Navigating Cannabis Restructurings: Strategies for Financial Distress and Recovery

The Financial Crossroads of the Cannabis Industry

The Canadian cannabis industry, once heralded as a booming sector with limitless potential, now finds itself navigating a complex financial reality. Regulatory constraints, oversupply, high taxation, and persistent market saturation have driven many cannabis companies to the brink of insolvency. In this challenging landscape, industry participants are increasingly turning to formal restructuring proceedings to stabilize operations and reposition themselves for long-term viability.

Yet, the road to financial recovery is not straightforward. The nuances of cannabis insolvency require a strategic approach, blending legal expertise with financial acumen, and an acute understanding of the sector's regulatory landscape. At the recent Distressed Cannabis Conference hosted by Insolvency Insider on January 29, a panel of restructuring professionals offered invaluable insights into the tools available to distressed cannabis companies.

Understanding the Legal Framework for Insolvency

Larry Ellis, Group Leader of Restructuring & Insolvency at Miller Thomson LLP, opened the discussion by demystifying insolvency proceedings. While the term "insolvency protection" often carries negative connotations, he emphasized that these legal frameworks are designed to offer breathing space for companies to restructure and reposition their business models effectively.

There are several options available, each with distinct implications for stakeholders:

• Receivership: A remedy typically initiated by secured creditors, receivership often signals the end of a company's operations. Assets are sold, and creditors are repaid to the extent possible.

• Companies' Creditors Arrangement Act (CCAA): This legal tool allows larger cannabis companies to remain in operation while renegotiating debt obligations, providing a structured path to financial rehabilitation.

• Notice of Intent (NOI) / Proposal under the Bankruptcy and Insolvency Act (BIA): More commonly utilized by smaller enterprises, this allows a company to propose a repayment plan to creditors while maintaining operational control.

In cannabis restructurings, the majority of filings occur under the CCAA or NOI frameworks, allowing businesses to continue operating while renegotiating their financial obligations.

Strategic Priorities During Insolvency Filings

Karen Fung (CPA, CA, CIRP, LIT), Senior Vice President at Ernst & Young Inc., highlighted the core aspects of a cannabis restructuring:

• Securing a stay of proceedings: This prevents legal actions from creditors, allowing companies time to assess restructuring options.

• Stabilizing cash flow: In many cases, this involves securing debtor-in-possession (DIP) financing to fund ongoing operations.

• Managing regulatory compliance: Ensuring that Health Canada licensing requirements and tax obligations remain in good standing is crucial to maintaining business continuity.

Karen noted that many cannabis restructurings involve pre-packaged transactions, where a sale is negotiated with a buyer before the insolvency filing. This structured approach can streamline the process and reduce uncertainty for stakeholders.

Howard Steinberg, Founder of Steinberg Advisory Corp., echoed these sentiments, stressing that early intervention is key. "By the time many cannabis companies recognize they are in financial distress, financing options have already dried up," he warned. "Early strategic planning is crucial in preserving enterprise value."

Challenges Unique to the Cannabis Industry

While restructuring mechanisms are well established in other industries, cannabis insolvencies present a unique set of hurdles. The panelists identified three primary challenges:

1. Structuring Transactions Within a Regulatory Framework

   • Unlike traditional businesses, cannabis companies cannot freely transfer assets due to strict licensing regulations.

   • Health Canada imposes significant restrictions on the transfer of cannabis licenses, complicating asset sales.

   • Reverse vesting orders (RVOs) are frequently used to separate liabilities from the operating entity, ensuring that licenses remain intact post-transaction.

2. Securing Financing Amid Industry Uncertainty

   • Traditional banks remain hesitant to fund cannabis businesses, particularly those in distress.

   • DIP financing is limited, often requiring engagement with niche lenders who specialize in cannabis financing.

   • Many distressed cannabis firms rely on private equity or strategic investors to inject capital and sustain operations.

3. Addressing Tax Liabilities and CRA Scrutiny

   • The Canada Revenue Agency (CRA) has intensified its enforcement efforts regarding excise tax arrears, further pressuring struggling cannabis companies.

   • The Delta 9 case, in which CRA pursued directors for unpaid excise tax, underscores the heightened risks of tax non-compliance.

   • Navigating tax obligations requires close collaboration with financial advisors and legal counsel to mitigate exposure and negotiate favorable outcomes.

A Roadmap for Distressed Cannabis Companies

The panelists underscored that while the cannabis industry faces formidable challenges, companies that take proactive steps can improve their prospects for recovery.

Howard emphasized that engaging with key regulators like Health Canada, CRA, and provincial authorities early in the restructuring process can prevent compliance headaches down the road. “Have a transition plan in place. Engaging a CRO to bring in new prospective can be very helpful both prior to and during the restructuring process.”

Karen advised cannabis companies to cultivate transparent relationships with lenders and creditors. "Creditors need to see a viable path forward. The more transparency and strategic planning you demonstrate, the more likely you are to gain stakeholder support."

Larry reiterated the importance of early intervention. "The biggest mistake cannabis companies make is waiting too long to seek restructuring advice. Cash flow issues do not resolve themselves—proactive planning is essential."

Is There a Path Forward?

Despite the turbulence in the cannabis industry, the panelists concluded that restructuring remains a viable option for well-managed companies willing to adapt. Those that engage with financial and legal professionals early, maintain regulatory compliance, and build a clear restructuring strategy have a greater chance of surviving industry downturns.

Ultimately, cannabis businesses must embrace financial discipline, regulatory agility, and proactive stakeholder management to navigate insolvency successfully. As the industry continues to mature, companies that strategically approach restructuring will be best positioned to emerge stronger in an increasingly competitive market.