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.

Cannabis business insuranceA client asked me earlier this week whether I thought his company should purchase insurance for their directors and officers. His accountant had advised them to do so, and he was looking for a second opinion. This issue has come up often over the years, so here’s a quick primer on D&O insurance and whether it makes sense for marijuana businesses.

At its core, D&O insurance is a way to protect a business’s directors and officers from being on the hook personally for their actions in their roles as directors and officers. Sometimes those suits can come from third parties, like creditors if the company is insolvent, or competitors for tortious interference with contracts, or customers for deceptive business practices. A large chunk of claims also can come from that same business’s shareholders.

Directors and officers owe multiple duties to their own companies. The big two are the duty of care and the duty of loyalty. The duty of loyalty mandates that the director or officer act in good faith in the best interests of the company, rather than for their own personal gain. The duty of care requires officers and directors act with reasonable care in exercising their company duties. You can violate the duty of loyalty by funneling company money toward your family members and you can violate the duty of care by making business decisions no reasonable person would make. Over the years, courts have tended to read the duty of care as an extremely limited duty — as long as there is a conceivable way to argue for what you did having been a business decision, it likely won’t violate the duty of care. If a director or officer violates one of these duties, one or more shareholders can sue those directors on behalf of the company, referred to as a “derivative suit.”

Company officers and directors don’t generally go into their jobs planning to violate their fiduciary duties to their companies, but they also don’t like the idea of being sued by shareholders for their management decisions. So companies make sure to sweeten the pot by offering protections against shareholder actions. One of them is indemnification, where the company agrees to indemnify an officer or director when sued in their role as officer or director. But indemnification is often limited by state law, where companies are not allowed to fully indemnify their officers and directors, especially for duty of loyalty violations.

The next layer of protection is D&O insurance. In a standard D&O policy, the individual officers or directors are covered when the company does not indemnify them. If the company does indemnify them, the company is covered for those costs. Finally, the company can be covered for additional claims against it, including potential securities claims.

For cannabis companies, the decision of whether to get D&O insurance is really no different than it is for other companies, except the premiums and coverage limitations may be different. Cannabis business is still pretty young in the actuarial world, and determining the exposure of directors and officers who are running companies that openly violate federal law is an interesting task. Like a lot of other services in the marijuana space, insurance underwriters tend to quote higher than ordinary rates for D&O insurance because of that uncertainty. For small marijuana businesses still run by their founders, D&O insurance plays the role of providing some liability coverage, but it isn’t necessary to attract outside talent.

Other than cost, one additional reason some companies choose to avoid D&O coverage is perception. If a director or officer wants a company to provide her with D&O insurance, that director or officer is saying she doesn’t want any of her personal assets to be on the hook for her company decisions. But if you look at it from the shareholder perspective, they already have significant personal assets on the hook. Many people have their life savings tied up in cannabis businesses, and there’s no such thing as shareholder insurance for bad decisions by management.

The vast majority of large public companies have some type of D&O insurance, and it is rare for really small companies. For those companies in the great middle, D&O insurance can make sense as a way to retain directors and officers, especially if the company is engaged in activities that invite lawsuits against directors and officers in their individual capacities. On the other hand, it is an expense, and shareholders like to see it when their directors and officers also have some skin in the game.

Cannabis fraud cannabis lawyersDon’t lie to your investors, and don’t be taken in by investments that don’t make sense. That’s the moral of this story, which made the rounds based on an SEC press release on Friday. A few years ago, the founder of a marijuana ancillary services company allegedly pumped up the value of that company with misleading press releases and created illusory revenues by transacting “sales” between the “operating” company and the publicly traded company. The SEC found out, investigated, charged the founder, and settled for a hefty fine. The cannabis industry is full of these stories. Every time a local newspaper touts how high marijuana tax revenues are or any new milestone in local marijuana sales, it invites investors to throw their money at any company they can. Investing in small, local, state-licensed cannabis companies is challenging and time-consuming due to state regulations, and the back-end return is fine, but usually not amazing. Public companies, on the other hand, promise enormous growth by having their hands in and around all aspects of the industry, and investors flock.

For those of us that try to do things the right way in this industry, it’s easy to highlight stories like this as indicative of bad actors and move on, but it’s important to remember a few things. The company described in the story was prominent in the cannabis industry for a while, and a lot of people thought it was making a lot of money and doing really well. It’s not just investors that get taken for a ride in cases like this. Attorneys, accountants, industry lobbying organizations, and others often get taken in the same way investors do, and they can face similar consequences. Public company fraud often relies on complicit actions by people who don’t realize they are a party to the fraud.

Here’s how things can spiral: Fraudco, Inc. puts out a press release touting big money and amazing technology. Small media outlets jump on it because they desperately need content. Attorneys, accountants, and potential business partners across the country that are looking for opportunities see the initial media coverage and rush in to see if they can do business with Fraudco. Fraudco is light on the details but says yes. Larger industry organizations get word that Fraudco is aligning itself with well-known professionals within the industry and give Fraudco a more prominent public and political role (after Fraudco pays to be a gold-level member). Larger media stories follow, and the public sees a company with positive reporting from large and small outlets and business relationships with recognizable and respected businesses and other professionals. Fraudco doles out just enough money to the industry groups and professionals to make it seem like they are doing real business and to avoid too many questions.

It can take months or even years to figure out that much or all of a company’s business can be fictitious. This happens because we fall into the trap of relying too much on trust. A modicum of due diligence can generally unravel most fraudulent schemes. Just last week, in Buying a Cannabis Business: The Top Five Due Diligence Items or Buyer Beware, we stressed the importance of due diligence when buying a cannabis business. The same holds true when investing in one. Despite what most people think, the fraud aspect isn’t usually that complicated. The problem is that even a modicum of due diligence is hard. It’s time-consuming, and short cuts are attractive. One of the most prominent shortcuts you see in small industries is to assume that a company is legitimate because the media and other businesses in your industry act as though they are legitimate. You say to yourself, “Well they can’t all be wrong about Fraudco,” and you let your guard down. Now you’re part of the problem — a self-reinforcing feedback loop that gives power to a company whose only output is a constant churn of press releases. See also Oregon Cannabis Fraud: How to Stay Out of the Newspapers

If you’re a potential investor in the cannabis space, it’s not that hard to protect yourself. Even if you don’t know the first thing about due diligence, you can still follow the tips that FINRA laid out in its stock scam investor alert of a few years ago. You can also make the decision to have your lawyer review all transactions and perform due diligence before you enter anything binding. There’s no reason to go it alone. See The Six Top Marijuana Scams to Avoid and Top Ten Marijuana Industry Red Flags.

But if you’re an attorney or an accountant or an industry organization or other professional to whom people look for guidance, you have a greater responsibility. It isn’t just to make sure that you don’t do anything illegal. Your associations and your reputation matter. They matter for your business and they matter to the outside world. If you haven’t done your homework on a company to be sure it’s legitimate, don’t vouch for it. If you’re an industry organization, make sure that the businesses you promote and put at the forefront are real, compliant, successful businesses. The overwhelming majority of cannabis businesses we see are legitimate, but I also can tell you right now that there are plenty of cannabis businesses in California, Oregon, and Washington that those in the know whisper about and will not touch, and yet plenty of others seem to have no problem just diving in.

As long as marijuana is illegal federally, the cannabis industry is in a somewhat precarious position and every prominent cannabis company that engages in illegal conduct — whether illegal drug trafficking or investor fraud — is a stain on the industry that makes progress that much harder. Industry participants can’t prevent bad acts, but they can do their part to make sure they don’t contribute, mistakenly or not, to those bad acts.

Cannabis merger risks
           Cannabis business risks. It’s no game.

Cannabis entrepreneurs have been riding an emotional rollercoaster these past few weeks. Just from Politico, we have seen the following headlines:

Running a cannabis business under these circumstances can be challenging. Employees get nervous about possible legal repercussions just for doing their jobs. It seems like all anyone wants to talk about is what the federal government is going to do about marijuana.

The uncertainty has started to affect the transactional market as well. Mergers and acquisitions in the cannabis industry are certainly still happening, but we are seeing the rate of deals actually closing slowing down a bit, at least in California, Oregon, and Washington. Would-be buyers of cannabis businesses are having a hard time deciding whether a licensed business that was worth $1.5 million four months ago is still worth the same price.

This type of short-term slowdown is typical of volatile markets, where parties are uncertain of how to price risk into their transactions. Looking back at the great recession, part of the reason economic recovery took so long was because firms were slow to deploy capital. Toxic debt had infected so much of the market that even companies with nothing to do with mortgage investments were affected by the outward ripple. They didn’t know if their investments would be caught up in the same debt spiral that killed so many other businesses. If enough people sit on their hands and wait for someone else to move, markets slow down.

Cannabis markets have always had their share of uncertainty. Legislatures and regulators continue to spend large amounts of time tweaking existing laws and regulations for marijuana businesses. Many of these changes happen at a moment’s notice and can absolutely sink people’s businesses. Sometimes they can save businesses and make them thrive. It’s not that regulatory and legal changes are inherently negative or positive — it’s that they create uncertainty. Local governments do the same thing. Unpredictable weather patterns can doom cannabis crops — more uncertainty.

When uncertainty, like that created by the back and forth Jeff Sessions drama, leads to short-term stagnation in sales markets. The first movers in that sort of market are either the most confident about their analysis of the situation or the most willing to gamble. Players in uncertain markets must price their perception of risk into what they are willing to spend. If I think there is a 90% chance the federal government will leave marijuana businesses alone and a 10% chance they will shut down marijuana businesses everywhere, there’s no way I should pay more than 90% of the value that would be there if the federal risk did not exist.

Where uncertainty and gambling converge is in judging that 90% chance. Do we think the chances that Jeff Sessions goes nuclear on cannabis are 10%? What if someone else thinks the chance is 20% or 30%? If you aren’t certain how to price that risk into your cannabis investments or acquisitions, you’re going to have a hard time participating in the cannabis market right now, and hence short-term stagnation.

At the same time, if you have a high level of confidence in your ability to perceive and price risk into your cannabis transactions, there is money to be made by playing the risk spread. There are sellers right now who think the federal government is going to destroy cannabis businesses everywhere and these sellers are willing to accept lower prices for their assets because they have a higher perception of the risks to that asset. If a buyer feels strongly that the risk is lower than the seller does, there’s room for a transaction.

The next few years are going to be interesting to watch, especially if the Trump administration remains cryptic about its attitude toward cannabis businesses. The risk-tolerant and the risk-intolerant are going to start showing their colors, and we will all learn a lot about the power that early movers in uncertain markets have when it comes to creating price anchors for business valuations and finding the biggest spreads between buyers’ and sellers’ risk perceptions. All of this is worth keeping an eye on, even if you aren’t in the short-term cannabis M&A or investment markets.

DEA and cannabisWe have our doubts that Sean Spicer’s comments last week will morph into active federal enforcement against marijuana businesses. Any federal action that interferes with state marijuana laws would be incredibly unpopular. Presidential administrations often use the media to float policy proposals to get a feel for how the public and Congress will react. In late January, the administration circulated a draft executive order that would have decreased discrimination protections for LGBT people, and the administration ended up scrapping it. Unlike immigration, marijuana policy was not a centerpiece of the Trump campaign. If reaction from the public and other government leaders is strong enough and swift enough, we may well see the administration avoid the topic.

On the other hand, the Trump administration has been savvy at manipulating the media. When there are stories that get real traction that can move voters (Trump’s Russia ties, incompetence with foreign leaders, etc.), the administration seeks to shift the media conversation. Much like the attacks on the media, moving on marijuana could be an attempt to move the national conversation away from the issues that truly scare them.

If it turns out that the administration wants to move more strongly against recreational marijuana businesses, they have a few distinct options in how to proceed.

  1. Boots on the ground law enforcement — This is the scariest option for marijuana business owners, at least if they are one of the unlucky few. It also is the most random and smacks the most of injustice. There are just under 5,000 special agents in the Drug Enforcement Agency. Most of these agents are tasked with working on things other than marijuana, like heroin, money laundering, and organized crime. The DEA does not have enough resources to use its agents to bust down doors of cannabis businesses right and left, but that doesn’t mean they couldn’t come in and make a few examples. It wouldn’t be effective at shutting down the cannabis industry, but it would be effective at creating fear.
  2. Asset Forfeiture — The federal government can seize any assets used in the commission of drug crimes or gained from the sale of drugs, including marijuana. Many marijuana businesses, especially cultivation companies, spend millions of dollars on their facilities, including greenhouses, HVAC equipment, lights, moisture control, etc. All this property is subject to federal seizure. The mere threat of seizure tends to affect capital markets as well. Lenders don’t value collateral at market rates because of the chance that it can be seized by the federal government. But just like boots on the ground enforcement, asset forfeiture cannot be used against thousands of state-legal marijuana businesses at once. Asset forfeiture cases can involve significant litigation, and it would take a huge influx of legal power in the Department of Justice to manage a significant increase in federal forfeiture cases.
  3. Withdrawing or Amending the Cole Memorandum — Remember that the Cole Memorandum from August 2013 was written as guidance to U.S. Attorneys on how to exercise their prosecutorial discretion. If the current administration lifted the Cole Memo, it may not mean we would see uniform enforcement of federal law. Instead, we may return to how things looked in 2011 and 2012, where each federal judicial jurisdiction had a different enforcement criteria determined by that district’s U.S. Attorney. In Washington, we had a relatively hands-off U.S. Attorney in western Washington and a significantly more aggressive U.S. Attorney in Eastern Washington. The law was not enforced uniformly even within the state, and California had it worse with its four judicial districts. Amending the Cole Memo could increase enforcement efforts if the administration puts new enforcement priorities in place. For example, they could seek to enforce against any marijuana business that gets too large and seek to limit sales growth.
  4. Coerce Local Law Enforcement — In interpreting the U.S. Constitution’s implementation of our federalist system, American courts have developed an anti-commandeering and anti-coercion jurisprudence. In short, the federal government cannot force state legislatures or state officials to act in certain ways. This limits the federal government’s ability to achieve state action through coercion. If the federal government wants to tie federal funds to state action, for instance, it must show links between the conditioned funds, the federal interest, and the state action in question. The classic example is that the federal government can coerce states into passing seatbelt laws by threatening to withhold highway funds. In the same way, the federal government could potentially threaten to withhold grants to local law enforcement agencies that don’t cooperate with federal government anti-marijuana law enforcement efforts. Any such action would be met with a constitutional challenge, but we could see a situation where a state governor and attorney general want to defend a state’s marijuana laws, while local law enforcement are coerced into assisting federal enforcement efforts.

All of this can seem frightening in a vacuum, but we will just have to wait and see what the Department of Justice says and does. This entire marijuana enforcement scare could (and probably will) end up amounting to nothing, but it is vital everyone stay engaged with the issue and make sure their government representatives know where they stand.

Cannabis business growthMany of the posts on this blog focus in one way or another on how tightly regulated marijuana industries force cannabis entrepreneurs to adapt their practices to stay within the rules. When you are getting started as a marijuana grower, processor, or retailer, you can afford to stay compliant with less organization. So long as your cannabis company’s key players know the rules, it is possible to keep 5-10 employees in check and make sure they (and you) are doing everything by the book. But as soon as a business starts to grow, whether internally through new employees or externally through new locations either in-state or out-of-state, it loses its ability to maintain regulatory compliance through sheer force of will. At that point It has to update its internal structure and systems so that the cogs of the machine can operate without direct oversight of the founders.

This advice isn’t really limited to regulatory compliance. Businesses looking to build a brand need consistent, reliable operations. At a certain point, the business’s founders are no longer able to micromanage every detail of compliance or operations, but they want the business to continue growing according to their vision. That period of a business — the transition from start-up to going concern — is always hard for founders. A business’s ability to rocket upward without constraints is going to falter sooner or later, and there is a plateau period, where every marginal gain in productivity starts to produce equal or greater levels of operational cost or risk of regulatory compliance.

Going back to compliance, this stage is when it is key to start implementing structures that may at first seem antithetical to rapid growth. I am referring to things like writing and maintaining standard operating procedures, company policies, and clear hierarchies and chains of responsibility. It makes sense to run a startup as a “flat” company, where everyone is expected to pitch in and do everything. But in a highly regulated industry, a clear organizational hierarchy is key. With written policies and procedures and clear levels of responsibility, it is easier for businesses to prevent problems and to develop and institute solutions when problems do occur. In every settlement conference that the Washington State Liquor and Cannabis Board has after it issues an Administrative Violation Notice, the hearing officer asks what steps the cannabis business has taken to prevent similar violations in the future. And if the cannabis business on the hot seat is able to explain clearly why the problem occurred and the corrective actions it has and will continue taking to make sure “it” never happens again, the penalty will be reduced.

But this isn’t just about penalty reduction; it is about a business’s founders being able to move from day to day management and micromanagement to bigger picture thinking. Startups succeed because their founders have a vision and they implement plans to achieve that vision. When a business reaches a certain size, the daily triviality threatens to overwhelm everything. By delegating authority, allocating responsibility, and creating standard operating practices, a founder is able to step back, review the broader picture, and chart the overall course for the business going forward.

In more practical terms, here are some steps to take when your cannabis business starts to hit that plateau period:

  • Adopt written standard operating procedures, written company policies, and a written employee manual;
  • Appoint one or more compliance officers at each business location who are absolutely responsible for knowing state and local regulations and how those regulations fit within the company’s standard operating procedures;
  • Revisit and update the standard operating procedures regularly, and have your company compliance officer(s) recommend amendments to procedures to ensure continued compliance with state and local regulatory changes.

For marijuana businesses with multiple locations, especially locations in different states, it will be important to separate the company-wide policies and procedures from the site-specific policies and procedures. The more that can be company-wide, the better, but vast variations in state marijuana laws call for variations in day to day practices in different states.

If you do take these steps, you have to take them seriously and stick to them. Written policies and procedures are worthless if a company doesn’t follow them. There are some growing pains — it isn’t fun to lose some of the flexibility that you had as a startup — but these steps really can help put your business on a path to healthy expansion and the failure to take them could be your downfall.

Marijuana cannabis potPresident Trump’s actions have sparked massive activist energy from progressives. His Executive Order on immigration created waves of protests at cities and airports across the country. Those protests have been significant in getting lawmakers that oppose Trump’s actions to take stands where possible. Without massive protests, Washington’s Attorney General Bob Ferguson may never have brought the case that put a temporary stand to the immigration executive order. The protests may also have had a chilling effect on new executive orders that would generate more protests, including one order that would have curbed LGBT rights that appears to have been scrapped. Basically, the activism appears to have had some impact.

What will it look like if the Trump Administration goes after cannabis?

With the confirmation of Jeff Sessions as Attorney General, we now have an ardent pot critic in charge of our country’s law enforcement apparatus. Because of the Rohrabacher Amendment, the Department of Justice cannot use resources to interfere with state implementation of medical marijuana laws, which includes medical marijuana businesses at least in the Ninth Circuit. However, recreational states such as Washington, Oregon, and Colorado could be targeted if Sessions and Trump decide to make this an issue.

If they do decide to go hard after recreational marijuana, with either a general notice or targeted civil actions or even criminal law enforcement actions against cannabis entrepreneurs, what will the public reaction be? It isn’t automatic that legal changes a majority of Americans oppose will lead to massive reaction and protesting. The administration has appointed someone to the Federal Communications Commission who threatens the open internet we have today and would like to replace it with a system where internet service providers can curate content. Yet, there have been no protests or even much public opposition by political leaders against this appointment. Net neutrality as a concept is very popular, but it does not provide the same energy spark as civil rights, LGBT rights, or immigration.

One of the best ways to prevent an attack on the rights of states to treat marijuana how they see fit is to convince federal officials that marijuana issues will spark the same kind of energy as the refugee ban. This means that people who don’t care at all about cannabis as a product have to get involved. There were tons of people involved in the immigration protests that have probably never known a Syrian refugee or Iraqi immigrant, but they protested because Trump’s immigration order struck them as un-American.

In the same way, using federal law enforcement authority to attack businesses and individuals that are fully compliant with a marijuana state regulatory system is deeply un-American. It has never been the job of the federal government to involve itself in intrastate issues unless it is trying to protect civil rights or voting rights. Every success the federal government has had at the intrastate level has been to curb discrimination and protect the rights of workers, voters, and others against state actions that violate federal law or the constitution. Federal action against intrastate activity outside of those types of issues has been seen as brazen overreach.

If we grant that public reaction and public protest is a real check on federal authority, then people who care about cannabis rights must place the issue within the framework of fundamental American values. Only through that structure, and through adoption of that structure by people who are not cannabis users or business owners, will there be enough potential or actual public backlash to avoid the administration upending the current cannabis status quo.

Cannabis exportsIsrael is moving toward authorizing the export of medical marijuana. Israel is an example of how advanced a market can get with a relatively small number of potential customers. With only around 23,000 patients, Israeli’s medical marijuana businesses have thrived, benefiting from the country’s open approach to research, unlike in the United States. So, how will potential Israeli exports affect markets in the United States?

Countries can regulate trade on two fronts — outgoing goods (exports) and incoming goods (imports). On the export side, countries will generally have limits or bans on the export of munitions or military items, items that have military applications, and items intended to go toward countries or individuals that the U.S. has designated under its sanctions regime. For imports, countries will generally track what is coming in for customs purposes to levy import duties and will require proof of licensure for the import of regulated goods that require licenses to possess. Israel may allow the exports, but it doesn’t mean that the United States will allow the imports. Because marijuana is still a controlled substance that is illegal to possess without permission from the DEA, medical marijuana patients in the United States likely won’t be able to import marijuana for their own use.

But for researchers, access to Israeli medical marijuana strains would be a huge boon. For years, the only marijuana researchers can use has been controlled by the National Institute on Drug Abuse at a licensed facility at the University of Mississippi. This has been a problem because NIDA’s Mississippi marijuana has often been found by researchers to be of inferior quality, and many research projects have ground to a halt after receiving all required licensing and permits because the NIDA facility simply didn’t have the type of marijuana that needed to be researched. In August, the DEA announced a new policy that would potentially expand the list of permitted facilities for the cultivation of cannabis for research. In that policy statement, the DEA used the Single Convention on Narcotics to provide it some cover for its continued limitations on cannabis growing for research. The primary limitation for those permitted by the DEA to cultivate marijuana is that they receive written permission from the DEA each time that they distribute marijuana.

The DEA continues with these limitations for a number of reasons as we have discussed here and here. But the DEA’s best arguments for its ongoing limitations are based on the U.S.’s obligations under the Single Convention. Articles 23 and 28 of the Single Convention make clear that countries that allow cultivation of cannabis for research purposes must ensure that research marijuana not be diverted to the illegal market. This is only a problem for the DEA domestically when the cultivation is in the United States, though. If the DEA licenses importers, only a limited quantity of marijuana comes into the United States, and protection against diversion from the grow operation is the problem of the exporting country.

The DEA has authorized importation before. In December 2015 it granted Catalent CTS, LLC of Missouri a registration to import “finished pharmaceutical products containing cannabis extracts in dosage form for clinical trial studies.” These imports would presumably be from GW Pharmaceuticals, which has a massive facility in the United Kingdom.

But Israel’s medical marijuana cultivators have a strong reputation around the world, and researchers will be eager to run trials with strains of cannabis they cannot get anywhere else. It will take some time for Israel to move the marijuana export allowance through its legislature (it has only been voted out of committee), but don’t be surprised if a number of U.S. based researchers start applying to the DEA for import permits and start getting their cannabis from Israel.

Cannabis regulatory lawyersOur cannabis regulatory lawyers are in the midst of a few different administrative cases right now dealing with violations of marijuana regulations. In Washington State, the Liquor and Cannabis Board treats its regulatory mandates as “strict liability” rules. This means the onus is on the cannabis business to comply, and a business that violates a regulatory mandate is liable even if it did absolutely everything it could have done to prevent the violation. This sort of strict liability for violating cannabis-focused regulations is fairly common across the country and is just another example of how cannabis businesses even in cannabis-legal states are treated differently from other businesses.

The theory behind strict liability for regulatory violations is that businesses are best positioned to make sure violations do not occur. Businesses need to pony up as many resources as it takes to prevent violations. This strict liability is opposed to a negligence standard, where if the business is found to have acted with reasonable care to comply with the rules, it would not be found liable.

The problem with strict liability, however, is that it can be unfair to businesses that try to have reasonable compliance programs but still slip up. There is no way to prevent employees from flouting the rules from time to time. It happens at every regulated business throughout the country. Employees often see compliance measures as a hindrance to getting their jobs done, and they look for workarounds. But in a strict liability system, a business whose employee violates a compliance program is treated the same as a business that didn’t have any compliance program at all. There is a certain unfairness to that.

The goal of any regulatory agency should be for businesses to have maximum compliance, and the best way to do that is to encourage self-policing. This is why most federal agencies have dedicated programs for regulatory compliance, self-policing, and self-reporting, where penalties against businesses are greatly reduced or even waived if the business follows certain compliance steps.

Washington State voters mandated the State implement this sort of favoritism for liquor merchants “that try” when it passed Initiative 1183, privatizing liquor sales. Under that program, Washington liquor sellers that implement specific best practices to avoid selling liquor to minors will face reduced and deferred penalties if they accidentally make such a sale. Regulatory partnerships like this benefit businesses by giving them guidelines on how to operate and they also benefit the public as a whole as they will lead to fewer overall sales to minors because businesses are so incentivized to implement effective programs.

For marijuana in Washington, the best that cannabis businesses can rely on are that the regulations allow the Liquor and Cannabis Board to reduce penalties if a cannabis business with violations can demonstrate that its business policies and/or practices will reduce the risk of future violations. And though mitigation like this is helpful, it is not the same as a standardized compliance program responsible companies can join to get across the board penalty mitigation.

Marijuana businesses should band together to demand such a “voluntary” compliance program. As everyone knows, regulatory costs for cannabis businesses are high, and even the most compliant cannabis company will have employee slip-ups or regulatory misunderstandings from time to time. The competitive aspect is also key; so long as cannabis compliance program guidelines are not set across the board, businesses will try to comply with the rules at the lowest cost, to the detriment of the compliance programs. Setting up minimum compliance guidelines will allow participating cannabis businesses to know their competitors are either on the same playing field as they are, or that they are risking harsher penalties for not being part of the voluntary compliance program. It’s a win-win for compliant cannabis businesses and for the state. Yet no matter what sort of state-law program to which your cannabis business is subject, it pays to constantly self-audit your company to work towards full compliance. See Understanding and Managing Cannabis Legal Compliance and Cannabis Compliance Audits.

What are you seeing out there? What are your thoughts on all of this?

Cannabis growsThe Seattle Times ran a story last week about the DEA continuing its marijuana eradication program even in states with legal marijuana like Washington. The DEA authorizes funding for state law enforcement to search for and eradicate marijuana, generally on public land.

Several of our clients asked us about this story, wanting to know if it meant the DEA was also taking action against state-legal marijuana businesses. Fortunately that is not the case. The DEA eradication program is specifically targeted at illegal operations on public lands. Federal law enforcement is going after cannabis grows it claims are operated by Mexican cartels. Regardless of who runs these cannabis grows, they are not compliant with state law. Under current federal enforcement policy, the federal government still has free reign to support law enforcement action against marijuana operations that are outside the bounds of a state-regulated system.

On one hand, this eradication program is in the best interests of compliant, tax-paying marijuana businesses as it eradicates competition from illegal cannabis. If we are going to have a Drug Enforcement Agency to which Congress appropriates funds, we would prefer it spend its time and money seeking to eradicate illegal marijuana grows than going after state-legal cannabis businesses. Even if the DEA is only scratching the surface with the total amount of marijuana it seizes, the mere threat of these eradication efforts forces illegal cannabis growers to try harder to hide their products, increasing their costs and forcing them to sell at a higher price. Anything that increases the legal market’s competitive edge against the illegal market has some benefit to our clients who pay taxes and registration fees and operate fully above board. Finally,  illegal, unregulated cultivation on public land, often in national parks or national forests, can have significant negative impacts on the environment.

Still, we have to ask if local marijuana eradication is the best way for the federal government to spend its money. In 2016, the DEA spent $760,000 in Washington, $200,000 in Oregon, and $4.3 million in California on eradication efforts. In Washington, because of the mountainous areas where illegal grows are found, the per plant eradication cost is $26.49. That’s a huge cost per plant when evidence has shown that these eradication efforts have not significantly reduced the total amount of illegal marijuana making its way to market.

Like a lot of other government programs, it seems that much of the reason for continuing with the cannabis eradication program is that the money is easy for Congress to spend and law enforcement jobs remain secure so long as they continue to receive this kind of money. If the federal government were serious about the ecological concerns of illegal marijuana growing, the eradication program would be run by the United States Forest Service or the Department of Interior or the EPA. Not by the state highway patrol with funding from the DEA.

One of the most pernicious challenges for marijuana decriminalization nationwide is the continued financial interest of those politically popular groups that generate revenue from illegality. Law enforcement and corrections officers represent a huge and organized political constituency, and though they don’t all speak with one voice (see Law Enforcement Against Prohibition), they tend to favor anti-cannabis programs that keep federal funds flowing their way because of the security it brings to the agencies as a whole and to the individual law enforcement officers. So long as marijuana remains illegal, we will throw money at quixotic eradication efforts.

In discussing this money tug, Lt. Chris Sweet of the Washington State Patrol told the Seattle Times that public perception that the money can be used for other programs like education and treatment is “definitely a big concern.” The pie is only so big, and those of us who think the money would be better spent on education or treatment need to make our voices heard too.

Cannabis ContractsOur cannabis clients often face the chicken and egg problem of trying to balance three or four decisions contingent on one another. A classic example is a new marijuana business licensee that wants the state agency to approve a certain location, wants a landlord to execute a lease for that location, and wants an investor to contribute capital to pay for equipment and build-out at that location. The state agency will only approve the location when it has a signed lease in front of it. The landlord will only execute the lease if a state license has already been approved and if the business is properly capitalized. The cannabis business does not want to be on the hook for executing the lease until it knows it has a good source of capital and that the land will be approved by the state for its cannabis business. And the investor will only put money into the cannabis business if there is confirmation the property works and the business has a lease.

Basically, everything is contingent on everything else. It can be a challenging situation for cannabis business owners, but there is a simple solution more companies should use — standard conditional agreements with agreed-upon closing periods. Anyone who has bought a home understands how closing works. You sign a purchase agreement, but you have 30 days to get inspections done to make sure the home has clear title and is adequately constructed. If there are any problems, you can walk away, less your earnest money.

The same structure can be used in startup cannabis business deals. So long as landlords get some earnest money up front, they are generally willing to execute commercial leases that allow tenant cancellation if the state does not approve the cannabis license or if the tenant discovers its cannabis business is not feasible at any point during the first few months of the lease. Similarly, cannabis investment contracts can and should be similarly conditioned. A loan agreement or an equity purchase agreement involving a cannabis business can have any time frame for closing, which can be defined as actually funding the investment or as the moment when the investor is fully obligated to pay the investment over time. Generally, the conditions will be that the company passes some standard due diligence, but it makes sense for the licensing and real estate portions to be added as additional closing conditions.

Using multiple conditional agreements, a cannabis business can ensure everything is aligned before obligations to pay money mature. And if things fall apart, the various conditions will not be met and everyone can walk away with minimum pain. When doing cannabis deals, it is important to think through the various facts that need to be in place before obligations start maturing. If you do this, you will be better able to walk the tight rope that heavily-regulated cannabis businesses on a timeline face during the cannabis licensing process.