535 B.R. 845
10th Cir. BAP2015Background
- Frank and Sarah Arenas owned a two‑unit commercial property in Denver; Frank legally grew and wholesaled medical marijuana under Colorado law and leased the other unit to a licensed dispensary (DPG).
- State litigation with DPG produced a $40,000 attorney’s‑fees judgment against the Arenases and threatened a $120,000 counterclaim; they filed Chapter 7 bankruptcy on Feb. 12, 2014.
- Schedules showed modest non‑marijuana income (Social Security and pension), most income/rental stream derived from the marijuana business, and nonexempt assets consisting of 25 marijuana plants and the Property.
- The Chapter 7 trustee initially filed a Notice of No Distribution but later considered administering the Property; the U.S. Trustee moved to dismiss under 11 U.S.C. § 707(a) arguing administration would violate federal law.
- The Arenases moved to convert to Chapter 13; the bankruptcy court denied conversion (finding lack of good faith / infeasible plan because plan depended on marijuana proceeds) and dismissed the Chapter 7 case for cause under § 707(a)(1).
- On appeal, the Bankruptcy Appellate Panel affirmed, reasoning that the marijuana business violates the federal Controlled Substances Act, making lawful administration or plan funding impossible and causing prejudicial delay to creditors.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether debtors may convert Chapter 7 to Chapter 13 when their income/assets derive from marijuana activity | Arenas: conversion permitted; no per se bar because activity is lawful under Colorado and debtors are sincere | U.S. Trustee: conversion may be denied if debtor lacks good faith or cannot propose a confirmable plan funded without violating federal law | Denied — conversion properly denied for lack of good faith because plan funding depended on proceeds from federally unlawful activity |
| Whether lack of good faith can be cause to dismiss under § 707(a) | Arenas: § 707(a) cause should be limited; they did not intentionally frustrate administration | U.S. Trustee: administering estate would force trustee to commit federal crimes or abandon assets, causing prejudicial delay to creditors | Dismissal affirmed — impossibility of lawful administration and prejudicial delay constitute cause under § 707(a)(1) |
| Whether trustee could simply abandon marijuana assets to preserve the case | Arenas: trustee could abandon assets, allowing case to proceed without risking criminal exposure | U.S. Trustee: abandonment would let debtors retain assets and receive discharge while creditors get nothing — also prejudicial delay | Rejected — abandonment not raised below and would produce prejudicial delay and no creditor recovery; dismissal appropriate |
| Whether federal prosecutorial discretion (lack of prosecutions) undermines the U.S. Trustee's position | Arenas: DOJ’s current non‑prosecution posture makes funding and administration feasible | U.S. Trustee: prosecutorial policy can change; CSA still criminalizes the activity and risk remains | Court: policy pragmatism insufficient — as long as CSA criminalizes activity, trustee would be exposed to legal risk; concern stands |
Key Cases Cited
- Marrama v. Citizens Bank of Mass., 549 U.S. 365 (2007) (a debtor’s bad faith can render them ineligible to convert to Chapter 13 and supports dismissal under § 1307)
- Kras v. United States, 409 U.S. 434 (1973) (no constitutional right to a bankruptcy discharge)
- Flygare v. Boulden, 709 F.2d 1344 (10th Cir. 1983) (factors for evaluating debtor’s good faith in Chapter 13)
- Salve Regina Coll. v. Russell, 499 U.S. 225 (1991) (standard for de novo review of legal conclusions)
- Walker v. Mather (In re Walker), 959 F.2d 894 (10th Cir. 1992) (appellate courts generally will not consider issues not raised below)