California Superior Court Upholds Creditor's Security Interest In Cannabis Business Assets, Including Cannabis Licenses

In a lawsuit filed in the Superior Court of the State of California for the County of Santa Clara, KLA Daylight LLC v. GWS Health, et al., the Superior Court ruled a creditor’s security interest in the assets of a cannabis business was valid and enforceable against assets of the cannabis business, including the cannabis licenses.  It is believed that this was the first time that a California court has made such a determination.

Hopkins & Carley represented the creditor, which obtained a blanket security interest in the assets of the cannabis business after the borrower defaulted under its loan obligations. After the borrower further defaulted, the plaintiff-creditor commenced litigation to collect monies owed to it by the borrower, and successfully obtained appointment of a receiver to take possession and control over the cannabis business, and to operate the business pending the sale of the company’s assets.

Hopkins & Carley argued on behalf of the creditor that it held a perfected security interest in all of the personal property assets of the defendant cannabis business, including the cannabis licenses. 

Over objections asserted by the borrower’s unsecured creditors, the Superior Court affirmed the creditor’s position in an Order issued by the Court.  In a later hearing, the court made history by conducting a sale of the cannabis business’ assets through a receivership auction.  The receiver’s auction, which was attended by several qualified bidders (i.e., those that held existing cannabis licenses), resulted in the sale of the cannabis company’s assets for $8.25 million and it is anticipated that the asset sale will result in full payment to the secured creditor.

Since a cannabis license issued by the State of California is not transferable or assignable, it is reasonable to question the value of receiving a security interest against a cannabis license.  While the secured creditor may not be able to foreclose against the cannabis license itself, the existence of the lien helps to eliminate any incentive by the borrower to circumvent the secured creditor’s secured position.  For example, in the absence of a security interest against the cannabis license, the borrower might attempt to sell the assets of its cannabis business to a qualified buyer, and to allocate a portion of the purchase price to the cannabis license or particular rights or assets of the business that represent a unique requirement for issuance of the cannabis license, thereby arguing that the proceeds derived from such assets are outside the secured creditor’s lien and therefore available to the borrower for some other use or purpose.  With the secured creditor having a secured interest against the cannabis license and proceeds thereof, the borrower has no incentive to attempt such a novel allocation and circumvention.

Key Take Away For Cannabis Business Owners and Investors:

  • Due to current federal law, cannabis businesses are unable to obtain funding through federally insured financial institutions (i.e., banks), so there is a substantial need for funding through alternative lenders, and potentially state chartered financial institutions.
  • The availability of secured financing for cannabis businesses should make lenders more comfortable with making loans in this sector, and should increase the availability of funding for cannabis businesses, under standard business terms.
  • Cannabis businesses and investors may take advantage of existing state law, including the Uniform Commercial Code, to obtain and make loans secured by cannabis business assets, just like any other business.
  • In the event of default, a cannabis business lender may pursue legal remedies provided by state law, including the appointment of a receiver to take control of, manage, and liquidate the assets of the business.
  • Also due to current federal law, cannabis businesses are unable to utilize the federal bankruptcy courts as a means of reorganizing or discharging their debts. However, analogous procedures are available under the state law assignment for the benefit of creditors (“ABC”) process.

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