Cannabis litigationOne of the unfortunate byproducts of cannabis legalization is cannabis litigation. With each passing month of legalization in the states in which our cannabis lawyers operate (California, Oregon and Washington) we see an increase in disputes. The most common cannabis litigation matters are disputes about medical and recreational grows, disputes between former business partners now going their separate ways, disputes between employee and employer, and cases involving cannabis intellectual property. This is the first in a series of posts I will be writing on cannabis litigation.

Today’s topic is criminal law, which to at least some extent, can permeate civil litigation involving any cannabis business. Criminal law is important in civil cannabis cases because conduct that is perfectly legal under state law may well be illegal under federal law. The risk of federal criminal liability means that a cannabis litigator in a civil case should at least consider whether to rely on the 5th Amendment privilege against self-incrimination, which can be asserted in in civil proceedings or in connection with oral testimony, pleadings, or requests to produce documents.

How do evaluate whether to take five, i.e., assert the 5th Amendment? Here is an overview of the three main legal issues to help you analyze whether associating criminal counsel is appropriate in your civil law matter.

1. Prior statements in a civil cannabis case could be admissions of criminal activity in another case: A large part of every civil case is explaining the facts which support your claims, and which contradict your opponent’s. A civil litigant will make statements about facts in her pleadings, in discovery before trial, or in testimony at trial. You should assume that almost anything a litigant or her lawyer says about facts in a civil case will be admissible in a later criminal proceeding, even if the statement is not made under oath. An example might be the opening allegation in a complaint against a business partner in a grow: “Pursuant to an agreement, plaintiff and defendant worked together to cultivate cannabis crops, which they intended to be sold, and did sell, pursuant to this state’s recreational cannabis laws.” Right there you are probably admitting that you violated federal criminal drug laws.

2)         Does testifying to potentially incriminating facts in the civil case waive the privilege? Courts have held that  waiver of the 5th Amendment privilege in a civil case will not waive the privilege in later criminal proceedings. But the practical effect of this principle is limited. Though a defendant who has waived her privilege in a prior civil case could testify in a later criminal case, any prior incriminating statements she made in the civil case can be used against her, even without her testimony.

3)         Risks of asserting the privilege in the civil case: In a criminal case, the fact finder may not infer that a defendant is guilty because she asserted the 5th Amendment. In civil cases, however, a jury may draw negative inferences against a party who declines to testify by relying on the 5th Amendment. So, a lawyer in the civil case might argue to the judge or to the jury: “Plaintiff claimed privilege when asked whether she grew cannabis. Doesn’t this suggest she did grow cannabis?”

Knowing and evaluating the legal issues is only the first step in deciding whether to assert the 5th Amendment. The more difficult next step is forecasting whether a prosecutor—now or in the future—will choose to bring criminal charges for conduct legal under state law.

In part 2 of my series on cannabis litigation I will discuss how early registration of trademarks and copyrights and protection of your trade secrets can help you both avoid litigaiton and prevail should it nonetheless be unavoidable.

California cannabis events
California cannabis events. So far, so good.

In case you missed it, on June 27, 2017, California Governor Jerry Brown signed into law the Medicinal and Adult Use Cannabis Regulation and Safety Act (“MAUCRSA”). MAUCRSA repealed the Medical Cannabis Regulation and Safety Act (“MCRSA”) while consolidating some of the MCRSA’s provisions with the licensing provisions of the Adult Use of Marijuana Act (“AUMA”). Our firm just recently held a webinar on the major changes between the MCRSA and MAUCRSA and what California cannabis businesses can expect from California’s Bureau of Cannabis Control (be sure to check in regularly as we’ll be posting the webinar on our site in the next couple of days). During the webinar we addressed a whole host of questions but due to the number of attendees (nearly 1,500 of you signed up) and the volume of questions, we couldn’t get to all of them. Fret not though my friends, as over the coming days we’ll be answering many of your questions here on the Canna Law Blog. As a matter of fact, how about I start now and discuss a topic on which we received a lot of questions: onsite consumption at cannabis events (where such events have slowly started to fade because of robust state cannabis regulations–see here and here).

The AUMA granted local jurisdictions the authority to decide whether smoking, vaporizing, and ingesting cannabis would be allowed by a retailer or a microbusiness. Ultimately, the ability to provide a unique and personal experience via onsite consumption will enhance California cannabis retailers and microbusinesses abilities to differentiate themselves in the marketplace. Onsite consumption will also prove to be a big advantage for California cannabis businesses bordering Nevada, as state regulators there grapple with the issue of onsite consumption.

The MAUCRSA also built on the AUMA’s concept of onsite consumption by allowing for temporary event licenses for onsite cannabis sales and consumption at district agricultural association events and your local county fair–just when you thought churros couldn’t get any better! Does that sound too good to be true? Well that’s because I haven’t mentioned the following caveats:

  • Only a licensee can receive the temporary event license;
  • Your local jurisdiction has to authorize such events in the first place;
  • Access to the area where cannabis consumption is allowed is restricted to persons 21 years of age and older;
  • Cannabis consumption is not visible from any public place or nonage-restricted area; and
  • Sale or consumption of alcohol or tobacco is not allowed on the premises. Sorry, but no jamming out to Phish with a beer and a pre-roll in your future.

The MAUCRSA also states the activities at such events must be “otherwise consistent with regulations promulgated and adopted by the Bureau [of Cannabis Control] governing state temporary event licenses.” What are these regulations you ask? Unfortunately we won’t know until the Bureau releases them in the fall. Normally we’d look to the draft medical regulations the Bureau released this past April for guidance but those regulations didn’t cover onsite consumption and they only apply to MCRSA (and have been withdrawn because of MAUCRSA). What we do know is there’s a lot of interest in how the Bureau will interpret the definition of premises. Premises is currently defined in the MAUCRSA as follows:

The designated structure or structures and land specified in the application that is owned, leased, or otherwise held under the control of the applicant or licensee where the commercial cannabis activity will be or is conducted. The premises shall be a contiguous area and shall only be occupied by one licensee.

If the area “held under the control of the applicant and licensee” is separate and distinct from the rest of the fairground, will that constitute separate premises and satisfy the alcohol restriction? At most county fairs you’ll find a great selection of local wines and craft beers and that’s not going to be changing any time soon. However we foresee county fairs will not want to miss out on the revenue and foot traffic a well-cultivated list (pun definitely intended) of cannabis businesses can attract.

Will the Bureau propose reasonable regulations (perhaps restricting cannabis consumption to evening hours?) to allow county fairs to provide for reasonable consumption of alcohol and cannabis on county fairgrounds? Will the one licensee restriction apply to temporary events? That seems unlikely, but until the State of California releases its cannabis regulations we won’t know for certain. What we do know is that these temporary event licenses will be a great way for entrepreneurial cannabis businesses to market themselves – let’s just hope the Bureau issues business friendly and reasonable regulations.

 

Cannabis taxesThe United States Court of Appeals for the Ninth Circuit recently ruled on its second tax case regarding IRC §280E.  Decisions from the Ninth Circuit are significant as they apply to the cannabis-friendly states of Alaska, California, Nevada, Oregon; and Washington. In Canna Care vs. the Commissioner, the Court of Appeals upheld the United States Tax Court’s ruling denying a California dispensary’s operating expense deductions under IRC §280E.

Background

Canna Care Inc. was a medical marijuana dispensary prohibited under California law from earning a profit on the sale of cannabis.  On audit, the IRS applied IRC §280E to deny the deduction of all operating expenses, including substantial officer’s salaries and automobile expenses. Canna Care appealed the tax assessment to the U.S. Tax Court. Canna Care made the following three arguments before the U.S. Tax Court:

  • That medical marijuana is not a Schedule I controlled substance;
  • That Canna Care was not “trafficking” for purposes of IRC §280E because its activities were not illegal under the California Compassionate Use Act of 1996;
  • That the Tax Court decision in CHAMP was incorrect.

The Tax Court denied all three arguments and upheld the tax assessment against Canna Care. First the Tax Court reiterated that medical marijuana is a Schedule I controlled substance. Second, the Tax Court held that the sale of medical marijuana is always considered trafficking under IRC §280E, even when permitted by state law. Thus, operating expenses associated with the sale, manufacturing or production of cannabis are always disallowed under IRC §280E.

Third, the Tax Court held that the CHAMP had been correctly decided. Canna Care’s argument that its sole business was providing charitable work like the taxpayer in CHAMP was without merit. The Tax Court held that because Canna Care’s only business was selling cannabis, none of its operating expenses could be deducted under IRC §280E. The Tax Court noted that Canna Care arguably had a second trade or business selling clothing and could have argued these expenses should be deducted. As that fact was not stipulated in its petition, the Tax Court could not consider that issue on the merits.

Appeal to the Ninth Circuit Court of Appeals 

Canna Care appealed to the Ninth Circuit Court of Appeals. None of the arguments before the Tax Court were made on appeal.  Instead, Canna Care raised three new arguments, two of which were unique to Canna Care’s facts and likely not applicable to most other cannabis businesses.

Canna Care’s primary argument was that IRC §280E violates the Excessive Fine Clause of the 8th Amendment of the United States Constitution. In oral argument before the Ninth Circuit Court of Appeals, Canna Care argued that IRC §280E was enacted by Congress to punish drug dealers, and as such, it imposes a fine on cannabis dispensaries. Canna Care noted that its income tax liability was 1000% of its net income and a 1000% tax rate for engaging in an activity allowed under California law constituted a grossly disproportionate fine on such activity. The tax rate impact under IRC §280E is especially disproportionate when compared to the tax rate of other business – both legal and illegal. Accordingly, Canna Care’s income tax liability imposed under IRC §280E constitutes an excessive fine in violation of the 8th Amendment.

In oral argument, the three-judge panel offered several observations:

  • A tax deduction is granted by the legislative grace of Congress. Congress has clear constitutional authority to deny a tax deduction. Why is IRC §280E outside Congress’ legislative authority?
  • IRC §280E was enacted in 1982, well before enactment of the California Compassionate Use Act of 1996. This means that anyone getting into the cannabis industry was and is on notice of its the burdensome tax liabilities cannabis companies face.  Given such notice, why does application of IRC §280E constitute an excessive fine under the 8th Amendment?
  • Why isn’t Congress the appropriate branch of government to address IRC §280E?

The Ninth Circuit Court of Appeals dismissed Canna Care’s appeal and upheld the Tax Court’s holding. Because the arguments presented were not raised in the lower court, The Court did not address the merits of each argument.

Assess Risk & Preserve Refund Claims

When filing their tax return, a cannabis businesses must understand the impact IRC §280E has on its tax liability. Equally important, cannabis businesses must understand the risk of not applying IRC §280E when filing their tax return. The immediate tax savings must be weighed against the risks and the costs of later having to defend the position in court.

Though it is difficult to challenge federal statutes on constitutional grounds, the constitutional arguments do have some merit. A cannabis business that challenges an IRS assessment under IRC §280E should raise all arguments early in the process to prevent a court from later dismissing arguments on procedural grounds.

Because the Ninth Circuit Court of Appeals did not rule on the merits of the 8th Amendment claim. it is possible a federal court could some day rule that IRC §280E is unconstitutional. To preserve a potential refund claim, all cannabis businesses should consider filing protective refund claims. A protective refund claim keeps the refund statute of limitation open beyond the standard three-year period. After October 15, 2017, a cannabis business cannot recover tax paid for tax year 2013. However, if a court were to hold after October 15, 2017 that IRC §280E is unconstitutional, a cannabis business that filed a 2013 protective refund claim can recover its taxes paid for that year.

It is likely more cases will be filed challenging IRC §280E.  A cannabis business should take stock of its current tax return filings applying IRC §280E and craft a strategy to defend its position.

California cannabis commercial leaseA contract isn’t worth much without your being able to enforce it, and the same goes for commercial leases. We’ve written about unique problems in cannabis contracts due to the state-vs-federal illegality problem (see here, here, here) and of how courts have navigated that inconsistency in the context of contract enforcement. But when it comes to commercial cannabis leases in California, landlords and cannabis companies alike want to know how likely it is a court will enforce their lease. The short answer: it’s much likelier now than five years ago.

The main challenge with California commercial cannabis leases, as with all cannabis contracts, goes back to the problem of federal illegality. Because cannabis is still federally prohibited under the Federal Controlled Substances Act, it is federally illegal to cultivate, manufacture, or sell cannabis for any purpose. This means cannabis contracts trigger the doctrine of illegality in contract law, which holds that contracts without a lawful object are void and unenforceable as against public policy. Though enforcement of contracts is generally governed by state law, state law includes federal law under the U.S. Constitution’s Supremacy Clause.

Courts have struggled with how to reconcile the different laws, but a consistent theme emerges in California court decisions: commercial cannabis lease agreements will generally be enforced so long as the dispute before the court is purely contractual and so long as the landlord and tenant are in an arms-length transaction for payment of rent. One infamous example of this is the Harborside case, where a U.S. District Court declined to void a commercial lease for a cannabis dispensary on grounds of illegality, where the dispensary was in compliance with California law.

Another more recent example is Mann v. Gullickson, a November 2016 Northern District of California decision involving a dispute between a creditor plaintiff who sold shares in two cannabis businesses to the defendant in exchange for a promissory note. When the creditor sued for nonpayment under the promissory note, the defendant argued federal illegality rendered the contract (the promissory note) unenforceable. Though the court acknowledged it could void a contract if it required a party to violate the CSA by, for example, requiring it to cultivate or sell cannabis, for several reasons, the court declined to do so in this case.

First, the fact that the court could order payment on the note without requiring any cannabis-related actions meant that enforcing the contract would not necessarily further an illegal purpose. Second, even if an illegal purpose were to be furthered, the court found it would be inequitable for the defendant to be unjustly enriched by not having to pay on the promissory note. Third, the court noted that many states, including California, had recently changed their laws to encourage state-legal cannabis business activities, thereby undercutting the defendant’s public policy argument. Fourth, and most interestingly, the court called out the observed effect of changing state laws on federal enforcement: “The federal government’s concern over the CSA’s medical marijuana prohibition has waned in recent years, and the underlying policy purporting to support this prohibition has been undermined.” The court also noted that under the McIntosh case, the Rohrabacher-Farr amendment prohibits CSA enforcement against medical marijuana in the Ninth Circuit (the federal appellate circuit that encompasses California).

The lesson to be drawn from these cases for California commercial cannabis leases is that cannabis leases should be written to keep the landlord-tenant relationship as an arms-length transaction. This means no profit-sharing arrangements, no payments in cannabis product, and no equity shares changing hands; just payment of rent. Ultimately, the best way to avoid enforcement problems for your California commercial cannabis lease may be to include a well-drafted arbitration clause that specifies choice of California state law, among other things, as that can to a large extent side-step the issue of court enforcement, at least until you need to get your arbitration award enforced by a court.

To help you better understand what is going on with California cannabis and what MAUCRSA means for your cannabis business, three of our California attorneys will be hosting a free webinar on Tuesday August 8, 2017, from 12 pm to 1 pm PT. Hilary Bricken from our Los Angeles office will moderate two of our San Francisco-based attorneys (Alison Malsbury and Habib Bentelab) in a discussion on the major changes between the MCRSA and MAUCRSA, including on vertical integration and ownership of multiple licenses, revised distributorship standards, and what California cannabis license applicants can expect more generally from California’s Bureau of Cannabis Control as rule-making continues through the remainder of the year. They will also address questions from the audience both during and at the end of the webinar.

To register for this free webinar, please click here. We look forward to your joining us.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Oregon cannabis Filing this in the odd news section: The Portland Tribune has reported that an Oregon dispensary owner has been fined $3,000 by Wood Village, Oregon for the mannequins he sets up on the sidewalk to advertise his cannabis. These blonde cannequins mannequins are animated and brandish “Got Chronic” signs at potential clients.

The town recently revised its sign code to prohibit Portable Signs, defined as “signs not permanently affixed to a building structure or the ground and designed to move from place to place except garage sale signs, special event signs, political signs, real estate signs or as otherwise provided in this Code . . .”

The owner sees the long list of exceptions as a clear sign that this ban is specifically targeted at his mannequins. After all, his dispensary is the only cannabusiness in town. He has also been fined under the new code for having a sign on the roof of his neighboring cupcake business.

Even if the ordinance isn’t specifically targeted at the mannequins, the ordinance is likely unconstitutional. Under first amendment jurisprudence, content-based regulation of speech is subject to “strict scrutiny,” that is, to survive, content-based regulations must 1) be passed to further a compelling government interest, and 2) be narrowly tailored to achieve that interest. In practice, strict scrutiny is a difficult hurdle to overcome.

In a recent case, the US Supreme Court struck down a similar city code governing outdoor signs. The offending ordinance identified various categories of signs “based on the type of information they convey, then subjects each category to different restrictions.” Sound familiar? The Supreme Court continues: “[A] municipal government vested with state authority, ‘has no power to restrict expression because of its message, its ideas, its subject matter, or its content . . . Content-based laws–those that target speech based on its communicative content–are presumptively unconstitutional and may be justified only if the government proves that they are narrowly tailored to serve compelling state interests.”

In one passage, the Supreme Court states “The restrictions in the Sign Code that apply to any given sign thus depend entirely on the communicative content of the sign. If a sign informs its reader of the time and place a book club will discuss John Locke’s Two Treatises of Government, that sign will be treated differently from a sign expressing the view that one should vote for one of Locke’s followers in an upcoming election . . . On its face, the Sign Code is a content-based regulation of speech.”

Let’s rewrite that passage with the facts at issue here: “The restrictions in the [Wood Village sign code] that apply to any given sign thus depend entirely on the communicative content of the sign. If a [portable] sign informs its reader [that a mannequin has “got chronic”], that sign will be treated differently from a sign [advertising a nearby garage sale] . . . On its face, the [Wood Village sign code] is a content-based regulation of speech.”

In this light, it is easy to see that the Wood Village ordinance will likely be struck down if the owner decides to take it up with the courts. We will have to see if the owner decides it is worth it.

Setting aside the specter of unconstitutionality, it is worth looking at whether state law prohibits the mannequins. The state is subject to the same restrictions on content-based regulations, so the Oregon Liquor Control Commission (“OLCC”) has issued loose cannabis advertising restrictions that seem designed to survive strict scrutiny. The OLCC’s stated goal is to prevent cannabis advertising that is attractive to minors, promotes excessive use, promotes illegal activity, or presents a significant risk to public health and safety. More specifically, cannabusinesses cannot advertise cannabis in any way.

  • That contains deceptive, false, or misleading statements;
  • That contains any content that targets minors, such as images of minors, cartoons, toys, etc.;
  • That encourages the transportation of cannabis across state lines;
  • That asserts that cannabis items are safe because they are regulated by the OLCC and have been tested by a lab;
  • That claims recreational cannabis has curative or therapeutic effects;
  • That displays the consumption of marijuana items;
  • That contains material that encourages excessive or rapid consumption; or
  • That contains material that encourages the use of marijuana because of its intoxicating effect.

These blonde got-chronic-bots don’t seem to fit neatly into any of these categories, so the mannequins are likely legal under state law. Accordingly, the owner may very well decide it is worth taking this dispute to the courtroom.

California cannabisThough we very much want states (and our clients) to follow the federal government’s “robust regulation” directives in the 2013 Cole Memo, we can’t help but bemoan when “robust” state cannabis regulations take the fun and creativity out of cannabis business operations.

Over the years, clients and potential clients have come to the cannabis lawyers at my firm with a bevy of business proposals that in federally lawful world would make sense and probably even be profitable. Unfortunately, we have to nix most of the “creative” business models and product proposals we see in California, Washington, and Oregon (the cannabis states in which we have our offices and in which our lawyers do most of their work) because these states rarely tolerate or permit unique business models or ideas.

In the spirit of the innovation that we have had to quash, the below are the five best/most interesting business proposals killed (or suffering a slow death) from comprehensive cannabis business regulation:

  1. Delivery. It’s a small miracle when a state allows cannabis delivery to customers by dispensaries. And even those few states that permit this typically put it under such serious restrictions you’d think the driver is moving millions in gold or a high level federal prisoner. Washington State doesn’t allow delivery, which helps the illegal market there. Oregon didn’t permit home delivery by retailers until February of this year. Even California’s proposed MCRSA retailer regulations (which will be withdrawn in full, but probably re-issued in similar form in the near future) restrict deliveries to retail licensees that have complied with a massive amount of security procedures.
  2. Fresh food manufacturing and manufacturing certain other products. States do not generally like cannabis manufacturers processing fresh foods or potentially hazardous foods or foods that might appeal to kids. The list of prohibited products varies by state, but the following fresh food items nearly always make the list: heated food, refrigerated food, anything with alcohol for drinking, pies, fruits, vegetable butters, dairy products, meats and seafoods. California planned to ban caffeinated products in its draft MCRSA manufacturer rules. And good luck trying to find any legally sold cannabis-infused gummy candies (or really any traditional candies other than chocolate and fruit chews) in California, Oregon or Washington.
  3. Cannabis events. We’ve previously written about how state cannabis regulations tend to be the death knell for the kinds of cannabis events that were immensely popular just a few years ago. Many states prohibit any gifting of cannabis and that has led to far fewer cannabis cups and cannabis parties.
  4. Marijuana online exchanges and marketplaces. Cannabis-legal states just aren’t ready for cannabis businesses to sell online or through exchanges of any kind. Whether it’s because of a lack of transparency or trust, or just the potential logistical nightmares, states pretty much force in-person transactions within the cannabis chain of distribution, all the way down to the consumer. California may be the one hope here since MAUCRSA retailers can use “technology platforms” they own and control for customer deliveries.
  5. On-site consumption and branded merchandise. No state allows public consumption of cannabis and most also prohibit their cannabis licensees from selling branded merchandise. Though some cities (Denver and Portland) have made a push for social, on-site consumption, most states loathe this as well, which is a real shame since consuming with others in a social setting normalizes cannabis and would likely boost tourism. California is another bright spot here as MAUCRSA will allow for consuming cannabis on the premises of retailers and micro-businesses, but only if the cities and counties in which those businesses sit also allow for this. As far as sales of branded merchandise, the majority of states prohibit cannabis businesses from selling any branded merch. from their licensed premises. For example, Washington State bans that practice (but Oregon does not). California is trying to take it a step further by stopping the sale of all branded merchandise by any cannabis businesses whatsoever.
California Cannabis Taxes
California Cannabis Taxes: taxes on taxes

California’s Medicinal and Adult Use Cannabis Regulation and Safety Act (MAUCRSA) will make dramatic changes to cannabis taxation in California in the following ways.

Marijuana Excise Tax (Effective January 1, 2018). MAUCRSA changes the structure of California’s Marijuana Excise Tax. Under prior law, a 15% excise tax was imposed on the gross receipts of any retail sale by a dispensary or other person required to be licensed to sell marijuana and marijuana products directly.

In contrast, MAUCRSA imposes a 15% excise tax on “the average market price” of any retail sale by a cannabis retailer. Potentially, there are two average market prices. The first is based on good faith negotiation in the open market, in which case the average-market-price is wholesale cost plus a mark-up determined every six months by the  California State Board of Equalization. The second is based on a “non-arm’s length transaction,” in which case, the average market price is the gross receipt from the sale.  Ignoring the irony that the good faith arms-length negotiation includes a mark-up determined by the Equalization Board, this distinction is crucial in determining how the tax is collected and remitted. Though the cannabis consumer is ultimately subject to the Marijuana Excise Tax, it is the Distributor that must collect the Tax from the Retailer and, in turn, remit the funds to the Equalization Board.

For “arms-length” transactions, the Distributor must collect the tax from the retailer “on or before 90 days after … the sale [from the distributor] to the retailer.” For non arm’s length transactions, the Distributor must collect the tax from the retailer when the retailer sells cannabis product to the consumer, but in no event more than 90 days after the Distributor’s sale to the Retailer.

The Marijuana Excise Tax is in addition to sales and use taxes imposed by California’s state and local governments and it is included in gross receipts for purposes of computing sales/use tax. This essentially creates a tax on a tax.

Cultivation Excise Tax (Effective January 1, 2018).  Under MAUCRSA, California’s Cultivation Excise Tax will be imposed on the cultivator after the cannabis is harvested and enters the commercial market. For cannabis flower, the tax is $9.25 per ounce. For Cannabis leaves, the tax is $2.75 per ounce. The Equalization Board has the authority to create a tax stamp/tax container system whereby proof of tax payment is evidenced by either a stamp or a pre-approved container.

The Cultivation Excise Tax is collected on the “first sale or transfer” of cannabis by the cultivator to the manufacture. What constitutes a first sale is not defined in the statutes. For a transfer of cannabis product to a distributor, this tax is collected when the cannabis “enters the commercial market.” When Cannabis “enters the commercial market” is defined as the time when the cannabis or cannabis product has completed all required inspection and testing. The cultivator is subject to the Cultivation Excise Tax, but is relieved of that burden so long as a manufacture or distributor provides detailed documentation. Under MAUCRSA, the Equalization Board has the authority to prescribe a substitute method and manner for collecting and paying the Cultivation Excise Tax and it is likely the collection and payment process will be fine-tuned.

Finally, a county may impose a tax on the privilege of engaging in a wide variety of cannabis activities, including cultivating, manufacturing and sales. Under MAUCRSA, counties have some latitude to structure their tax including: the tax rate, method of apportionment, and manner of collection. The county tax may be imposed in addition to the various other local ordinances taxing cannabis.

Anyone who knows California knows it is serious about tax collection in general and MAUCRSA’s treatment of cannabis excise taxes is no exception. Strict record-keeping and compliance is going to be essential for all participants in California’s cannabis market.

Cannabis financing
Cannabis financing. Cash is good.

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

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

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

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

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