Cannabis business disputesThe cannabis litigation lawyers at my firm have litigated many partnership lawsuits involving cannabis businesses where better planning could have avoided the dispute. Business owners will always disagree with one another, but good partnership agreements, LLC operating agreements, and shareholder agreements figure out ways to get past disputes without going to trial. Litigation is expensive and stressful and doesn’t leave either side feeling great. In a business ownership dispute we are working on now, in addition to legal fees, both sides are hiring their own forensic accountants to come up with a company valuation more favorable to their side, and this is before a complaint has even been filed. Costs add up fast. Partnership disputes have a lot in common with divorces disputes, where logic and reason often give way to emotion, and the parties seek to punish each other more than they try to come to a reasonable settlement. The best time to plan for disputes is before your company has any revenue, any investment, any debt, or any obligations. In this post and subsequent posts in this series, I’ll discuss negotiable provisions in partnership agreements that business owners should make sure to address as early in their business’s life cycle as they can.

Today’s post will talk about individuals getting ownership for services and what happens when a company needs to raise more capital.

Ownership Interest in Exchange for Service

This is a common arrangement, but companies often get themselves into hot water by not thinking through the implications. If an individual is going to receive a significant percentage of equity in a company without putting in a proportional value of cash or property, company owners need to think long and hard about the implications. The question that all too often goes unasked is what happens if the partner receiving the equity in exchange for services stops working for the company or fails to perform those services well? If the partnership group doesn’t put thought into how it structures the grant of ownership in exchange for services, it can find itself having signed away a large chunk of equity in their cannabis business without any recourse if the service-for-equity owner stops working.

There are a couple of solutions to this. One common fix is for the equity interest to vest over time. Every month or quarter or year in which a partner contributes services corresponds to a partial grant of the equity interest. With a vesting schedule of three to five years, the company knows it will either be getting good value for the services or it will be able to terminate the services and cut off any further vesting. But another problem shows up even if the services are terminated — you have a voting owner of the company who likely holds some ill will against the other partners. This is where another clause in the operating agreement can help – company buyout right triggered by termination of the partner’s services. The company will still have to pay out for the equity vested to date by the services provider, but it has a clean way of removing that person from the company, likely avoiding additional clashes.

Additional Financial Contributions

It’s hard to estimate how much capital a company is going to need. Many of our cannabis producer clients found out mid-stream that they were having a tough time selling their dried marijuana flower, so they pivoted and moved into the oil extraction business. But the capital equipment needed for that and the construction costs to set up the lab can be expensive, and when those expenses are not planned for additional capital is needed.

One of the main differences between LLCs and corporations is that default corporate law makes it easier to bring in new capital in exchange for equity than default LLC law does. In corporate law, the board of directors generally has the authority to issue new shares in exchange for capital. And if the current shareholders don’t have a negotiated right of first refusal, the directors are free to look to whomever they want, whether that person is a current shareholder or not. Compare to LLCs, where the default law tends to say that unless the operating agreement says otherwise, the members of the company must unanimously approve of any new members. LLC agreements, then, should have clear clauses on what happens when the company needs more money. If only one member is willing to put that money in, do they get additional interest that dilutes the other members? If the company doesn’t want a dilutive issuance but wants a member to loan money to the company, does that member get priority payback on the loan debt? And if no one in the company is willing to pay money, can they still vote against allowing a new member into the company in exchange for capital? Because if they can refuse to put in more money themselves and can keep the company from raising money from an outsider, they have the power to tank the company. Any negotiated partnership agreement needs to address this issue.

California cannabis contracts We previously explored enforceability problems presented by commercial cannabis contracts in California, as well as some examples of how courts have strained to reconcile state-legal conduct with federal illegality. On October 6, California Governor Brown signed into law AB 1159, a short bill with important implications for commercial cannabis operators, service providers, and investors relating to the enforcement of commercial cannabis contracts in California.

Section 1 of the bill states that “commercial activity relating to medicinal cannabis or adult-use cannabis conducted in compliance with California law and any applicable local standards, requirements, and regulations shall be deemed to be: (1) A lawful object of a contract; (2) Not contrary to, an express provision of law, any policy of express law, or good morals; and (3) Not against public policy.”

California statutory law requires contracts have a lawful object, but until now it was not clear whether this legality requirement encompassed federal as well as state law. And since cannabis is illegal under federal law, both state and federal courts wrestled with how and whether to enforce contracts that involved cannabis. Even though California law allows for commercial cannabis activity, the law pertaining to interpretation and enforcement of contracts in California remained ambiguous, and as noted in the Senate Floor Analysis of the bill, many California cannabis companies have been reluctant to litigate meritorious claims for fear the courts would not enforce their contracts. AB 1159 changes that by making clear that parties to contracts involving commercial cannabis activity can now rely on statutory law in making sure those contracts are enforceable—provided that the underlying activity complies with California state and local laws and provided the contract is interpreted under California law.

This will make it crucial you think carefully about the jurisdiction and the choice of law provisions you put into in your cannabis contracts.

The second section of AB 1159 is essentially an amendment to the California Evidence Code that solidifies the attorney-client privilege for “legal services rendered in compliance with state and local laws on medicinal cannabis or adult-use cannabis, and confidential communications provided for the purpose of rendering those services … provided the lawyer also advises the client on conflicts with respect to federal law.” The general rule in California (as elsewhere) is that the attorney-client privilege does not apply to legal services sought or obtained to enable or aid a crime or fraud. Because cannabis activity is still a crime under federal law, some thought this jeopardized the confidentiality of the attorney-client relationship in the event of an indictment or litigation. AB 1159 changes that by securing the attorney-client privilege where it pertains to cannabis activity, but only if the legal services were rendered in compliance with California state and local law and only if the lawyer advises the client on conflicts regarding federal law.

Bottom Line: California is making serious and productive moves to normalize things for its cannabis businesses. But for California cannabis businesses to take advantage of these new opportunities, they must be sure to comply with California state and local laws.

Cannabis trademark litigation
Can they live together?

A recent post here looked at the “Gorilla Glue” trademark dispute between a cannabis business and a glue maker. As we’ve often seen, the cannabis business gave up its brand, rather than litigating. Sometimes a settlement is the best choice. When the cannabis business is the smaller, newer, less financially-sound company, facing an established brand holder with more resources for litigation, it may be smart for the cannabis business to spend its money on rebranding rather than on litigation. But settlement is not the only option when a cannabis business uses a mark similar to the mark used by a non-cannabis business.

Imagine a hypothetical business, “Naturewave Furniture, Inc.” (“NFurn”). NFurn has been selling furniture for 25 years throughout the United States to consumers who want environmentally-friendly products. In 1995, NFurn federally registered “Naturewave” in international trademark class 20, “furniture.” Though NFurn is a player in the enviro-friendly products market, it is not a household name. Now imagine Naturewave Cannabis, LLP (“NCanna”), an Oregon cannabis producer that also sells branded rolling papers. In June 2016, NCanna registered “Naturewave” with the Oregon Secretary of State under class 131, “agricultural products,” and class 134, “tobacco & smokers articles.”

NFurn sues NCanna in federal court, alleging 1) NCanna’s use of Naturewave infringes on its trademark because confusion with NFurn’s Naturewave® mark is likely, and 2) NCanna’s use of Naturewave® to sell cannabis and rolling papers is diluting or tarnishing its mark. But NCanna has invested heavily in marketing its cannabis products and accessories under the Naturewave name, and its Naturewave cannabis products are popular and profitable. Does NCanna have good defenses to either claim? You bet it does.

The basic question for trademark infringement is whether consumers would mistake the source of the goods. Here, the goods offered by each party—furniture and cannabis—are unrelated. No stores sell both furniture and cannabis and the marketing channels for these two products do not overlap. The customers for both goods are sophisticated, careful shoppers. People looking for enviro-furniture usually spend at least 10 hours before buying a particular item. Cannabis consumers are known for research that borders on the obsessive, as shown by the proliferation of sites like MassRoots, Leafly, and Fresh Toast. Neither company is going to move into the other’s product line. Though NCanna had heard of Naturewave Furniture, the words “nature” and “wave” have different connotations in the different industries. NCanna isn’t branding itself as environmentally friendly, and NFurn isn’t suggesting its furniture will let the buyer “ride a wave.” It is unlikely a customer would think NFurn is the source of the cannabis sold by NCanna, or that one of NCanna’s customers would walk into a natural furniture store looking to buy cannabis.

The claim for tarnishment requires a different analysis. Under trademark law, the owner of a famous trademark can sue for using its mark in a way that dilutes or tarnishes the mark. There is no need to show a likelihood of confusion in a tarnishment claim; you only need to show that your mark is famous and similar to the accused mark. Although it is easier to list famous trademarks—Coke®, Amazon®, Google®, Starbucks®, Xerox®—than it is to define “famous,” generally a highly distinctive mark that is very well-known throughout the market, and has been used extensively and continuously for a long time, can be found to be famous. NFurn argues that NCanna’s use of Naturewave® with a traditionally illegal product will tarnish or dilute its mark. But is Naturewave® “famous” under trademark law? Arguably not, at least on our hypothetical facts. In that case, NFurn would not have a claim for dilution.

The upshot of this imagined case is that NCanna could evaluate NFurn’s lawsuit and know it had solid arguments to defend the case. The strength of the litigation position is, however, only one factor. Ultimately, whether to litigate a trademark dispute or settle or seek a coexistence agreement is a business decision for the cannabis company.

Related posts:

 

 

Cannabis edibles and the FDA
The FDA is the 800 pound gorilla of cannabis edibles.

The Food & Drug Administration (FDA) has only the jurisdiction Congress gave it in the Food, Drug and Cosmetic Act (FDCA). Under this act, the FDA has broad regulatory powers over legal drugs, with more limited powers over food.

Under the FDCA, the FDA categorizes a substance as either a food or a drug depending on how it is labeled or advertised. If labeling suggests the substance is “intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease, or is an “article[]” (other than food) intended to affect the structure or any function of the body of man or other animals,” the FDA will regulate it as a drug (except as noted below).

Cannabis edibles should stay out of the drug category if possible because drugs are subject to a comprehensive regulatory scheme that controls every part of the process, including formulation, testing for safety and efficacy, pre-clearance, manufacturing, labeling, sales, and recalls. For drug firms, the FDA is the 800-pound gorilla in the room.

The FDA categorizes food as anything people ingest that is not a drug. The FDA’s role in food is essentially hands-off. Though the FDA has promulgated hundreds of pages of food regulations, it mostly relies on food makers to self-enforce these regulations. However, when the FDA learns of regulatory violations it can and will take action.

The food/drug distinction is not always clear. In the Dietary Supplement Health & Education Act (DSHEA), Congress permitted some labeling claims for food (including dietary supplements) formerly limited to drugs. Under DSHEA, the FDA has issued regulations allowing certain specific health claims to be made on foods, e.g., “Three grams of soluble fiber from oatmeal daily in a diet low in saturated fat and cholesterol may reduce the risk of heart disease.” Food makers can also ask the FDA to permit other health claims if supported by scientific evidence. Other claims may be made, e.g., the role of an ingredient intended to affect a structure or function of the human body, under certain limited circumstances.

What does all of this mean for makers of cannabis edibles? If your cannabis label or your advertising does not make claims that bring your product within the FDA’s drug definition, the FDA will not treat your edible as a drug under the FDCA Act. This does not make it federally legal of course; it just means you won’t have to spend time having to deal with the FDA.

What if your edibles are marked with health claims or structure/function claims under DSHEA for cannabis or cannabis components, e.g., THC or CBDs? The FDA has in the past sent warning letters to firms making claims like these:

  • Studies have found CBD to possess the following medical properties: … Antipsychotic – combats psychosis disorders…combats neurodegenerative disorders … Anti-tumoral – combats tumor and cancer cells …combats…depression disorders
  • CBD helps with cancer, multiple sclerosis …diabetes, arthritis, dystonia, Crohn’s disease
  • Treats rheumatoid arthritis

The FDA has said that: “It is important to note that these products are not approved by FDA for the diagnosis, cure, mitigation, treatment, or prevention of any disease. Consumers should beware purchasing and using any such products.” If you make any health claims regulated by FDA for cannabis edibles, you risk federal administrative enforcement action.

For more on what the FDA has done with marijuana, check out the following:

There may though be change on the horizon. FDA Commissioner Scott Gottlieb recently said that “It’s high time [pun intended?] to start looking at rules around the [cannabis] plant, which some states have legalized for medicinal or recreational use.” Gottlieb also predicted that “We’ll have some answers to this question very soon because I think we do bear some responsibility to start to address these questions.”

 

Stay tuned.

 

 

Cannabis TaxesI regularly speak with clients regarding the tax issues that impact their buying, selling or operating a cannabis business. There are certain things I hear again and again regarding their taxes and their tax planning that are simply not true. The below are the five most common.

1. Calculating the Odds of Getting Audited Constitutes Tax Planning. It does not. This is a dangerous myth as it causes businesses to focus on the wrong question. This handicapping is called “audit lottery” and it will always lead you astray. The IRS only audits a small portion of small business and individual returns, but as Mark Twain once said, there are “lies, damn lies and statistics.”  Stating the obvious, a cannabis business is just not comparable to any other legal business and its odds of being audited by both the federal government and the state where it operates are much higher than for other types of businesses.

Other factors auger against playing the audit lottery. To increase efficiency, the IRS selects issues or industries it believes are rife with noncompliance or abuse. Based on a history of noncompliance by cannabis businesses, the IRS is active in auditing cannabis businesses. A recent law change has made it easier for the IRS to audit partnerships and LLC’s and beginning in 2018, the partnership/LLC is responsible for remitting tax due on any IRS adjustment on audit.

The energy spent guessing the odds of an audit are better spent understanding how to comply with federal tax law and how to document transactions in the most efficient manner.

2. Drafting Legal Documents Are Sufficient To Support My Tax Return.  We have written on the importance of corporate governance and compliance here, here and here.  The same concepts apply to taxes.  You should have legal documentation to support the fundamental financial events of your business. Is this transaction a loan from an owner or a contribution to equity? What are the management rights and responsibilities of a new partner? The answer to these and other questions should be supported by your legal documentation.

But having contracts in place is merely the starting point when it comes to your taxes. An important tax law maxim is that the “tax follows economics.” This means the proper tax treatment reflects what happens in your business, not what contracts are drafted and placed in a file.

In evaluating the tax consequences of a transaction, the IRS will always start with the documents, but it will then analyze how the business really operates (i.e., its economics) and compare that to the documents. Unsigned documents are ignored. Documentation that does not support the economics of the business are ignored. Contracts and legal documents not reflected in your books and records are ignored. Your contracts and corporate documentation must reflect how your business operates. Then, and only then, are they useful in determining the correct tax treatment.

3. Compliance with State Law is not Relevant for Federal Income Tax Purposes. Our cannabis clients often wrongly believe state law operates independently from federal law. In administering federal tax law, the IRS often restructures or ignores transactions with no business purpose or that were structured solely for tax avoidance purposes. Most often, the starting point in that evaluation is state law and a transaction that comports with state law has a greater chance of being viewed favorably by the IRS. Conversely, a transaction or structure that does not comport with state law, will most likely be rejected by the IRS on its face.

4. Having a Tax Professional Prepare My Return Limits My Responsibility.  Wrong. You the taxpayer have the ultimate responsibility for the information presented on your return. By signing your tax return, you are declaring, under penalty of perjury, that to the best of your knowledge, the information presented is, true, correct and complete. This includes information presented on schedules and statements. It is therefore crucial you have a clear understanding of the facts presented on the return and the reasons behind any tax treatment of a transaction.

5. Tax Law Applies to My Cannabis Business Differently Than Other Businesses. This is true to the extent that cannabis businesses are forced to reckon with IRC §280E. But generally, the principles of federal income tax law apply to a cannabis business the same as they do for a non-cannabis business. The tax law allows for a degree of flexibility in evaluating how a legal entity and its owners are subject to tax. A business may choose to operate as a limited liability corporation, and as such, be treated for tax purposes as a disregarded entity (i.e., the sole member is subject to tax) a partnership (i.e. each partner is subject to tax) or as a “C” corporation (i.e. the corporation is subject to tax). The tax law governing these options are no different for a cannabis business.

The cornerstone of the cannabis industry is strict state regulation, reporting, and compliance. Understanding and avoiding the tax myths discussed above will assist you in evaluating how to properly and effectively comply with both state cannabis law and federal income tax law.

Cannabis patentsOur previous post in this series discussed the legal sources for cannabis patent rights. This post and later posts will address some questions about what patents could mean for the cannabis industry.

Today’s question is: Do cannabis patents create monopolies?

Today’s short answer is: Yes and No, but probably less than you might think.

A patent is a government-created monopoly, giving the patent holder an exclusive right to make, use and sell the patented invention. A patentee doesn’t have to let anyone else use her patent (there is no mandatory licensing in the United States), or even use the patent herself. Once the patent expires, it belongs to the public forever. Though the law abhors a monopoly, patents are an exception. The theory is that granting inventors a few years of exclusivity encourages the creation of products beneficial to society.

A patent is not an unlimited monopoly, however. To start, a patent is only good for a limited time, usually about 20 years from the patent filing date. Since it can take three or more years to get a patent granted, that often means a patent lasts 17 years or less in the real world. Patents cannot be renewed; once the patent expires, anyone can practice it at no cost.  Compared with trademarks, which could have indefinite terms, or copyrights, some of which can last as long as a century, the patent term is short.

Also, only inventions that are new and not obvious can be patented. If something has been publicly used or on sale for at least a year, it’s probably unpatentable by anyone. The legal meaning of “obvious” is different and more complicated than the dictionary definition. For our purposes, if a claimed invention could be readily made by a skilled person who was familiar with the prior art, it is obvious. These two requirements of novelty and nonobviousness are intended to ensure that the patent system narrowly rewards creators, not merely collectors or aggregators of products to which the public already has access.

Perhaps most importantly, a patent’s coverage is often much narrower than it appears. You can consider a patent to be like a real estate deed. The deed for your house may refer to the property at “1st and Main,” but that doesn’t mean you own everything at that address. Your actual property lines are set out in the deed’s legal description, e.g., by detailed surveying designations. Similarly, the scope of a patent is limited by the claim or claims, which are found in the last part of the patent following the words “I claim” or “What is claimed.” Here is a hypothetical cannabis utility patent claim, based on an issued patent:

What is claimed is:

1) A cannabis plant that produces a flower comprising:

[a] a terpene profile where myrcene is not the dominant terpene;
{b] a terpene profile defined as terpinolene, alpha phelladrene, and myrcene;
[c] a terpene oil content greater than 1.5%; and
[d] a CDB content of less than 3%.

Properly interpreting a patent claim is a notoriously squirrely activity. Even if you understand the technical features of the claim, there is an entire body of often-conflicting law on claim interpretation. But one principle is paramount in determining the scope of a claim: the patent covers only inventions that have each characteristic, known in patent law as an “element,” set out in the claim. If a plant had elements [a], [c] and [d], but did not have terpinolene in its terpene profile as required by element [d], it would not infringe that patent.

Our next post will consider more issues about patents and their effects in the cannabis industry.

cannabis Intellectual property
I want my own IP….

If you co-own a cannabis business, you probably have a formal operating agreement that sets out who owns what—at least if you’ve been reading this blog. As I noted in my previous blog post, your cannabis company probably owns some intellectual property (IP): trademarks, copyrights, trade secrets, or patents. But who owns the IP, if, as is common, the operating agreement is silent on this issue? You may not have thought much about this, but you should. As any divorce lawyer can tell you, many assumptions about who owns what turn out to be mistaken.

LIke any other kind of property, IP is subject to general default rules that establish ownership, at least to begin with. The default owner of a patent is the human inventor. The default owner of a trademark is the entity (human or not) that uses the mark in commerce. Caution: it is easier to state these IP default rules in the abstract than to apply them in the real world. For example, though there is an ownership rule in copyright law called “work for hire,” it turns out it doesn’t apply to many people who are hired to create copyrightable works. Making mistakes about these default rules can lead to disappointment, or litigation.

You can diminish this risk, however, by making your own IP ownership rules. Virtually all of the default IP rules can be contracted around. A well-drafted IP ownership contract allows the parties to arrange their conduct knowing who will own the resulting IP. It will also discourage those who might try to take advantage of uncertainty to claim ownership of IP.

Co-owners of a business: IP issues arise in connection with a business formation in at least two situations: (1) some or all of the owners come to the business with preexisting IP, like brand names or trade secrets; and (2) the business will create new IP during operation. An IP agreement can define ownership so that the business will not be left without important assets (such as the brand name of the company) if the partner who brought IP to the business decides to leave. It can also provide ways to protect IP owned by the corporation, such as by requiring inventors to assist with patent filings or assign IP rights.

Deals with other businesses: Many deals between businesses have IP consequences. For example, a joint venture to create new growing processes could result in creating trade secrets or patentable inventions. In a distribution agreement, it is common for one party to have a license to use the other party’s trademarks. Determining the ownership of IP is critical when two companies work together.

Employer/employee/independent contractor: Any time a business entity pays a human being to create something, IP ownership issues will arise. Many businesses assume they know the default rules that apply depending on whether the human is called an “employee” or an “independent contractor.” The rules distinguishing these categories, however, vary from state to state, and are notoriously hard to apply. So, an IP agreement should not turn on the classification of the worker. Having a solid IP ownership agreement will allow both parties to concentrate on creating IP, and will lower the risks of disputes if and when the relationship ends.

IP ownership agreements need not be separate documents. The appropriate language can be included in your cannabis company’s operating agreement or even in its employee handbook. If you really want your own IP, however, don’t rely on the default ownership rules.

For more previous posts on cannabis litigation, go here for Cannnabis Litigation: Spotting Criminal Law Issues in Cannabis Cases and here for Cannabis Litigation: How to Avoid IP Disputes by Changing Your Oil Filter.

Cannabis business lawyers
Why so few cannabis warehouses?

Among several changes to marijuana laws that SB 5131 enacted in July, Washington’s license cap on retailers moved from three licenses to five licenses. The Washington State Liquor and Cannabis Board at first wanted to delay implementation of the new license allotment to 2018, but has now consented to begin processing license acquisition applications immediately. This isn’t for new license issuance — that window is still closed. But existing retailers that own three licenses can now acquire two more.

As market consolidation occurs in Washington’s retail cannabis space, our cannabis business lawyers have been working with retailers on the problem of inventory management in the marijuana space. Inventory issues represent a misunderstood but glaring headache for marijuana businesses across the state.

Any time a retail operation has more than one location, that operation wants to run its inventory processes as efficiently as possible. Many multi-location retail operations in other industries utilize centralized warehousing as a key cog in their inventory management systems. Having a single regional warehouse able to directly supply many retail stores has significant benefits. First, the per square foot price of storage at a warehouse location is significantly cheaper than at a high-traffic retail area. Additionally, if a retailer controls the warehouse, it effectively separates itself from the friction point of dealing directly with suppliers. All outside vendors can deliver to the warehouse and the warehouse can distribute the goods to the individual retail stores at a time and method convenient for the retail stores — delivery becomes less of a hassle and negotiation.

But, as always, this is significantly more challenging in the cannabis space. The state’s tied-house rules and tiered licensing severely limit the movement of marijuana product and who can control it at any stage in that process. A single retail license works for a single retail location   — a licensed retailer cannot maintain a separate warehouse and a retail store with a license. Every retail location must negotiate and organize shipments from licensed processors that, because of the tiered licensing rules, are third parties. If I own five retail locations and I want to stock them all with a specific product, I must organize five different shipments of that product.

There are two different fixes to this predicament. One is to take advantage of WAC 314-55-079(8), which states: “A marijuana retailer may transport product to other locations operated by the licensee or to return product to a marijuana processor . . . .” So if I own four retail locations, I have a little bit of flexibility. I could maintain a networked internal distribution model, where each location transports to each other location when necessary. Or, I could use one location as my de facto warehouse. If I have three retail stores in the city and one out in the county, I could expand the county’s inventory space, direct all deliveries there, and manage distribution from that central location.

There’s a catch, of course. This rule only applies if all the retail stores are owned by a single entity — a real liability concern. Most companies with multiple retail cannabis locations that each carry their own liability insurance hold the locations in separate business entities. This limitation of liability strategy is a core component of U.S. corporate law. If there is a massive tort or contract claim against a single retail location held in its own entity, the plaintiffs have access to every asset and insurance policy of that specific entity, but they don’t have any claim to the parent company or to other affiliated retail entities. Managing liability exposure through different business entities can represent the difference between a disastrous occurrence killing your profits for a year and killing your business forever. Retailers in that context must undertake a cost benefit analysis by figuring out whether the liability risk is worth the gain from increased inventory management efficiency?

The other solution is to negotiate a form of symbiotic relationship with a licensed processor. As stated, before, tied-house rules limit the ability of retailers and processors to engage in many business arrangements. Retailers cannot borrow money from, get discounts from, or receive gifts from licensed processors. They cannot enter any binding agreement where the purchase of one product is contingent upon the purchase of another product.

However, the rules don’t prohibit communication between cannabis retailers and processors and they don’t prohibit processors from making purchases based on the needs of retailers with which they do business. In theory, then, a processor could know the demand schedule of a retail group with whom it does business and act as an intermediary purchaser for that retail group. The retail group would probably end up paying a higher price for the product, as it would be adding an additional middle-man to the transaction, but this model pulls in some of the benefits of centralized warehousing. This system does present some risk to both parties, though, as their ability to enter contingent contracts is severely limited. A processor making a bulk purchase it assumes the retailer is going to buy may find itself in deep financial straits if the retailer chooses to buy elsewhere.

There are a few rule changes that could make things easier for retailers here in Washington State, but the WSLCB’s goal isn’t necessarily to make things easy for marijuana retailers. Outside of increased lobbying, cannabis business owners will need to continue doing the best they can within the system we have.

Cannabis lawyers
A good look indeed.

The Irish poet and dramatist Oscar Wilde once said, “You can never be overdressed or overeducated.” There were no cannabis companies in those times, but the idea that a little formality never hurt anyone holds true today. In the context of running a pot venture, Wilde’s aphorism remains particularly useful as a matter of policy. So, this is a post about cannabis companies doing things right.

We represent a large number of marijuana companies up and down the west coast. Though they are all eager to comply with state and local laws, some of our clients are dangerously informal regarding company structure and documents. These companies may suffer from inexperience, budgetary constraints, practical hurdles (i.e. lack of banking services), or lack of discipline. In nearly every interaction we have with informal businesses, we admonish them to get some basic paperwork in order. Today.

Marijuana companies are similar to other companies in that a lack of formality can be fatal. Take your standard C-corporation, for example. At a minimum, this type of company should have bylaws, a shareholder agreement, stock certificates, subscription agreements and articles of incorporation that comport with state statutes. When key company decisions are made, they should be documented through consent resolutions. Company funds should be kept separate from personal funds, and actions by directors and officers should be taken in their official capacities. Failure to follow these touchstones will expose shareholders to both legal and tax liability (through “piercing the corporate veil”). Often, lack of basic documents defeats the purpose of having a company altogether.

Long-time marijuana entrepreneurs are accustomed to informality. Historically, these individuals come from black and gray markets, and are used to operating underground. New market entrants tend to be more cautious, but as a general matter, they too have a belly for risk, given the status of federal law. But, although federal illegality is a difficult risk to mitigate, running an unstructured and improperly documented business is wholly unnecessary. It is taking risk for risk’s sake, and it is unwise.

In seven years of representing cannabis businesses, our firm’s cannabis lawyers have yet to see a client shuttered by federal agents. We have, however, seen plenty of them buckle under from disputes or tax headaches that were foreseeable, preventable and directly attributable to either a lack of basic documentation, or a lack of adherence to protocol. Often, we meet these clients for the first time mid-stream: sometimes the situation is salvageable; other times, not.

Even a company with the tightest, most polished documents possible may stumble if its owners or agents fail to follow formalities. Having an exquisitely tailored operating agreement, for example, will not avail an LLC member if he commingles business and personal funds. Similarly, if a corporation’s president ignores her company’s bylaws for an end-run around the board, she could find herself in peril. It is not enough to have good paper: good governance is also needed.

Getting appropriate documents in place should not be terribly challenging for a cannabis venture. It is something that should be done thoughtfully at the outset with guidance from an experienced corporate cannabis attorney, and it should not break the bank. As the business grows, existing documents will be amended or restated from time to time, and new documents will be generated. And if company owners and agents keep it formal enough — as Oscar Wilde would have it — things are likely to work out fine.

Cannabis litigationIn a 1970s TV commercial, the Fram oil filter pitchman observed that it is cheaper to change your filter than to rebuild your engine: “You can pay me a little now. Or you can pay him (expensive engine rebuilder) a lot later!” This auto maintenance rule also applies to your cannabis business in the area of intellectual property (IP) litigation. Today’s post is on avoiding expensive IP  litigation later by doing preventative maintenance on your IP now.

The first step to protect your IP is to know that you have it. You may not realize it, but almost every cannabis business has one or more of these kinds of IP assets: trademarks, copyrights, trade secrets, or patents. Even if you’ve never registered your IP, you almost certainly have some combination of the first three IP types, which don’t require registration. But just like your oil filter, you can’t maintain it if you don’t know it is there.

Once you know what you have, the next step is to protect it. Each type of IP is protected differently. Here is an overview that will fit in your glove compartment:

  • Trademarks: Trademarks protect brand names, e.g., “FlyBoy Cannabis,” that signify you as the source of the goods and services you offer. Although trademark rights are established by use of the trademark, not registration, you should still register your trademark with state trademark office(s), and the federal trademark office in some cases. Once you’ve registered your trademark, you should tell the world this is your trademark. Using ® is a good first step, but you should also establish a trademark use policy so that your customers consistently link you with your products. Registering your mark makes it easier to protect your brand in court, and will give notice to infringers that your brand belongs to you.
  • Copyrights: Copyrights protect the expression of a creative idea in a tangible form, not the idea itself. Your copyright applies as soon as your creation goes from your mind into a tangible form, such as writing an article on your computer or creating a CAD drawing of your design. You should take steps, including using the ©, to identify your work as yours. You should also register with the U.S. Copyright office (don’t bother sending your content to yourself in certified mail). As with trademarks, copyright registration gives you increased protection over your rights. Being able to threaten a lawsuit can be a powerful incentive to convince an infringer to stop instead of litigate.
  • Trade secrets: Trade secrets are commercial information, including technical and business information, which give you a competitive edge because they are not publicly known. For example, your confidential process for extraction could be a trade secret, so long as it cannot easily be “reverse engineered.”  The most important step to protect trade secrets is to keep them secret. However, you will likely need to share trade secrets with your own employees, and also with others outside your organization with whom you do business. Thus, nondisclosure agreements are one important feature of a trade secret policy. Depending on your business, you may need to take other steps as well. By the way, you can’t “register” a trade secret.
  • Patents: Although plants are generally patentable, the U.S. Patent Office traditionally refused to patent DEA Schedule I cannabis plants, though this appears to be changing. But many other inventions that can be used with cannabis could be patentable, such as vaporizers, smoking devices, and test equipment. An inventor has no patent rights until he or she files a patent application with the federal patent office (there are no state patents), and these rights won’t be enforceable, if at all, until the patent is granted, usually several years later.

Consider this article a free oil filter for your cannabis business.