Cannabis Production

So you’ve set your sights on joining the next generation of Oregon cannabis producers. Congratulations! You’ve identified talented growers, you’ve resolved the intractable indoor vs. outdoor cannabis growing dilemma, you’ve saved up some money, and now you are eager to get your cannabis operation up and running.

But what’s next? Your first question is a classic: Where will I grow?

When you apply for an Oregon Liquor Control Commission license, you will need to prove you have a deed or lease to an eligible property. A letter of intent to lease or to purchase will also suffice, but the OLCC will not actually issue the license until you close the lease or sale. You should work with a realtor with experience in the cannabis industry to identify a few possible locations. As you begin your search, remember the following:

Not all counties and cities are alikeOn the most basic level, you need to be aware of the various cities or counties that have banned recreational producers outright. The OLCC maintains a list of these hostile local governments and you may be sad to hear that Grass Valley, Oregon is still off-limits!

Even the cannabis friendly local governments vary significantly in their local requirements, with some counties going to great efforts to be cannabis friendly, and others putting up an unfortunate amount of red tape. An exhaustive county-by-county or city-by-city analysis is beyond the scope of this post and we recommend you speak with cannabis entrepreneurs and professionals who have worked with your top choices for county or city to get a sense of potential local government roadblocks.

Distribution Channels. Though rural land is likely cheaper, your best markets will likely be in the cities. It is never too early to begin cultivating relationships with wholesalers, processors and even retailers to help bridge this gap. Proximity to testing labs is also a plus.

Perform Your Due DiligenceOnce you find a location in a friendly area with room for your operation, you need to ensure that the property complies with all state, county, and municipal requirements and regulations. This can be done by thoroughly reviewing county codes, city comprehensive plans, land use regulations, relevant zoning ordinances, and CC&Rs and, in some cases, talking with the appropriate government officials. You also need to be sure your property has access to adequate water as you will be required to show proof of “water rights,” and adequate power.

Failing to do due diligence on a property can have disastrous consequences. We recently had a cannabis client come to my law firm ready to close on a perfect piece of real estate in a location with a cannabis-friendly local government. This company had even paid for certain improvements to the property, and it was just days away from closing on the property transaction. Fortunately, as soon as we were provided the counties’ records on the property, we noted a provision from the 1980s that prohibited their business. We identified this issue just in time to prevent the purchase and free up our client to move on to greener pastures.

Once you’ve acquired rights to your perfect cannabis property, you are ready to apply for a Land Use Compatibility Statement (LUCS) from the local jurisdiction and to begin preparing the property for the OLCC licensing/inspection process. Check back soon for part 2 of this series.

How to choose your cannabis business lawyerThis blog and our Facebook page (which is nearing 175,000 likes) have given our law firm a national and even a global reach. On top of this, our cannabis attorneys have spoken on cutting edge cannabis legal issues in around half of our states. But we do not have a national cannabis practice. No firm does. To practice law in any given state, the lawyer should be licensed in that state. And though our lawyers are frequently retained by lawyers in states in which we are not licensed, the bulk of our cannabis work is in California, Oregon and Washington, where we have our offices and multiple lawyers with a host of specialized cannabis law expertise.

Yet cannabis businesses constantly contact us for legal help in states where we do not usually practice. We are not the right law firm for a cannabis dispensary in Maryland that needs a lawyer to tell it what must do to operate legally there. We are not the right law firm for a marijuana grower in Alaska that wants to make sure it is complying with local zoning laws. We are not the right law firm for a group that wants legal help in structuring a cannabis investment fund for Nevada. And yet we constantly get calls like these due to the dearth of established cannabis business law firms in most newly legalized states.

When one of our existing clients is seeking the right law firm to represent them in states we don’t cover we help them track down the best firm for them. But when a non-client asks us what law firm they should use in one of those states, we are reluctant to provide names. So we instead usually ask them a few questions about their situation and then we suggest a few things they should consider in choosing the best law firm for their company. This post is intended to answer the question of how to choose the right cannabis law firm for your cannabis business. How should you go about choosing a cannabis business lawyer who is both a good business lawyer and the right lawyer for you?

1. Unless you are a really big company for whom money is almost no object, we recommend you avoid “nationwide” legal behemoths with 100+ attorneys. These firms typically have all sorts of minimum fee requirements and all sorts of hourly billing requirements for their attorneys and these things conspire to drive their legal bills into the stratosphere. Why pay for nationwide legal coverage if you have no plans to operate in Massachusetts, Michigan, Texas and Alaska? But if you know that you will be taking your business into both Michigan and Ohio, it might be a good idea to retain a law firm that covers both states.

2. We recommend you avoid solo practitioners and micro-firms (5 or fewer attorneys) as your only source for all your legal advice because they cannot sufficiently cover and address all of the things required to represent a cannabis business, including the following:

  • Corporate law
  • Contract law
  • Intellectual property law
  • State licensing
  • Local zoning issues
  • Real estate law
  • Intellectual property law
  • Government relations
  • Administrative law
  • Compliance law
  • Employment law
  • Litigation
  • Insurance

3. Avoid law firms that do only cannabis law. How good can a law firm be if it does only one thing and that thing only recently came into existence? If they are now nothing but cannabis law, what were they doing before cannabis became legal? How much experience do they really have with representing companies on complicated business transactions or bet your company litigation matters?

4. Avoid law firms essentially made up of lobbyists and/or criminal defense lawyers. Lobbying lawyers are great for lobbying and criminal lawyers are great if you are facing jail time. But if cannabis is legal in your state and you are looking for a law firm to represent you on your cannabis business or your cannabis litigation matters, you need a law firm with experience handling business and civil (not criminal) litigation matters. You need lawyers who above all else know business law and work exclusively in that realm and lobbyists and criminal lawyers need not apply. Whenever we say this, we get a slew of complaints from lobbyists and criminal lawyers who are trying to make the transition to doing business law.

5. Closely review the credentials of the lawyers at the law firms you are considering. Did they go to top tier law schools? Do they have lawyers from a variety of law schools, not just those local to the law firm? Do their lawyers get plum speaking engagements on cutting edge legal issues? Do their lawyers speak before other lawyers (sorry, but speaking at cannabis conventions and teaching at cannabis “schools” should not count for anything but a demerit)? Do their lawyers speak and write on legal issues relevant to your cannabis business? How do their lawyers rank on various lawyer ranking sites? These sites are not definitive, but they can be a good indicator of the law firm’s reputation among the legal community.

6. Speaking of the legal community, if you know and trust any lawyers in the community in which you are seeking cannabis law help, ask them what lawyer they suggest you use.

7. Make sure you like your lawyer. We know most people don’t “like” lawyers, but because the lawyer you choose now may be your lawyer ten years from now, you really should choose someone who is a good fit for you. This means that before choosing the person or law firm that will be representing your business you should be sure you are comfortable communicating with them. If your gut is telling you not to hire a particular lawyer or law firm, you shouldn’t. If their views on cannabis make you uncomfortable because they are too “corporate” or too zealous or too much or too little anything for you on something important to you, move on. The attorney-client relationship should be built on trust and compatibility, and this is even more important when wading into the murky waters of legalized marijuana.

Choose wisely.

We’ve written previously on options cannabis companies have when seeking financing. Since passage of Proposition 64, investor activity has noticeably picked up in California. It’s not surprising, as California is both the largest projected cannabis marketplace as well as home to roughly half of the country’s venture capital investors.

Cannabis Financing 101
Cannabis Financing 101

How are these investments structured? Below is a list of the more common types of cannabis investments we’re seeing, mostly in California, but in Washington State and in Oregon as well, in rough order of popularity:

Equity Financings. Our firm is doing “priced rounds” in the form of Series A equity financings with multiple investors, as well as individual investors purchasing minority ownership interests in LLCs. Cannabis companies are generally (but not always) preferring to have all investors within California so that they can do an intrastate offering for securities purposes.

Debt Financings. Companies with a track record of success are often preferring debt, as are investors that prefer not to have the exposure that comes with equity ownership. However, uncertainty on licensure processes and the timing when companies can fully operate has made payment schedules particularly risky for companies counting on revenues to pay back loans.

Convertible Notes. Convertible debt is traditionally used pre-Series A when a company is developing a product and still determining the size of the opportunity. A Convertible Note corrects for the difficulty in determining valuation at such an early stage by kicking the valuation can down the road to the Series A, but ensuring the investor gets at least as much value (and almost always more value) for their invested dollar, compared to the Series A investor. Typically notes have low interest rates, as investors are seeking equity upon conversion rather than by repayment.

For cannabis companies in California, convertible notes are taking on a new purpose: extending the question of valuation until 2018, when more will be known about the state’s cannabis regulatory regime. Conversion that is not automatic, but rather the option of the investor, also gives the investor an “out” should the investor not like the political climate around cannabis in 2018.

A slight variation on a convertible note is a “debtquity” arrangement where an investor provides a line of credit with a sliding scale of equity issuance based on the amount of capital accessed.

Alternative Financing Arrangements. Cannabis companies are proposing some non-traditional financing structures, such as investment via equipment leases, consulting arrangements, turn-key real estate, or investor-funded capital improvements. These are often a product of investor preferences or investor residency restrictions. Though these alternative financing arrangments are sometimes trickier for the lawyers to structure than a traditional investment, they often make for a good vehicle to provide cannabis companies with key resources needed at an early stage.

 

 

Cannabis securitiesLike tech startups, or any new business, cannabis startups need investment. Though most tech startups are organized as corporations, with the ultimate goal of acquisition or IPO, cannabis businesses are more often (but not always) organized as LLCs. But cannabis startups too often fail to realize that if they are seeking investors, they are probably selling securities.

Tech startups begrudgingly accept that compliance with securities laws are a fact of business life. With each financing, their attorney tells them: utilize a securities exemption or register the securities.

LLC membership interests, however, don’t fit into the common perception of the term “security.” Even many attorneys wrongly believe that securities are limited to stocks, bonds, and the like, and that a minority stake in an LLC is not an investment in securities.

In 2008, the case of US v. Leonard defined when a membership interest constitutes an “investment contract” — “a contract, transaction or scheme whereby a person invests his money in a common enterprise and is led to expect profits solely from the efforts of the promoter or a third party.” The court wrestled with extending the definition to LLC membership interests but concluded that LLC interests require a “case-by-case analysis” into the “economic realities” of the underlying transaction.

In short, the investor must “exercise meaningful control over his investment.” The touchstone of what constitutes a security is not the form of investment, but rather whether or not it is a “passive investment.” If the investment requires active management engagement by the investor, it is not a security. But if it is a passive investment where the investor relies on others to run the business, it is a security.

Investors often have the right to give input into management decisions but do not ever actually exercise this right. The trend in securities regulation is to look beyond the terms of the agreement to analyze the practical realities. Cannabis businesses should be aware that in US v. Leonard, the individuals were convicted of securities fraud and went to prison.

The big takeaway is that businesses can choose to have all investors as active member-managers, and thus can plan around (and draft their operating agreement around) the need for securities compliance. The following are some practical points to ensure that your investors are “active member-managers” rather than “passive investors”:

  • Investors have voting rights in the LLC operating agreement, and exercise those rights in practice.
  • Investors have a management role and are “actively engaged” – they can have titles or membership on committees tasked with certain aspects of business operations.
  • Investors have input into and negotiate the terms of the LLC agreement.
  • Investors have full information rights, and actually receive and approve reports regularly.
  • Investors have input on key company strategic decisions – major decisions are made after consultation with investors.

Ensuring that your investors have an active, participatory role in management allows you to avoid entirely having to deal with securities law. When choosing your investors, you can help yourself in this context by seeking out investors that, in addition to money, have experience in the cannabis industry or in management so they can provide a value-add to your business.

Of course, this type of active management role won’t be acceptable to investors in every circumstance. As the number of cannabis investors grows and becomes more geographically diverse, however, the more likely they are to be considered “passive.” Marijuana businesses must understand that taking on passive investors means it’s time for securities compliance. At that point your attorney should be telling you to utilize a securities exemption and make the appropriate filing, or register the securities.

California cannabis businesses may recognize “management control” from California’s recently-released proposed regulations. We’ve written about these here and here. The regulations define as an “owner” any person who participates in the “direction, control, or management” of the cannabis business. Individuals having management rights will need to be disclosed to and vetted by state regulators in license application processes. Therefore, securities compliance and cannabis regulatory compliance are now two sides of a coin. Investors either lack management rights, meaning they are passive investors and securities compliance is required. Or investors have management rights, meaning they are “owners” and disclosure to cannabis regulators is required.

Cannabis businessLast week, I spoke at a legal education event on advising corporate and officers and directors. It wasn’t a cannabis-specific event, so there were speakers with various backgrounds. One interesting commonality that a few of the speakers discussed was the value of corporate mission statements, both in the for-profit and non-profit worlds. I don’t know of many cannabis businesses that have mission statements, but I am convinced they can be useful grounding forces for growing businesses.

A good mission statement strives to capture in as few words as possible the essence of your business’s goals and underlying philosophies. A business with a well-crafted mission statement can align its various owners, officers, directors, and employees toward the same objectives. By providing an underlying ethic, it can assist various team members in their decision-making. Standard operating policies and procedures help, but they are never exhaustive. Business representatives need to make their own decisions. A mission statement and a body of practice that backs up the core values underpinning the mission statement provides a framework for your decision-making processes. And for a business that is getting off-track, a mission statement provides a clear target for changes. Business shifts and realignments without a clear mission statement can feel aimless and scattershot — the mission statement gives business team members stability when business decisions are clearly focused on a specific goal.

A company’s first step, then, is to determine its goals and philosophies. A company cannot just say, “We want to sell as much pot as possible for as much money as we can get.” Of course, most for-profit businesses seek to generate profits and wealth for the owners. Every business owner wants that, though, and profit-generation is less of an achievable goal and more of an effect of achieving your goals. A mission statement should tie your company’s brand identity with its ethics, and it should provide a roadmap on how to achieve high revenues and profits. Here are a few examples, both good and bad:

  • Amazon: To be Earth’s most customer-centric company, where customers can find and discover anything they may want to buy online, and endeavors to offer its customer the lowest possible prices.
  • Kickstarter: To bring creative projects to life.
  • Sony: To be a company that inspires and fulfills your curiosity.
  • Starbucks: Establish Starbucks as the premier purveyor of the finest coffee in the world while maintaining our uncompromising principles as we grow.
  • Hyatt: To provide authentic hospitality by making a difference in the lives of people we touch every day.
  • USAA: To facilitate the financial security of its members, associates, and their families through provision of a full range of highly competitive financial products and services; in doing so, USAA seeks to be the provider of choice for the military community.

You can judge yourself which of these you think are useful and which aren’t. Some corporate mission statements serve primarily as public-facing advertising mottos. But for most businesses, especially small and growing businesses, the most effective statements drive internal decision-making. Amazon’s statement, for instance, hones in well on the company’s core goals and philosophies. If I work as a mid-level manager at Amazon, the mission statement provides gives me a clear framework for judging my decisions.

I hate corporate speak. Many companies try to organize their missions around statements that lack any real substance or underlying ethic. Mission statements that fall into that category have little to no value. But if you can distill your company’s strategy to obtain and keep customers while getting the most out of your employees, a substantive mission statement can focus your energy toward achieving your goals.

Cannabis business ownership lawsMany marijuana businesses include one or more people in their ownership group that contributed “sweat equity” to their business, rather than cash or other valuable assets. Because of the level of state regulations, even small cannabis businesses typically require a lot of capital to start. Many experienced entrepreneurs have had to team up with investors to get their cannabis businesses off the ground. Many other people looking to start cannabis businesses have had to entice experienced growers to help set up their facilities by offering equity in lieu of or in addition to salary.

But working relationships don’t always last. Whether it be for poor performance or for more serious issues (violating state regulations, stealing from the company, etc.), cannabis companies often find themselves wanting to part ways with senior employees that also have an ownership interest in the company.

For large publicly traded companies, this is no big deal because they can easily terminate employees that have received stock — even a large amount of stock. All the company must do is finalize the termination, stop paying salary, and determine whether there are any stock options or grants subject to a vesting schedule that need to be finalized. Then, the company and the employee simply go their separate ways. There is no reason for a large publicly traded company to worry about the stock already issued, as it is likely only a minute fraction of the company’s overall capitalization.

For small, closely held companies, however, stock grants and LLC membership interests held by employees can be far more complicated. The employment relationship and the ownership relationship tend to intermingle, especially if the owner/employee was also one of the company’s founders. Depending on the size of the ownership group, even a 10% share of the voting ownership interest can be significant and can handcuff owners trying to bring on more capital in the future while also trying to retain a voting majority.

First, it is important to decouple the ownership interest from the employment relationship. For businesses that are taxed as corporations (subchapter C or S), owner/employees likely receive a significant part of their compensation as standard W-2 employees. For businesses taxed as partnerships (how most multi-member LLCs are taxed), the employment portion of income is likely categorized as a guaranteed payment. Regardless, this is the issue that should be dealt with first. Company owners with work obligations should be treated like employees for purposes of those obligations. The company should set expectations for employment, and best practice is to have a written employment agreement specifically drafted for the owner/employee scenario. That employment agreement, or the LLC operating agreement or shareholder’s agreement, should determine who can decide to terminate an owner/employee. The decision will need to be made by a majority of either the company’s managers, members, directors, or stockholders. There is no cookie-cutter answer on how to do this as every situation is different.

Once the employment situation is handled, the next issue is what to do with the lingering ownership interest in the cannabis business. Inexperienced business owners that gave away equity as compensation too often treat it as something more temporary than it is. There are mechanisms to provide a worker with profit-sharing so long as that person is working, only for that profit-share to disappear when the person is no longer working for the company. But that is something different than standard ownership of stock or membership interests, which we see far more often. There is a property right in the stock or the LLC membership interest, and it isn’t just going to disappear.

One option is to let the departed employee keep the stock or membership interest. If there is no pressing need, there is nothing inherently wrong with having a former employee continue to have an ownership interest in your cannabis company. They are still entitled to their vote and to their distribution of profits, but that does not mean they need to play a day to day role in company business.

But for cannabis companies looking for a clean break, their easiest option is to have an agreement, either in the LLC operating agreement or in the corporation’s shareholders agreement, providing the company with a buyout option for owners that no longer work for the company. Making it optional helps the company if it does not want to be forced to make a significant cash payment, but the employee would likely want the buyout to be mandatory. The value can either be set by a mathematical formula or the agreement can refer to a third party appraiser. The payment terms are set, and the company is able to buy out the owner/employee.

The important thing is that this is something that needs to be laid out ahead of time. If there is no buyout mechanism in an LLC operating agreement, there is no automatic right under most states’ LLC laws to remove individual LLC members. It is to both the company’s and the owner/employee’s benefit to figure this out up front when negotiating the original hiring. Once termination has started, it can be really hard for the cannabis company and the owner/employee being terminated to cooperate. If you set up from the outset what a break-up will look like both parties will have an easier time dealing with the change and moving on.

Buying and selling cannabis businesses We like to blog about buying and selling pot businesses. It’s a rich topic and the transactions can be memorable for both entrepreneurs and attorneys. In our recent posts, we have canvassed subjects from diligence items for buyers to checklist items for sellers. We also have covered important transactional topics such as how much your cannabis business may be worth and what you can actually sell. Today’s entry covers a structural part of many business sale agreements: the earn-out.

An earn-out is a contractual provision that entitles a seller to additional compensation in the future, if the business achieves stated financial goals. Earn-outs are used when the asking price for a business is more than a buyer is willing or able to pay up front. A well drawn earn-out can bridge the valuation gap between an optimistic seller (pretty much all of them) and a skeptical, cash-strapped, buyer (just some of them). It can also provide a buyer with additional financing. In an industry where hard money is the rule and bank loans are not available, that can be compelling.

The primary objective in an earn-out is to allow the buyer to make payments over time. The earn-out may also require the seller to step into a consulting role post-sale, and actually “earn” the post-transaction payments. In those cases, it is important to clearly outline the parties’ expectations. This scenario makes for a less clean break, but sometimes a seller has invaluable expertise and experience—particularly in a local marijuana market—that can be passed along with the sale.

In addition to seller support, there are many factors to consider in negotiating an earn-out agreement. Five important ones include: (1) the earn-out period; (2) payment structure; (3) payment schedule; (4) performance matrices; and (5) accounting standards. Earn-out payments may also be capped or uncapped, and the parties can stipulate that future events (like federal enforcement action, for example) will offset earn-out payments. Depending on the type and size of the deal, and the parties’ personalities, an earn-out can be simple or extremely complex.

If the goal is to keep things simple from both a payment and audit perspective, the parties will choose an easy-to-peg accounting and payment metric. For example, sellers often suggest an earn-out based on sales, because this line item is never disputed and the calculation is simple. A buyer, on the other hand, may push for an earn-out based on net income, as this metric accounts for all nuances of a business’ operations. A middle road would peg the earn-out at a multiple of EBITDA, usually over a certain number and in each relevant year. Ultimately, simpler calculations mean fewer disputes.

Given the nature of federal law, the earn-out metric for a pot business must also consider factors mainline businesses needn’t entertain. One of these is the oppressive effect of IRC 280E, the tax code provision that cuts into marijuana business profits. Another is licensing implications at play in the relevant state: readers of this blog know that states have strict rules on who can hold a financial interest in a pot business, and how that interest may be postured.

At the end of the day, many deals in the cannabis industry are structured to account for a lack of institutional financing. Like the marijuana sale-and-leaseback or the ubiquitous seller carry, an earn-out may be a way for a cash-light market entrant to gain a toehold in state-legal cannabis. We expect that earn-outs will remain an attractive option for the industry until things change at the federal level. Given the current shape of things, that could be a while.

Happy 4/20.

China counterfeit lawyers
There are a lot of fakes out there, in the cannabis industry too.

As we’ve previously written, my law firm, which does considerable international trade and China law work in addition to our regulated substances practice, has on all fronts been getting an influx of clients complaining about counterfeit cannabis goods and seeking our help in dealing with the problem. The problem of counterfeit goods in the cannabis industry has only continued to grow over the last year.

I was interviewed earlier this year about the lawsuits brought by Roor pipes against nearly 200 smoke shops and convenience stores, alleging those stores are selling counterfeit Roor bongs in violation of Roor’s U.S. federal trademark registration. Though those lawsuits may be on uncertain ground from a federal trademark law perspective, Grenco Science, maker of the G-Pen brand vaporizer, recently found success in federal court against counterfeiters.

Earlier this year, Grenco sued more than 65 different online retailers for selling counterfeit G-Pen products. Most of the offending companies were based in China, which is consistent with the majority of the counterfeit cases my firm handles. Some of the lawsuits settled out of court, but many of the Chinese companies failed to respond to Grenco’s complaints filed in court – also a common occurrence when trying to pin down a Chinese company in U.S. court. In light of this, a federal judge in Illinois granted Grenco $47 million in damages, which equates to $1 million from each of the 47 companies found to have infringed Grenco’s federal trademarks, as well as injunctions against each of the companies ordering them to cease sales of the counterfeit goods.

Of course, getting a judgment against a Chinese company for trademark infringement is only half the battle – Collecting on these judgments is another matter. Oftentimes, U.S. judgments against Chinese companies are worth very little. A U.S. judgment against a Chinese company can lead to collection, but for that to occur, one must know about the operations of the Chinese company and one must be prepared to be legally creative in figuring out how and where to act in using the U.S. judgment to go after the Chinese company’s assets.  We’ve written extensively about this process on our firm’s China Law Blog, and you can read more about it here and here.

Given the difficulty in enforcing these judgments it is critical that you as a business owner take preventative steps to ward off counterfeiters, and to know what to do in the unfortunate event someone does counterfeit one of your goods. And as we tell all our clients: investing in these preventative steps now is always way less expensive than fighting a legal battle (and trying to enforce a judgment) in court down the road.

So what preventative steps should cannabis businesses take to address counterfeiting? Prevention hinges on first identifying your intellectual property (IP), determining what categories it falls into, and then protecting it accordingly in the relevant jurisdictions. The design of a novel device like a water pipe, for example, could be subject to patent protection. Though we’ve blogged extensively about the difficulty in obtaining federal cannabis trademarks, federal patent law does not contain the same “legal use in commerce” requirement, or a prohibition on “immoral or scandalous” matter. A patent is the grant of a property right to the inventor, issued by the United States Patent and Trademark Office (USPTO), and this property right gives the inventor “the right to exclude others from making, using, offering for sale, or selling the invention in the United States or importing the invention into the United States.” Patents are often the most powerful tool in fighting counterfeit goods.

Patent infringement is not the only way counterfeiters can rip off products. Oftentimes, when talking about counterfeits, we’re talking about trademark infringement (as in the G-Pen and Roor cases) rather than patent infringement. A counterfeiter could, for example, slap your logo on its vape pen, exploiting the goodwill and notoriety you’ve established through your brand. Of course, the best way to prevent trademark infringement is to register your trademark with the USPTO. Though it is not possible to obtain a federal trademark for use on goods that violate the Controlled Substances Act (CSA), it is often possible to obtain trademark protection for goods that do not violate the CSA, like many smokers’ accessories. A trademark gives the owner the exclusive right to use their mark on the specified goods in commerce, and it gives the owner a right to seek remedy in federal court in the event of infringement.

If you are having your products manufactured in China (or anywhere else overseas), as is the case these days with so many of our clients, you need to protect your IP there as well. Because if you don’t register your trademark or your design patent in China, someone else almost certainly will and then that someone else will be able to stop your products from leaving China because those products violate their intellectual property! For more on this, check out China: Do Just ONE Thing: Register Your Trademarks AND Your Design Patents, Part 1 and China: Do Just ONE Thing: Register Your Trademarks AND Your Design Patents, Part 2. You should also check out Your China Factory as your Toughest Competitor for the contractual steps you need to take to prevent your own manufacturer in China from selling your product worldwide, and likely at prices far lower than you can ever match.

But logistically, how does enforcing your IP rights against counterfeiters play out? Typically, it doesn’t make sense to take the alleged infringer straight to court. Litigation is expensive, and there is often room to negotiate. When you know who the infringing party is, your attorney can contact them with a cease and desist letter directly. But when the party is, for example, a third party seller on a larger platform like Amazon or Alibaba, tracking down the infringer is much more difficult. See also China Counterfeiting: 8 Common Myths and Alibaba and Small Business Owners.

The protocol for dealing with online retail platforms in taking down counterfeit goods will vary depending on the company. With every online retail platform with which our lawyers have worked (be they in the United States or in China), the process is expedited greatly when our client alleging a counterfeit is able to offer up proof of its own IP rights. This is particularly true with trademarks, where infringement is often apparent, and the retail platform can quickly decide to suspend a counterfeiter’s account. Without verifiable IP rights, the retail platform is put in a difficult position of having to figure out who has the right to sell what. This involves complicated legal analysis, and takes substantial time and resources, as well as back-and-forth with both parties. In the meantime, you’re likely losing business. See How To Remove Counterfeits From Alibaba.

So the lesson here is two-fold. First, make sure you’ve identified your intellectual property and that you’ve taken every step possible to register and protect it. Second, if you suspect a company is selling a counterfeit of your product, contact your attorney immediately and develop a strategy for blocking the counterfeit sales, whether through direct communication with the counterfeiter, or by working with the relevant online retail platform. There is often much that can be done to stop a counterfeiter before resorting to filing a lawsuit, and ending up with potentially un-collectable judgment.

Cannabis credit cards

Because of federal prohibition, marijuana businesses have limited access to financial services. Distributing cannabis is a federal crime and proceeds from cannabis sales trigger anti-money laundering laws. The Bank Secrecy Act requires banks combat fraud and money laundering and protect against criminal activity. This Act mandates banks investigate their customers for criminal activity and it prohibits banks from doing business with bad actors. Additional banking laws also require national banks file Suspicious Activity Reports (SARs) with the federal government when they know or suspect an account holder is engaged in or trying to cover up illegal activity.

Yesterday, I participated on an educational panel entitled, “The Marijuana Industry & Financial Services: What’s Happening? What’s in Store?” at the American Bar Associations’ Business Law Section Meeting in New Orleans. This panel was co-sponsored by the ABA’s Credit Card Committee, highlighting how important the banking and financial services issues are to both the cannabis industry and to the financial services industry. Federal cannabis prohibition has been hugely costly to the cannabis industry and its customers and to the financial services industry as well, not to mention the massive public safety issues engendered by having to work in an all-cash business.

Federal banking laws kept most banks and credit unions from knowingly working with marijuana businesses until February 2014, when the Financial Crimes Enforcement Network (FinCEN) and the Department of Treasury issued guidelines for financial institutions that want to bank cannabis businesses. These guidelines require banks and credit unions vet their marijuana business customers and regularly report their marijuana customers’ activities to the federal government to ensure compliance with the 2013 Cole Memo.

Though the FinCEN guidelines address getting a bank account (and thoughseveral U.S. Senators have asked for increased guidance from FinCEN regarding banking marijuana ancillary businesses), there are no federal guidelines regarding credit card usage in the cannabis industry, and so none of the big credit card networks (Visa, MasterCard, American Express, Discover) allow their cards to be used for buying or selling of cannabis. This means that even if a marijuana retailer manages to open and maintain a bank account, it likely has no way to accept credit card payments and cannabis customers still typically pay in cash to purchase marijuana products. Even the FinCEN guidelines don’t completely alleviate the cash issue as a result.

These cash payment issues have forced marijuana retailers to employ alternative payment processing methods, such as cashless ATMs, third party payment programs, and bitcoin. These non-bank financial services address many of the problems that arise from running a cash-only business, but they also come with their own set of challenges. Just by way of one example, my law firm’s cannabis business lawyers have handled many cases where banks stopped paying third party payment processors,  resulting in our clients (the cannabis businesses, themselves) not getting paid. No alternative payment service matches traditional credit cards on safety, costs or ease of use. Unless and until cannabis becomes federally legal, cannabis businesses and their customers will still need to employ credit card workarounds (for better or worse).

For more on cannabis and the banking industry, check out our following posts on this topic:

 

Cannabis business lawyersIn a multitude of marijuana-regulated states, certain individuals and companies cannot own or even finance a marijuana business due to state regulations on residency and criminal and financial background checks. This means the cannabis business lawyers at my firm often get clients interested in getting involved with an ancillary cannabis business so as to avoid these heavy regulations.

Whether it is technology, real property development, or consulting,  how you structure your services or licensing agreement can control whether the ancillary company violates applicable state marijuana regulations. And marijuana equipment leases are no different. Done right, leasing expensive equipment to marijuana producers and processors is a great way to service state licensed marijuana businesses without violating state rules. However, just like real property lease agreements, garden variety off the shelf boilerplate marijuana equipment lease agreements will not cut it in the cannabis space. So here’s what you need to know when leasing equipment to a licensed or permitted marijuana business in a heavily regulated marijuana state:

  1. Marijuana Regulations: How the Lessor Gets Paid. Every equipment lease agreement must be structured so as not to violate applicable marijuana rules in a given state. This usually means the lease agreement must clearly address how the lessor will get paid and that payment plan cannot violate state law. In a number of states, if the lessor takes an equity interest in the marijuana company in exchange for lease payments, or if the lessor is entitled to receive net or gross profit from the marijuana business, or if the lessor’s equipment lease payments hinge on the marijuana business’s financial performance or harvest or manufacturing yield, the lessor must be disclosed to and vetted by the relevant government agency. Most states require a fixed fee for rental payments and anything different will likely lead the state to believe the lessor is really a hidden profit sharer. The higher the lease payments, the more likely regulators are to think there’s some unlawful profit sharing taking place. Be sure you can defend your above-market-rate charges.
  2. Marijuana Regulations: Lessor Control Over the Marijuana Company. In addition to lease equipment payments, state regulators also want to know and approve of any person or company exercising any control over the marijuana company. States don’t usually fully define what constitutes an impermissible level of control, but you can assume the definition will be fairly broad and will be analyzed on a case by case basis. In the context of an equipment lease, an impermissible control provision would be the lessor restricting the marijuana business from renting equipment from another equipment lessor. And if the lessor wants to throw in some consulting services as a supplement to leasing the equipment, the lessor’s control over the staff of the marijuana business regarding the use of the equipment may also create a control violation if lessor oversight goes too far.
  3. Marijuana Regulations: Contract Rules. As an equipment lessor, you have to make sure your lease doesn’t violate any applicable state law contract rules. For example, in Washington State, the term of the contract cannot be indefinite — it needs a termination date. This stems from state regulations prohibiting third parties from locking marijuana businesses in too long to term contracts that could create “undue influence” over the licensee. We constantly see equipment leases that violate this simple rule.
  4. Security Interests. Make sure your security interest in your equipment is valid. In most states, state regulators should have no issue with a lessor’s security intern est in its equipment. However, if the lessor tries to maintain a security interest in marijuana inventory or ithe licensed business itself, it is going to have a control problem. State receivership proceedings may be another collection option, but you need to make sure that’s a realistic scenario in your state and that your equipment lease carefully details how that will happen.
  5. Defaults. The rules governing cannabis businesses are unpredictable and ever-changing and this means you as the lessor must stay on top of the rules and make sure you remain in compliance with them. This also means your equipment lease needs to account for very specific events of default that should include the marijuana business having to maintain good standing with regulators and any permissible appeal/cure period if the marijuana business is hit with a marijuana regulation violation that carries shutdown or crippling fines as penalties.
  6. Access to the Equipment. You can’t just come and check up on your equipment whenever you want. All states control physical access to the marijuana business itself, so be sure your equipment lease takes that into account. Most times, you’re going to have to consent to applicable security procedures, including scheduled visits, the donning of ID badges, and being escorted at all times by an employee of the marijuana business.
  7. Disputes and Repossession of Equipment. Because many marijuana businesses fail in their first year, you need to be ready for the eventuality of a default on your equipment lease. Your contract should include the right laws and the right venue for your dispute. Since marijuana is still federally illegal, you should consider private mediation and/or arbitration of your disputes and you should ensure that any court filings go through state court, which is more likely to recognize and honor your equipment lease than would a federal court. We sometimes use provisions mandating state court and prohibiting removal to federal court. You’ll also want to give yourself an easy route to repossess the equipment, so don’t ignore the benefit of providing for self-help repossession methods in your equipment lease agreement, so long as they don’t violate applicable marijuana rules.

Just as is true of cannabis commercial property leases, your cannabis equipment leases need to account for all sorts of cannabis-specific situations.