TIPSA couple of years ago, I wrote on this blog that we are never not litigating cannabis disputes. As a direct result, we have written dozens of articles on the subject. This year and next, as the adult use market expands into key states like California, the sheer number of cannabis businesses coming online will result in a further expansion of contested matters. We wish that were not the case, but we have been staffing up our Oregon, Washington and California office with litigators, partly in response to growing demand for cannabis dispute resolution services.

Some cannabis business disputes are short and sweet; others protracted and difficult. Common sense would dictate, and we have always found, that the more efficient and disciplined a litigant is, the better the result, from both a cost and results perspective. The most efficient litigants are those who work closely with counsel to take responsibility for their case, set a goal at the outset, and keep that goal in mind throughout the process.

Here are five tips for working with an attorney to resolve a cannabis business dispute.

Hire the right attorneyAs much as we hate to say it, it is easy to hire poorly in the context of cannabis disputes, for a couple of reasons. First, many lawyers who work in this industry come from a criminal law background and rode the wave into legalization. Much like a business attorney would struggle in drug court, attorneys who lack business law experience are ill equipped to handle corporate cannabis beefs. Second, many good business litigators are still unwilling to service the industry, given the status of federal law. And third, many business litigation firms that do wish to work with the industry are new to cannabis law and its steep learning curve. Most cannabis disputes have significant underpinnings of state and local administrative law and policy. These rules run into the several hundreds of pages, are constantly evolving, and generally are supplemented by unwritten agency policies. Even the brightest non-industry lawyers incur significant time and client expense just getting up to speed.

Be Organized. The most critical client-side component to any litigation is organization. When you hire a lawyer, assemble any and all relevant materials in one place (contracts, emails, voicemails, texts, etc.), and transmit these materials in aggregate to the attorney. Supplement them, if you can, by a chronology and/or written summary of your case. This will save the attorney significant time and energy in assembling the facts of your dispute, and will result in less back-and-forth from the attorney attempting to elicit information he or she may need for your case.

Put all of your cards on the table. Don’t shield any information from your attorney that you find embarrassing, or that you think is less compelling than other facts, or that you feel may damage your case. You should feel incentivized to pass along anything relevant, or even possibly relevant, for four primary reasons: (1) everything you pass along will be protected by the attorney-client privilege; (2) anything damaging will almost certainly come out at depositions or elsewhere in the discovery process, anyway, and is best dealt with beforehand; (3) when an attorney lines up the facts of your case with the legal elements of potential claims, minor facts, which you may not find compelling, tend to come out of the woodwork and play a significant role; and (4) trust us, we have seen worse.

Step back. Throughout the arc of any litigation, there will be a volley of correspondence, filings and other developments between the parties – shots across the bow. When a development occurs, you may feel a very strong urge to immediately pick up the phone and offer an extended hot take on the latest item. Most of the time, these conversations are less productive than if both litigant and attorney allow the new information to percolate in advance of a structured conversation. The one exception here is any development that truly requires immediate action, and those developments are rarer than many people think. We realize that stepping back is easier said than done, but taking a measured approach throughout the arc of a contest preserves energy and controls costs. Think of litigation as a marathon, not a sprint.

Be Realistic. As attorneys, we like to think we excel at getting efficient, advantageous results for our clients. And we generally do, within the realm of the possible. For example, we may be able to recover your costs or attorney fees in litigation, but only if you have a contractual or statutory basis for doing so. Similarly, we may be able to resolve a dispute with a strong letter or a well-written complaint, but only if the other side is acting rationally. Understanding the strengths and weaknesses of your position will lead to a realistic appreciation of the gamut of possible outcomes. At that point, you and your lawyer can maximize every tool at your disposal to pursue, and attain, the best possible result.

 

Cannabis attorneysThe owners of a vineyard in Yamhill County, Oregon, filed a lawsuit in April to block a neighboring property owner from using his land to grow and process cannabis. The plaintiffs alleged that the odor and runoff from the cannabis farm will negatively affect their grapes and claim to have already lost one buyer. Another neighbor, who has plans to turn its property into a vineyard as well, has joined the lawsuit.

The case is interesting because it is in response to a novel fact situation that has not been the subject of much real-world study or legal precedent.

The idea that the odor of cannabis plants could materially alter the quality of grapes in an adjacent parcel of land is a significant divergence from more typical odor-related lawsuits that allege a neighbor’s cannabis activities create a nuisance. Those lawsuits have sometimes succeeded, but in this instance the trier of fact will need to determine whether there actually is an impact on the grapes. Though the plaintiffs say they have already lost a buyer, it is unclear whether that was because the buyer speculated there could be an impact on the grapes or whether there was in fact such an impact. The case has not gotten far enough along for discovery to reveal exactly what kind of evidence the plaintiffs actually have.

As for the cannabis farm owner, he states that he can grow cannabis on his property without seeking permission because it is zoned for that kind of agricultural use and because he is following all rules and regulations. He also asserts that he uses cannabis processing techniques to minimize the smell from his property.

Depending on the results of this case, the issue of adjacent cannabis farms and wine vineyards may be an issue for the Oregon state legislature. Both the cannabis and wine industries are important components of Oregon’s economy and there is significant overlap between locations.

The lawsuit was filed in Yamhill County earlier this week so there is a long way to go for it to reach resolution. If it goes to trial, the court’s reasoning when it comes to the interaction between the two crops and the relationship with their owners’ property and economic rights could be instructive for similar conflicts in the future. We will keep an eye on this case and update you as the lawsuit progresses.

Oregon cannabis laws

We recently discussed proposed legislation to prevent Oregon marijuana retailers from recording, retaining, or transferring any information “that may be used to identify a consumer,” such as a consumer’s name, birthday or address. Some marijuana retailers had been collecting and storing this information for marketing purposes, often without their customers’ knowledge. The Oregon legislature was concerned that this practice would create a paper trail the federal government could use against cannabis consumers in a federal crackdown on recreational marijuana.

As we predicted, the legislature moved quickly. Yesterday, Oregon Governor Kate Brown signed SB 863 into law less than two months after the bill was introduced. In a strong signal to Oregon’s marijuana businesses and consumers, the bill enjoyed broad bipartisan support and passed the Oregon Senate by a vote of 21-6 and the Oregon House by a margin of 53-5. The bill requires all Oregon recreational marijuana retailers to destroy existing customer personal information within 30 days and it prevents cannabis retailers from collecting personal information in the future without the customers’ informed consent.

The bill is an explicit response to the Trump administration’s recent comments calling for a crackdown on the recreational marijuana industry and it is widely viewed as part of Governor Brown’s commitment to protect Oregon’s marijuana consumers from federal intervention or harm. SB 863’s streamlined journey from bill to law was helped by Section 4 of the bill, which declared that the Trump administration’s regressive statements regarding marijuana legalization have created a state of emergency requiring immediate action to preserve the public peace, health and safety.

Oregon’s consumers can now rest a bit easier, knowing their local retailer will not be maintaining a database of personal information to which an unfriendly federal government may someday have access.

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.

Oakland cannabis regulationsTuesday night, in a continuation of more than ten months of contentious debate and revisions, the Oakland City Council revisited and reargued the terms of its yet-to-be-implemented Equity Permit program for cannabis businesses. The program aims to address inequity in the local cannabis industry by prioritizing permit issuance to those with roots in certain identified Oakland neighborhoods that have been historically impacted by disproportionate drug law enforcement, and to members of the Oakland community that have been arrested and convicted of cannabis crimes in Oakland in the last 20 years. The law moves qualifying Equity Applicants to the front of the cannabis permitting line, and it also creates access to approximately $3.4 million in earmarked interest-free business loans and other assistance.

The law was first introduced in May 2016, but in response to community concern about how it might affect the local economy, the City Council commissioned an extensive race and equity analysis of medical cannabis regulations and scheduled another vote for early 2017. Among the most jarring of the City Council’s findings was that over the past 20 years, African Americans, particularly those living within certain Oakland police beats, have been dramatically and consistently overrepresented in cannabis-related arrests, reaching as high as 90% of all cannabis arrests in the late nineties.

Two weeks ago, the Oakland City Council approved a last-minute amendment to the program mandating that any general (non-Equity) applicant must have lived in Oakland for at least three years to get a cannabis business permit. Because Equity Applicants must already demonstrate residency and a past connection with Oakland, this amendment would have effectively placed a residency restriction on all new or existing cannabis businesses. After a motion passed 6-2 Tuesday night removing the residency requirement for general applicants, the current version (which still requires another Council vote to become law) provides that, when issuing permits for any kind of cannabis business, the City must give half (i.e. maintain a 1-to-1 ratio) of all permits issued in its initial issuance phase to “Equity Applicants,” defined as Oakland residents with an annual income at or less than 80% of the City average and who either lived in certain defined Oakland police beats for 10 of the last 20 years, or who have been convicted of a cannabis crime committed in Oakland within the last 20 years. Tuesday night’s motion also requires dispensary staff be at least 50% Oakland residents with at least half of those residents from areas identified as having high unemployment or low household incomes.

Though Oakland’s Equity Permit program has garnered praise for its stated policies and goals, it also has generated controversy—as illustrated by the lively hearing Tuesday night—particularly due to its now-withdrawn general residency requirement. Some questioned its efficacy in achieving the City’s goals, while others argued that it would benefit the City by requiring that Oakland cannabis business permits go only to those living in Oakland. The proposed residency requirement would have jeopardized any existing cannabis businesses that could not meet the residency requirement, regardless of how many jobs or how much tax revenue those entities were contributing to the local economy.

Though it is unclear what the ordinance will look like in its final form, and though the residency requirements were relaxed by Tuesday night’s revision, a residency requirement remains for Equity Applicants and dispensary staff. Because the City of Oakland intends to issue only eight cannabis dispensary licenses per year (excluding delivery-only operations), an aggrieved party may challenge the ordinance for favoring longtime residents of certain Oakland neighborhoods at the expense of newer Oakland residents and those living in other neighborhoods, or even for favoring Oaklanders over out-of-towners. Some who spoke at Tuesday night’s meeting explained how, despite having lived all of their lives in Oakland, but not in one of the identified neighborhoods or having lived in a historically disadvantaged neighborhood but not for long enough or having been forced to move out of Oakland after many years because of gentrification, they would not qualify as Equity Applicants. It is these sorts of presumably unintended consequences of the residency requirements that could lead to the program getting bogged down in legal challenges.

The Equity Permit Program’s express preference for Oakland residents over out-of-towners, as an element of its greater approach to addressing longstanding systemic racial disparity in cannabis enforcement, raises some important legal issues. We have previously touched on the constitutionality of residency requirements and the potential difficulties presented by California’s own residency requirement in Proposition 64, such as access to funding from out-of-state investors—a challenge that has been somewhat ameliorated by Oakland withdrawing its requirement that majority ownership and control of cannabis permittees must be strictly City residents.

The Privileges and Immunities Clause of the U.S. Constitution and the Dormant Commerce Clause generally prevent states from discriminating against residents of other states. When a state or local government enacts legislation that facially discriminates against nonresidents, reviewing courts will ask whether the government has a “substantial reason” for the difference in treatment, and whether the law is “closely related” to that rationale. But because cannabis is federally illegal, constitutional claims would likely be a stretch.

As California rolls out its new regulations under the Adult Use of Marijuana Act (AUMA), it will be important to watch how those laws address a state licensee’s right to do business within the state, and how local regulations interact with state law. Though the Medical Cannabis Regulation and Safety Act (MCRSA) requires local government approval before a state license can issue, the AUMA does not, but the AUMA does allow localities to enact their own regulations so long as they do not conflict with state law. It remains uncertain how the AUMA will apply to a state-licensed cannabis entity seeking to conduct business in Oakland if that entity is unable to obtain a business license from Oakland because of its residency requirements. We will be tracking the rollout of California’s new regulations and how the interplay between the state and localities like Oakland will affect cannabis businesses and the state’s soon-to-be massive regulated cannabis economy.

Editor’s Note: Daniel recently joined our firm as an attorney in our San Francisco office, where he will be focusing on mostly California cannabis real estate and dispute resolution issues.

Oregon cannabis lawyersOregon lawmakers are considering legislation to protect Oregon cannabis consumers and patients against potential federal government enforcement actions. Proposed legislation, Senate Bill 863, would require marijuana retailers to purge patients’ personally identifiable information and would prohibit dispensaries from “record[ing] and retain[ing]” such information. This bill seeks to shield individual cannabis patients and consumers from federal authorities by eliminating a potentially damning piece of evidence. Oregon dispensaries currently keep much of this information, in contrast to other states where purges are commonplace by law or custom.

SB 863 defines “information that may be used to identify a consumer” to include information found on a consumer’s passport, driver’s license, or other identification document.” The information is protected whether it is on a physical copy of the identifying document or stored otherwise, such as in a customer database. Though dispensaries may collect aggregate non-identifying information, the bill would make it unlawful for dispensaries to “record or “retain” individual customer data. The legislation would further limit the spread of personally identifiable information by prohibiting dispensaries from requiring customers to produce any other form of identification.

In addition to preventing the recording of personally identifying information, the bill would also prohibit transferring any personally identifying information in the dispensary’s possession. On its face, this would appear to prevent dispensaries from cooperating with federal enforcement against customers, though it remains to be seen whether a state law requiring something like this would hold up in a federal court.

What personally identifying information does the bill not cover? The bill does not cover other forms of record-keeping that could contain personally identifying information. For instance, the bill would not prevent dispensaries from retaining recorded security footage that could include recognizable images of its customers or from capturing license plate numbers of cars coming and going from the parking lot. The bill also would not cover information received incident to credit and debit card-based transactions.

What about data retained for marketing purposes? A dispensary may record and retain the name and contact information of a consumer for the purpose of notifying them of products, services, discounts, etc. if the consumers gives informed consent. Even then, however, the dispensary may not transfer the information to another person — good news for those wary of their personal data being sold to third party marketers.

Will the bill pass? It seems likely some form of the bill will succeed and our Oregon cannabis lawyers are predicting passage. SB 863 enjoys bipartisan support and lawmakers are moving quickly to consider the proposal. Of course, the bill may change significantly as it gets through committee.

The next action on the bill should come this week of March 20, so keep an eye on this fast-moving issue.

Cannabis tax lawyer 280EWhen folks in the medical and adult use marijuana industries hear “280E,” they tent to shudder since they know it means a large protion of their revenues will be going to the IRS without the usual deductions. However, just this week, Grover Norquist, a GOP political advocate and the well-known president of Americans for Tax Reform (which favors repealing 280E), opined that our GOP-led Congress may enact sweeping tax reform this year that would reduce the stress of 280E on state-legal marijuana businesses by lowering corporate income tax rates.

In case you missed it, 280E is the provision of the Internal Revenue Code creates such an onerous tax burden for cannabis businesses because it provides as follows:

“No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.”

Congress passed 280E in 1982 in response to a Tax Court ruling that a taxpayer could deduct expenses relating to his sales of cocaine, amphetamine, and marijuana. Deductible expenses included the costs of packaging, travel, and even scales used to weigh the illegal substances. This is no longer possible in the world of 280E.

Since cannabis is a Schedule I controlled substance, the IRS uses 280E to disallow marijuana businesses from deducting their ordinary and necessary business expenses. The result is that marijuana companies — regardless of their legality under state law –face higher federal tax rates than similar companies in other industries. There are differing opinions on the level of tax rates imposed on marijuana companies – from 40% to 70% to as high as 90% – all of which are higher than the 35% corporate tax rate paid by most other businesses in the United States.

But if Norquist’s predictions are accurate, there may be a bit of light at the end of the 280E tunnel for cannabis businesses. though if Norquist’s predictions are accurate. In an interview with MJ Business Daily, Norquist stated:

There’s a big tax bill this year – the tax reform package that takes corporate rates to 20% – which solves some of the problem for marijuana producers because now you’re paying 20% on all your sales instead of 35%. But we still need to get normal and reasonable and legal deductions made legal and normal for the marijuana industry, as well as for all other industries. Marijuana could get into that package if some of the libertarian Republicans made that a condition of voting for the whole package.

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So, as we build support for a fix, we need to build support state by state, where we say, “Look, you don’t want federal tax law used to gut the effectiveness of federalism. Because you could say something can be legal at the state level, but if the federal government is going to tax it into oblivion, you really haven’t allowed federalism at all.

Norquist then went on to predict these tax law changes will occur within the “next few years.” Though our cannabis tax lawyers do see cannabis tax changes coming, they are less confident than Norquist on timing. There has been no successful standalone 280E fix bill in Congress and the current presidential administration’s back and forth policies on marijuana legalization make predicting such federal action difficult. But with legalization in California and marijuana reform in 28 other states and more coming soon, the odds of Congress rectifying this tax situation are increasing. We cannot and should not expect favorable 280E changes from either the Tax Court or the IRS unless and until Congress mandates such changes. It is therefore good to know that such changes are at least on the table.

Cannabis lawyersJust about whenever Attorney General Jeff Sessions speaks, the cannabis industry panics. Stop it people.

This week Jeff Sessions gave an interview where he was asked about possibly using the federal Racketeer Influenced and Corrupt Organizations (RICO) Act to tackle legal marijuana. The media (the cannabis media in particular) have covered that interview as though it sets forth a roadmap for federal cannabis policy. And since that interview, probably every single cannabis lawyer at my law firm (in California, Washington and Oregon) has received at least one client call seeking an opinion on it.

Stop it everyone. Just stop it. Really. Sessions didn’t do anything in this interview but muse about a seldom used federal statute.

In this interview, Sessions hinted that he might be open to using RICO to pursue cannabis businesses in cannabis legal states:

INTERVIEWER: One RICO prosecution against one marijuana retailer in one state that has so-called legalization ends this façade and this flaunting of the Supremacy Clause. Will you be bringing such a case?

SESSIONS: We will, marijuana is against federal law, and that applies in states where they may have repealed their own anti-marijuana laws. So yes, we will enforce law in an appropriate way nationwide. It’s not possible for the federal government, of course, to take over everything the local police used to do in a state that’s legalized it. And I’m not in favor of legalization of marijuana. I think it’s a more dangerous drug than a lot of people realize. I don’t think we’re going to be a better community if marijuana is sold in every corner grocery store.

Of course he might be open to using RICO to pursue federal criminal law violations by cannabis businesses. I actually do not believe Attorney Generals Holder and Lynch, who were the Attorney Generals during the Obama Administration) would have answered this question substantively much differently. You are not going to get an Attorney General to say, “yes, we have this really important law on the books, but nobody worry because we will never enforce it. Just go ahead and violate it.” Really?

And if you listen to the entire interview here, you will hear Sessions poo-poo the benefits of bringing a RICO action against state-legal cannabis businesses:

INTERVIEWER: [I]t would literally take one racketeering influence corrupt organization prosecution to take all the money from one retailer, and the message would be sent. I mean, if you want to send that message, you can send it. Do you think you’re going to send it?

SESSIONS: Well, we’ll be evaluating how we want to handle that. I think it’s a little more complicated than one RICO case, I’ve got to tell you. This — places like Colorado — it’s just sprung up a lot of different independent entities that are moving marijuana. And it’s also being moved interstate, not just in the home state.

RICO was designed to pursue the mafia and other organized crime groups. RICO provides powerful criminal and civil penalties against people who engage in a “pattern of racketeering activity” and have a relationship to an “enterprise.” “Racketeering activity” includes roughly a hundred different offenses, including violations of the Controlled Substances Act. A “pattern” is established when an offense occurs more than one time in a given statutorily defined time period. An “enterprise” includes any individual, partnership, corporation, association, or other legal entity, and any group of individuals associated together even if they are not in a formal business relationship.

The broad interpretation of “enterprise” means that on a technical legal basis, RICO could pose a significant risk to cannabis businesses. The production and sale of cannabis is prohibited by the CSA and, therefore, regular sales of cannabis could serve as the predicate offense for a RICO charge and all those involved with legal cannabis sales, including vendors, contractors, landlords, lawyers, accountants, and even state officials could arguably be in an enterprise engaging in illegal activity.

But nobody should panic about this, not even close. RICO is a powerful but seldom used tool and that is because both prosecutors and judges view it as a very powerful weapon that should only be used in limited circumstances. The RICO statute has been around since 1970 and I cannot recall a single cannabis case having been brought under it. I am not saying there has never been such a case, but I am saying that it has been used sparingly in dealing with cannabis, if at all, including during Nixon’s “War on Drugs” and Reagan’s “Just Say No” administrations. In this same interview Sessions noted that the federal government has limited resources and it cannot simply commandeer local police forces to pursue RICO charges against cannabis users. RICO cases take a massive amount of effort to prosecute criminally and apparently not even Jeff (“good people don’t smoke cannabis“) Sessions deems this would be money and time well spent.

It also bears mentioning that a few years ago, some private citizens brought RICO claims against marijuana businesses and non-cannabis businesses alleged to have been operating in concert to sell cannabis. As we wrote here, the federal court dismissed those claims.

There is though one important thing cannabis businesses should take from this interview. Sessions is concerned about cannabis businesses that move marijuana from state to state. Note how he brings this up when he says: “it’s also being moved interstate, not just in the home state.” This IS important. The states are mostly in charge of prosecuting criminal activities that happen entirely within their own state borders. A robber in Portland or Seattle or San Francisco will almost certainly be prosecuted by state-city prosecutors; but a robber who brings stolen goods from Seattle to San Francisco could very well be prosecuted federally. The same has always been true of illegal drugs, including cannabis. If you are caught with weed in Newton, Iowa, you risk city or state prosecution. But if you are caught transporting cannabis from Iowa to Illinois, you risk federal prosecution.

So if you want to panic based on this Jeff Sessions interview, you should if you are planning to transport cannabis across state lines. The federal government has never liked interstate cannabis transport and it has always made this clear, as have we, in the following posts:

In Marijuana Law Myths. Not Everything Changes With Legalization, in Myth #2, we explain why it is so dangerous to fall for the myth that you can legally transport cannabis from one legal state to another and why this myth is so dangerous:

2. Now that marijuana is legal in Washington, Oregon, and Alaska, it is legal to sell Washington-grown marijuana in all three states. We hear this one ALL the time, mostly from marijuana businesses that intend to do this, believing it to be legal. It isn’t and please, please do not do this, unless you want to go to federal prison. The same holds true for Washington D.C., where marijuana was just legalized. You cannot just take your “legal” marijuana there and start selling it.

Taking legal pot across ANY state borders by boat or by car or by air is a big deal as it amounts to unlawful interstate drug trafficking.

More importantly, taking marijuana from one marijuana legal state to another is a federal crime. Marijuana is still a Schedule I Controlled Substance. The U.S. Constitution gives the federal government the authority to regulate interstate commerce. This means that it can (and does) prosecute people for transporting marijuana across state lines, even if the transport is from one marijuana legal state jurisdiction to another.

We are not saying that you should expect FBI agents to be sitting at the borders waiting to arrest people for going from one state to another with marijuana, but this is to say that traveling from state to state with marijuana is not advised, particularly by boat or by airplane. More importantly, a business plan that assumes this is legal is a business plan that will set you up to fail, especially if you publicly reveal that your business does this.

This is also a good time to remind you that if you are going to drive from state to state, clear out your cars, your boats, your airplanes, your clothes and your luggage before going from a cannabis legal state to one that is not. State troopers in states like Nebraska, Kansas, and Idaho (and even Nevada where cannabis is legal for medical us but not recreational) love making easy money by arresting and fining people entering with marijuana from Colorado and Washington.

Transporting a Schedule I Controlled Substance, including marijuana, across any state line is a federal felony. This is the case even if your medical marijuana patient card is honored in the next state over, and even if you are moving between jurisdictions that have legalized recreational marijuana. Keep and consume your cannabis in the state where you purchased it, or you run the risk of federal criminal charges for transporting a controlled substance.

So yeah, moving cannabis across state lines (yes, even from one cannabis legal state to another) is a really bad idea.

Oh, and one more thing, many (even some in the cannabis industry) are acting as though one RICO case would do what this interviewer says and “send the message” to all those in the cannabis industry to terminate all their employees and shut down their state-legal cannabis businesses. In other words, many are acting as though one RICO claim would be “lights out” for legalized cannabis all across the country.

This is absurd. The federal government has been trying to shut down cannabis for more than one hundred years, and for much of that time, it had overwhelming popular support for doing so. Today though, the majority of Americans favor legalization and those numbers keep getting better. Were the federal government to pursue “just one” RICO claim, it would likely be against a really large cannabis business that transported cannabis across state lines and I do not believe such a lawsuit would lead to a single state-legal cannabis business shutting down. If anything, it would be more likely to galvanize our country to legalize cannabis once and for all.

So please, nobody panic.

Oregon cannabis lawyersOur Oregon office forms three or four cannabis companies per week. Our Washington office has formed hundreds of these businesses in the past four or five years, and our California office has seen a major uptick in company formation work since AUMA passed last fall. Though every state brings unique considerations for entity choice and structuring, most of these businesses (outside California) end up registering as either LLCs or C-corps. And most of them involve owners who bring different things to the table.

The most common example of differing contributions comes when one person brings skill and labor to the table, while another brings cash. The “sweat equity” partner may have expertise and relationships related to production or processing of cannabis, for example, while the traditional equity partner has the ability to immediately fund the marijuana business. In a classic scenario, these two individuals come to one of our cannabis business lawyers and say they would like to own the business “50/50”, or thereabouts. This raises some serious tax implications for the sweat equity partner.

The Internal Revenue Code values capital over labor, especially when that labor constitutes future services a person will contribute to a business in exchange for ownership. From the IRS’ perspective, if Party A contributes $100,000 in cash to an LLC or corporation, and gives a 50% interest to Party B (for a sweat equity contribution), the IRS will also value Party B’s interest at $100,000. Unfortunately, Party B will have to pay tax on that income, which is sometimes referred to as “phantom income.”

The following are a few of the more common ways to deal with phantom income in a situation where one member of a cannabis business provides the capital, and the other provides services:

Vesting. It is possible to have the sweat equity partner’s interest vest over time, through options allocated to that partner under a shareholder or operating agreement. The sweat equity partner will purchase and pay for his or her equity through distributions or dividends earned as an owner of the company. The vesting schedule here is very important. If the schedule is too long, the value of the membership (and the amount payable) may increase. If the schedule is too short, repayment may not be viable.

Company Loan. Often, the partner without cash at the onset will issue a promissory note to the company. Here, the sweat equity partner is acknowledging having received a valuable interest in the company, for which he or she owes a debt. The promissory note can be made with a commercially reasonable repayment period and interest rate, and the member can pay down the note with income received from the company. It is important to remember, though, that the note payments will be made from taxable income. This is simply a way to extend the tax hit over time.

Owner Loan. Sometimes, neither partner will contribute a sizable amount of cash up front. Instead, both partners will contribute a nominal amount, like $1,000, and the partner with cash will make a loan to the LLC. This option should be considered carefully, for a couple of reasons. First, from a tax liability perspective, the IRS may consider a company with a debt to equity ratio over 3:1 or 4:1 to be “thinly capitalized” and subject to scrutiny. From a legal liability perspective, an undercapitalized company may leave its owners open to vicarious liability on a “piercing the corporate veil” theory.

The above are simplified, high-level summaries of common methods lawyers and CPAs use to deal with phantom income in cannabis start-ups. It is important to note that each situation is unique and depends on a variety of factors. It is also important to note that sweat equity is not the only way phantom income is created in cannabis companies. Almost all pot companies have some amount of phantom income due to IRC 280, for example. That rule alone is a crucial business planning consideration for every marijuana entrepreneur.

Legal and tax structuring are critical decisions that can determine whether a marijuana venture succeeds or fails. Learning to look out for phantom income is key part of this analysis. That’s true for both sweat equity and cash investors — especially in this unique and highly dynamic industry.

tenth-amendmentYesterday, we wrote about the various ways that enforcement of federal cannabis laws could ensue, if the current administration were bullheaded enough to attempt such a thing. The day before, we wrote about the Washington State Attorney General’s promise to fight any potential enforcement action. Today, we offer a brief primer on what rights the states may have to uphold their medical and recreational marijuana programs in the face of federal enforcement action. The answers may surprise you.

As a baseline matter, it is imperative to note that Article VI, Clause 2 of the U.S. Constitution declares that federal law is “the supreme law of the land,” preempting conflicting state laws. This means—and courts have confirmed—that if the federal government wants to enforce its draconian marijuana laws by targeting specific actors, it can, and states cannot stand in the way. However, if the federal government wants to force states to shut down their marijuana programs, or to use state resources to enforce federal law, it probably cannot.

The constitutional question that will determine the outcome of any lawsuit to invalidate state cannabis laws, whether for medical or recreational marijuana programs, is whether those state laws impermissibly conflict with the federal Controlled Substances Act (CSA). Another way of asking this would be: “Does the federal CSA ‘preempt’ state cannabis programs?” Given the plain language of the CSA, we think the answer is “no.”

Section 903 of the CSA includes express anti-preemption language:

No provision of this subchapter shall be construed as indicating an intent on the part of Congress to occupy the field in which that provision operates, including criminal penalties, to the exclusion of any State law on the same subject matter which would otherwise be within the authority of the State, unless there is a positive conflict between that provision of this subchapter and the State law so that the two cannot consistently stand together. (Our bold emphasis.)

What would a “positive conflict” with state law be? It may sound funny, but a positive conflict might consist of a state law requiring a citizen or state official to possess or distribute marijuana. Such a law would almost certainly violate the CSA. But, state marijuana programs that only permit individuals to traffic in federally controlled substances—because states do not proscribe them—make no such requirement. Think about it: anyone in Oregon, Washington, California, or any other state with a cannabis program, is free to ignore these state programs and follow federal law.

This begs the question as to whether the federal government could require states to shut down their programs, and assist in enforcing its horrible laws. Again, we think the answer is “no.” The Tenth Amendment to the Constitution serves as a constitutional check to the Supremacy Clause. The Tenth Amendment provides that the federal government cannot “commandeer” states by forcing them to enact laws in the federal interest, or to enforce federal laws whatsoever. In the context of cannabis, this means that neither Congress nor any federal actor can require states to enact or maintain laws prohibiting the cultivation, distribution or intra-state sale of pot.

The upshot here is that the Tenth Amendment, coupled with the express, anti-preemption language of the federal CSA, grants the states authority to run cannabis programs. This paradigm gives the states a strong argument in any potential lawsuit by the feds seeking to shutter those programs. Thus, the extremely tall and unpopular task of chasing state-approved pot merchants, would be left to the resource-poor federal government. And if the federal government really wants to go there, well, we’re in for another kind of fight.