Receivership in the Cannabis Industry

Allen Wilen:
Thank you very much.

EA:
Allen, what does it mean when a company goes into receivership?

AW:
So a receivership cannot use the federal bankruptcy code when they're in distress or financial trouble, and therefore have to reply upon state methods of restructuring of a business. So for example, if you have a lender who was trying to foreclose on their collateral or a lender who's trying to find a way to deal with a distressed cannabis company, a receivership becomes probably the only methodology they can use.

EA:
Are there technical differences between a receivership and bankruptcy? I know cannabis companies cannot avail themselves of the bankruptcy protection because of the federal legality. What are the differences between a receivership and a bankruptcy?

AW:
So a receivership does not give you the stay of any litigation that's outstanding against the parties. It doesn't stop your creditors from pursuing actions. It really just provides a forum for you to go address issues of a business. It doesn't give you the same protections that a bankruptcy would give you.

EA:
And why isn't bankruptcy available to companies in this industry? Is it just a federal illegality or are there other issues?

AW:
It's the federal illegality, although there is some recent case that's flowing out of the State of California where a cannabis company that was shut down was able to avail itself of the bankruptcy code. However, the United States Trustee's Office that oversees the bankruptcy process has filed an appeal of that decision by that bankruptcy court under the issues of the legality of cannabis.

EA:
Does New York or New Jersey do anything differently than any other states regarding bankruptcy or receivership laws?

AW:
Nothing different under the receivership laws in those states versus other states. It's really a simple process, although I will tell you that the State of New Jersey, in my experience, has better success with this process than some other states because the judges are looking for a solution to a problem that otherwise would be in a bankruptcy court.

EA:
Can a company come out of receivership, or does receivership mean the end of the enterprise as we know it?

AW:
Effectively, it's the end of the enterprise, but what happens is oftentimes you'll see a receiver take the business and sell the business out of the receivership without the liabilities coming with it. And in essence, the business continues on, but with new ownership.

EA:
And typically, how long do companies stay in receivership? Is this a lengthy process? Is this a relatively short process?

AW:
It's all over the place. It depends upon the situation. Some receiverships are very fast when everything is prearranged and pre-structured. There's a buyer that's pre-structured, a process in place, and it's just a tool for effectuating a transfer of business or transfer of assets. However, I've been in receiverships that have lasted years.

EA:
Can the receivership be used to help the cannabis company rehabilitate its finances?

AW:
Not really. It's really used as a tool when you've come to the end and you're trying to figure out how to either transfer the assets or liquidate the value of the asset for purposes of paying debts.

EA:
Besides cannabis companies, are there other industries that have used receiverships and experienced positive results?

AW:
Yes. Quite frankly, the one that comes to mind is real estate. There are receiverships done in real estate on a daily basis. It's a very effective way of doing the real estate transfer without using the bankruptcy system, which is very expensive and time-consuming.

EA:
Allen, you're acting as a receiver and a cannabis company, and we'll get into that in a little while, but how different is it acting as a receiver in a cannabis company compared to acting as one... I was going to say a less volatile industry, but I think that all the industries are volatile, but certainly maybe a legal industry is a better way to phrase it.

AW:
Well, the biggest issue is getting statewide cannabis review commission approval. You have to get background checks done. You need to go through the entire fingerprinting process, criminal background check as a receiver. Something you would never do in another environment. Secondly, you have to get yourself up to speed on the cannabis laws in the state and understand procedures and processes and the reporting requirements.

EA:
The cannabis companies, because of the federal legality, it's an interesting operation because they have to compete with legacy or gray businesses. For a legal business, how hard is it to compete with those legacy businesses?

AW:
It's extremely difficult. However, what I have found is that the legal cannabis businesses service a different market. They are all about serving the middle to upper class communities who are looking for a product that is clean, regulated, et cetera. So for example, that is the reason why the pricing is so much higher for a cannabis coming through a regulated cannabis facility than if some were to buy illegally.

EA:
It's interesting, you walk around midtown Manhattan and there is a dispensary almost on every corner it feels like. Yet in the state of New York there, I think there are 23 or 24 legal dispensaries. So all these other dispensaries are illegal, but they're popping up left and right.

AW:
They are very contested issue, obviously. You can't walk through the streets of New York without smelling cannabis, and the city has to figure out a way to address it or else the regulated facilities will cease to operate. A lot of those facilities apparently are organized and supplemented their product illegally from third parties.

EA:
How is a receiver selected or appointed?

AW:
So receivers are usually put in place officially by the court. However, oftentimes a creditor will come to the table and request that a receiver be put in place. And they suggest the name of a receiver and the court will sign off on that receiver as the individual to be utilized.

EA:
What are some of the high profile companies that have gone into receivership cannabis and non-cannabis?

AW:
So cannabis companies, you're dealing with a lot of the California companies in the cannabis space that have shut down, some of the Colorado businesses that are shut down, who are early achievers in the space who couldn't adapt. I am right now a custodian, which is similar to a receiver, of a cannabis company that's a not-for-profit in the State of New Jersey called Harmony.

EA:
And are there any specific issues dealing with an emerging industry like cannabis that come up in your role as a receiver?

AW:
Yes. Some of it is based upon product changes. Some of it's based upon law. I will tell you that because it's state mandated, you have players coming in and out of states. So for example, New Jersey is a very hot state right now for cannabis companies coming into it for a number of reasons, one of which it is fairly early in the adoption cycle.

Number two is because there are so many towns in the state that are not allowing dispensaries, especially in the northern part of the state, you're finding those that open up in the northern part of the state have a much larger scope of customer base than you might have in other parts of the country.

EA:
And typically we accounts don't like surprises. Were there any surprises during your time as a receiver or acting as the receiver of a cannabis company?

AW:
Every day. Every day you have a surprise because we have a large growing operation, a large canopy in a facility. We have two facilities growing, as well as a retail location and two other retail locations under development. So the surprises you run into were things like, I'll give you an example of something from last week, a electrical circuit blew on a Friday night at 11:30 at night. Our lights went on, the growing lamps went on in one corner of the facility at 3:00 in the morning.

Well, if there's no air conditioning in place, you basically cook the cannabis. So we lost the better part of order of the facility of a grow because of a simple air conditioning circuit breaker going. Those are the surprises in this business that are very different than most other businesses. You're growing a live product and differentiations in the product growth cycle can affect the quality tremendously of what you're growing.

EA:
One of the things I read in today's newspaper was the concern that there aren't enough dispensaries for the cultivators to sell product to. I'm focusing on New York State in particular. New York State is opening up the marketplace to more future dispensaries and more licenses. Do you find that with this company that it's a problem to find outlets to sell product?

AW:
Yes. So we're running into a problem, which is, I'll give you an example, the wholesale price of a gram of product is about $13 a gram wholesale at retail at 65. I can't find enough places to sell the product. So we're sitting with a couple million dollars of inventory and we continue to grow and just building up inventory.

EA:
And for everybody that's listening, for the way the rules read now, cannabis, there's no interstate commerce in cannabis. Though there is discussion about having some states allow that to happen, but typically there is no interstate commerce. So the product has to be cultivated and consumed in the product. It's cultivated and sold. So that becomes an issue is whether or not there's enough distribution marketplace to sell product.

AW:
Correct. And one of the things you'll see in New Jersey, and I think New York probably has a similar issue, although New York's slightly different issue, New Jersey's issue is that it's taken a long time to get through the licensure process for retail operations to sell. Once those retail operations get up and selling, the wholesalers will be able to push their product out the door. I think that there was a lot of wholesale operation, growing operations built and not enough retail operations that got up and running because of the towns in question where you would sell this product didn't want it.

This is not a product that sells and it has to sell in a upper middle class community is where you want to be located. That impacted the process because many of those communities didn't want dispensaries in them. In New York State, you have a slightly different issue because New York State has, especially Upstate New York, a large number of hemp growers who have now tried to convert their product.

So they already had the fields in place, they already had the facilities in place ready to go, and that's caused that problem. Along with the fact that, for example, as you said earlier, there were only 20 plus licenses in the state to sell to, and they can't sell to these what I call illegal locations under their state charters.

EA:
Allen, my last question is what is the one thing you would suggest a cannabis company now to do to prepare for the future?

AW:
Put in controls. Put in systems. They are notoriously bad at accounting systems, internal inventory control systems. Yes, there are seed to sale systems in place in these locations, but that doesn't help you understand and control what I'll call cost accounting.

When I ask people what it costs to produce the product, they struggle. There's no way of knowing what it costs. They look to the fact that they can sell their product at whatever the market is at that point in time, and my comment to everybody is, how do you know you're making money selling the product if you don't know what it costs you?

EA:
Allen, as an auditor, what you say is music to my ears. Controls are so important, especially in this industry, which is so focused on cash because you still can't accept credit cards for sale of product and MasterCard recently left the industry as far as debit cards. So you're in a cash business basically. And without having good internal controls over your cash function, all your other functions, it's really hard to be successful.

AW:
It's inventory and cash. I will tell you that we have more cameras than I've ever seen anywhere in my life in this facility to track product. Because it's so easy for product to just walk out the door, that we have controls in place related to that. We have controls related to the cash that we have coming through the front door. That is the part that puts me in a very difficult spot every night. We have safes. We have security guards that are armed. It's a different kind of business, and you have to know what you're getting into.

EA:
Well, thank you, Allen, for joining us today, and thanks for listening to CannaCast as part of the EisnerAmper podcast series. Visit www.eisnerer.com/cannabis for more information on podcasts and for more information on Allen Wilen and myself, Join us for our next CannaCast Podcast where we'll discuss other budding issues. Thank you.

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