to a particular licensee for specific premises, and no two licensees may control the same premises which are the subject of their licences at the same time. As a result, there was no established mechanism prior to the JWC-Trichome transaction to effect the going concern sale of a cannabis business by way of an asset purchase agreement. This issue often forced undesirable and inefficient solutions, such as the destruction of the debtor’s valuable cannabis inventory⁵.

The JWC-Trichome transaction

The company

JWC was a publicly-listed, vertically-integrated cannabis company which specialized in growing, cultivating and marketing premium aeroponically-grown cannabis to both medical and recreational markets in Canada. JWC’s capital structure consisted of its secured debt (which included a senior-ranking credit facility with Trichome, as lender), unsecured debt and common shares.

As a result of its negative cash flow and significant capital expenditures relating to an expansion of its production facilities, JWC foresaw that it would shortly become unable to meet its liabilities as they became due. Accordingly, JWC and Trichome entered into discussions to implement a consensual restructuring under the CCAA that would inject liquidity into JWC’s operations, smooth its troubled balance sheet and allow its business to emerge as a going concern.

The CCAA proceedings

Following its application to the Commercial List (the Court), JWC obtained a CCAA initial order on April 1, 2020 (the Initial Order). KSV Kofman Inc. was appointed as Monitor in the proceedings, and Trichome acted as DIP lender. The DIP financing provided JWC with the liquidity necessary to continue operations without disruption and to fund the CCAA proceedings.

Trichome entered into a stalking horse agreement with JWC (the Stalking Horse Agreement), which provided, among other things, for: a) the purchase and sale to Trichome of substantially all of JWC’s assets; including its existing cannabis inventory and the premises used to cultivate cannabis (i.e., the sale of JWC’s business as a going concern); and b) the establishment of a sale and investment solicitation process (the SISP) for JWC’s assets. The Court approved both the Stalking Horse Agreement and the SISP by way of an order entered April 9, 2020, following JWC’s comeback hearing.

Over the course of the 45-day SISP, 26 interested parties executed confidentiality agreements with JWC and numerous of those parties conducted extensive due diligence on its business and assets. At the conclusion of the SISP, the Stalking Horse Agreement was declared the winning bid, Trichome was declared the successful bidder and the parties obtained an approval and vesting order from the Court on June 2, 2020.

The Stalking Horse Agreement

The purchase price paid by Trichome for JWC’s assets was an estimated $16 million, comprised of Trichome’s credit bid of its pre-filing debt, Trichome’s assumption of certain JWC obligations and a closing cash payment. The assumed obligations included Trichome’s DIP facility, most of JWC’s operational contracts (including the leases for its production facilities) and cure costs in respect of certain contracts.

Among the assets purchased by Trichome under the Stalking Horse Agreement were: 1) JWC’s cannabis production facilities—being two facilities located in Kitchener, Ontario with operational areas of 15,000 sq. ft. and 99,000 sq. ft., respectively— capable of a combined annual cultivation capacity of approximately 7,000 kilograms of premium cannabis (as of the date of the Stalking Horse Agreement); (2) JWC’s proprietary aeroponics system for growing premium cannabis, including the patents and trademarks in respect thereof; (3) the JWC brand, including its various trademarks; and (4) the JWC cannabis inventory, including seeds, plants, fresh and dried cannabis, a variety of “cannabis 2.0” products and other miscellaneous assets.

The licensing process

Closing was conditional upon Trichome obtaining the replacement Health Canada licences necessary to acquire and operate JWC’s regulated cannabis assets and business. Two licences were required to operate the purchased business: a standard processing and cultivation licence, and a standard processing, cultivation and sale for medical purposes licence. There were two primary challenges to obtaining these licences.

First, Trichome’s purchaser designee could not obtain its licences until its proposed directors and officers, and the directors and officers of its parent corporation, obtained their security clearances from the RCMP. This process took approximately three and a half months to complete, resulting in a two-month delay to the closing. During this time period, JWC’s proceedings under the CCAA continued and Trichome financed JWC’s operations under an amended DIP facility.

Second, the Cannabis Act does not provide a mechanism for the transfer of Health Canada licences, nor does it allow for the simultaneous licensure of two licensees in respect of the same premises. In order to overcome this challenge, the parties worked in close collaboration with Health Canada staff from the onset of the transaction through to its closing. The result of this collaboration was a back-to-back licensing arrangement, whereby Health Canada authorized the following three events:

1. Health Canada granted to Trichome new licences which became effective on August 28, 2020;
2. JWC transferred the regulated cannabis assets to Trichome, under a separate bill of sale from the non-cannabis assets, at 11:59 p.m. on August 28, being the moment before the stroke of midnight; and
3. Health Canada revoked JWC’s licences on August 29 at 12:00 a.m. through a pre-authorized revocation.

As a result of this stroke-of-midnight timing, Trichome obtained ownership of the assets and control of the premises at the precise moment before JWC’s licences were revoked; from Health Canada’s perspective, there was neither simultaneous licensure nor a licensure gap in respect of the premises and regulated assets. Thus, on August 28, 2020 at 11:59 p.m., the deal was closed.

Takeaways and recommendations

The JWC-Trichome transaction demonstrates that court-supervised going concern sales of distressed or insolvent cannabis companies are viable means of monetizing and acquiring regulated cannabis assets. By doing so, it contributes to a financial and legal environment which is conducive to the development of the cannabis industry and ultimately furthers Parliament’s stated policy goal of eliminating the illicit market for cannabis. This is particularly important given the capital-intensive nature of the industry and the leading role played by secured debt financing in its growth.

However, regardless of this improved environment, potential suitors and distressed cannabis businesses alike must remain proactive in order to be competitive during future going-concern sales within insolvency proceedings.

Among the factors considered when assessing offers to acquire assets in this context are the anticipated closing timelines and the risks of a derailed closing. Prospective purchasers of cannabis assets who already hold the necessary security clearances gain a competitive advantage, as they can potentially obtain the licence on an expedited basis. There is also certainty that their security clearances will not be rejected. If, on the other hand, a prospective purchaser does not have the necessary clearances, it should determine who will act as the directors and officers of the licensed entity and its parent companies and begin the process of obtaining these clearances as far in advance as possible of any acquisition.

Finally, because the Cannabis Act doesn’t codify procedures for secured creditors or others to take possession of regulated assets in the context of an insolvency (or otherwise), collaboration and effective communication with Health Canada are the keys to a smooth licensing process. Both the distressed cannabis business and potential purchaser should work through established relationships with Health Canada early in the transaction process to develop an approach to licensing that addresses all of Health Canada’s requirements and fits the context of a particular transaction.

Mike would like to thank Scott Bomhof and Frazer House for their assistance and guidance with this article.

Torys LLP acted as counsel to Trichome Financial Corp. and its purchaser designee.

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¹ RSC 1985, c C-36.

² SC 2018, c 16.

³ Cannabis producers must also obtain licenses from the Canada Revenue Agency and applicable provincial authorities.

⁴ Cannabis Regulations, SOR/2018-144, s 50.

⁵ See, e.g., Pure Global Cannabis Inc. et al, Re, Amended and Restated Initial Order of Hainey J., dated April 3, 2020 (Ont Sup Ct J (Commercial List)), Court File No. CV-20-00638503-00CL, where the Court granted an Order requiring that the applicants, among other things, arrange for the lawful disposal or destruction of their cannabis or cannabis products in consultation with the CRA and Health Canada.

Le mois dernier, le Canada a publié sa première Stratégie industrielle de défense (la Stratégie), qui souligne l’engagement du Canada à développer une base industrielle de défense solide et à stimuler la croissance économique. Ces efforts pourraient aussi comprendre le renforcement de l’état de préparation à la biodéfense et aux contre-mesures médicales, ce qui pourrait constituer des débouchés pour le secteur canadien des sciences de la vie en raison de l’importance accordée aux capacités nationales en ce sens et de la nécessité d’atténuer les risques d’urgences sanitaires.

Développement de contre-mesures médicales au Canada

Comme indiqué dans les bulletins précédents, le quatrième pilier de la Stratégie est axé sur la « sécurisation des chaînes d’approvisionnement pour les intrants et les biens clés » par le renforcement de la production nationale et le stockage de ressources. L’accent est mis tout particulièrement sur les contre-mesures médicales, en précisant que nos « alliés ont établi un lien explicite entre l’état de préparation à la biodéfense et aux contre-mesures médicales et leur sécurité économique et nationale, en élaborant de nouvelles stratégies et de nouveaux mécanismes pour faire progresser ces travaux ». Les contre-mesures médicales désignent divers produits réglementés pouvant être utilisés pour protéger la population lors d’une situation d’urgence de grande ampleur, comme l’éclosion d’une maladie ou une attaque impliquant des armes chimiques, biologiques ou nucléaires. Il peut s’agir de vaccins, de médicaments thérapeutiques et produits biologiques, de dispositifs de tests diagnostiques, des équipements de protection individuelle ou industrielle, et d’autres dispositifs médicaux. Les contre-mesures médicales sont essentielles à la réduction et à l’atténuation des dommages lors d’une urgence de santé publique.

Exploiter les voies réglementaires mises en place lors de la pandémie de COVID-19

Pendant et après la pandémie de COVID-19, le Canada a mis en place plusieurs nouvelles voies réglementaires comme mécanismes d’accélération des approbations de produits médicaux, ce qui pourrait offrir au gouvernement des options pour déployer des contre-mesures médicales afin de faire face aux risques pour la santé publique. Au début de la pandémie, Santé Canada a émis diverses ordonnances provisoires pour permettre l’importation et la vente de médicaments et de dispositifs médicaux qui n’avaient pas eu l’approbation des voies réglementaires traditionnelles. Or, Santé Canada a plutôt fait confiance aux voies d’approbation réglementaire et de l’exemption de certaines exigences en homologation de produits des pays impliqués dans la transaction. Beaucoup de ces règles provisoires ont depuis été officiellement intégrées à la réglementation en vertu de la Loi sur les aliments et drogues et ont été appliquées bien après la COVID-19. Conformément au Règlement sur les aliments et drogues, Santé Canada tient à jour la Liste des maladies qui menacent la santé publique et utilisera une procédure d’autorisation modifiée pour les médicaments d’urgence de santé publique pouvant traiter les affections figurant sur la liste. De même, le Règlement sur les instruments médicaux a établi une liste d’instruments médicaux répondant à un besoin urgent de santé publique, ce qui permet à Santé Canada d’autoriser la commercialisation de ces instruments de manière accélérée. Ces outils réglementaires sont utilisés automatiquement quand une situation médicale présente un grand risque pour la santé publique au Canada et nécessite une action immédiate pour contrer ce risque.

Le rôle de la Stratégie dans le renforcement du régime réglementaire de la santé au Canada

La stratégie prévoit que le Canada adoptera une approche proactive en matière de planification en amont des crises sanitaires. Le gouvernement entend s’assurer que les produits médicaux sont déjà disponibles au Canada afin qu’ils puissent être distribués rapidement en cas d’urgence. D’autres modifications récentes au Règlement sur les aliments et drogues permettent de prépositionner au Canada tous les médicaments d’urgence en santé publique, ce qui signifie qu’ils peuvent être importés dans des installations d’entreposage canadiennes avant que leur mise sur le marché n’ait été autorisée. La Stratégie s’appuie sur ces fondements, en faisant référence à l’organisme existant Préparation aux crises sanitaires Canada (PCSC), un organisme opérationnel spécial au sein d’Innovation, Sciences et Développement économique Canada (ISDE), et à un nouveau Fonds des sciences de la vie, lesquels « collaborent avec des partenaires internationaux et de soutenir l’élaboration et la production de contre-mesures médicales ». PCSC supervise la Stratégie en matière de biofabrication et de sciences de la vie du Canada, qui vise à développer un secteur national des sciences de la vie fort et compétitif doté de capacités de biofabrication de pointe, en mettant l’accent sur la capacité à se préparer et à faire face aux futures priorités et crises sanitaires. Dans cette optique, il y aura des occasions pour les fabricants de nouer des collaborations de recherche et des accords commerciaux ou d’approvisionnement liés aux contre-mesures médicales financées par des programmes fédéraux.

Étroitement lié aux capacités nationales, le pilier III de la stratégie implique « Investissement ciblé pour renforcer un secteur canadien de la défense novateur », avec la promesse que le gouvernement fédéral « soutiendr[a] la recherche et le développement, protéger[a] la propriété intellectuelle, soutiendr[a] les petites et moyennes entreprises, investir[a] dans les compétences et la formation, et encourager[a] les exportations afin de créer un secteur de la défense agile et concurrentiel à l’échelle mondiale ». La nécessité de favoriser le développement de la propriété intellectuelle (PI) et la conservation des droits du Canada est mentionnée à plusieurs reprises dans la Stratégie. Par exemple, la Stratégie prévoit l’établissement de partenariats officiels avec l’industrie canadienne qui « [assureront] la propriété et le contrôle nationaux de la propriété intellectuelle (PI) et des capacités essentielles. » La Stratégie reconnaît l’immense talent des établissements canadiens et la précieuse recherche qui y est menée actuellement et qui est déjà financée par des subventions de recherche d’organismes tels que le Conseil de recherches en sciences naturelles et en génie et les Instituts de recherche en santé du Canada, et fait aussi référence à l’engagement de 1,6 milliard de dollars pour de nouveaux fonds de recherche dans le budget de 2025. Cette prise de conscience de la nécessité de promouvoir et de soutenir l’innovation au Canada laisse présager des possibilités de financement, notamment dans les domaines où le Canada accuse un retard en matière de production nationale et où des engagements d’investissement et de fabrication au Canada peuvent être pris.

Prochaines étapes

Dans les prochains mois, nous prévoyons que le gouvernement du Canada publiera d’autres directives et des mesures de suivi. L’équipe de défense des conservateurs poursuivra sa couverture de perspectives sur la défense au Canada en publiant une analyse supplémentaire pour donner des précisions sur l’incidence de la Stratégie sur de multiples secteurs.