Law firms and accounting firms are preparing for a wave of cannabis company failures, even as questions remain about how bankruptcy cases will be handled in the new, highly regulated industry.
Many marijuana growers are barreling towards insolvency. The devastating sell-off in pot stocks has made investors wary of putting more money into the industry, while most producers are still unprofitable and rapidly burning through their remaining cash. Two licensed producers, Wayland Group Corp. and AgMedica Bioscience Inc., entered creditor protection in December. Several other producers have said they are insolvent.
“For those who do get into a credit crunch because they run out of cash or liquidity, it’s going to be much more challenging to raise capital to extend their runway to build out their business models and allow the market to mature," said Alex Morrison, a partner with Ernst & Young LLP’s (EY) restructuring practice.
"So there likely is going to be more insolvencies over the upcoming year,” he said.
The situation at AgMedica is indicative of the industry more broadly. The Chatham, Ont.-based cannabis grower tried to raise money several times throughout 2019 to fund expansion into the recreational cannabis market.
A planned initial public offering fell through over the summer after the underwriters withdrew, “on the basis that the market did not support such a transaction,” according to an affidavit sworn by AgMedica chief executive Trevor Henry as part of insolvency proceedings. The company then tried to raise $60-million in debt in September, only to have the lender back out a month later.
“The prospective lender advised that it was no longer willing to lend into the cannabis space due to prevailing market conditions,” Mr. Henry wrote.
Dozens of cannabis companies are in similar predicaments, and many have impending walls of debt – largely in the form of unsecured convertible debentures – that are coming due over the next 12 months.
Some of the more proactive companies been preparing for insolvency for months, said Steven Graff, a partner with Aird & Berlis LLP, and co-head of the law firm’s financial services practice. Many others, however, are just beginning to realize they may need to seek protection from creditors.
“A lot of companies in this space are managed by people who don’t have the depth of expertise in financial type analysis and the management of capital the same way as some of the bigger public companies might, so they may have been less tuned to how quickly the crisis was going to come upon them," Mr. Graff said.
The likelihood that there will be a spate of insolvencies is something that most professionals advising the industry agree on. It is still unclear, however, how these bankruptcies will play out.
The biggest unresolved issue is the fact that cannabis licences can’t be transferred unless the buyer is already licensed by Health Canada to handle cannabis.
That significantly reduces the pool of possible buyers for distressed assets, said Natalie Renner, a partner at the law firm Davies, Ward, Phillips and Vineberg LLP. It also limits the type of insolvency proceedings a company can enter. In particular, creditors may have trouble putting a cannabis company into receivership — a situation where a trustee actually takes possession of the company on behalf of lenders.
"There's a need to address the gap in the legislation; other regulated industries have carve-outs to deal with insolvencies and transfers of licences,” Ms. Renner said.
"In liquor, which is a great example, they have the ability to transfer a licence to the insolvency professional, a receiver, and they have the ability to hold the licence for the purposes of operating the business in lieu of the company's management,” she added.
Until questions of transferability are resolved, most of cannabis insolvencies will likely be managed under the Company Creditor Arrangement Act (CCAA), said Ms. Renner. In this situation, the company’s management team will remain in place throughout the “restructuring” process, which will be overseen by a court-appointed monitor.
This is the route taken by AgMedica and Wayland, whose CCAA proceedings are being overseen by EY and PricewaterhouseCoopers respectively. Both companies are pursuing the sale of assets under the guidance of monitors.
Grant Bazian, president of the insolvency practice at accounting firm MNP, said he’s hopeful that questions around the transferability of licences will be answered by regulators or through clarification by the courts in the near term.
“Even though the logistics haven’t been worked out 100 per cent, the courts are very pragmatic and they realize in order to facilitate a going concern sale which would maximize realizations and dividends to the stakeholders and creditors who are owed money, they’re [going to have to be] pretty innovative,” he said.