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The city of San Bernardino, California is in the process of preparing a bankruptcy plan in its ongoing bankruptcy case. While a Chapter 9 case, applied specifically to municipalities, might have some superficial similarities to an individual’s Chapter 13 bankruptcy case, cities and towns typically have issues that differ from both personal and business bankruptcy cases. The city is currently considering removing its ban on medical marijuana dispensaries, which would provide new sources of tax revenue. This is legal for cities and counties under California law, but it still conflicts with federal drug laws. In personal bankruptcy, individual debtors may be able to find a higher-paying job, take additional jobs to supplement their income, or go back to school to improve their job prospects. A debtor risks criminal penalties by disclosing income derived from illegal activity in a bankruptcy case, but he or she also risks revocation of the bankruptcy discharge if he or she fails to disclose that income.

San Bernardino filed for Chapter 9 bankruptcy in 2012, and it is still working on its exit plan. The city attorney proposed medical marijuana dispensaries in July 2014 as a means of increasing revenue, and the matter went to the full City Council in mid-September. Voters in California passed Proposition 215 in 1996, which amended the state Health and Safety Code to exclude individuals from state drug laws if they possess small amounts of marijuana with a valid doctor’s prescription. Senate Bill 420, enacted in 2003, further defined the scope of the program and created a system of identification cards for medical marijuana patients.

A 2009 California Supreme Court ruling required all of the state’s counties to participate in the program. Cities, however, are not obligated to allow dispensaries to operate within their jurisdictions. Oakland became the first city to tax marijuana sales in 2009, and others have followed. San Bernardino’s city attorney cited Palm Springs, which has about one-fifth the population of San Bernardino but brings in about $500,000 per year from its ten-percent marijuana tax.

It goes without saying that the bankruptcy courts frown upon marijuana sales as a means of generating income in personal bankruptcies. The question of whether to report income derived from illegal activity presents a conundrum for debtors. Full disclosure of income sources obviously creates a public record that determined law enforcement investigators could find and use. Failure to disclose such income, on the other hand, could result in revocation of a discharge, or even charges of bankruptcy fraud.

A trustee in one Chapter 7 case moved to revoke the debtor’s discharge based on fraud under 11 U.S.C. § 727(a), based on income discovered through the debtor’s post-discharge conviction for drug trafficking. In re Shiloh, No. 1:09-bk-07392, opinion (M.D. Pa., Jul. 26, 2011) (PDF file). The court stated that the debtor had a duty to report all of her income but declined to revoke the discharge. It held that the trustee did not prove that the debtor acted intentionally or knowingly.

Bankruptcy attorney Devin Sawdayi has represented clients in the Los Angeles area in Chapter 7 and Chapter 13 bankruptcy cases since 1997, helping them repair their finances with dignity and respect. To schedule a free and confidential consultation to see how we can help you, please contact us today online or at (310) 475-9399.

More Blog Posts:

California Bankruptcy Court Rules on Dischargeability of Debt Allegedly Incurred through “False Pretenses”, Los Angeles Bankruptcy Lawyer Blog, July 27, 2014

California Cities File for Bankruptcy, Although It’s Different from a Personal Bankruptcy, Los Angeles Bankruptcy Lawyer Blog, December 4, 2013

Reality TV Couple Faces Bankruptcy Fraud Allegations Years After Unsuccessful Closure of Chapter 7 Case, Los Angeles Bankruptcy Lawyer Blog, October 23, 2013