Wednesday, July 12, 2017

FYI: 10th Cir Reverses Dismissal of Lawsuit on Financial Services to Marijuana Related Businesses

In a cautionary tale for financial institutions considering doing business with marijuana-related businesses (MRBs), the U.S. Court of Appeals for the Tenth Circuit cleared the way for a lawsuit by a credit union created to service legal marijuana businesses against the Federal Reserve Bank of Kansas City, but with a complicated caveat.


A copy of the opinion is available at:  Link to Opinion


The Federal Reserve Bank refused to grant the credit union a master account because, even though recreational marijuana is legal in Colorado, it is still illegal at the federal level and would violate the federal Controlled Substances Act (CSA).


The credit union sued the Federal Reserve Bank in federal court in Colorado seeking an injunction to force the Federal Reserve Bank to issue it a master account. The Federal Reserve Bank moved to dismiss the complaint and, in response the credit union filed an amended complaint asserting that it would serve MRBs only if authorized to do so by law. In response, the Federal Reserve Bank again moved to dismiss.


The trial court granted the Federal Reserve Bank's motion to dismiss, explaining that it did not accept the credit union's allegations that it would follow the law and that the court could not grant the injunction because "courts cannot use equitable powers to issue an order that would facilitate criminal activity."  The credit union appealed.


On the appeal, the Tenth Circuit vacated the trial court's ruling and remanded the case with instructions to dismiss the amended complaint without prejudice, leaving the credit union in a position to continue the lawsuit.  


However, this diminished the credit union's original purpose of serving MRBs because the credit union can now proceed on the allegation that it will serve MRBs only if authorized to do so by law, which the CSA still prevents. 


As you may know, most banks have refused to open accounts for the many MRBs in Colorado and other states that have legalized marijuana, which has resulted in a cash economy. This has led to public safety issues, difficulty in collecting taxes, regulating, and auditing such businesses, and a lack of access to the benefits business gain from working with established financial institutions. The state of Colorado and its governor encouraged the opening of the credit union to help address these issues. 


The credit union was approved pending its license from the Federal Reserve Bank for a master account, which is an account with the Federal Reserve for a depository institution that enables it to electronically transfer funds to and from other financial institutions.


Initially the credit union attempted to secure a correspondent relationship with another financial institution that already had a master account, but it was unsuccessful.


The credit union's application did not state that it would service MRBs but the Federal Reserve Bank heard from a third party that the credit union intended to do so. The Federal Reserve Bank conducted an examination and denied the credit union's request in part because the credit union intended to service MRBs.


The credit union's lawsuit sought an declaratory judgment that it is entitled to a master account and an injunction requiring the Reserve Bank to issue it one arguing that the Federal Reserve Bank does not have discretion under 12 U.S.C. § 248a to deny it one.


The Federal Reserve Bank disagreed, arguing that it has discretion to deny master-account applications, that the court cannot use its power to facilitate illegal activity in violation of the CSA, and that the credit union's state charter is preempted and void under the Supremacy Clause of the U.S. Constitution because it conflicts with the CSA.


On appeal in the Tenth Circuit, the three appellate court judges each reached a different conclusion and provided three separate opinions. The first judge would affirm the dismissal with prejudice. The second judge would vacate and remand with instructions to edemas the amended complaint without prejudice on prudential-ripeness grounds. The third judge would reverse the dismissal of the amended complaint. 


To resolve this impasse the appellate court ruled that two of the judge's rulings would be effectuated by remanding with instructions to dismiss the amended complaint without prejudice.


The first judge addressed the Reserve Bank's illegality argument, that by granting a master account to the credit union, the Reserve Bank would be fostering illegal activity. The credit union had responded in its brief that the MRBs it proposed to serve were not violating any laws because they were legal under state law and the state law had not been formally invalidated. The credit union abandoned that position at oral argument because, under the Supremacy Clause, when state law conflicts with federal law, the federal law prevails.


Thus, the first judge concluded that providing banking services to MRBs would facilitate activity that is prohibited by the CSA, which includes the manufacture, distribution, dispensing, or possessing controlled substances such as marijuana.  According to this judge, a master account from the Reserve Bank would "serve as a linchpin for the Credit Union's facilitation of illegal conduct."


The first judge rejected the credit union's reliance on federal memorandums and guidance for marijuana-banking related activities because they did not create a defense for violation of the CSA. The first judge also concluded that the credit union's allegations that it will follow federal law were conditional and thus illusory so that they were not owed the presumption of truth and, on a practical level, did not alleviate the judge's concern that granting a master account would facilitate illegal activity. Accordingly, the first judge stated that he would affirm the dismissal with prejudice.


The second judge concluded that the case should be dismissed on ripeness grounds. He reasoned that, once the credit union amended its complaint to state that it would only serve MRBs if doing so was legal, the credit union became "a fundamentally different entity" than the one that had applied for the master account so that its claim was not ripe for adjudication.


The second judge pointed out that, under the fitness prong of the ripeness analysis, the facts had not been sufficiently developed concerning whether the Reserve Bank would grant an application to the credit union if it agreed to serve MRBs only if doing so was legal, which was not a pleading defect but a hypothetical dispute. Under the hardship prong of the ripeness analysis, the second judge concluded that the potential hardship the credit union might suffer from the withholding of judicial review did not overcome the lack of ripeness of the dispute and pointed out that now that the credit union knew that servicing MRBs is illegal, it can choose whether to re-apply for a master account under those terms.


Accordingly, the second judge stated that he would dismiss the appeal as premature and remand to the district court to vacate the judgment and dismiss without prejudice.


The third judge found that the trial court's ruling was incorrect for two reasons: (i) the trial court should have presumed the credit union would follow the law as determined by the court, and (ii) the credit union promised to obey the law in its amended complaint. The third judge pointed out that the district court's interpretation of the credit union's promise to obey the law was skewed in that the court had assumed that the credit union was promising to obey its own understanding of the law, not the court's pronouncement of the law.


The third judge opined that this improperly discounted the credit union's stated intent to obey federal law and constituted a factual allegation that should have been interpreted in the credit union's favor at the motion to dismiss stage of the litigation.  The third judge noted that nothing in the amended complaint overcame the presumption that the credit union would obey the law.


Thus, the third judge concluded that the district court had misapplied the standard on the motion to dismiss and stated that he would reverse dismissal of the amended complaint.


The third judge further explained that he rejected the Federal Reserve Bank's contention that financial institutions do not have a right to a master account and that it has discretion not to grant a master account.  The judge based his opinion on the text of 12 U.S.C. § 248a(c)(2), the persuasive interpretations of it and the legislative history. The judge also rejected the Reserve Bank's obstacle preemption argument that the credit union's charter is an obstacle to Congress's goals under the CSA because, even if the credit union did not service MRBs, it could still service supporters of the legalization of marijuana, which would provide sufficient grounds to entitle the credit union to a master account and only partial obstacle preemption at best.


With three different opinions by each of the three judges on the panel, the Tenth Circuit accepted the resolution of two of the three judges and vacated the trial court's ruling on the motion to dismiss and remanded with instructions to dismiss the amended complaint without prejudice. 



Ralph T. Wutscher
Maurice Wutscher LLP
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