Photo of Vince Sliwoski

A well-rounded attorney with experience in areas such as music and trademark law, Vince heads up Harris Bricken's Portland office and is a leading practitioner in Oregon's ever-evolving cannabis industry.

Cannabis law
No biggie, apparently, per DOJ

U.S. Attorney General Jeff Sessions is worried about this country’s “historic drug epidemic and potentially long-term uptick in violent crime.” Because he is so worried, Sessions has spent the past month doing things like: (1) asking his old colleagues for funds to prosecute the War on Drugs, including medical marijuana; (2) writing letters to state Governors with “serious questions” about their local cannabis programs (which letters the states have politely observed are misleading and inaccurate); and (3) disseminating bogus weed statistics far and wide. Every day that Sessions perseverates on cannabis enforcement, an average of 142 Americans die from opioid abuse, per the Centers for Disease Control. And since 1999, a total of 560,000 drug overdose deaths have occurred. That number is accelerating.

If Jeff Sessions were truly concerned about our nation’s historic drug epidemic, he would not be scheming to shutter state cannabis programs. Instead, he would be taking action against the bad actors who have fueled the opioid epidemic. Specifically, he would be filing public interest lawsuits, like last week’s bombshell filed by Multnomah County (the home of Portland, Oregon). As it stands, however, the federal government has done little to engage the opioid crisis apart from commissioning a report, and Sessions has done nothing. It tends to boggle the mind.

As with cannabis law and policy, the federal government has been terribly slow and backward in its consideration of the opioid crisis. This means that once again, states and local jurisdictions are being forced to take the lead. Lately, these localities have been doing so with gusto: a growing number are suing pharmaceutical companies and doctors for causing a public health hazard by pushing opioids on their citizens. Fundamentally, this is the same strategy that states first pursued in the 1990s with lawsuits against Big Tobacco. The local governments are essentially saying: you guys knew what you were doing all along with opioids; we are going to make you stop and make you pay.

In legal terms, the allegations in these cases include tort claims like public nuisance, fraud, conspiracy, negligence, gross negligence, etc. These lawsuits contain jarring and memorable lines, such as “the Purdue Frederick Company, Inc., is a convicted felon and admitted liar.” The filings also detail the methods used by the defendants to push their highly addictive products, and they contain demoralizing statistics, such as:

  • Opioids are now the most prescribed class of drugs, generating $11 billion in revenue for drug companies in 2014 alone;
  • Since 1999, the amount of prescription opioids has nearly quadrupled;
  • In 2010, some 254 million prescriptions for opioids were filled in the U.S. – enough to medicate every adult in America around the clock for a month;
  • In 2010, 20% of all doctors’ visits resulted in the prescription of an opioid;
  • While Americans represent only 4.6% of the world’s population, they consume 80% of the opioids supplied around the world and 99% of the global hydrocodone supply; and
  • By 2014, nearly two million Americans either abused or were dependent on opioids.

And Jeff Sessions is concerned about marijuana.

According to its website, the mission statement of the Department of Justice (DOJ) is to “…ensure public safety against threats foreign and domestic; to provide leadership in preventing and controlling crime; [and] to seek just punishment for those guilty of unlawful behavior…”. With respect to controlled substances in general and opioids in particular, DOJ should be doing all of these things. It is not. Instead, it is beating about the bushes with states on cannabis.

The opioid crisis kills 146 Americans every single day; conversely, even the U.S. Drug Enforcement Administration acknowledges that no one has ever died of a cannabis overdose. If Jeff Sessions and DOJ continue to waste valuable federal resources investigating state-legal weed and not the opioid crisis, it will be an American travesty. In fact, it already is one.

Cannabis lawyers
Jeff Sessions: Titling at Marijuana Windmills

On Monday, the National Conference of State Legislatures (NCSL) adopted a formal resolution that Congress enable financial institutions to serve marijuana businesses. The most interesting thing about the resolution was its forcefulness: it did not ask Congress to pass a banking bill specific to cannabis, or even to revisit the FinCEN guidelines for financial services. Instead, NCSL cut to the heart of the issue, telling Congress to deschedule marijuana altogether.

NCSL is a big deal. The bi-partisan organization represents all state legislators and their staffers nationwide. And NCSL seems to get more progressive on cannabis policy with each passing year. Last year, for example, NCSL issued a resolution that marijuana be removed from Schedule I, but not descheduled entirely. Next session, NCSL may adopt a separate resolution calling on Congress to “make medical cannabis policy a national priority to expand access to affordable medicine.” That resolution is rooted in fighting opioid addiction.

The timing of the NCSL action is important. We know that recently, Attorney General Jeff Sessions received recommendations on marijuana enforcement policy from a Justice Department task force. Sessions is keeping those recommendations under wraps, probably because they provided him with nothing to support his enforcement animus (a finding confirmed on Friday by an Associated Press report). At this point, it’s clear that Sessions is on a quixotic, lonely mission, when it comes to the issue of cannabis.

Still, Sessions is not throwing in the towel. After failing to convince Congress to allocate funds for the prosecution of medical marijuana operators two weeks ago, Sessions wrote the governors of a number of states with “serious questions” about their state cannabis programs. This letter was sent while federal agency representatives held veiled meetings about marijuana policy with state and local officials in Colorado. What exactly those meetings covered has not been ascertained. We do know, however, that Sessions has been using bogus weed statistics in the hopes of furthering his aims.

With Sessions working around the edges to promote his retrograde War on Drugs agenda, it is heartening to see legislative groups like NCSL proclaim that states are having none of it. Going forward, states will continue to set the trend on cannabis legalization, although Congress may find itself having to act sooner rather than later to re- or deschedule marijuana. Ironically, the catalyst for that action may be Attorney General Sessions, who continues tilting at windmills in his own strange reality.

Oregon Cannabis and PhysiciansOn Saturday, I gave a fun talk at the National University of Natural Medicine’s Medical Cannabis Conference on “Oregon Cannabis Laws and Naturopathic Doctors.” I say it was fun because almost always, we corporate cannabis lawyers wind up speaking in front of other lawyers, accountants or industry entrepreneurs. Health professionals have a different and unique perspective. This talk was also enjoyable because I got to reacquaint myself with the caregiver side of the Oregon Medical Marijuana Program, a program my firm rarely advises on anymore, because, as a business proposition, it is all but dead.

Perhaps the most fun part of the presentation, though, was the incredible number of questions called out in this one-hour talk on “Oregon Cannabis Laws and Naturopathic Doctors.” Here are some of the highlights.

What’s the deal with CBD/hemp right now? This spring, the DEA announced a new Final Rule regarding its classification of “marihuana extracts,” which caused a bunch of Colorado hemp growers to file suit. Even without the questionable DEA action, though, CBD remains firmly entrenched on Schedule I of the federal Controlled Substances Act. (Bills pop up from time to time attempting to change that.) Like medical marijuana, CBD may be legal under many states’ laws, including Oregon’s, but the federal picture is a whole ’nother story. Therefore, physicians should steer clear of advising patients that CBD extracts, topicals, concentrates, etc., are non-controlled substances when extracted from U.S. hemp– even if one can buy some of these products easily online, or in big box grocery stores.

Who can dispense medical cannabis in Oregon? Only an Oregon Health Authority (OHA) registered caregiver or grower, or a licensed OHA or Oregon Liquor Control Commission (OLCC) retail dispensary, can dispense medical cannabis in Oregon. Further, for a patient to acquire cannabis from any of these sources, the patient must first secure an “Attending Physician Statement” explaining that the individual “has been diagnosed with a debilitating medical condition and that the medical use of marijuana may mitigate the symptoms or effects…”. OAR 845-008-0010(4). The term “Attending Physician” is defined as “a Doctor of Medicine (MD) or Doctor of Osteopathy (DO).” OAR 845-008-0010(3). This means that naturopathic doctors, chiropractors, acupuncturists, etc., cannot facilitate access.

What have courts said about physicians discussing medical marijuana with patients? Mostly good things. Conant v. Walters, 309 F.3d 629 (9th Cir. 2002) held that the feds cannot revoke a physician’s DEA license to prescribe controlled substances, or investigate that physician, solely for “recommendation” of the use of medical marijuana. Other cases, like Rust v. Sullivan, 500 U.S. 173 (1991) and Planned Parenthood of S.E. PA. v. Casey, 505 U.S. 833 (1992) observe that regulations on physician speech may “impinge on the doctor-patient relationship” and that doctors have a First Amendment right not to speak, respectively. Because the Oregon Constitution has even broader speech protections than the U.S. Constitution, it seems that physicians in Oregon would be within their rights to discuss medical marijuana treatment of debilitating conditions with their patients.

What about other types of claims? In theory, we could see a patient or a patient’s representative bringing a tort claim against a doctor, if the doctor had recommended cannabis while the patient was prescribed other substances, resulting in a negative reaction. Unfortunately, due to the status of federal law, there is a relative paucity of cannabis research as compared to other controlled substances; but if there were not, it is possible cannabis would be contraindicated for any number of scheduled pharmaceutical drugs. Aside from traditional tort claims, we could also see a doctor get roped into a RICO suit for encouraging the violation of federal laws through providing basic patient services. We are not aware of any case involving physician liability for malpractice or RICO claims to date, but it’s possible.

How many cannabis patients can an Oregon physician have? A total of 450, without significant additional compliance hurdles. Yes, that’s a lot!

Oregon cannabis lawAs the marijuana industry grows and consolidates, marijuana businesses are forced to consider more complex business structures to meet their business needs. Such business structures must reduce costs, increase operating efficiency, and most importantly, strictly comply with federal and state law.

One strategy for cannabis retailers, especially those with multiple outlets, is to establish an employee leasing company. If the retailer has three stores, for example, each organized as an LLC, its owners may organize a fourth LLC to lease employees to the stores. This leasing company will then contract with, and act as paymaster for, each store LLC. In this arrangement, the employees who work at each store LLC are not store employees; rather, they are leased employees who receive their W2s from the leasing company. Accordingly, the employee leasing company is solely liable for employment tax.

Employee leasing companies offer two key benefits: consolidation of costs and employee retention. Without the leasing company, each retailer in the example above is required to manage the compliance costs of accounting, employment taxes, workman’s compensation, and medical benefits. By consolidating these functions, the employee leasing company should be able to reduce these compliance costs.

Employee leasing companies also benefit employees by making the marijuana retailer a more attractive employer. As leasing company employees, they receive their W2s from a non-cannabis company, it may be easier for them to sign leases, acquire mortgages and take on other formal obligations. In addition, the consolidated purchasing power of the employee leasing company should provide more robust employee benefits at a lower price.

State law on employee leasing companies varies considerably. Some states scarcely address the concept; others regulate extensively. A good example of the latter is Oregon. In Oregon, employee leasing companies must be licensed by the state’s Workers Compensation Division. The completed application is detailed, takes a few months to process, and entails a $2,050 licensing fee (paid every two years). Once licensed, the leasing company is jointly responsible for the hiring company’s entire workforce—including non-leased employees—which requires special procedures and insurance.

In a payroll leasing arrangement, the leasing LLC will have service agreements with each store LLC. Such agreements must reflect an arm’s-length market rate. Many methods are used to determine an arm’s length market rate but all are based on the facts and circumstances of your business. One common methodology is “Cost-Plus.” In a Cost-Plus arrangement, the employee leasing company compiles its costs and adds an arm’s-length market profit. The IRS carefully examines on audit, arm’s-length charges between affiliated entities.

Finally, employee leasing companies cannot be used as a device to avoid taxes, circumvent the correct application of Code §280E, or to launder money.

The use and benefits of an employee leasing company are not limited to retailers; producers, processors, and manufactures may also benefit from using an employee leasing company. But before you establish an employee leasing company for your cannabis business(es), it is critical you have an operational strategy in place and reasonable projections of the costs. It is even more critical that you understand 280E and structure your entities to comply fully with that. Only after having done all this will you be in a good position to evaluate whether an employee leasing company is best for your cannabis business.

The cannabis movement has always had a benevolent streak. Many people produce and disseminate the plant to alleviate illness and suffering. Others support legalization for social justice reasons– unwinding the prison industrial complex, for example. And still others are simply interested in solving hard problems, such as the outsized environmental footprint of cannabis grows. When people of this general orientation approach our cannabis attorneys to start cannabis businesses, they often ask about “benefit company” status.

Over the past several years, most states in the U.S. have adopted benefit company statutes. Generally speaking, a benefit company is a type of corporation or limited liability company that considers its impact on society in making decisions. Sometimes, B Corps and B LLCs are said to have a “triple bottom line” which includes not just profits, but also the community and the environment. A few well known benefit companies include Patagonia and Ben & Jerry’s.

Because of the triple bottom line ethos, benefit companies do not impose a strict duty on their directors, officers, managers or members to maximize profits. This differs from a traditional corporation, where governing individuals can be exposed to shareholder litigation for failing to make decisions that maximize profits. Cannabis entrepreneurs, like business people in other industries, may find this element of benefit company status attractive.

Benefit companies may sound a bit like non-profit corporations, but they aren’t. For state and federal tax purposes, benefit companies are considered for-profit entities. They also tend to be structured no differently than for-profit companies, in terms of underlying company paper and personnel. Benefit companies do behave like non-profits in the sense that they are mission-oriented, but that’s about it.

Almost all states now accept benefit companies and follow the model B Corp legislation, which hasn’t been around all that long. As a result, the process of becoming a benefit company is fairly consistent from state to state. Some especially progressive states, like Oregon, have adopted a broader version of the benefit corporation law that allows founders to form benefit LLCs, in addition to corporations. In the Oregon cannabis industry, we have formed both kinds of companies.

In most states, forming a benefit company isn’t terribly difficult: as far as filing, it’s typically a “check the box” election that is made in the entity’s Articles of Organization (LLC) or Articles of Incorporation (corporation). It’s what comes after the election that takes some thought. The benefit company is required to adopt a third party standard to judge its efforts to accomplish a public benefit (such as the B Labs Impact Statement). Each year, the company must also draft a benefit report detailing its efforts in achieving its public benefit, and distribute the report to its owners and through its website.

Benefit companies often help owners and investors feel good about their enterprises, and, from a branding point of view, the B Lab certification is a great look. Looking back, the cannabis industry has made big strides over the past few years with respect to community integration and acceptance. Let’s see whether recreational pot businesses continue to embrace the benefit model, especially as key states like California come online in 2018.

Oregon Cannabis laws
Oregon’s Cannabis Laws

Last week, the 2017 Oregon legislative session came to an end and it wound up basically how we thought it would. During the five-month term, the Oregon legislature passed a raft of cannabis bills related to medical marijuana, adult use pot, and industrial hemp. In addition to the new laws (which I’ll get to in a minute), this session was notable for the dissolution of the aptly named Joint Committee on Marijuana Regulation. The Joint Committee was created over two years ago for the express purpose of implementing Oregon’s Measure 91. Now that the Joint Committee has dissolved, you can expect to see fewer bills on cannabis going forward: most of the work to shape legislation and public policy is done in committee.

With no more Joint Committee and only a short legislative session to look forward to in 2018, industry players can only prepare for what probably feels like water torture at this point: the seemingly never-ending treacle of administrative rule-making by the Oregon Liquor Control Commission (adult use / recreational, and now medical marijuana); Oregon Health Authority (strictly medical marijuana) and Oregon Department of Agriculture (industrial hemp). Each of these agencies will make rules to implement and interpret Oregon’s revised cannabis statutes, as summarized below.

Senate Bill 1057. This was the big one, which, among other things: (1) requires medical growers use the METRC tracking system; (2) establishes immature plant limits for medical growers; (3) allows OLCC licensees to declare themselves as exclusively medical cannabis growers; and (4) assigns all cannabis labeling operations to OLCC. For a full list of the SB 1057 provisions and our take on their impact go here.

Senate Bill 56. Because the immature plant limitation in Senate Bill 1057 had many people freaked out, especially medical growers in transition to OLCC, the legislature quickly scrambled to pass SB 56, which suspends the immature plant limitation for a premises at which an OLCC application was pending as of June 23, 2017. This one seemed to make sense to everyone. The new law also allows for limited cannabis processing by small, licensed OLCC producers (<5,000 square feet of canopy; water or mechanical extraction only) and provides for the immediate suspension of any marijuana license for diversion of product to the illegal market.

Senate Bill 302. This bill removes provisions related to marijuana offenses from the state Uniform Controlled Substances Act. It also removes and/or reduces various criminal penalties related to marijuana crimes by unlicensed operators. The thrust of this bill was to treat marijuana crimes more like alcohol crimes, and it achieves that purpose. Because penalties for marijuana offenses were scattered throughout the Oregon statutes, this one has an enormous amount of tedious, conforming amendments, to something like 125 statutes.

Senate Bill 303. This law is similar in nature to SB 302. It amends, clarifies, and reconciles statutes related to minors possessing and purchasing both cannabis and alcohol. Generally speaking, it should have little effect on the cannabis industry.

Senate Bill 863. This one concerns consumer privacy, and it serves as a further attempt by Oregon to shield its citizens’ information from the federal government. The new law prohibits marijuana retailers from recording, retaining and transferring “information that may be used to identify a consumer.” This bill was short, sweet and non-controversial.

Senate Bill 1015. This new law provides that industrial hemp growers may transfer hemp to OLCC licensed processors. Similarly, industrial hemp handlers may transfer both hemp concentrates and extracts to processors. Expect a fee and some forms.

House Bill 2197. This is a neat bill that passed toward the end of the session. It allows the Oregon Department of Revenue to enter into agreements with the governing body of federally recognized Indian tribes (read: The Confederated Tribes of Warm Springs). Under those agreements, the State of Oregon would make rebate payments to the tribes for the estimated tax on marijuana items sold by tribes. Let’s wish the Warm Springs tribe luck.

House Bill 2198. HB 2198 is the only bill on this list that is not yet a law. It currently sits on Governor Brown’s desk for review, and we expect she will sign it. If she does, the bill would establish an Oregon Cannabis Commission, to report back to the legislature on the status and condition of the Oregon Medical Marijuana Program (which the legislature keeps curtailing). The idea here is to find a way to help medical marijuana patients who might otherwise be left behind. Among other things, this bill contains the controversial “20 pound amendment” which would allow designated Oregon medical marijuana growers to sell up to 20 pounds of excess flower annually into the OLCC market. It also makes changes to miscellaneous items, like the buffer rule related to schools and cannabis dispensaries.

Cannabis real estateHaving a bank loan on your cannabis property is usually not the greatest business plan. If you already own a property encumbered by a bank loan, commencing cannabis operations is a risky proposition. If you don’t own property but apply for a bank loan on a parcel to grow, process or sell marijuana, the banker will likely send you away in ten seconds or less. In our experience, even equipment loan offerings by small credit unions to cannabis businesses are vanishingly rare.

Because it’s so hard to get institutional financing for cannabis properties, we have facilitated many seller-carried property transactions over the past few years. Those transactions are a breeze when the seller owns the land free and clear. When the seller does not, however, things can get interesting– especially so when the transaction happens anyway. The vehicle for many of these unusual transactions is a wrap-around mortgage.

A wrap-around mortgage (a “piggy-back” or “wrap”) is a junior mortgage where a seller has one or more existing trust deeds on his or her property– typically, with a bank as beneficiary. Together, the seller and pot farmer or processor, or what-have-you, enter into a land sale contract or a promissory note and trust deed. These documents cover the full purchase price, minus whatever earnest money is agreed upon, and minus any down payment. Every month, the buyer pays the seller, and the seller pays the bank. In a classic wrap, the parties agree not to notify the bank of the transfer, although sometimes a memorandum is recorded in the public record. The laws surrounding wraps differ state by state.

Why do sellers like wraps? Because they can be lucrative, especially in the cannabis industry, where land has premium pricing. If the bank loan is at 5%, and the seller is getting 10% or 12% on a junior note, for example, a wrap can be highly profitable. Why do buyers like wraps? Sometimes, it’s the only way for a cannabis business to get a foothold on a property. The big risk here for both buyer and seller is that the bank will cite the trust deed’s “due on sale” clause, wiping out the buyer’s interest, and resulting in foreclosure for seller. With a cannabis wrap, there may be several contractual levers a bank can pull to trigger this clause: the senior mortgagor is permitting “illegal activity” on the property; the senior mortgagor has given a deed to its junior mortgagee; etc.

Wrap mortgages were prevalent in traditional, non-cannabis property loans five to seven years back, especially in residential real estate. This was due to the slowdown in real estate generally and to the scarcity of bank financing at that time. With cannabis—where bank financing is nearly impossible, still—wraps are one of several creative real estate options for entrepreneurs looking to make an industry play.

It is critical for all parties, including attorneys and realtors, to be aware that a wrap mortgage in the cannabis context often involves a seller triggering the due on sale clause in the first lender’s deed of trust. For that reason alone, we generally steer our buyer and seller clients away from wraps. Do our clients always listen? No. Many cannabis businesses and landlords are already taking on mortgage risk, or are determined to do so, by facilitating weed activity on a mortgaged property. And many take heart in the reality that banks are loathe to call loans: banks love getting paid, hate owning property and often ignore the “due on sale” remedy for convenience.

Given the above, we expect to see a continuing stream of wrap-around mortgages on cannabis properties. After all, when your core business activity involves violating federal law, a little extra business risk may not seem so bad.

For more on the unique issues involved with cannabis real estate, check out the following:

Oregon cannabis due diligenceWelcome to the latest installment in our series on Oregon cannabis company acquisitions. In Part I of this series, we wrote about the general deal structures these acquisitions tend to take. In Part II, we wrote about how those structures are outlined at a high level, through term sheets. Today, we offer additional details on a topic we have covered before, for purchasers: due diligence on the target company.

If you are the type of person who enjoys sifting through large stacks of files and correspondence, or more likely, wandering around online in a virtual data room, you will love due diligence. If you are not that type of person, well, you get to do it anyway. The good news is that a corporate cannabis lawyer skilled in acquisitions can start things off with a comprehensive due diligence checklist, and begin looking under rocks on your behalf. Note that the form of checklist provided will vary, depending on whether the acquisition of the cannabis company is an asset purchase agreement, stock sale, merger, or other form of agreement.

Because due diligence occurs after a term sheet is executed, but before an acquisition is final, the due diligence period is the parties’ last big chance to walk away from a deal. On several occasions over the past few years, we have spotted show-stopping issues during the due diligence period, on either side of a transaction. If the issues cannot be fixed, these deals tend to die. Other times, the due diligence period will turn up nothing remarkable at all. And that is what you want, because in the world of due diligence, turning over rocks and finding nothing is progress.

When we covered this topic in March, we wrote that too often cannabis deals involve two sides rushing to complete a transaction without having done adequate due diligence on the potential cannabis company purchase. We offered a top five of due diligence items for purchasers, including some of the big ones: state and local law compliance, state law procedures for ownership changes, corporate authority, real property, and financial liabilities. We recommend you revisit that post, and today offer five more crucial items to look for during the diligence period.

Funky financial statements. Oregon cannabis companies tend to be new companies, and businesses with three or four years worth of financial statements, or even tax returns, are almost unheard of. Many cannabis companies stuff their skinny financial statements with unreasonable assumptions, under-estimates of working capital requirements, misleading margins, etc. If you are not comfortable auditing this type of information, enlist someone who is, and do not be afraid to ask lots of questions as you attempt to read the tea leaves.

Intellectual property. In an ordinary business transaction, a purchaser will be very interested in the target’s intellectual property. In the Oregon cannabis trade, brand power is important, but formally registered IP is less common than in other businesses, given the nature of federal law. That said, do not overlook: trade secrets (particularly for cultivators and processors), state trademark filings, and licensing agreements, to start.

Sales and Clients. Before investing in or purchasing a marijuana producer, processor or wholesale business, a buyer should understand who its top 5 or 10 clients are, whether these clients (who are usually other Oregon cannabis businesses) are loyal to the company, whether their operations will cause fluctuations in company revenues (common with producer clients, for example), and other factors. This means that in addition to doing diligence on the target company, it’s worth looking into the target company’s clients, at least in a cursory way.

Contracts. Like most businesses, a cannabis business will be party to numerous material contracts; and if the target business has no contracts for review, RUN. Types of contracts worth a close look include: customer and supplier contracts, equipment leases, real estate leases and purchase agreements, employment agreements, loans and credit agreements, and non-competes. Internal company contracts are also key, beginning with charter documents like shareholder and operating agreements.

Disclosure Schedules. As a part of any large or mid-sized acquisition, the target company will prepare a disclosure schedule addressing due diligence items, and identifying any exceptions to the representations and warranties requested by the buyer. If you are a target company, this will be the most important and laborious portion of the sale: so, it’s wise to start early, involve key employees and work with an attorney. If you are the buyer, this is the document you will cross-check against everything requested in your due diligence checklist.

If you make it through this vetting period, and are satisfied with what you have seen, congrats! It’s time to close the sale.

business-1320058_960_720Last week, I wrote on Oregon cannabis company acquisitions, and the types of deal structures these transactions tend to follow. I mentioned that before a transaction is consummated, but after discussions have commenced, the purchasing entity will typically discuss its plans with counsel. The lawyer will then draft a letter of intent or a term sheet to present to the target company. If the target company accepts outright, the transaction will proceed. If the target company does not accept outright (more common), it will submit proposed revisions.

Term sheets take many forms, but in a basic sense a term sheet describes the terms of the acquisition at hand. Because each transaction is a snowflake, each term sheet is also unique and must be carefully considered and prepared. Sometimes, the parties will skip the term sheet and simply proceed to the transaction in an attempt at “efficiency.” We strongly advise against this: it invites a substantial risk of misunderstanding as to which documents will follow, and when, and may even cause confusion as to deal points themselves.

Here is a basic list of items for inclusion in any term sheet for an Oregon cannabis company acquisition:

Binding vs. non-binding provisions. As a general concept, a well written term sheet will be organized by binding and non-binding provisions. The binding provisions will include items like non-disclosure, exclusivity, jurisdiction, and choice of law. The non-binding provisions will include the unique deal point items, such as purchase price, payment terms and collateral agreements (e.g. consulting agreement, non-compete, lease or land sale contract, etc.). When a non-binding provision is misplaced into the “binding” category, or vice versa, both buyer and seller can expose themselves to serious legal risk.

Nature of acquisition. The term sheet should clearly lay out whether the transaction is an asset sale, stock sale or merger, and whether the purchase price will be paid via cash, debt, equity swap, or other method. This portion of the document should also detail whether the buyer will proceed in its own name, or through a newly created entity.

Liabilities. In nearly all acquisitions, the purchaser will assume certain liabilities of the seller. These liabilities may include everything under the sun related to seller, or liabilities may be limited to select items, like assignable contracts. If specific liabilities are known at term sheet preparation, they should be listed, perhaps on a separate schedule.

Indemnification. Limitations on both seller and buyer liability can be a heavily negotiated portion of any term sheet. The term sheet should deal with any potential claim that may arise out of the parties’ pending agreements. It should also address claims existing prior to the transaction, the possibility of breaches of representations and warranties, issues of title to assets, tax obligations, employee benefits, claims arising out of marijuana’s status as a controlled substance, etc.

Employment agreements. Every term sheet should deal with the seller’s employees. Will they stay, or will the seller be required to fire them? What happens with regular employees versus executives? When can employees be apprised of the transaction? Failure to address employment can cause serious headaches for both parties.

Conditions to closing (contingencies). This list may be long and varied, and include items from the acquisition of third-party financing, to approvals by the shareholders and/or directors of the purchasing and selling entity. The satisfactory completion of due diligence by the parties is always a crucial item, and in the cannabis context, licensing (see below) is a critical issue.

Marijuana licensing. Like other adult use states, Oregon requires its cannabis companies to maintain state licensure. In certain areas, a local license may also be required. The administrative protocol for changes in license ownership can be complex and time-consuming, and may take on a unique character, depending on the type of acquisition. The licensing update or transfer protocol must be carefully thought through and delineated in the term sheet.

If you made it this far, congratulations; but please note that the above list is not at all exhaustive. There are many nuances to a letter of intent or term sheet beyond the deal points highlighted here. Once a term sheet is negotiated and signed, the parties can move into the formal due diligence phase mentioned above, and ultimately, to closing.

Oregon cannabis In the past six months or so, we have begun to see an increase in consolidation throughout the Oregon marijuana industry. Large companies from other states are moving in, and Oregon companies are buying each other’s assets or stock and integrating to form verticals. In business parlance, we have entered the scaling portion of the inevitable consolidation curve. This development should make for a lively second half of 2017.

Generally speaking, there are three primary structures that acquisitions follow: (1) stock purchase; (2) asset purchase; and (3) merger. Each comes with a raft of legal and tax implications, and each is discussed very briefly below:

  1. Stock purchase. Stock purchases tend to be favored by sellers. In these transactions, the buyer purchases some or all of the seller’s shares (or, in the case of an LLC, its units or membership interests). Sometimes, a buyer will purchase only a majority of the shares, and later force a sale of the remaining shares by statutory short-form merger, or simply as permitted under internal company documents. Unlike a buyer in an asset sale, a buyer of stock is purchasing the target company’s assets and liabilities.
  1. Asset purchase. Asset purchase agreements tend to be favored by buyers. Under an asset purchase agreement, the buyer purchases the seller’s assets and assumes no liabilities, unless the parties agree otherwise. Assets can be both tangible (e.g., inventory and equipment) and intangible (e.g., intellectual property and goodwill), but generally do not include cash. Unlike with a stock purchase, an asset purchase allows the buyer to “step up” the company’s depreciable basis in its assets, within IRS guidelines. From a taxation perspective, that can be crucial.
  1. Merger. In a merger, two entities combine to form one upon the issuance of a “certificate of merger” by the State of Oregon. The surviving company (purchaser) assumes all liabilities and receives all assets of the disappearing company (seller). We have seen fewer mergers in the cannabis space than stock purchases or asset purchases; the exception would be “downstream” mergers where the holding company absorbs its wholly owned subsidiary.

Before a transaction can be consummated, but after discussions have commenced, the purchasing entity will typically discuss its plans with counsel. The attorney will then draft a term sheet or a letter of intent, to present to the target company. Once the parties have negotiated and executed that foundational document, the purchaser will be ready to undertake the time and expense of performing due diligence on the seller and any related parties.

If the due diligence checks out, the purchaser may form a wholly owned subsidiary to purchase the target business, and to further insulate itself from liabilities of the purchased entity. In Oregon cannabis, there are also critical state licensing strictures related to consolidation. Those conversations are important to facilitate early on: in this way, the purchaser will not find itself sitting on unproductive assets after putting a bow on the transaction.

Acquisitions can be an intense process, and the blizzard of documents and disclosures can feel dizzying at times. Ultimately, though, these transactions tend to be memorable experiences for clients and attorneys alike. And in certain instances, an acquisition is crucial for a company to achieve its ultimate goals.

Stay tuned for Part II of this series, where we will discuss the cannabis acquisition term sheet, a critical document in these transactions.