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`UNITED STATES BANKRUPTCY COURT
`FOR THE DISTRICT OF COLORADO
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`Case No. 20-12692-JGR
`Chapter 11
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`IN RE:
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`United Cannabis Corporation
`Tax ID / EIN: 46-5221947,
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`Debtor.
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`UNITED STATES TRUSTEE’S OBJECTION TO DEBTOR’S MOTION
`TO REJECT PATENT LICENSE AGREEMENTS WITH
`LASCO MANUFACTURING LIMITED AND FLRISH IP, LLC
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`Patrick S. Layng, the United States Trustee for Region 19 (the “UST”), by and through
`counsel, objects to Debtor United Cannabis Corporation’s Motion to Reject Patent License
`Agreements with Lasco Manufacturing Limited and FLRish IP, LLC (Docket No. 68, the
`“Motion”), and in support of the objection, states as follows:
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`Background
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`1.
`UC Colorado Corporation (“UC Colorado”) and United Cannabis Corporation
`(“UCANN” and together with UC Colorado, the “Debtors”) filed their respective voluntary
`petitions for relief under chapter 11 of title 11, United States Code, on April 20, 2020 (the “Petition
`Date”). Pursuant to Sections 1107 and 1108, Debtors continue to manage their affairs as debtors-
`in-possession.
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`2.
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`An official committee of unsecured creditors has not yet been appointed in this
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`case.
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`3.
`On April 22, 2020, the Court entered its Order to Show Cause, which observed that
`the Debtors appear to be engaged in the marijuana industry, observed that activities associated
`with marijuana are illegal under federal law and cannot be condoned by the bankruptcy courts, and
`directed the Debtors and the UST to show cause why these cases should not be dismissed.
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`4.
`On May 11, 2020, the Debtors and the UST filed their responses to the Order to
`Show Cause. For their part, the Debtors’ Response (Docket No. 53) essentially denies any
`involvement with illegal marijuana.
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`5.
`By contrast, the UST’s Response (Docket No. 55) identified the Debtors’ plain
`representations concerning marijuana-related assets or activities made in publicly available filings
`with the U.S. Securities and Exchange Commission (the “SEC”) and on the Debtors’ website. For
`example, the UST observed that the Debtors’ homepage at that time promoted products containing
`tetrahydrocannabinol (“THC”), which is an illegal Schedule I substance under the Controlled
`Substances Act (“CSA”). As another example, and as a matter important to the Motion and this
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`1
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`Objection, the UST observed that the Debtors have been issued US Patent #9730911 (the “911
`Patent”) which pertains, in part, to THC.
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`6.
`On May 15, 2020, UCANN filed the Motion, by which it seeks this Court’s
`approval of the rejection under 11 U.S.C. § 365(a) of two license agreements by which it licensed
`the right to use the 911 Patent.
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`The 911 Patent:
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`7.
`The 911 Patent appears to be one of UCANN’s more significant assets. In its
`Schedules, UCANN lists over $28,000,000 in liabilities compared with only about $107,000 of
`assets, including an encumbered vehicle and an investment in WeedMD, Inc., plus certain assets1
`with an “unknown” value. See Docket No. 39 at p. 23-39.
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`8.
`UCANN also disclosed its ownership of the 911 Patent, but assigned a $0.00 value
`to it. See id. at 29.2 This is perplexing (and doubtful) as UCANN treats the 911 Patent as highly
`valuable. UCANN has been an active plaintiff seeking to protect its interest in litigation asserting
`infringement of the 911 Patent beginning in 2018 and up to the Petition Date.3 Patent litigation is
`not inexpensive. UCANN scheduled a claim of $779,910 in favor of Cooley LLP, which is the
`law firm that has been prosecuting UCANN’s patent infringement action. See id. at 35. Therefore,
`UCANN’s assertion now that the 911 Patent is worthless is inconsistent with UCANN’s recent
`and informed decision to incur $779,910 of unpaid legal fees relating to the patent, plus any other
`legal fees that may have actually been paid with cash or stock.
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`9.
`One can only surmise that UCANN valued the 911 Patent at $0.00 because it
`pertains, in part, to THC and because UCANN is a chapter 11 debtor seeking the benefits of federal
`bankruptcy law. In their Response to the Court’s Order to Show Cause (Docket No. 53), the
`Debtors acknowledge the 911 Patent, but carefully omit the material fact that the 911 Patent
`involves THC, stating: “The 911 Patent claims various liquid cannabinoid formulations that
`contain the non-psychoactive cannabinoid, CBD, among other cannabinoids.” Debtor’s Response
`at ¶ 17 (emphasis added). One of the unidentified “other cannabinoids” is THC.
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`10.
`The Debtors were not nearly as reluctant to acknowledge the 911 Patent’s
`connection to THC in their SEC Form 10-Q report for the third quarter of 2019 (the “Form 10-
`Q”), which is the most recently filed quarterly report.4 In that recent public filing:
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`a. the Debtors disclose that they “own distinct intellectual property relating to the
`legalized growth, production, manufacture, marketing, management, utilization
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`1 Assets assigned an “unknown” value include interests in certain subsidiaries, including Debtor UC Colorado, and in
`joint ventures, causes of action, and UCANN’s websites. See Docket No. 39 at pp. 25-30.
`2 UCANN also disclosed that it owns US Patent #10,555,928. See id. According to the Debtors’ testimony at the
`Meeting of Creditors held on May 28, 2020, this second patent is related to the 911 Patent.
`3 The patent infringement action is styled United Cannabis Corporation v. Pure Hemp Collective, Inc., 1:18-cv-01922-
`WJM-NYM, pending in the United States District Court for the District of Colorado. See id. at p. 2.
`4 Per the SEC’s EDGAR System, the Form 10-Q was filed November 14, 2019. The UST attached a copy of the Form
`10-Q to his Response to the Court Order to Show Cause at Docket No. 55.
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`2
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`and distribution of medical and recreational marijuana and marijuana infused
`products;”
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`b. the Debtors disclose that they “license [their] intellectual property to businesses
`in the cannabis industry;” and
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`c. the Debtors disclose that the 911 Patent was issued on August 15, 2017, and
`that it pertains to “proprietary formulations based on compounds extracted from
`cannabis plant materials” including cannabinoids, with one of the cannabinoids
`being “tetrahydrocannabinol (THC).”
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`Form 10-Q at p. 27 (emphasis added).
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`11.
`A copy of the 911 Patent is attached hereto as Exhibit “A.”5 As set forth in a
`summary, the 911 Patent includes formulations of cannabinoids, including THC:
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`See Exhibit “A” at page (column) 1.
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`12.
`The 911 Patent then describes various formulations and processes, many of which
`involve THC. As just a few examples:
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`UCANN explains that THC is the “principal psychoactive constituent” and
`that “[n]on drug plants produce relatively low levels of THC and high levels of
`CBD, while drug plants produce high levels of THC and low levels of CBD.” See
`id. at p. 4.
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`“In some aspects the cannabis plant material is derived from a cannabis
`strain having a minimum of 15% THC and less than 1% CBD.” See id. at pp. 2, 9
`(italics in original).
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`5 UCANN attached the 911 Patent to its First Amended Complaint in the aforementioned patent infringement
`litigation.
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`3
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`“In other aspects the cannabis plant material is derived from cannabis
`strains having a minimum of 10% CBD and less than 10% THC.” See id. at p. 9
`(italics in original).
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`In one formulation, THC is less than or equal to 9% and CBD is greater than
`or equal to 40%. See id. at p. 8.
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`UCANN claims numerous formulations involving THC, including for
`example, “[a] liquid cannabinoid formulation, wherein at least 95% of the total
`cannabinoids is tetrahydrocannabinol (THC).” See id. at p. 18 (Claim No. 5); see
`also Claims No. 6, 7, and 9, in which at least 95% of the cannabinoids are THC.
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`13.
`In the Form 10-Q, the Debtors assert that, on a consolidated basis, they derive
`revenue from hemp processing and from licensing their intellectual property: “All of the
`Company’s revenues are derived from the sale of legal CBD products that were extracted from
`industrial hemp plants or from licensing fees for the use of our patented product formulations.”
`Form 10-Q at p. 7 (emphasis added).6
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`14.
`The Debtors also advise that future enforcement of the Controlled Substances Act
`“may cause significant financial damage to us.” See id.
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`15.
`The Debtors further advise that “[t]he factors that will most significantly affect
`future operating results will be:
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`State by state regulatory changes with respect to marijuana in the United
`States; and
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`Rescheduling of marijuana by the federal government.”
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`See id. at p. 32.
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`The License Agreements:
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`16.
`Through the Motion, UCANN requests that the Court apply federal law under 11
`U.S.C. § 365(a) to allow UCANN to reject (i) a Supply, Distribution, and Licensing Agreement
`between UCANN and Lasco Manufacturing Limited and (ii) a Licensing Agreement between
`Debtor and FLRish IP, LLC (together, the “License Agreements”). UCANN Attached both
`License Agreements as exhibits to its Motion.
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`17.
`911 Patent.
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`In both License Agreements, UCANN granted the counterparty a license to use the
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`6 The 911 Patent and the apparently related Patent #10,555,928 are the only patents disclosed by the Debtors in their
`Schedules. See Docket No. 39 at p. 29; see also Docket No. 37 in Case No. 20-12689-JGR at p. 49.
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`Objection
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`18.
`As discussed in detail in the UST’s Response to Order to Show Cause (Docket No.
`55), under the CSA, it is unlawful for any person knowingly or intentionally “to manufacture,
`distribute, or dispense, or possess with intent to manufacture, distribute, or dispense, a controlled
`substance.” See 21 U.S.C. § 841(a)(1). The term “controlled substance” means “a drug or other
`substance, or immediate precursor, included in schedule I, II, III, IV, or V of part B of [the CSA].”
`21 U.S.C. § 802(6).
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`19.
`Congress has designated both marijuana and THC as Schedule I substances. See
`21 U.S.C. § 812, Schedule I (c)(10) & (17).
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`20.
`It is a violation of the CSA to conspire with another to violate any part of the CSA.
`See 21 U.S.C. 846. Anyone who “aids, abets, counsels, commands, induces or procures” a
`violation of federal law, including the CSA, “is punishable as a principal.” See 18 U.S.C. § 2(a).
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`21.
`The Motion pertains to the rejection of License Agreements relating to the use of
`the 911 Patent, and the 911 Patent relates in part to illegal THC. The UST objects to the Motion
`for the following reasons:
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`22.
`First, the License Agreements submitted with the Motion are unclear as to whether
`the licensees are authorized to use the 911 Patent to manufacture, sell, or distribute products
`containing THC. However, it is clear that the licensees are authorized to use the 911 Patent, and
`the 911 Patent pertains in part to THC.
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`23.
`UCANN should explain whether either of the License Agreements contemplate or
`allow the use of the 911 Patent to manufacture, sell, or distribute products containing THC. If so,
`the Court should not provide a federal benefit to one party to a contract the purpose of which was
`the violation of federal criminal law. See, e.g., In re Rent-Rite Super Kegs West, Ltd., 484 B.R.
`799 (Bankr. D. Colo. 2012) (as an aspect of its business, chapter 11 debtor was a lessor to a
`marijuana grower, which was cause for dismissal under § 1112(b)); In re Medpoint Management
`LLC, 528 B.R. 178 (Bankr. D. Ariz. 2015), vacated in part on other grounds, 2016 WL 3251581
`(B.A.P. 9th Cir. June 3, 2016) (bankruptcy court would not grant federal bankruptcy relief to
`petitioning creditors who financed a medical marijuana business in violation of the CSA).
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`24.
`By seeking court approval of rejection, UCANN is asking this Court to entangle
`itself in readjusting the debts of those who seem to have conspired to violate the CSA. This is not
`the type of issue that belongs in federal bankruptcy court. As Judge Tallman emphasized in the
`Rent-Rite decision, the “Court’s power to adjust the debtor-creditor relationship . . . goes to the
`essence of the Court’s equitable jurisdiction and requires the Court to look to equitable factors to
`determine the propriety of the Debtor’s filing.” Rent-Rite, 484 B.R. at 806. Again, proceedings
`in equity to adjust obligations incurred to further criminal conduct cannot be a valid purpose of a
`bankruptcy.
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`25.
`Second, according to case law cited by UCANN, its request for authority to reject
`the License Agreements requires a showing that rejection will benefit the estate. See Motion at ¶
`7. However, UCANN does not adequately explain whether rejection of the License Agreements
`would actually result in a benefit to the estate. To the extent that the License Agreements are
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`executory contracts, rejection generally would constitute a breach of the contract immediately
`before the date of the filing of the petition. See 11 U.S.C. § 365(g)(1). UCANN would be relieved
`of its obligation to perform under the agreements, but UCANN does not explain in the Motion
`whether it actually has any remaining performance obligations under the agreements that would
`be avoided by rejection.
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`26.
`By contrast, rejection may give rise to breach of contract claims in favor of the
`licensees, and presumably would deprive the estate of contractual rights to fees and royalties for
`the balance of the license terms. Furthermore, if UCANN’s objective is to prevent the licensees
`from using the 911 Patent, licensees under rejected agreements generally may elect to retain their
`rights under the agreements. See 11 U.S.C. § 365(n)(1); see also In re Matusalem & Matusa of
`Florida, Inc., 158 B.R. 514, 521-522 (Bankr. S.D. Fla. 1993) (under § 365(n), rejection of licensing
`agreement would not deprive licensee of right to use intellectual property, but may give rise to
`rejection damages claim; debtor did not demonstrate economic benefit to the estate from proposed
`rejection).
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`27.
`Third, UCANN does not explain why it seeks rejection of the License Agreements
`at this early stage. To the extent that the License Agreements are executory and therefore governed
`by § 365, UCANN generally may make the decision to assume or reject the License Agreements
`at any time before confirmation of a plan. See 11 U.S.C. § 365(d)(2). Again, UCANN does not
`explain whether some performance obligation or some expense would be avoided by a prompt
`rejection.
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`28. With respect to its Order to Show Cause and the Responses thereto filed by the
`Debtors and by the UST, the Court has not yet determined whether the Debtors have demonstrated
`sufficient cause for these cases not to be dismissed. To the extent that these cases remain pending
`before this Court, the Motion might be the first of several instances in which the Court will be
`asked to determine whether it may grant relief under federal law to Debtors with assets and
`transactions connected to federally illegal marijuana and THC. The UST submits that it would be
`more efficient for the Court to first determine whether these cases may remain in chapter 11 before
`taking up issues relating to the 911 Patent or other issues relating to marijuana.
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`WHEREFORE, the UST objects to the Motion for the reasons set forth above.
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`Dated: June 5, 2020
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`Respectfully submitted,
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`PATRICK S. LAYNG
`UNITED STATES TRUSTEE
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`By: /s/ Alan K. Motes
`Alan K. Motes, #33997
`Trial Attorney for the U.S. Trustee
`Byron G. Rogers Federal Building
`1961 Stout Street, Suite 12-200
`Denver, Colorado 80294
`(303) 312-7999 telephone
`Alan.Motes@usdoj.gov
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`CERTIFICATE OF SERVICE
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`I certify that on June 5, 2020, a copy of the UNITED STATES TRUSTEE’S OBJECTION
`TO DEBTOR’S MOTION TO REJECT PATENT LICENSE AGREEMENTS WITH LASCO
`MANUFACTURING LIMITED AND FLRISH IP, LLC was served on the following parties in
`compliance with the Federal Rules of Bankruptcy Procedure and the Court’s Local Rules:
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` Attorney Aaron J. Conrardy, via CM/ECF
` Attorney Lindsay Riley, via CM/ECF
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`/s/ Alan K. Motes
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