Where a Chapter 13 debtor proposed a plan that would have been funded with earnings from his employment at a cannabis dispensary, a U.S. Bankruptcy Court decision to deny confirmation should be upheld because plans funded with the proceeds of Controlled Substances Act violations are categorically prohibited by 11 U.S.C. §1325(a)(3).
“Before and after the filing of his chapter 13 petition, Scott H. Blumsack worked at a cannabis dispensary in the Commonwealth of Massachusetts, where state law permits the retail sale of marijuana. The debtor proposed a plan that would have been funded with earnings from his employment at the dispensary. Citing a federal statute — the Controlled Substances Act — the United States Trustee asked the bankruptcy court to deny confirmation of the debtor’s plan and to dismiss his case. The court granted both requests, and the debtor now appeals.
“Although the bankruptcy court erred in fashioning a rule of law that categorically prohibits an individual employed in the cannabis industry from seeking chapter 13 relief, this debtor’s case was properly dismissed for cause. Dismissal was warranted because the bankruptcy court properly denied confirmation of the plan and did not abuse its discretion in denying the debtor an opportunity to file a modified plan. …
“We examine the two components of cause under §1307(c)(5) separately, first looking at whether the bankruptcy court properly denied confirmation of the Plan and then examining whether the court properly denied the debtor an opportunity to submit a modified plan. As discussed below, although we disagree that the debtor’s chapter 13 petition was filed without the requisite good faith for purposes of §1325(a)(7), we agree that the Plan was not proposed in good faith as required by §1325(a)(3). On this record, we discern no abuse of discretion in the bankruptcy court’s decision to deny the debtor’s request for additional time to propose a modified plan. We affirm the dismissal of the case but do so on grounds other than those articulated by the bankruptcy court. …
“The debtor proposed to fund the Plan with the income he derived from his employment at the dispensary; he did not offer his spouse’s income or assets unrelated to marijuana activities until after the Trustee filed the Motion to Dismiss. When given the opportunity at the evidentiary hearing, the debtor did not establish that he segregated his marijuana income from his spouse’s income or other assets unrelated to his employment. The Plan he proposed would have placed the chapter 13 trustee in the untenable position of knowingly administering assets derived from an activity illegal under federal criminal law.
“The debtor can point to no case law supporting the notion that a chapter 13 plan is proposed in good faith and by lawful means, as required by §1325(a)(3), when the income the debtor would use to fund that plan is derived from activities criminalized by federal law. Instead, the caselaw — although distinguishable in some respects — stands for the opposite proposition. Bankruptcy relief is generally unavailable where the trustee ‘will necessarily be required to possess and administer assets which are either illegal under the CSA or constitute proceeds of activity criminalized by the CSA.’ …
“… As discussed above, the nature of the debtor’s employment, by itself, does not render him ineligible to file a chapter 13 petition in good faith. However, his Plan would have funneled his income from the dispensary into the chapter 13 trustee’s office, and from there to creditors, bringing the proceeds of illegal activity directly into the administration of the bankruptcy case. … Here, where the debtor proposed to fund his reorganization with the proceeds of illegal activity, the degree of connection between that criminal activity and the debtor’s reorganization efforts crossed a line into bad faith territory. On these facts, we agree with the bankruptcy court that the Plan did not satisfy §1325(a)(3).
“We reach this conclusion even though it establishes the sort of per se rule discouraged by [Berliner v. Pappalardo (In re Puffer), 674 F.3d 78 (1st Cir. 2012)]. In that case, the First Circuit held that fee-only chapter 13 plans are not categorically prohibited by §1325(a)(3). Here, we hold that plans funded with the proceeds of CSA violations are categorically prohibited by §1325(a)(3). The distinction is that the Bankruptcy Code does not prohibit fee-only plans, but federal law does proscribe the sale of cannabis. Moreover, formulation of a plan is at the heart of the chapter 13 process. The chapter 13 trustee is, in most instances, the person who collects the debtor’s payments and disburses money to creditors. While not entirely free from debate, we believe that bankruptcy courts have license to pass judgment on chapter 13 plans — including the source of funding for those plans — in a way that is materially different from passing judgment on whether a person gains access to the bankruptcy court in the first place. One can easily imagine a situation involving a debtor who needs the relief afforded by chapter 13 and can fund a plan with money that was not derived from pre- or post-petition cannabis-related employment, even while that debtor continues working in the cannabis industry. If the chapter 13 trustee is not required to receive and disburse money obtained from that employment, sound bankruptcy policy dictates that the debtor be given a chance to pursue a chapter 13 discharge. So, too, with a chapter 7 debtor whose post-petition wages are not part of the bankruptcy estate. This rationale becomes more compelling when, as the Bankruptcy Code requires, the interests of creditors are put into the calculus. Here, however, the Plan could not be confirmed because it would have been directly funded by the proceeds of illegal activity. Such a plan is, per se, proposed in bad faith.”
In Re: Blumsack, Scott H. (Lawyers Weekly No. 03-002-24) (20 pages) (Fagone, J.) Appealed from a decision by Katz, J., in the U.S. Bankruptcy Court for the District of Massachusetts. Dmitry Lev, Esq., on brief for the debtor; William K. Harrington, Ramona D. Elliott, P. Matthew Sutko, Frederick Gaston Hall, Eric K. Bradford and Stephen E. Meunier on brief for the appellee (BAP NO. MW 23-003) (March 5, 2024).
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