Regulatory bars to receiverships in the cannabis industry?

The Ontario Superior Court of Justice (the Court) rejected a cross application for a receivership order brought by the secured creditors of Pure Global Cannabis Inc., a producer and distributor of cannabis products in Canada, and certain of its subsidiaries (Pure Global). Instead, the Court granted a limited Initial Order under the Companies’ Creditors Arrangement Act (Canada)(CCAA)—which was ultimately consented to by the secured creditors—pursuant to which the applicants are required, among other things, to arrange for the lawful disposal or destruction of their cannabis or cannabis products in consultation with Canada Revenue Agency (the CRA) and/or Health Canada and to permanently shutter their business and operations. This bulletin focuses on the proceedings and implications for lenders and others in the cannabis sector.

What you need to know

• Under the Excise Act (Canada), any person who cultivates, produces or packages cannabis products is required to obtain a cannabis license from CRA. CRA may suspend or cancel a cannabis license upon the holder of the license: (i) becoming bankrupt or the subject of a receivership proceeding; (ii) failing to comply with the Excise Act; (iii) failing to have sufficient financial resources to operate their business in a responsible manner; or (iv) failing to provide the necessary financial security.
• The Cannabis Act (Canada) and its regulations and orders do not provide for the transfer or assignment of a cannabis license.
• Pursuant to most Receivership Orders, the receiver takes possession of all of the debtor’s property, and has the ability to sell, convey, transfer, lease or assign the debtor’s interests in such property.

Pure Global proceedings

• Pure Global filed an application for an Initial Order under the CCAA seeking, among other things, interim financing, administration and directors’ charges in the aggregate amount of $2.15 million.
• The application was opposed by all of Pure Global‘s secured creditors, who argued that the applicants’ business was not viable and that a receivership was more appropriate.
• The Court refused to grant the Order sought by Pure Global. However, and notwithstanding the continued opposition from Pure Global’s secured creditors, the Court granted a scaled down version of the Initial Order providing for, among other things, interim financing, administration and directors’ charges (collectively, the Charges) in the aggregate amount of $750,000.
• The parties reappeared before the Court on April 3, 2020, where the applicants sought an amended and restated Initial Order that would, among other things, extend the stay of proceedings to May 15, 2020, increase the Charges to $1.7 million, expand the powers of the Monitor to provide enhanced supervision of the applicants, and approve a Sales and Investment Solicitation Process (SISP) to solicit bids for the applicants’ business on a going concern basis and for the assets on a piecemeal or en bloc basis.
• The secured creditors argued that the applicants have no business prospects and that a receivership order would be a more appropriate remedy than an initial order under the CCAA.
• CRA and Health Canada filed submissions setting out the various regulatory issues that arise with a receiver taking possession of the applicants’ cannabis assets, including CRA’s ability to suspend, or cancel licenses, the fact that duty stamps cannot be transferred to another cannabis licensee, and that the Cannabis Act does not provide for the transfer of a license.
• In light of the foregoing, the secured creditors proposed that the Court approve an amended and restated initial order under the CCAA that requires the applicants to permanently shut down their business. The Court agreed and granted such Order requiring the applicants to, among other things: (i) arrange for the lawful disposal or destruction of their cannabis or cannabis products in consultation with CRA and/or Health Canada; and (ii) permanently shutter their business or operations.

Implications

Impact on lending. For secured lenders, the decision further increases the risk associated with extending financing to cannabis companies given that enforcement tools otherwise available to secured lenders may not be accessible against a cannabis company. If a significant portion of an estate’s entire realizable value must go towards interim financing, administration and director’s charges, and the company’s business is, in fact, not viable, this will leave much less to be distributed to secured creditors.

Impact on insolvency proceedings. The decision may also add CRA and Health Canada as new key stakeholders in any liquidation proceedings that involve the disposition of cannabis related assets. Further, while courts are generally reluctant to allow CCAA proceedings in the face of unanimous opposition from secured creditors, this decision shows that secured creditors may have less of a say when the debtor is operating in the cannabis industry. Finally, the decision underscores how CCAA proceedings continue to supplant receiverships as a realization tool, even in cases in which such proceedings are not necessarily the secured creditors’ preferred tool of choice.

Impact on insolvency professionals. The decision may discourage insolvency professionals from consenting to act as receivers or trustees where the debtor company’s assets primarily include cannabis or cannabis products, since such assets may simply have to be destroyed, as opposed to converted into cash. This may, in turn, leave insufficient funds in the debtor’s estate to cover the professional fees associated with the administration of the estate.

To discuss these issues, please contact the author(s).

This publication is a general discussion of certain legal and related developments and should not be relied upon as legal advice. If you require legal advice, we would be pleased to discuss the issues in this publication with you, in the context of your particular circumstances.

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