I always had a bit of a fascination with marijuana law, and now have seen it cross into the bankruptcy world a few times. As it continues to evolve, it’s been interesting from the legal perspective to watch it develop from an illegal and taboo topic, to a progressively acceptable business model, medical treatment and recreational activity in many parts of the country.

My state of residence California passed the Compassionate Use Act of 1996. This proposition permitted medicinal use of marijuana. But frankly, as far as I can tell, the majority of people using prescription marijuana use the medicinal card as a way to enjoy marijuana recreationally. And maybe that was what was needed in 1996: put the toes in the dirty bong water and see how it feels.

California is poised to place two marijuana initiatives on the ballot in 2016. Both the Marijuana Control, Legalization and Revenue Act of 2016 (MCLR) and California Cannabis Hemp Initiative seek full legalization and regulation of marijuana.

Even assuming one or both of these ballot measures pass, the federal Controlled Substances Act (“CSA”) lists marijuana (or “marihuana” as the CSA says), as a Schedule I drug. One can get licenses and permits from the Drug Enforcement Agency (“DEA”) to use scheduled substances under the CSA, though I am not aware of any recreational growers, distributors or sellers who have obtained such a permit. In other words, something can be perfectly legal under state law, but illegal under federal law or vice versa. And sometimes when the two conflict, there is concept called “preemption,” meaning the federal law overrides the state law.

Enter Frank Anthony Arenas and Sarah Eve Arenas. They are a married couple in Colorado, where recreational marijuana was legalized in 2012. Mr. Arenas obtained all appropriate permits and licenses to produce and distribute marijuana legally under Colorado law. In 2014, the couple filed for Chapter 7 bankruptcy.

The United States Trustee, which is a division of the Department of Justice (“DOJ”) that would actually prosecute the violations of the CSA, moved to dismiss the Chapter 7 bankruptcy. The court found that while the growing and distribution of marijuana under Colorado law was legal, the same conduct was a criminal offense under federal law via the CSA and dismissed the bankruptcy case.

The court pointed to two problematic issues that were triggered by the bankruptcy case.

First, a debtor in bankruptcy is seeking to avail himself or herself to the benefits and protections of federal bankruptcy law, while continuing to violate another federal law, the CSA. This was an internal inconsistency that the court could not reconcile.

Second — and I thought this was a more interesting point in the bankruptcy context — sometimes Chapter 7 bankruptcies like the one filed by the Arenas’ is what is referred to as an asset case. It means that a Chapter 7 trustee may take and liquidate some of your assets. In this case, the trustee was faced with the potential prospect of liquidating marijuana and marijuana business-related materials. By operation of the bankruptcy code and rules, the Chapter 7 trustee is a fiduciary charged with selling assets to pay back unsecured creditors. In other words, the Chapter 7 trustee would be forced to engage in the potential illegal activity of selling marijuana and marijuana business equipment in violation of the CSA in order to recover money for the creditors. The court found it to be a strange outcome that a trustee could be forced to engage in criminal activity, and thus dismissed the case.

The court referenced the infamous Cole memo from 2013. In that memo, James Cole, the Deputy Attorney General for the DOJ acknowledges that states are legalizing marijuana, and essentially states that the federal government will look the other way if certain conditions are met, such as not selling to minors, not shipping interstate into a state where it is not legal, etc. But as the Arenas court noted, it’s a memo, not the law. It provides no guarantees of any kind that compliance with state laws that legalize marijuana in various forms means the feds won’t be knocking on your door some day if you are taking advantage of such state laws.

The Arenas have appealed, so this will rear its head again the future.

There are growers all over California with pretty large swaths of land dedicated to marijuana growth and distribution. Businesses that were once black market only, continue to gain credibility, albeit under the guise of medicinal marijuana at the moment given the current restrictions in California.

I admire those who take the risk of openly operating such businesses in the face of a potential federal crackdown at any moment. It has a bit of Boardwalk Empire / prohibition, mixed with an entrepreneurial spirit. But I suspect bankruptcy courts will not blaze any new trails (pun totally intended) in favor of debtors operating businesses related to marijuana until the federal laws are changed.