Debt Swamp: Considerations for Cannabis Companies Incurring Secured Debt

As a company, secured debt may be your only option for a line of credit or for funding the evolution of your business.

Secured debt is where the lender takes a lien against either all assets or a particular set assets of a borrower as collateral for a loan. As can be imagined, trudging blindly into this type of debt can sink your business. Moreover, there are particular concerns when companies incur secured debt.

Increasingly, experienced secured debt lenders are entering this space, but a significant portion of those potential partners remain prohibited by federal law from participating in company debt. In the meantime, it falls disproportionately on cannabis companies to educate and steward and carefully consider potential debt partners. Unless you have been active in the space before, it is going to be hard for you to judge what is right, wrong or weird without trusted advisors.

The responsibilities between a borrower and the lender are commonly misunderstood. It is not an equal (or close to equal) partnership, which is the universal issue of this article. If you incur secured debt, it is your responsibility to understand that your lender has a right to your collateral—a right that is superior to rights of all others.

The consequence of misunderstanding this relationship can be the lender calling default on your loan.

Grasping this responsibility involves two important concepts under Article 9 of the Uniform Commercial Code (UCC):

(1) Attachment: This pertains to how a security interest grant is enforceable against the borrower, requiring the occurrence of each of the following events: (i) the borrower receives value for the grant; (ii) the borrower has rights in the collateral; and (iii) the secured lender receives a grant in the collateral, usually pursuant to a written security agreement; and

(2) Perfection: This pertains to how a secured lender’s security interest has priority to all other creditors.

With respect to secured debt, it is easier to ensure attachment when working with a trusted attorney. Following the elements above, here’s what happens: (i) You receive value in a secured debt transaction through a loan of funds or the promise to access to a loan of funds, (ii) you typically have rights in the collateral, but an attorney will help investigate potential issues, and (iii) the transaction documents should contain a specific grant of collateral as required under the UCC, but there are other methods to receive a grant.

Here is where you will run into your initial problem as a cannabis company.

Except in limited instances, including in Oregon and Maryland, legal regimes prohibit cannabis companies from granting a security interest in the applicable license and/or cannabis. Poof, your two most valuable assets–the right to engage in the cannabis industry and your inventory–are eliminated from the collateral package offered to lenders.

So, what else might a business have to offer? You will need to frame discussions with your lender to highlight the values on your balance sheet in equipment, land or other assets, and

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