Written by Gavin Finlayson, Alexander Payne and Shaan Tolani
As the cannabis industry has matured, investor enthusiasm has been tempered by financial results that have fallen short of projected figures. The industry continues to face retail regulatory hurdles, particularly in Ontario. As a result, many cannabis companies are now facing liquidity constraints and may have to begin considering insolvency and restructuring alternatives. This is borne out as relatively large players such as AgMedica and Wayland—which appeared to be thriving—have recently acquired creditor protection under the Companies’ Creditors Arrangement Act (CCAA).
As originating participants in the legal cannabis space, and one of the first firms to address cannabis industry specific issues in the context of insolvency and restructuring proceedings, the Bennett Jones Cannabis group has developed an extensive network of contacts across Canada and beyond that can help distressed cannabis companies to source refinancing, and, where appropriate, assist cannabis companies and creditors in navigating the unique—but not insurmountable—challenges industry participants face in the context of insolvency and restructuring proceeding.
Given that Parliament designed the Cannabis Act from a public health and safety standpoint, there are gaps when it comes to insolvency proceedings. Health Canada is aware of the need for regulatory change, which has generally followed market experience in other emerging industries. However, while growing pains are addressed, some companies, and unwary creditors, may find themselves unprepared for the challenges of insolvency and restructuring proceedings.
Directors need to identify early signs of financial distress and understand their duties to other company stakeholders as a cannabis company nears insolvency. They should consult with professional advisors to understand and plan for restructuring alternatives, particularly given that there are cannabis-specific considerations and uncertainties that can complicate an already complex restructuring and insolvency process. Creditors need to be alive to the unique aspects of the industry that may affect outcomes, as well as strategies to protect the value of their investment in light of these industry specific issues. These industry specific issues include:
- limitations on the sale or transfer of a cannabis licence;
- strict security clearance requirements for individuals who exercise, or who are in a position to exercise, control over a cannabis licence or a corporate cannabis licence holder;
- uncertainty about the mechanism for and availability of buyers when selling inventory;
- the unstable market valuation of cannabis products; and
- the reluctance of court officers to take possession of cannabis inventory and assets.
Cannabis companies and creditors that recognize these issues and seek professional advice to adequately address them will be better positioned to maintain value for stakeholders.
Limitations on the Sale or Transfer of Cannabis Licences
Cannabis licences, which are issued by Health Canada, are essential for all market participants, allowing them to engage in all of their basic operations—including producing, testing, cultivating and/or selling cannabis.
Despite their standalone value and necessity to operations, there are potential impediments to realizing upon that value. While Health Canada has the authority to approve or reject any assignment of a licence, the process—and perhaps more importantly the timeline—related to such a sale or transfer is somewhat unclear.
Limitations on the sale or transfer of cannabis licences have also created some uncertainty when seeking to use a cannabis licence as collateral. Creditors may be unwilling to accept a licence as collateral where they are uncertainties about whether they can in fact take security at all in a licence and/or properly enforce their security to effect the transfer of a licence when a debtor defaults.
Strict Security Clearance Requirements
The Cannabis Act and Cannabis Regulations require any individual who exercises, or is in a position to exercise, direct control over a cannabis licence holder to hold a security clearance before assuming the duties of the position. Achieving security clearance under the Cannabis Act has historically been a slow process, attracting a lengthy wait time. Under some state cannabis legislation in the United States, there are exceptions from security clearance requirements in the context of a trustee or receiver. However, the Canadian legislation is silent on this, and so in the absence of any express carve-outs or permission from Health Canada, court officers in insolvency proceedings may be required to hold security clearance before assuming a role that would require them to exercise control over the cannabis licence or corporate cannabis licence holder. This requirement is a further impediment that may limit the type of insolvency proceeding available to insolvent cannabis companies.
Limitations on Selling Inventory
Given the restrictions on retail sales and the need for a licence to sell cannabis commercially, there is a relatively limited market for inventory. In the context of an insolvency proceeding, there is some uncertainty whether a trustee or receiver can use the debtor’s licence to liquidate inventory.
Unstable Market Valuation of Cannabis Products
Assuming an interested purchaser exists, there can be complexities in valuing cannabis at a particular time, given its nature as organic matter. The number of growth cycles, yields per plant, market prices, cost per gram, and other factors can also create variability in the market valuation of cannabis products. As the fair value of a plant is not linear through its growth, there can be valuation-related challenges (see BDO's article Valuing Biological Assets in the Cannabis Industry), during asset sales while insolvency proceedings are ongoing.
Reluctance of Court Officers in Taking Possession
Court officers have shown an aversion to operating or having a significant hands-on involvement with cannabis operations, expressing concerns about potential ramifications in respect of international travel and other activities due to the legal status of cannabis in other jurisdictions, most notably the United States. As well, the aforementioned issues surrounding the sale and transfer of licences and security clearance requirements may limit the practical ability of court officers to exercise possession and control of a cannabis company.
This issue is not insurmountable, and can largely be mitigated through careful amendments to the court orders that empower court officers in insolvency proceedings, as seen in the Curative Cannabis receivership and in both of the Wayland and AgMedica CCAA filings.
Despite the recent liquidity constraints and market correction the Canadian cannabis industry continues to have significant potential. Canada is the first G20 country to legalize cannabis nationally and has the opportunity to become a world leader in the cannabis industry. In addition, the recent announcement that the Ontario lottery-based system for retail stores will be abandoned and the cap on retail store licences will be removed indicates that Canada's most populous province is conscious of the impact of the retail regulatory hurdles on the industry.
Bennett Jones has developed significant expertise in addressing the unique issues particular to cannabis industry insolvency and restructuring proceedings. For guidance, please contact Gavin Finlayson.