Our Oregon lawyers have been fielding many questions regarding a recent civil RICO complaint filed in the federal court in Portland, Oregon styled as McCart v. Beddow et al. This case was filed on the heels of the Safe Streets decision out of Colorado that we discussed recently, and was clearly heavily influenced by that decision. You will recall that in Safe Streets, the Tenth Circuit allowed a private civil RICO action by a neighbor of a cannabis grow operation to survive a motion to dismiss.

As a reminder, RICO is a federal statute that provides for a civil cause of action for acts performed as part of an ongoing criminal organization (in addition to criminal penalties). It has become fashionable for meddlesome neighbors to bring these lawsuits against cannabis operators and their business affiliates. Because RICO complaints sound in federal law and implicate supply chain defendants, these cases differ from your ordinary nuisance-and-tresspass actions, which pursue only the marijuana grower itself, and also have been recently brought against Oregon marijuana growers.

Though McCart shares many similarities to the facts in Safe Streets, it is the differences that make things interesting. These differences let us tease out a couple of lessons for other cannabis companies seeking to avoid a similar lawsuit.

Oregon Cannabis First the similarities: Plaintiffs in both suits are bringing RICO claims against neighboring cannabis grow operations and alleging direct injuries to plaintiffs’ properties in the form of noxious odors that allegedly reduce property values. They also allege the mere presence of a “criminal enterprise” next door decreases property values.

But McCart is not Safe Streets. Taking the McCart complaint on its face, the direct operators of the neighboring grow operation are alleged to have gone out of their way to intentionally provoke the Plaintiffs at every turn. This isn’t just a case about noxious odors and neighboring criminal enterprises (although it is that); rather, the Plaintiffs are asserting this case is the culmination of a bitter dispute between neighbors in which cannabis is more of an extra than a star.

Specifically, the McCart Plaintiffs allege that:

  • The defendant cannabis growers menaced Plaintiffs and “made obscene gestures” and “screamed obscenities” at Plaintiffs;
  • The grow operation increased traffic on a shared driveway by an excessive amount;
  • The Defendants caused direct injuries to the property by leaving tire tracks on Plaintiffs’ property;
  • The Defendants revved their car engines when they saw Plaintiffs outside;
  • The Defendants “discharge firearms for extended periods”;
  • The Defendants frequently “blast the air horn of their dump truck”;
  • The Defendants damaged the shared driveway and at times blocked it; and
  • The Defendants littered on Plaintiffs’ property.

Whether these allegations are true will be Plaintiffs’ burden to prove. However, two immediate lessons come to mind:

Lesson 1: To paraphrase Wil Wheaton: don’t be a jerk. Be a good neighbor. If the McCart allegations are true, the behavior of these growers reflects poorly on the entire industry. If you want to be treated like a serious business, act like one. Recognize the precarious legal situation afforded by inane prohibition policies, and strive to be ideal neighbors.

Lesson 2: Control the odors. The Safe Street court found that the cannabis smell released by the Colorado grow op was enough to assert a claim for RICO damages. You should do everything you can to minimize odors on your businesses.

But what about the other McCart defendants?

Like in Safe Streets, the McCart plaintiffs seem to have sued everyone even tangentially related to their hated neighbors, including cannabis dispensaries that just happened to stock the neighbors’ products. These “Dispensary Defendants” are probably in much better shape than the growers.

A civil RICO claim under 18 U.S.C. Section 1962(c) (at issue in both Safe Streets and McCart) requires a plaintiff prove:

  • The existence of an enterprise affecting interstate or foreign commerce;
  • The specific defendant was employed by or associated with the enterprise;
  • The specific defendant conducted or participated in the conduct of the enterprise’s affairs;
  • The specific defendant’s participation was through a pattern of racketeering activity; and
  • Plaintiff’s business or property was injured by reason of defendant’s conducting or participating in the conduct of the enterprise’s affairs.

In Reves v. Ernst & Young, the US Supreme Court held that the language of 1962(c) requires the defendant have “participated in the operation or management of the enterprise itself.” (page 183). There are a few out of jurisdiction cases that have held that mere business relationships and supplier-purchaser relationships are insufficient to establish RICO liability, even with knowledge of the illegal activity. If you are curious, take a look at In re Mastercard Intl. Inc., (page 487) and Arenson v. Whitehall Convalescent & Nursing Home, Inc. It seems unlikely the Dispensary Defendants in this case had anything to do with operating or managing the enterprise. They appear to have merely been customers, in which case they shouldn’t have liability here.

Though there is a dispensary defendant in Safe Streets, the Tenth Circuit appears to have found the conduct requirement was met because the Safe Streets defendants admitted they all “‘agreed to grow marijuana for sale’ at the facility adjacent to the [plaintiffs’] property.” The Safe Streets dispensary defendant was directly involved in operating the specific grow operation at issue. This is not the same thing as an innocent dispensary accepting product from a third-party farm.

We will be watching this case and reporting back if anything of importance breaks, but in the meantime, it never hurts to be a good neighbor, and to take steps to minimize odors.

California cannabis leaseWe’ve written previously on arbitration and why it so often makes sense for cannabis business contracts, primarily because of enforceability issues stemming from cannabis being illegal under federal law. But in the realm of commercial real estate leasing, cannabis uses can present other unique challenges that require thoughtful solutions to disputes, and, more importantly, thoughtful planning to prepare for potential disputes down the road.

Below are some of the issues our California cannabis lawyers typically consider when anticipating how to draft dispute resolution clauses for commercial cannabis leases.

  1. Enforceability of the lease and the arbitration award. Federal illegality of cannabis impacts all cannabis business transactions. Though the Federal Department of Justice has issued cannabis enforcement guidelines in the Cole Memo (and every cannabis-touching lease agreement should include language mandating compliance with these guidelines), this does not guarantee against federal civil asset forfeiture or other federal enforcement actions. Another consequence of federal illegality is that cannabis companies must consider what recourse they will have in enforcing their contracts and account for federal district courts being unwilling to enforce any such contract. For this reason alone, it will nearly almost always be better for you to have your disputes resolved in a California state court that will be far more likely to apply and enforce California state cannabis laws. California state courts can also apply federal law, but because there is often a risk of your case being removed to federal court you should always consider putting an arbitration clause in your cannabis commercial leases, specifying the arbitral body, limiting how the lease and the arbitration award can be enforced (confining it to state courts, perhaps) and limiting potential appeals.
  2. Choice of law. We’ve written about how California commercial cannabis landlords (and tenants) should consider beefing up their lease’s indemnity provisions, allowing for early termination in the event of enforcement actions, disallowing federal illegality as a grounds for invalidating the lease, and generally requiring strict compliance with California state law for the specific proposed cannabis use. For similar reasons, arbitration clauses can include a mandate that the arbitral body apply state law and the California Arbitration Act, and not, for example, the Federal Arbitration Act, which allows an award to be vacated where the arbitrator “manifestly disregards the law.” It is not difficult to imagine a scenario where a federal court vacates an arbitral award for an arbitrators having failed to apply the Controlled Substances Act or void the cannabis lease ab initio. California arbitration clauses should, at minimum, specifically outline 1) the method for choosing the arbitrator, 2)  the laws the arbitrator must apply in resolving the dispute, and 3) the standard of review any reviewing court must apply. For many California real estate transactions, the arbitration clause should also include specific statutory notice language.
  3. Carve-outs for Unlawful Detainer, Nonpayment, and other Early Termination Causes. Though arbitration can be a highly useful tool, landlords will also want to maintain their ability to seek remedies for nonpayment of rent and unlawful detainer (eviction) without having to go through the arbitration process. Similarly, if a tenant faces a state or federal enforcement action, the landlord (and even the tenant for that matter) will likely want to maintain its ability to terminate the lease quickly and without arbitration. The parties to a California commercial cannabis lease should always consider carving out exceptions to arbitration to keep options open and to encourage timely performance of the lease.
  4. Arbitrator’s industry expertise. California arbitrators tend to be retired California state court judges and the changes of this sort of arbitrator having deep knowledge about the cannabis industry or cannabis laws are not good. But spelling out the arbitrator selection process in your commercial lease agreement (or even naming the specific arbitrator or arbitrators) can allow you to make certain your arbitrator has sufficient cannabis industry knowledge to understand any eventual dispute.
  5. Consider making mediation the first step. Arbitrations can be expensive and their outcomes uncertain. So instead of drafting a commercial lease agreement that requires you to jump right into that process whenever a dispute arises, consider making private mediation a mandatory first step before a demand for arbitration can be made.

Though every commercial lease dispute is unique (even more so for cannabis commercial leases), there are common themes and one is that private dispute resolution tends to work best for disputes between cannabis businesses.

Washington State cannabis lawsAs Washington’s cannabis industry continues to develop, marijuana businesses continue to face new challenges. And with an ever growing number of consumers buying and using marijuana the risk of lawsuits against those who produce or sell cannabis keeps growing as well. Under what is called product liability law, manufacturers, distributors, suppliers, retailers, and others who make products available to the public can relatively easily be held liable for any injuries those products cause. Cannabis business owners must be mindful of product liability lawsuits arising from the cannabis products they make or sell.

In Washington State, product liability law is codified in the Washington Product Liability Act (WPLA), which broadly applies to virtually any injury claim resulting from a product covered under this act. The WPLA distinguishes between product manufacturers and non-manufacturer sellers. Washington’s marijuana market is divided between businesses who grow and process cannabis and businesses that sell the product to consumers. Manufacturers, for WPLA purposes, are the licensed producers that grow cannabis and turn that cannabis into edibles, extracts, concentrates, and other marijuana products. Non-manufacturer sellers are retailers that sell marijuana to consumers. A business can hold a license to produce and process marijuana but it cannot also have any ownership interest in a retail business. In turn, a retailer may have not an ownership interest in a cannabis producer or processor.

A product manufacturer is subject to liability under the WPLA if it was negligent or failed to provide proper warnings or instructions or if the product was not designed as reasonably safe. A plaintiff can show negligence by proving the manufacturer owed a duty to the plaintiff, the defendant breached that duty, and the breach caused the plaintiff damages. A plaintiff can prove a manufacturer failed to provide an adequate warning by showing that a product’s warning or instructions were not likely to notify the consumer of the potential harm and the manufacturer could have provided instructions or warnings that would have been adequate. A plaintiff can show that a product was defectively constructed by establishing that “when the product left the control of the manufacturer, the product deviated in some material way from the design specifications or performance standards of the manufacturer, or deviated in some material way from otherwise identical units of the same product line.” Finally, a plaintiff can prove that a product lacked adequate warning and was designed defectively if the product “was unsafe to an extent beyond that which would be contemplated by the ordinary consumer.”

Washington’s robust marijuana regulations may provide producers and processors with some safeguards against claims brought under the WPLA.  Producers and processors may present evidence of compliance with Washington’s extensive cannabis laws and regulations as a defense to a product liability lawsuit. However, compliance with these state law cannabis standards does not automatically bar products liability claims as it is still possible the state required warnings or acceptable standards for growing and processing are inadequate.

Under the WPLA, non-manufacturer sellers can be liable in some scenarios, but simply selling a product that eventually leads to injury does not by itself establish liability. This means that retailers have a lower risk of being subject to product liability than a manufacturer because they do not manufacture the products they sell. However, a retailer may be liable to an injured consumer if the consumer’s harm was caused by the seller’s own negligence by the breach of a warranty made by the seller, or by a seller’s intentional misrepresentation of facts about the product it is selling. A seller may also be liable if there is no financially solvent manufacturer. Because many producers and processors do not have the funds or the insurance to pay off on large (or even not so large) product liability lawsuits, even cannabis retailers in Washington State need to be wary of product liability lawsuits.

Marijuana businesses operators can reduce their product liability risks by doing the following:

  1. Set up your cannabis business so as to protect yourself from personal liability. See Cannabis Businesses And Corporate Separateness and Cannabis Business and Corporate Separateness, Part II
  2. Vet the businesses with which you conduct business and, in particular, seek to ensure they are complying with applicable regulations and industry standards. See Buying a Cannabis Business: The Top Five Due Diligence Items or Buyer Beware.
  3. Draft your contracts so that vendors must indemnify you for any damages arising from their defective product.
  4. Use appropriate packaging and warning labels on the products you sell. See Cannabis Products and Dosing: Educate, Educate, Educate and Label, Label, Label and Pot Puppies? Let’s Talk Labeling and Packaging. NOW.
  5. Get good insurance for your business. The LCB requires cannabis licensees carry and maintain commercial general liability insurance, but you should also consider adding additional insurance to cover potential product liability lawsuits.

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.

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.

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.

Cannabis litigation lawyerThough we are hoping 2017 will bring you nothing but prosperity when it comes to your cannabis business. But if you are headed to court in 2017 or even if you are just just sensing a company dispute stirring, the following five tips will help you avoid or mitigate the negative impact of a business dispute.

  1. Make your business relationships crystal clear from the start. The days of handshake deals regarding ownership in a cannabis business are over. You should do no deals of any real size without first getting everything in writing. Operating agreements, bylaws, and shareholder agreements exist to ensure that your company structure and the relationship between its owners is abundantly clear. When starting a company together, you and your fellow owners should have at least some understanding on how your company will be operated and on how such things like equity versus debt, voting rights, sweat equity, preferred returns, owner employment will be navigated. Most of the ownership disputes our cannabis litigation lawyers have handled have been because of badly done initial company contracts and filings.
  2. Perform due diligence on your partners. If you want to increase your odds of avoiding a dispute with your cannabis business partners, the most important thing you can do is to choose your partners wisely. What never ceases to surprise us is how often we are told by a party locked in a life or death ownership dispute regarding a cannabis business is that they barely knew their business partner before they started the business with them. If you are going to start a cannabis business (or any business for that matter), the first thing you should do is find out as much as you can about your putative partner’s financial and business history. You should do this before you sign away your soul and money to joining with this person on a business project. It’s neither rude nor unexpected to ask your potential partners for documentation showing their financial and criminal history–the state licensing regulators will ask for this information anyway. It is even more important to conduct thorough due diligence if you are buying into an existing cannabis business. At minimum, this due diligence should include investigating and analyzing the assets and liabilities of the company and its current owners. Your due diligence should also include confirming the appropriate standing of the company with state and local government regulators, and determining that the company and its principals understand how to comply with state and local laws as well as the Cole Memo. This is routine in every other industry and it must become routine in the cannabis industry as well.
  3. Get your own attorney from the start to protect yourself. More often than not, the company has an attorney looking out for the company’s interests. But it is important to realize that the company attorney is not your personal lawyer and that lawyer will almost certainly be conflicted out of any dispute between you and your business partners and/or investors. For this reason (and many others) you need your own lawyer providing you with your own counsel and protection regarding your role in the company and your ownership rights. This lawyer should also make sure that the written agreements work for you and not against you. This lawyer will also be an asset for you personally if any dispute arises. For more on how to avoid a dispute relating to your cannabis business, check out Five Tips on How to Avoid Cannabis Litigation and How to Avoid Costly Marijuana Business Disputes. For more on how to choose the right lawyer for your cannabis business check out How To Choose Your Cannabis Business Lawyer.
  4. Know your dispute resolution options. Well drafted corporate documents and contracts should cover most possible breakdowns in the business or the relationship and set out the options for handling internal strife. If there is a fight or a tie on a vote, what happens? How are problems resolved and when? Who makes what decisions and how? What about liquidating the business? What about selling an ownership interest and for how much? Can you sell just your membership interest or shares without going through a vote of the members? Can you keep running the business free of your partners if there’s a fight? What about dissolving the company and winding down? What happens if there is a contract breach? All of these things can and usually should be covered in your corporate governing documents or in any other contract you sign, and by doing so, you greatly minimize your likelihood of destructive problems down the road. Your company documents and contracts should also make clear exactly how disputes are going to be handled. Are you going to want your dispute made public in a court, or kept quiet in an arbitration or mediation? It is a lot easier to reach agreement on such things when you are starting your business or your relationship than when you are already in the midst of a hard fought dispute with costly lawyers.
  5. Make sure your lawyer knows what he or she is doing. When hiring a lawyer to help protect you when getting into a cannabis business, you should be sure to hire a law firm with lawyers who know both business law and cannabis law. And when confronted with a dispute involving your cannabis business, you need to be sure to hire a law firm with lawyers experienced in civil litigation (criminal litigation experience does not count here) and cannabis law, if possible. For more on choosing your cannabis lawyer, check out How To Choose Your Cannabis Business Lawyer.

Be careful out there, and have a happy 2017.

Cannabis business lawyersWe’re in that time of year when at least some of the licensed cannabis producers in Washington tend struggle. A short-term glut of marijuana on the market makes it harder to stand out and make sales, and businesses that aren’t competitive on price or quality get left behind. I bring this up because it is also the time of year when financiers come to my firm’s cannabis business lawyers looking for a way out of deals they fear will never pay off.

“Financiers” in the Washington marijuana system generally refers to debt investors that get a set interest rate of return rather than a profit-interest in a business. Mark Cuban once said that only a moron would start a business on a loan, but the limitations on out-of-state equity ownership leave many newish cannabis businesses cash-strapped, so they turn to debt. We have also seen that many of the creditors involved in the local marijuana industry are not seasoned small-business investors. They are people looking to take advantage of an industry that seems to be printing money. Debt feels less risky than equity, so they throw some money into a cannabis business or two, believing they will be able to get 10%-20% interest annually.

Because so many of these investors are new to small business investing, many don’t protect themselves. Lenders have a lot of tools to make sure they get paid. Security interests in real, personal, and intangible property provide avenues for seizing assets. Marijuana inventory is complicated to secure, but most marijuana businesses have at least some high dollar capital equipment. Personal guarantees from major players put personal assets on the hook as well, and signed confessions of judgment make the process of obtaining a judgment on the debt significantly easier. Most loans do not involve all of these protections, but most smart lenders are not willing to provide completely unsecured capital to brand new businesses without any way to get a return if the business folds.

If you are one of those unsecured investors and the cannabis company to whom you loaned money defaults on your loan, what can you do? If you want any chance of recouping your investment, you really only have two options. First, you can renegotiate the debt. In most well-drafted promissory notes, an uncured event of default causes the debt to accelerate and mature. This means that if your cannabis borrower misses a payment and doesn’t make a late payment by the cure date, its entire debt becomes due. Once this happens, it is just a matter of negotiating an extension on the note. During that extension, you as the creditor have significant leverage to extract concessions from your cannabis borrower, such as personal guarantees, security interests, or even pledges of ownership interest in the cannabis company. The reason you as the creditor have leverage is because your only other viable option would be to obtain a judgment against the borrowing company and that judgment will likely be a nightmare for your borrower. If you are wiling to brave the legal fees and get a judgment against your borrower, you can then use that judgment to begin levying on the cannabis business’s assets as though you had a security interest in the property to begin with. In most states, once you get the judgment, at least some of what you spend collecting on it, including your attorneys’ fees, will be collectable as well.

Companies that owe debts to third parties and realize that they are about to go under sometimes look for ways to avoid paying the debt. This is a good time to bring up fraudulent transfers. As defined in most states, a fraudulent transfer occurs in a few different ways, the most common of which is when an insolvent debtor transfers property without receiving a reasonably equivalent value in the exchange. If an “insider” — someone connected to the company like a director or a director’s spouse — is involved in the transaction, showing fraudulent transfers becomes far easier. For example, if a debtor  company has a bunch of equipment and transfers it to the company owner’s brother, that is potentially a fraudulent transfer, and the property can be clawed back for creditors.

The stickiest situations come when there are multiple debts. A company is not necessarily breaking any laws if it chooses to pay one creditor before it pays other creditors. Unless the creditor is an “insider,” the company can generally choose which of its debts to pay unless it is in a formal bankruptcy (probably not available to marijuana businesses) or a state receivership proceeding. In certain circumstances, multiple debt investors have signed promissory notes in which the company promises not to pay the notes proportionally and not to provide any payment preference. If the debtor company does pay one holder disproportionately to the others in that circumstance, the creditor left-behind may be entitled to a clawback of the payment.

These collections matters don’t usually end with either side truly happy. Attorneys make some money, and investors can often recoup a portion of their investments, but debt litigation against a business is an unpleasant affair. If you are looking to lend to a cannabis company, make sure you know what your plan is if things turn south. It’s better to have a security interest up front than it is to fight the company and other creditors in court to get the right to levy.

RRLast week, the Oregon Land Use Board of Appeals (LUBA) ruled against a certain cross section of pot growers in the state. The Petitioners at issue wanted to grow medical marijuana on land covered by a “rural residential” zoning designation. When Jackson County adopted a zoning ordinance prohibiting such activity, the growers sued. Because LUBA sided with the County, medical marijuana grows in that jurisdiction will be limited to land zoned exclusively for farm (EFU), forest or industrial use. In that sense, the ruling is fairly narrow, although it could discourage prospective litigants in other counties on similar appeals.

As covered in the LUBA decision itself, the zoning change was consistent with Jackson County’s Comprehensive Plan and ORS 475B.500, which allows cities and counties to adopt “reasonable regulations on the operation of marijuana grow sites.” The Board found that a county keeping medical marijuana grows off rural residential land is “reasonable” for a couple of reasons, including that there are over one million acres of land in Jackson County that remain suitable for marijuana cultivation under the new ordinance.

The growers took an interesting approach to the “reasonable regulations” issue; they first argued that marijuana production is an exercise in free speech under the First Amendment of the Constitution. Due to this broad protection, the growers argued, the County’s zoning amendments would have to serve a “significant government interest” to withstand scrutiny. As you might expect, LUBA dismissed that argument quickly. More compellingly, the growers also argued that marijuana is now a “crop” under Oregon statutes, and the County did not prohibit other “crops” from being grown on rural residential land. In response, LUBA pointed to the large amount of land still  available for medical marijuana grows even outside the rural residential context.

Though not mentioned in the opinion itself, LUBA surely took note of how Jackson County entertained significant public input before adopting the zoning regulations. Local jurisdictions tend to do this ahead of controversial decisions. In theory, the jurisdictions want to gain as much public input as possible before making impactful decisions; but cynics argue that this process affords only the veneer of democracy, designed to insulate government from criticism and lawsuits. In our experience, early advocacy may be fruitful, if the approach is correct.

As further background to this case, LUBA also surely understood that farmers who had been on rural residential land prior to the ordinance can still “grandfather in” as a non-conforming use under Jackson County Code. We have worked on this issue with growers all around the state, as most local land use codes contain a section on non-conforming uses and vested rights. These concepts allow people to continue to operate as they had operated before a zoning change, even after the change occurs. As such, the only people that should be effected by this decision are those who will resist paying the fee to grandfather in, and those who had not yet begun to operate on rural residential land when the ordinance passed.

The growers in this case have vowed to fight on, which means a date in the Court of Appeals. They will argue, as they did in the press last week, that “it is hard to understand how an ordinance that stops 3,500 farmers from producing medicine for their patients is a reasonable regulation.” It is possible, but unlikely, that they will win. Meanwhile, prospective litigants around the state will have some food for thought when it comes to challenging local land use regulations.

Fortunately, there will be opportunities to distinguish the claims brought by the Jackson County growers, which are limited to a certain class of land in a certain county. This adverse decision should have only minimal impact on the Oregon cannabis industry’s momentum overall.