## Facts

- Rent-Rite Super Kegs West, Ltd. (Rent-Rite) owned a warehouse in Colorado.
- The warehouse served as collateral for an approximately $1.8 million loan; the lender assigned the loan to VFC Partners 14, LLC (VFC).
- Rent-Rite leased part of the warehouse to tenants operating marijuana grow operations.
- Although the tenants’ activities were arguably permitted under Colorado law, marijuana remained illegal under federal law as a Schedule I controlled substance under the Controlled Substances Act (CSA).
- Rent-Rite knew the tenants were using the space to grow marijuana.
- Rent-Rite received about 25% of its total revenues from rent paid by these marijuana-related tenants.
- Rent-Rite filed a Chapter 11 petition and listed VFC as a secured creditor.
- VFC moved to dismiss the Chapter 11 case under 11 U.S.C. § 1112(b), arguing that Rent-Rite had unclean hands and that its ongoing marijuana-related leasing constituted cause for dismissal, including gross mismanagement and exposure of the estate and collateral to federal forfeiture risk.

## Issues

1. Whether a Chapter 11 case should be dismissed for “cause” under 11 U.S.C. § 1112(b) when the debtor knowingly derives a significant portion of its revenue from leasing property for marijuana grow operations that violate the federal CSA.
2. Whether the bankruptcy court, applying equitable principles such as unclean hands and considering forfeiture and criminal-liability risks, should refuse to keep the debtor in Chapter 11 while the debtor continues the CSA-violating leasing activity.

## Decision

- The court granted VFC’s motion and dismissed Rent-Rite’s Chapter 11 case.
- The court found “cause” under § 1112(b) based on the debtor’s ongoing knowing involvement in CSA-prohibited activity through its leases, which the court treated as gross mismanagement of the estate and a substantial risk to estate property.
- The court relied on the equitable doctrine of unclean hands, concluding it would not use bankruptcy’s equitable protections to assist a debtor that was continuing conduct prohibited by federal criminal law.
- The court concluded that the debtor had not shown “unusual circumstances” under § 1112(b)(2) that would justify denying dismissal despite the existence of cause.

## Legal Principles

- A bankruptcy court may dismiss a Chapter 11 case for “cause” under 11 U.S.C. § 1112(b) when a debtor’s ongoing business operations involve knowing violations of federal law and thereby expose the estate to significant legal and financial risk.
- “Cause” under § 1112(b) is not limited to the enumerated examples in § 1112(b)(4); continuing use of estate property in a manner that violates federal criminal law and threatens forfeiture may constitute gross mismanagement and support dismissal.
- Bankruptcy courts are courts of equity and may apply the unclean-hands doctrine to deny relief where a debtor seeks court protection while continuing conduct prohibited by federal law.
- State-law permission for marijuana-related activity does not eliminate federal illegality under the CSA for purposes of administering a federal bankruptcy case.
- Even when cause exists, the debtor bears the burden to show “unusual circumstances” under § 1112(b)(2) sufficient to avoid dismissal or conversion; failure to present a credible path to stop the illegal activity and the related risks supports dismissal.

## Conclusion

The bankruptcy court dismissed Rent-Rite’s Chapter 11 case because the debtor knowingly leased warehouse space to marijuana grow tenants in violation of the CSA, received a substantial share of its revenue from that activity, and exposed the estate and secured collateral to serious federal criminal and forfeiture risk; applying § 1112(b) and equitable unclean-hands principles, the court declined to keep the case in Chapter 11 absent any unusual circumstances warranting continuation.


In re Rent-Rite Super Kegs West, Ltd., 484 B.R. 799 (2012)