Photo of Robert McVay

Robert is a partner at Harris Bricken focusing on corporate, finance, and transactional matters for clients both inside and outside the cannabis industry.

When Bernie Sanders announced he was in favor of removing marijuana from any schedule in the Controlled Substances Act, it was a big deal. He was the first serious presidential candidate in either a general election or a primary to take such a forward-looking stance, and it at least temporarily brought the issue of cannabis legalization to the front of voters’ minds. In the general election, of course, neither Hillary Clinton nor Donald Trump supported legalization. Clinton’s position was to do more research and otherwise leave it to the states, while Trump waffled between supporting medical marijuana, to leaving it to the states, to outright hostility.

When 2020 rolls around, however, it is becoming increasingly likely that whomever the Democrats nominate will be vocally in favor of legalization. Less than a year into President Trump’s term, Democratic senators are already moving to position themselves as the party’s next nominee. And, as reported in Politico, those candidates are increasingly moving in the direction of legalization. Senator Kamala Harris of California, a former prosecutor and state Attorney General, has voiced support for decriminalization. Senator Kirsten Gillibrand of New York has vocally supported various medical marijuana bills in the past few years. Finally, Senator Cory Booker of New Jersey has gone so far as to introduce a bill fully legalizing marijuana at the federal level. Booker’s bill would deschedule marijuana, retroactively expunge the criminal records of those convicted of federal marijuana possession or use charges, and withhold federal law enforcement dollars from states with arrest rates and incarceration rates for marijuana crimes that skew heavily against poor people and racial minorities. Unfortunately, Booker’s bill has no chance of passing or even being debated while Republicans hold the House, the Senate, and the White House. But it does draw a clear line in the sand for all would-be 2020 contenders on the Democratic side.

The real story here is that the Democratic Party is getting to the point where it must support legalization to stay relevant. There seem to be three types of Democratic politician right now: Sanders-style social-democrats, Clinton-style Baby Boomer liberals, and Booker/Harris/Gillibrand style young liberals. There are a few centrist/conservative Democrats still out there (e.g. Joe Manchin of West Virginia), but most of the rest of the party falls largely into one of the other alignments. The difference between the Clinton group and the Booker group isn’t based so much on policy as it is on candidate age and priorities. Baby Boomers (people born between the mid-1940s and the early 1960s) were the generation most influenced and susceptible to the War on Drugs. For as long as the Boomers have made up the core of the Democratic party, the party has been unwilling to move strongly in support of marijuana legalization. But we are now seeing a shift in the political landscape. White working class voters were up for grabs in the past, but that demographic seems to be moving toward the Republican party in droves. For Democrats to survive, they need to pull stronger numbers from their core demographics, including minorities disproportionately affected by the War on Drugs and millennials who never understand why marijuana was demonized, groups that overwhelmingly support cannabis legalization.

President Trump has always been shifty on policy, but his ardently anti-cannabis Attorney General, Jeff Sessions, presents an easy foil for pro-legalization Democrats to compare themselves to. Other than exceptions like Rand Paul and Dana Rohrabacher, the Republican party remains generally anti-marijuana. And marijuana legalization is the kind of simple, understandable policy that Democratic politicians should point to as positive differentiators from their competitors. If Republicans start to see their stance against marijuana as a political liability, they too will start shifting in large numbers. Looking forward to 2018 and 2020, it is becoming increasingly clear that cannabis legalization will be both good policy and good politics.

Cannabis lawyersPresident Trump spent some time attacking Jeff Sessions on Twitter in July. There are plenty of reasons why that was a bad thing. You don’t want the leader of the executive branch attacking the chief law enforcement officer in the nation for failing to stand in the way of an investigation into that leader. But if you temporarily ignore the threats to democracy, it was pretty fun watching Sessions get metaphorically slapped around. Mr. “Good people don’t smoke marijuana” was only able to come back with a lame comment that Trump’s behavior was “kind of hurtful” while still calling him a “strong leader.” Show some backbone.

Despite the attacks, it looks like Sessions is sticking around, which means we have to continue guessing how his Department of Justice is going to treat marijuana. On that front, there is some bad news and some potentially good news.

On the negative front, the Huffington Post uncovered a letter Sessions sent to Washington Governor Jay Inslee on July 24. In that letter, which was in response to various requests to Sessions from Inslee and others that Sessions reaffirm the validity of the Cole Memo, Sessions does not deviate from the Cole Memo. Instead, he cherry picks data and presents statistics in a way that negatively reflects on Washington’s marijuana regulatory system. The vast majority of his criticisms are unfair or are outright misleading.

This post isn’t a good place to refute each of his arguments, but here are some of the highlights. He states that Washington’s medical marijuana system is considered “grey” due to a lack of regulation. But his information dates back to 2014 — Washington folded medical marijuana into its regulated system in 2015. He claims that 90% of the “public safety violations” that occur in Washington involve minors. But this is because Washington groups its violations into four categories, and all violations involving minors are in the “public safety” category. Other violations that are more common are in other categories. Additionally, a percentage without any reference to the whole is meaningless — referring to the 90% without reference to the whole is purposefully misleading. Finally, he stupidly claims Washington State isn’t well regulated because the leading regulatory violation is “failure to utilize and/or maintain traceability.” If the state is policing traceability so much that it is consistently nailing businesses for any deviation from the law, that is the definition of robustly regulating an industry. Regulatory enforcement isn’t evidence of a lack of regulation — it is the opposite.

My firm’s cannabis lawyers have since 2010 represented clients all over the country, and from this I can tell you that Washington State tends to have the toughest regulations and the strictest enforcement. The idea that Washington isn’t robustly regulating the cannabis industry is laughable. If Jeff Sessions wants to attack the principles of the Cole Memo, he should just do it instead of hiding behind weak accusations that Washington is violating its tenets.

But this is where the potential good news comes in, or at least a reason why Sessions is trying to couch his arguments within the terms of the Cole Memo. Sitting on Sessions’s desk right now is a report from his own Task Force on Crime Reduction and Public Safety. The Department of Justice hasn’t released that report, but the Associated Press got a copy of it, and contrary to expectations, the Task Force does not recommend any changes to current DOJ policy in the Cole Memo. That makes sense of course. Even if you hate marijuana, the Department of Justice doesn’t have an unlimited budget. Every penny and every man-hour dedicated to marijuana is taken away from opioids, terrorism, violent crime, etc. If the states are not acting as partners in federal law enforcement, why would the feds use resources to target marijuana businesses and their customers in those states?

But no matter what policy the Department of Justice ends up pursuing, Sessions will never back down on the marijuana rhetoric. “Drugs are bad” are ingrained in his identity, as they have been in every hippie-hating conservative politician since Nixon. Marijuana usage, homosexuality, and alternative lifestyles that are indicative of someone being an “other” are anathema to the Sessions dream of Americana. But as demographics and polling show us, there are a lot more of us than there are of him.

Cannabis financing
Cannabis financing. Cash is good.

Washington State marijuana businesses face heavy regulations regarding business financing. One of the unique aspects of Washington’s cannabis business regulations is its level of control over every dollar contributed to a licensed cannabis company. Prior to receiving a license, a marijuana company must declare all capital it will receive, whether in the form of equity or in the form of debt. There is no de minimis exception, so if someone is putting a thousand dollars into a million dollar company, that thousand dollars and whomever contributed it must go through the state’s pre-clearance process. Once a company is licensed as a Washington cannabis business, any additional contributions or loans to that business must be approved by the Washington State Liquor and Cannabis Board (LCB) before they can be paid to the company, including additional loans or contributions from individuals who were previously approved. The one exception to this rule is that loans from chartered financial institutions do not need LCB approval.

This creates a major problem when cannabis licensees get into financial danger, which can happen for any business. Sometimes, money problems arise with very little notice. Whether due to a failed crop, unexpected bills, an employee emergency, or something else, cash crunches happen. Even for cannabis businesses with access to banking, it is rare for them to have access to an unsecured line of credit similar to what other non-cannabis businesses can get. When a cannabis business runs into a cash crunch, it has to figure out how to keep things afloat while figuring out how to infuse capital without violating Washington regulations. If a business is lucky, its current owners have sufficient personal capital to make additional contributions, because the LCB clearance process is shorter for individuals already in the system. If a business is unlucky and it has to bring in outside capital, it is looking at what can be a months long approval process before any of that capital can be paid in. Those months can mean the death of a business.

All of this leads to a common outcome — cash contributions to businesses without LCB clearance in violation of LCB regulations. When the worst thing the LCB can do is cancel a business’s license, you can understand why someone would be willing to violate those regulations when the alternative is worse. Many marijuana business owners have more tied up in their business than just the business assets — they signed personal guarantees with landlords and other vendors that will survive business failure. If you are in that scenario, it is hardly illogical to bring on an outside financier outside the rules and hope you don’t get caught.

But regulations that put business owners into this type of quandary are the type that should be revisited and revised. There are plenty of simple fixes to avoid or at least mitigate the current challenges struggling cannabis businesses face. For example, the LCB could change the structure of approval for interest rate lending to make it more of a notice requirement — save the hard approval process for equity owners and profit-sharers.

Unless and until the LCB takes another look at this issue, the best advice we can give is to shore up your capital reserves. If you are just starting out in the cannabis industry, contribute more capital than you need to your cannabis business and let your unused capital sit in the bank as a rainy day fund. If you are making sales, put a portion of that money to the side and don’t use it for either reinvestment or profit distributions. The more cash you have on hand to deal with unexpected challenges, the greater your chances of surviving those challenges long enough to go through the LCB’s regulatory process of getting new lending or capital contributions approved.

Cannabis tax lawyer
Sweat equity: it’s complicated

When our lawyers set up legal structures for cannabis companies, the choice of legal entity is one of the most important things we must consider. Many cannabis businesses use limited liability companies. For tax purposes, an LLC is typically treated as a partnership or as a disregarded entity. In both of these cases, the tax liabilities pass through to the partner/members. However, an LLC may check-the-box to be taxed as a corporation. In that instance, the LLC is subject to tax, whereas its partner/members do not pay tax. Once an LLC is formed, the next important decision is how to fund the LLC.

In this two-part series, we will outline some of the tax traps and opportunities in the initial funding of your LLC. Part I will discuss opportunities in capitalizing your businesses with equity and creating an ownership relationship with the business. Part II will discuss opportunities and risks in funding a cannabis business using debt and creating a debtor/creditor relationship with the business.

The Benefits of Contributing Property. Generally, the contribution of “property” in exchange for a membership interest is tax-free. Members often contribute cash, land, and equipment to a cannabis business in exchange for an interest in a partnership/LLC. This is a classic tax-free contribution. What is often overlooked is that intellectual property may be property for purposes of a contribution. Industrial processes, formulae, designs and “know-how” in the right circumstances are considered property and can be contributed to a partnership tax free. However, this approach should only be taken with careful consideration, analysis and documentation.

The most straight-forward contribution is a contribution of cash in exchange for a member interest in a Partnership/LLC. A member may contribute cash in exchange for a membership interest in an LLC. Such a contribution is typically tax free under federal partnership tax law. If an LLC elects to be taxed as a C corporation, a member may contribute cash in exchange for a deemed “stock interest”. Again, such contribution is typically tax-free. Many companies start with extremely small cash contributions, like $1.00 for each member. However, there is some risk there to equity holders, since some courts have pierced the corporate veil against undercapitalized entities. Nonetheless, there is no minimum amount of cash required to form a valid partnership or corporation for tax purposes. In determining the appropriate dollar amount of contribution, a cannabis business’s founders should use common sense and good business judgement.

Sweat Equity may be Painful but is not Prohibited. Investors often can bring valuable experience and “know-how” to a cannabis business and want to contribute such “know-how” in exchange for an ownership interest in the LLC. In general, a mere promise to contribute services in exchange for a membership interest is subject to tax. This is generally considered a “capital interest” in the partnership. Capital interests are defined by the IRS as ownership interests where the member has a right immediately following the contribution, to its share of the liquidation value of the partnership/LLC. To illustrate, imagine one member contributed $1,000,000 in cash to a new company, and the other member agrees to do all the work for the company, and they split the LLC up 50/50. Even if the business doesn’t generate any revenue, the member contributing sweat equity is going to be on the hook for $500,000 on that year’s tax returns. This is because if the LLC liquidated the next day, that member would be entitled to receive the $500,000 as a liquidating distribution. Although the guidance in this area can be complex, it is based on a simple, maxim – “You can’t get something for nothing (in tax)”

One way to get around this is for a member to receive a “profit interest” instead of a a standard equity interest. A profit interest is defined as an interest where the new member would not receive any value if the partnership were to be immediately liquidated after the contribution. Note however, that this treatment has some strict limitations and requires careful drafting of an operating agreement.

In capitalizing a cannabis business, founders all bring different skills and resources to the new venture. All founders should carefully consider the mechanics of offering equity interests to each new member. As we will discuss in Part II, the use of debt financing brings additional, flexibility, risks and opportunities to funding a new cannabis venture.

Washington state cannabis compliance
Prohibition lives on in Washington State’s cannabis laws

Washington State continues to regulate intra-industry cannabis transactions more than just about any other state. When Washington voters passed I-502, they did so based on a campaign that said we should regulate cannabis like we do alcohol. It turns out that certain legacy alcohol-style regulations can be extremely onerous and simple business transactions that most people wouldn’t imagine could violate any rules can get marijuana licensees into hot water.

The term “tied-house” refers to a statutory scheme implemented for alcohol in the wake of prohibition to regulate both the marketing and cross-ownership of licensed operations. The goal of a tied house regime is to prohibit vertical integration or dominance by a single producer within the marketplace. These rules were also intended to discourage bribery and certain predatory marketing practices and overconsumption of alcohol. The whole idea was that if things were sufficiently difficult for the businesses involved, it would somehow lead to less alcohol use by the populace. It’s like a reverse version of trickle-down economics.

The Washington State’s Liquor and Cannabis Board’s most recent update newsletter specifically brings up Washington’s implementation of tied-house rules in the marijuana marketplace under both RCW 69.50.328 and WAC 314-55-018. We’ll focus on the WAC — the rules issued directly by the WSLCB. In terms of my Washington State cannabis regulatory practice, this rule is the one that comes up the most often by far. WAC 314-55-018 broadly prohibits various practices, including:

  • Any agreements that would cause one industry member to have “undue influence” over another industry member;
  • Any advances, discounts, gifts, loans, etc. from a producer/processor to a retailer;
  • Any contract for the sale of marijuana tied to or contingent upon the sale of something else, including other marijuana.

These prohibitions can be extremely broad in scope. They prohibit any type of agreement for the sale of more than one shipment of product, so a cannabis retailer and a cannabis producer/processor cannot enter an agreement where the retailer agrees to be bound to purchase regular monthly shipments of product. Every transaction must stand alone pursuant to its own purchase order. Recently, and as repeated in its newsletter, the WSLCB has focused on producer/processors that want to provide display equipment to retailers. The WSLCB’s position is that, under WAC 314-55-018, even a lease of a branded display case would constitute a “loan” in violation of this section. This type of arrangement — the leasing of branded display coolers from manufacturers to retailers — is common in other industries.

Confusingly, section (1) of WAC 314-55-018 contains a caveat that states, “This rule shall not be construed as prohibiting the placing and accepting of orders for the purchase and delivery of marijuana that are made in accordance with usual and common business practices and that are otherwise in compliance with the rules.” However, that caveat only applies to agreements that would otherwise create “undue influence” in Section 1 — it doesn’t mean that contracts that violate the LCB’s interpretation of the other sections are okay so long as they are part of usual and common business practices.

Regulations like WAC 314-55-018 have a few different effects. They are vague enough that it is difficult to tell whether an activity is or is not prohibited, which drastically increases compliance costs for cannabis businesses that either pay their attorneys to review transactions or try to get an answer from an LCB enforcement officer — a process that can take an extremely long time and often leads to inconsistent answers given by different LCB officers. To give you an idea of the scope of these issues, we have roughly an equal number of cannabis clients in the three states in which we mostly practice (California, Oregon and Washington) and we probably see double the compliance problems in Washington as in the other two states combined). The risks to these companies range from fines to a termination of their cannabis license.

These complicated compliance issues also create a situation lawyers dread — what to do when your clients want to follow the lead of market participants that openly violate the rules. Many cannabis industry members are willing to ignore the rules and enter into sales agreements or other agreements that technically violate WAC 314-55-018. This, in turn, disadvantages those that seek to remain compliant. When the LCB then doesn’t consistently enforce those rules, it maintains the disadvantage for the compliant industry members.

Tied-house rules are always going to be annoying to industry participants — that is the point. They are purposeful wrenches thrown into the works of the open market because government believes an open cannabis market would lead to intemperance. These same rules don’t exist for apples because the government doesn’t care if you eat too many apples, but it doesn’t want you to smoke too much marijuana or drink too much. There isn’t a clear logical line between tied-house rules and a reduction in either intemperance or corruption, but the rules do seem to be here to stay and this means industry members should stay on top of current interpretations to make sure that their deals are not running afoul of Washington rules.

Cannabis IPO going publicWe write a lot about cannabis business fundraising here, but it’s usually in the context of private offerings. Getting investment from friends and family or by directly pitching investor funds and venture capitalists is the traditional model for most new businesses, and cannabis is no different.  More companies, however, are starting to explore the idea of public financing — which creates its own unique set of issues. Investors like the idea of public financing because it potentially provides a short-term avenue for liquidity that doesn’t exist for private companies. Companies like it because they are more likely to get the valuation they want in large public capital markets than when pitching to individual venture capitalists. I’ll write a bit here about what is involved in public capital raising, but then I will bust the balloon by mentioning some of the reasons our cannabis business lawyers generally advise against it for cannabis companies.

Any type of financing that includes a “general solicitation” can be considered a “public” issuance of securities. Publicly traded companies are often associated with famous listed exchanges like the New York Stock Exchange and NASDAQ, but a company could list its shares on Craigslist and accept orders and be considered to have essentially gone public, though we certainly would not advise doing that. The primary barrier to companies going public are securities laws. Prior to initially offering publicly available shares, a company needs to register the class of shares being sold and file an S-1 to register the individual shares available for purchase. These registrations include significant substance and formal review by the Securities Exchange Commission (SEC) before being accepted.

To date, no cannabis company that we know of has successfully gone public in the United States using that traditional route. Instead, they use something called a reverse merger. A reverse merger happens when a private company purchases a controlling interest in a public company and transfers its primary line of business to the new combined public company. The only asset the public company generally has in this scenario is that it has already gone through the registration process with the SEC — the private company is benefitting by being able to skip the regulatory step involving registration of a share class. But the company still isn’t able to issue new shares to the public before it files an S-1 to register the new individual shares it wants to sell.

That S-1 step can be very expensive and and is often why you don’t see companies do a traditional public offering in the first place. That said, companies strapped for cash can still get there. New capital is still raised on private markets through a PIPE — private placement in public equity. A PIPE is simply a private fundraising transaction from a publicly reporting company. Because there still is no registration statement, stock issued in a PIPE has to be restricted against resale on the open market and is discounted in value because of the restriction. But after a successful PIPE, a company now has some money and a registered class of securities. It can engage in broader public fundraising and allow for trading of its shares on the open market as soon as it files an S-1 that gets accepted by the SEC. And though that can be challenging, we know the SEC has accepted S-1s for cannabis companies in the past.

All of that being said, we tend to advise our clients against public markets for a few reasons. First, for those of us based in Washington State, any type of public financing is impossible. Under Washington State regulations, every single shareholder in a licensed cannabis business must be vetted by the state prior to acquiring an interest in a licensed cannabis company. Other states have similar restrictions that make public company work impossible. But even if you are in a state like Oregon or Nevada that has looser restrictions on who can own shares in your company, having owners you don’t know presents some risks. One takeaway from the Department of Justice’s 2013 Cole Memo was that federal law enforcement was (and still is) worried about legal marijuana systems being used as a front for illegal activity. Any system that allows for even partial shadow ownership of a business is more likely to run against Cole Memo priorities. A marijuana business that is fully engaged in its compliance work should do its best to ensure that none of the value it is creating and none of the profits that it is distributing are being diverted to illegal destinations.

Practically speaking, the reverse merger we just discussed still involved a private placement using a PIPE, so the company often has at least some exposure to private markets. A lot of headache could be avoided by continuing to raise capital in private markets. There are reasons most tech companies avoid going public for years. Your early stage investors are looking to get value over time when the company really takes off — they don’t necessarily need the short-term liquidity public markets can provide. And there are still many cannabis investors. If you feel like the private investment market isn’t giving you what you want, it’s worth sitting back and thinking about whether those investors are correct before dismissing them and raising money from public shareholders. The government generally lets wealthy investors take what risks they want and it doesn’t make it easy for them to sue companies when their investments go sour. But if you have public shares, the SEC and your state agencies are going to be much more protective of those shareholders.

And that brings up the last point, which is that publicly traded markets of cannabis stock are rife with fraud. Even if you are raising money publicly for completely legitimate means, being public in the cannabis space will raise red flags from regulators, the public, and federal law enforcement. If that’s not the kind of attention you want, going public will probably not be the best route for you.

Cannabis banking lawsJune produced two pieces of interesting news on marijuana banking. First, the FinCEN issued its newest Marijuana Banking Update. This update provides information regarding the number of banks and credit unions that are providing services to marijuana businesses and are complying with their Bank Secrecy Act compliance obligations and reporting those services to FinCEN. If a financial institution has a customer that is a marijuana related business, that financial institution is supposed to file a suspicious activity report (SAR) quarterly with FinCEN. These reports are generally used for banks to report potential illegal activity. Given that all marijuana businesses are illegal at the federal level, FinCEN still requires the reports, but it doesn’t force banks or credit unions to shut the accounts down as long as the customer does not violate federal marijuana enforcement priorities.

The data from the report shows that at the end of March 2017, nearly 300 banks and around 50 credit unions were providing banking services to marijuana related businesses. That will seem like a really large number to industry participants that continue to struggle to find banking solutions in most jurisdictions. In Washington, there are 5-10 financial institutions that openly provide banking services to marijuana businesses, close to the same number in Colorado, and far fewer than that in Oregon and California.

So, where does the big number come from? The two main culprits are financial institutions that provide services to ancillary businesses and still file reports, and financial institutions providing services without being public about it. On the first point, many institutions do not feel comfortable providing deposit services to a marijuana cultivator or retailers, but they do feel comfortable providing such services to a marijuana business’s landlord, or to a staffing company or consulting company that works with cannabis businesses. Determining whether FinCEN would consider a business to be a “marijuana related business” is not an exact science, and many financial institutions take a broad view of that term.

The numbers also get inflated by financial institutions that don’t want to market themselves as marijuana businesses but are willing to take on a small number of them for purposes of customer retention. Banking is a business like any other, and many cannabis entrepreneurs have other business interests. If a really good banking customer wants to start a marijuana company, financial institutions are often willing to make an exception to their general policy.

But regardless of whether the number is a little inflated, the fact it is so high is really good news for financial institutions that are in the industry or are considering moving into it. There are still legal risks involved for financial institutions that work with marijuana businesses. Their only protection from regulatory and criminal enforcement are enforcement memoranda issued by the Department of Justice and FinCEN, and the DOJ memos don’t carry legal weight. The more that authorities perceive that bank and credit union industry participants are widespread, the more carefully they will step regarding enforcement action. It’s easy to make an example of an outlier business — it’s harder to do when the business is one of several hundred.

In other news, Fourth Corner Credit Union got a mixed result in its appeal to the 10th Circuit Court of Appeals. We have been following this case for a while because of its potential impacts on access to banking for cannabis businesses. The basics of the case are that Fourth Corner received a state charter from Colorado to operate as a credit union and its business plan clearly included the provision of banking services to marijuana businesses. Two federal agencies, the NCUA and the Federal Reserve, refused to work with Fourth Corner, denying it deposit insurance and a master account respectively. This appeal specifically relates to Fourth Corner’s attempt to get a master account from the Federal Reserve. In an interesting legal decision, the three judge appellate panel had three different approaches to resolving the case, and each one wrote separate concurring opinions.

The downside for Fourth Corner is that none of the judges indicated any sympathy for the original argument that the Federal Reserve had the obligation to provide a master account to Fourth Corner because it had received a state charter. The judges all seem to agree that the Federal Reserve has discretion there even with the state charter in place. The good news for Fourth Corner is that the judges vacated the original order of dismissal “with prejudice” and instead mandated that the trial court dismiss the case without prejudice. Over the course of litigation, Fourth Corner sought to amend its proposed business model set forth in the complaint. It decided to argue that it would only provide services to marijuana businesses if they were legal. Based on this opinion, they can now reapply for the master account with that caveat, and if the federal reserve denies them again, Fourth Corner would have a stronger case. So, that’s good news if you are Fourth Corner and want to open and provide banking services at all, but it doesn’t help marijuana businesses.

Still, this isn’t a ground-shaking decision for the industry as a whole. The Federal Reserve and the NCUA are not punishing existing banks and credit unions that work with marijuana businesses, especially those that are not over-exposed to the cannabis industry. So though it will be extremely challenging to open a new master account for any new chartered institution that wants to work with marijuana businesses, it isn’t at the moment as much of a concern for existing institutions with existing master accounts and insurance policies. As we have said thousands of times, however, the status quo on cannabis banking is barely workable, and everybody’s lives will be easier when Congress acts to clarify that banking marijuana businesses is entirely legal.

Cannabis ComplianceWe have previously written about the need for cannabis businesses to systematize their policies and procedures. See Improving Systems and Structures for Cannabis Business Expansion and Understanding and Managing Cannabis Legal Compliance: No Excuses. Marijuana businesses are not standard startups — they are highly regulated and need to act like it from day one. But there is one thing worse than not having systematic procedures in place across your cannabis business — having systems in place but ignoring them.

For example, look at the employment side of the cannabis industry. Many cannabis businesses understand the need to have an employment policy manual, so they find a nice template online, find and replace some words, and adopt it themselves. Other businesses are savvier and work with attorneys or HR professionals to create professionally tailored employment policies. In both circumstances, that manual may include references to things like “performance management plans” or “performance improvement plans.” The plans can have step by step procedures for what happens in the case of employee performance problems. They often include a multi-step process for performance correction, review notes in the employee file, interim sanctions, and finally termination. But life moves fast, and it’s often easiest for business managers to talk to employees on the fly. Let’s say that an employee is consistently late. Instead of going through the formal process, the employer makes a couple of corrective comments, and then terminates the employee when the poor performance continues.

If a disgruntled former employee brings a complaint for wrongful termination, that employee’s case is immensely improved if she/he can show the employer did not comply with the employer’s written policies and procedures. At-will employees are still protected against termination for certain reasons. You can’t fire someone for reporting discrimination, for taking protected leave, and for several other reasons. Even if you had a good reason for the termination, if the former employee can connect the termination to a protected scenario, the employer’s lack of compliance with its own policies and procedures can be the kiss of death.

But employment isn’t the only area where this is important. We advise marijuana businesses to have compliance programs in place. Let’s say your written compliance program includes a weekly audit of your on-site security cameras and alarms to make sure they are all working. State laws often provide for penalty mitigation or even penalty waivers when companies act in accord with written compliance programs. But to get that mitigation or those waivers, you need to be able to document that you actually complied with your written procedures. In fact, if you submitted your written compliance program to the state as part of the licensing process, your noncompliance with that written compliance program can actually be considered an independent regulatory violation.

So what does this all mean? Written policies and procedures are vitally important for highly regulated businesses and any business looking to grow beyond a single location. But written procedures are not about putting in place a program that looks good on paper but is never really implemented. Your compliance programs for your cannabis business should be written and tailored so that the standard procedures set forth within them are achievable by your company’s management and staff. And once you have an achievable system in place, it is likewise supremely important that your company abide by it and stick with it. If you have written procedures and you find that you aren’t doing a good job complying with them, you need to either adjust your actions, adjust the procedures, or both. Otherwise, you will run into a host of problems.

Cannabis startup lawyerSerial tech entrepreneur Steve Blank defined a startup as an organization built to search for a repeatable and scalable business model. The basic idea is that a group of people within a startup run a version of the scientific method as quickly as they can, while learning from their successes and failures. Every idea is like a hypothesis you build out and evaluate, applying lessons learned to adapting the idea as you go. Over time, startups are supposed to continually pivot in the directions that will lead to the greatest overall business growth. In practice, this generally involves having small, flexible teams with largely undefined rolls. Communication is key, but the entire early stage business model should be built around the ability to rapidly change resource allocation and focus.

Large businesses, on the other hand, have significantly more inertia. Established companies focus primarily on keeping costs low and revenues high within the bounds of already established business models. Deviations from that model or large shifts in corporate focus are major decisions. These decisions require multiple layers of bureaucratic approval within a company, including endless meetings. Getting anything done can be slow because of the nature of getting approval multiple times within a hierarchy.

But despite the allure of startup-style flexibility, cannabis businesses, like other highly regulated businesses, do not have the luxury of acting like startups. State government regulations force them to act more like established large companies both through required state approval for significant business changes and through implicitly requiring certain internal governance structures. Licensed marijuana businesses have significant record-keeping requirements. They are required to implement seed to sale tracking of all products that run through the business. They must have written operations plans and security plans, and they must have one or more representatives authorized to speak on behalf of the business to government regulators. For significant deviations from these plans, additional state approvals are generally required. Depending on the state, these approvals can take months to secure.

And on top of all the explicit governance requirements, there are significant compliance requirements. For example, Washington State has more than 49 different possible regulatory violations that exist in four different categories. The violations are judged on a strict liability standard, meaning the state does not need to show intention or even negligence by the cannabis business to prove that a regulatory violation has occurred. These violations can carry huge monetary penalties, including license cancellation. And some violations can happen because of the actions of one rogue employee. Diversion of marijuana from the legal market to the illegal market usually carries the harshest penalties in state licensing systems, and it only takes one person to do it. So even where state law does not mandate any specific approach to avoiding diversion, it implicitly requires significant employee training and the implementation of layered compliance protocols to make sure that a single negligent or malicious insider cannot commit a serious violation.

Our firm works with clients all the time who are frustrated by the shackles state regulatory systems put on cannabis entrepreneurs. Cannabis is still a cool new industry, and cannabis business owners want to experiment with different financial, operational, and marketing approaches to the industry. And though our job as attorneys is to show businesses how to cut through the regulatory morass as efficiently as possible, regulated businesses are still cumbersome to adapt and they require the type of structured advanced planning you see in established companies more than startups.

Cannabis trade associationsLast week, we wrote about a new cannabis industry group in Oregon, the Craft Cannabis Alliance. In addition to national groups like the National Cannabis Industry Association, more and more regional, state, and local cannabis trade associations have been forming. Generally, they begin with political goals in mind. The national groups work toward marijuana legalization at the state level and on lifting restrictions at the federal level. State and local cannabis groups typically work for specific regulatory fixes or lobby local governments to resolve land use challenges. When cannabis trade associations go beyond run of the mill lobbying work, however, they can present legal risks to their members with potentially harsh consequences. Specifically, if trade association members take steps to limit their competition with one another, they can face massive civil penalties.

Competition law, referred to in the United States as antitrust law, has both federal and state components. Federally, antitrust law stems from the Sherman Act of 1890, the Federal Trade Commission Act of 1914, and the Clayton Act of 1914. The Sherman Act prohibits every “contract, combination, or conspiracy in restraint of trade.” The Sherman Act has been interpreted by courts over the years not to outlaw every restraint of trade — it specifically targets “unreasonable” restraints such as price fixing, dividing markets, and rigging bids. Most states also regulate unfair competition. In Washington State, we have the Consumer Protection Act, which largely mirrors the Sherman Act’s prohibitions in restraint of trade.

In most international jurisdictions, actions for violation of competition law are limited to governments. In the United States, however, both state and federal statutes provide for private rights of action. This means private parties that are damaged or potentially damaged by unreasonable restraints of trade may be able to collect treble damages, attorney’s fees, and injunctions against any company that is a party to the unreasonable restraint of trade.

Trade associations, then, provide an easy pathway to violations of state and federal competition law. Many of the smaller regional trade associations are focused on a specific sector of the industry. Retailer groups as well as cultivation groups have formed across the legal cannabis states in the western United States. Imagine this situation: a trade group made up of farmers meets to discuss lobbying on state pesticide rules. As the meeting winds down, conversation turns to talking about the glut of supply in the market, driving down prices. One producer says she has no plans whatsoever to sell below a certain price. Another producer says the same thing, and others nod in assent – agreeing it would be unprofitable for any of them to sell below that price.

That conversation can create huge liability problems for all its participants and for the trade group as a whole. Even if there isn’t a formal written agreement, an aggrieved party could still show an unreasonable restraint of trade. Actions of an association or actions of its members consistent with an unreasonable restraint of trade can be evidence of an agreement of the association’s members. Certain agreements, including price-fixing and market allocation agreements, can actually be crimes that include jail time. And though federally criminal conduct is nothing new for participants in the cannabis industry, those that violate competition law are not even granted the minimal protections of the Cole Memo.

Trade associations are particularly susceptible to certain types of anti-competitive behavior. Associations with codes of conduct, standard setting, and certification can unwittingly create anti-competitive behaviors. If a provision of the code of conduct is unreasonable and deemed to act as a restraint of trade — as opposed to a reasonable attempt to pursue a legitimate goal –could make association members that act pursuant to that code section liable for antitrust violations. Judges and juries have large amounts of discretion in determining whether a restraint on trade is unreasonable or not, so a legitimate safety standard to one person may be an illegal attempt to force a boycott of a competitor to another person.

Trade associations need to take steps to ensure their group does not create antitrust liability for its members. Anti-competitive agreements can be inferred if two or more market actors are taking parallel action and it can be shown that the competitors have engaged in illicit communications. So it makes sense for a trade association’s leadership to run tight meetings. All business should be formally proposed to an executive committee, which then limits discussion at broad group meetings to the specific business on the table. Agendas and presentations can be distributed in advance, and participants should be informed to stick to the specific issues at hand. Leadership can further inform the members that certain topics are completely off limits: pricing, whether to do business with certain market participants, decisions regarding company product output, and complaints about the business practices of other companies.

By taking these steps, an association can help prevent its meeting minutes from being used as proof of anticompetitive conduct. And if individual members engage in such conduct with one another, it is easier for other members to claim they were not involved in the anticompetitive acts.

There are many areas of law that the young cannabis industry hasn’t had major problems with yet. Products liability laws, antitrust laws, and others have seemed like distant problems, given that simple banking and taxation has been such a problem. But it is vital for industry members to remain proactive. Otherwise, public and private actors can upend the industry with a well-timed lawsuit.