California cannabis rulesAt a Sacramento conference I attended last week, a panel of California’s cannabis regulators discussed the status of the state’s new cannabis laws under the Medicinal and Adult Use Cannabis Regulation and Safety Act (“MAUCRSA” a/k/a SB 94) that aim to reconcile California’s 2015 Medical Cannabis Regulation and Safety Act (MCRSA) and the 2016 Adult Use of Marijuana Act. MAUCRSA comes on the heels of a comprehensive set of proposed MCRSA regulations (see here, here, herehere, and here) and a slew of pubic hearings and commentary on those proposed rules. According to regulators, they are now incorporating public comments as well as MAUCRSA into their efforts to finalize the licensing rules before licenses begin to issue in January 2018.

Here are some of the potential changes to the MAUCRSA regulations discussed at Monday’s panel:

  1. The MCRSA proposed rules will be withdrawn in full, and new MAUCRSA rules will likely come in the fall that cover both medicinal and adult use. Some regulations likely will change from their current MCRSA form, but what likely won’t change is the license application requirements, and the state expects to begin issuing temporary licenses in early December for applicants with prior local approval. The temporary licenses will be good for only four months, though, and these licensees will still have to go through the full application process.
  2. Based on public feedback received to date, the regulators expect some cultivation rules to change, including the definitions for “mixed light,” “indoor,” “outdoor,” and “owner.” Also, the requirement for 42% renewable source energy for indoor grows will likely be revised to define exactly what qualifies as a renewable source and to potentially alter the percentage mandated, though it is unclear whether that would increase or decrease.
  3. MAUCRSA allows individuals to hold both medicinal and adult use licenses but only if there are located at “separate and distinct” premises. The MAUCRSA regulations will aim to clarify what “separate and distinct” means, and regulators on the panel didn’t seem to want a strict interpretation of that term so as to require entirely separate parcels, but instead discussed the possibility of allowing “physical barriers” of some sort between separately licensed medicinal and recreational activities.
  4. Under California’s existing Compassionate Use Act, medical cannabis operators have utilized mostly non-profit mutual benefit corporations as the preferred corporate form for compliance. What MAUCRSA doesn’t do is explicitly clarify how these non-profits might transition to for-profit companies without jeopardizing their licenses or prior local approval or triggering regulator scrutiny. The regulators acknowledged that this omission in MAUCRSA may foreclose specific regulation on the subject until further “cleanup” legislation is handed down from the legislature.

Though the public comment period on the MCRSA proposed rules has already passed, regulators stressed that they welcome further feedback from cannabis industry stakeholders ahead of their releasing proposed MAUCRSA regulations in the fall. They made clear that public input is an essential element of making sure California “gets it right” on developing and regulating a successful and safe recreational and medical cannabis industry.

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

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

California cannabis financing

For cannabis companies in California, 2017 is a period when neither companies nor investors are living in the moment. In addition to all of the risk factors cannabis investors need to heed, everyone is planning for future uncertainty because of  the recent passage of MAUCRSA. The state is currently working on MAUCRSA regulations, and local governments are changing policies with what seems like every public hearing – not to mention comments from our federal leadership that seem tailor-made for cooling investment into cannabis companies (the job creators!).

At the same time, California cannabis companies need funding now to scale up their operations in anticipation of future licensure under MAUCRSA and to appease local regulators through local licensing and permitting processes. The result of all this is that our California cannabis lawyers are seeing and working on many deals involving hybrid financing structures – an element of cash investment now, and warrants, options, and convertible debt later. Each has different triggers and rights for the cannabis company and investors, but all are in essence a different form of “kicking the can down the road” to 2018.

Three big factors are driving hybridized financing in The Golden State:

1. Regulatory Uncertainty and Red Tape.

Investors inherently accept risk in any investment, but they do not enjoy reading the tea leaves on major issues that are out of the control of company and investor – any of which could pose an existential threat to their entire investment. This means investors are searching for creative ways to mitigate these risks, and risks abound in cannabis regulations that change pretty much all the time. Many cannabis investors are uncertain whether they want to cross the 20% ownership threshold to be considered an “owner” under MAUCRSA, which ultimately requires they be disclosed to and heavily vetted by California state regulators.

2. License Transfer and Corporate Structuring Issues.

California’s draft cannabis business regulations make clear that future licenses are not transferable. And many local governments are also making sure cannabis operators cannot transfer their permits or local licenses after-the-fact. Further, most existing medical cannabis operators are organized as non-profit entities pursuant to Proposition 215, and there’s an outstanding question as to whether these entities will be able to merge into for-profits once they have their state licenses under MAUCRSA, though such a move could potentially jeopardize state and local licensure altogether. Though all parties should undertake their cannabis financings with this knowledge, investors understandably still want to reduce risk by withholding some of their investment until 2018 when more of these questions will likely have been resolved by state and local governments.

3. The Size of the Opportunity.

In the last two weeks, we’ve seen the situation in Nevada where despite a 33-37% tax on all retail sales, dispensaries simply cannot keep up with demand and are selling out of supply. In the event California has a similar supply crunch, we are seeing investors in California cannabis cultivators seeking warrants or options as a “kicker” for additional upside – more equity in the event the opportunities prove even greater than anticipated.

This is not to say that investors are dictating all terms in the world of cannabis finance. Cannabis companies, too, can and do negotiate for control of the trigger points or adjustments to the future exercise price (or regulatory triggers). Some cannabis companies are choosing hybrid investment structures because they, too, want to feel out the size of the opportunities and many believe they will be able to demand much greater valuations and investment terms in 2018, once the initial dust settles on the regulatory sphere.

What are you seeing out there by way of California cannabis funding?

 

The cannabis movement has always had a benevolent streak. Many people produce and disseminate the plant to alleviate illness and suffering. Others support legalization for social justice reasons– unwinding the prison industrial complex, for example. And still others are simply interested in solving hard problems, such as the outsized environmental footprint of cannabis grows. When people of this general orientation approach our cannabis attorneys to start cannabis businesses, they often ask about “benefit company” status.

Over the past several years, most states in the U.S. have adopted benefit company statutes. Generally speaking, a benefit company is a type of corporation or limited liability company that considers its impact on society in making decisions. Sometimes, B Corps and B LLCs are said to have a “triple bottom line” which includes not just profits, but also the community and the environment. A few well known benefit companies include Patagonia and Ben & Jerry’s.

Because of the triple bottom line ethos, benefit companies do not impose a strict duty on their directors, officers, managers or members to maximize profits. This differs from a traditional corporation, where governing individuals can be exposed to shareholder litigation for failing to make decisions that maximize profits. Cannabis entrepreneurs, like business people in other industries, may find this element of benefit company status attractive.

Benefit companies may sound a bit like non-profit corporations, but they aren’t. For state and federal tax purposes, benefit companies are considered for-profit entities. They also tend to be structured no differently than for-profit companies, in terms of underlying company paper and personnel. Benefit companies do behave like non-profits in the sense that they are mission-oriented, but that’s about it.

Almost all states now accept benefit companies and follow the model B Corp legislation, which hasn’t been around all that long. As a result, the process of becoming a benefit company is fairly consistent from state to state. Some especially progressive states, like Oregon, have adopted a broader version of the benefit corporation law that allows founders to form benefit LLCs, in addition to corporations. In the Oregon cannabis industry, we have formed both kinds of companies.

In most states, forming a benefit company isn’t terribly difficult: as far as filing, it’s typically a “check the box” election that is made in the entity’s Articles of Organization (LLC) or Articles of Incorporation (corporation). It’s what comes after the election that takes some thought. The benefit company is required to adopt a third party standard to judge its efforts to accomplish a public benefit (such as the B Labs Impact Statement). Each year, the company must also draft a benefit report detailing its efforts in achieving its public benefit, and distribute the report to its owners and through its website.

Benefit companies often help owners and investors feel good about their enterprises, and, from a branding point of view, the B Lab certification is a great look. Looking back, the cannabis industry has made big strides over the past few years with respect to community integration and acceptance. Let’s see whether recreational pot businesses continue to embrace the benefit model, especially as key states like California come online in 2018.

California cannabis leaseCommercial leases for cannabis businesses are unique and require special considerations for risk management during the tenancy. Commercial cannabis leases in California are prone to the following pitfalls inherent in a landlord doing business with a cannabis tenant, and these risks should be considered when deciding how to structure your landlord-tenant relationship:

  1. Accepting ownership in the cannabis tenant company. Buying and selling shares in privately held cannabis companies can trigger state and federal securities laws and create regulatory problems under California’s cannabis licensing program. A landlord’s acceptance of an ownership share from a tenant in lieu of or in addition to rent can jeopardize the cannabis tenant’s California state cannabis license status. California’s proposed cannabis rules define an “owner” as a person with 20% or more ownership in the licensed cannabis company, a CEO or board member with 5% or more ownership in an entity with 20% or more ownership in the licensed entity, or any individual that exercises “direction, control, or management” of the licensed business. All such “owners” are subject to thorough background checks as part of the company’s ability to acquire and maintain its cannabis business license. A change in ownership or control puts the tenant’s license at risk of being revoked, harming both landlord and tenant.
  2. Receiving cannabis product as rent payment. Though cash-poor cannabis tenants may have trouble finding financing, they usually have plenty of valuable cannabis product. But for the same reasons landlords should avoid accepting ownership in their cannabis tenants business entities, they should also avoid accepting cannabis product as well. Not only does a tenant providing its landlord with cannabis jeopardize the tenant’s license (and thus the landlord’s source of rent revenue), it also exposes the landlord to liability for operating as an unlicensed cannabis merchant. California’s proposed cannabis rules strictly control who can and cannot handle or accept cannabis product as part of a licensed operation, and circumventing those strictures exposes both landlord and tenant to liability.
  3. Profit/revenue sharing. Commercial leases for garden-variety business tenants sometimes include terms requiring the cannabis tenant pay a certain percentage of its profits or revenue to its landlord in addition to or as part of rent. Though this sort of arrangement can be advantageous in other situations, it raises problems for cannabis tenancies since receipt of profits or revenue specifically tied to cannabis sales can expose the landlord to liability for unlicensed cannabis activity as a de facto owner. 
  4. Liens for build-outs. Indoor agricultural grows require unique environmental control systems and this in turn often means cannabis tenants must engage in expensive build-outs. Landlords may want to seek lease provisions ensuring all alterations be authorized in writing beforehand, that the landlord acquires no ownership or benefit from any alterations, and that all alterations must be removed when the tenancy ends unless the landlord elects otherwise, in addition to serving notices of non-responsibility where appropriate. Essentially, landlords will want to avoid allowing build-outs that might result in liens filed against their real property. On the other hand, the landlord may want to be involved in the build-out to outfit the facility to its own preferences. In other words, landlords should seek to avoid unintended entanglements while structuring their leases to reflect their intent.
  5. Access and security. Though landlords typically want commercial cannabis leases to allow them access at any time with reasonable notice for things like maintenance, inspections, and showings, the situation is different for cannabis business tenants. California’s proposed cannabis rules under the Medical and Adult Use Cannabis Regulation and Safety Act (MAUCRSA) require cannabis tenants to set up and maintain a rigorous security protocol that only allows product to be handled by authorized individuals, and that only allows authorized individuals to access the premises. Unfettered access by a landlord will likely raise problems with California’s cannabis regulators, and with good reason. Part of the rationale for complying with strict state-mandated security requirements is to further federal enforcement goals, such as preventing diversion of product to minors or to states where cannabis has not been legalized. By failing to sufficiently regulate access in the lease, the landlord can unintentionally entangle itself with the operations of the licensed cannabis entity and thereby place its tenant’s cannabis license in jeopardy.

Bottom Line: California commercial cannabis tenancies benefit from being kept as arms-length transactions so as to protect against problematic entanglements, both intended and unintended and any proposed tenancy should be analyzed with this goal in mind.

Cannabis attorneysIn Joe Hemp’s First Hemp Bank and Distribution Network v. City of Oaklanda federal judge ruled against a cannabis business that had sued the city of Oakland for putting it out of business for having failed to obtain proper permits.

The plaintiffs in this lawsuit were Joe’s Hemp and its founder David Clancy. The plaintiffs claimed they operated a “warehouse” to store medical marijuana for members using a “closed distribution network.” According to plaintiffs, members could pay a fee to store marijuana in the warehouse and then remove it from the warehouse when necessary.

Oakland requires any dispensary operating within the city have a cannabis dispensary permit and pay necessary fees and it deemed Joe’s Hemp to be a dispensary.  When Joe’s Hemp refused to apply for the required Oakland city dispensary permit, Oakland imposed fines against Joe’s Hemp and mandated Joe’s Hemp vacate the premises. Joe’s Hemp then sued the City of Oakland in federal court claiming it was not operating a dispensary, but rather a warehouse.

Joe’s Hemp contended that it was operating legally under federal law under the “warehousemen exemption” to the Federal Controlled Substances Act (CSA) which exempts common carriers and warehousemen from criminal liability for possessing Schedule I substances. Joe’s Hemp also claimed this exemption removed it from Oakland’s cannabis dispensary permit scheme. The court was not impressed, calling the alleged warehouse arrangement “a sham” that involved nothing more than its purported members paying fee to get marijuana. The court found this transaction to be a sale of cannabis and held that Joe’s Hemp sat squarely outside any purported warehouseman exemption.

Joe’s Hemp argued the CSA preempted Oakland’s cannabis permitting scheme. The court held the CSA did not preempt Oakland’s ability to permit marijuana business because there was no “positive conflict” between the City of Oakland’s cannabis permit scheme and federal law. The CSA did not preempt Oakland’s permitting scheme “because the permit scheme itself does not violate the Controlled Substances Act, but rather regulates certain entities that do.” The court also ruled that Oakland’s cannabis permitting scheme did not create obstacles to CSA execution because the federal government was free to enforce federal law and the permitting scheme did nothing to prevent that.

Plaintiffs also claimed Oakland’s permitting scheme required they forfeit their Fifth Amendment rights against self incrimination by requiring those running Joe’s Hemp to admit they operate a cannabis dispensary, pushing them outside the warehouseman exemption. The court ruled that even if Joe’s Hemp was only storing cannabis, it would fit Oakland’s definition of a dispensary because the city defines an entity that “stores” or “makes available” marijuana as a dispensary. In other words, an Oakland “dispensary” could — in theory — be a warehouse. The court also found that the permit itself did not require that the business actually admit to cultivating or selling marijuana.

In considering the self incrimination issues the court concluded as follows:

In any case, plaintiffs can simply stop their activity and avoid having to admit anything, i.e., get out of the [cannabis] business and avoid any penalties and admissions. If they choose to continue in an activity that is on the borderline of illegal under federal law, then they cannot escape compliance with local police regulation by saying compliance would constitute an admission under the Fifth Amendment.

The court granted the City of Oakland a motion to dismiss and terminated the case. However, Clancy and Joe’s Hemp have appealed the decision to the Ninth Circuit Court of Appeals and we will provide an update if and when the Ninth Circuit issues an opinion on appeal.

 

NOTE: The above is part of our plan to summarize all cannabis civil cases with a published court decision. By civil case, we mean any case that involves cannabis or the cannabis industry that is not a strictly criminal law matter. These cannabis case summaries are intended both to keep you up to date on cannabis laws as interpreted by the courts and also to serve as a resource for anyone conducting cannabis law research. We also will seek to provide key unpublished cannabis law decisions as well, when available.

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.

Sonoma County cannabis lawsCalifornia has 58 counties and 482 incorporated cities across the state, each with the option to create its own rules or ban marijuana altogether. In this California Cannabis Countdown series we’re updating Sonoma County because Sonoma County will begin accepting applications for commercial medical cannabis businesses on July 5th at 8am (enjoy your 4th of July but be ready bright and early to get your application in at the permit center).

Our last California Cannabis Countdown post was on the City of Davis, and before that the City of Santa RosaCounty and City of San BernardinoMarin CountyNevada County, the City of Lynwood, the City of CoachellaLos Angeles County, the City of Los Angeles, the ,City of Desert Hot Springs, the City of Sacramento, the City of BerkeleyCalaveras CountyMonterey County and the City of Emeryville.

Welcome to the California Cannabis Countdown.

The 411 on Sonoma County. We should start off by stating that Sonoma County is only accepting applications for medical cannabis businesses — recreational cannabis businesses are still prohibited but may be considered by the Board of Supervisors in the future. But starting on July 5th, Sonoma County will begin accepting applications for medical cannabis cultivators, manufacturers, dispensaries, and distributors. Here’s some important information (not an exhaustive list) for those interested in operating a medical cannabis business in Sonoma County:

  • Permits will not be limited to local cultivators. However, local cultivators operating prior to 2016 with a local hiring plan will receive priority processing.
  • An individual or entity can apply for multiple medical cannabis cultivation permits, so long as their total combined cultivation area does not exceed an acre (nurseries are considered cultivation and will be included in the one acre limit).
  • An individual or entity can hold a medical cannabis cultivation license and apply for a medical cannabis manufacturing permit (non-volatile) or other medical cannabis business.
  • Stand alone delivery services will not be allowed – deliveries will only be allowed as part of a medical cannabis dispensary use permit.
  • Sonoma County will cap the number of medical cannabis dispensaries at nine. There are currently five permitted dispensaries and three applications currently pending.
  • If you granted the Sonoma County Agriculture and Open Space District (“District”) an easement then you can say goodbye to your hopes of operating a medical cannabis cultivation site on your property. The District collaborates with the Federal Government and it will not risk the potential for federal enforcement.
  • Edible cannabis manufacturers and dispensaries will require a health permit with the County Environmental Health and Safety Division on top of a minor and conditional use permit.
  • Edible cannabis products cannot be designed to appeal to children or include other addictive substances (such as tobacco or alcohol), and must list ingredients and allergens. They must also indicate serving size, servings per container, and have a host of warning labels (font size could be an issue when it comes to packaging).
  • Taxes for medical cannabis manufacturers and dispensaries will be based off of gross receipts. Medical cannabis manufacturers will have to pay a 3% tax while medical cannabis dispensaries will be taxed at 2%. Medical cannabis cultivators will be taxed per square foot. Taxes will range anywhere from $1.00 to $11.25 per square foot depending on the cultivation license type.
  • On May 23rd, 2017, the Sonoma County Board of Supervisors passed a Code Enforcement Temporary Penalty Relief Program which allowed certain cannabis businesses to operate without being subject to land use fines while their permit applications are being reviewed.

Sonoma County should be considered a progressive and enlightened jurisdiction for its sensible cannabis regulations and well-informed staff (unlike many other parts of California). With skyrocketing real estate prices in San Francisco and Oakland, our Bay Area attorneys are seeing increasing interest in opening up cannabis businesses in Northern California and Sonoma County.

Well played Sonoma, well played.

Dear Californian cannabis entrepreneurs,

As you prepare to open your cannabis businesses under the MAUCRSA, perhaps with a few lifelong friends, you may be tempted to think “we’re friends, we don’t need to get the lawyers involved.” We don’t mean to be blunt, but you need to get it in writing regardless of the current camaraderie.

Cannabis contracts
Cannabis contracts. Because they make sense.

Failing to properly paper your company or your company’s transactions is a recipe for trouble in any cannabis state. In the rush to license, many Oregon and Washington State entrepreneurs skipped these vital steps. The result is that a few years after Oregon and Washington legalized recreational cannabis, we are seeing a rise in litigation among formerly friendly service contractors and marijuana businesses and especially between partners of marijuana businesses fighting over percentages, control, and responsibilities.

With the classic marijuana business ownership dispute, you have a case that makes attorneys, judges, and litigants pull their hair out. Two people start a business with the basic understanding that they are 50/50 partners. A third partner is introduced and they agree to give that person a stake but they never specify the amount of that stake nor whether the original partner shares will be equally diluted. The parties do not even know if they have entered into a binding contract. Nothing specific is in writing, but various emails and phone calls reference slightly different versions and iterations of the same deal. There is no right answer in a case like this, but everyone knows that if they do not settle, litigation will be expensive and contentious and risky.

Compare this to when a licensed marijuana business orally agrees on the basic terms for a future cannabis product transaction. We have written before about the Uniform Commercial Code (the “UCC”), which applies to transactions for the sale of goods. Though the lack of a written document in the business ownership matter (as discussed above) leads to all sorts of difficulties, in a sale of goods situation, the lack of a written contract can (but does not always) work out just fine. The default provisions in the UCC exist to protect parties with reasonable contract terms where they fail to bargain on those terms, even if there is nothing in writing. In other words, the UCC will fill in with clear-cut default provisions whatever the parties failed to agree upon. Nonetheless, having clearly worded and detailed contracts avoids any need to rely on the default provisions of the UCC, which may not be to your benefit if left ignored.

Without written agreements, these fights devolve into often intractable (and nearly always expensive) court battles over who said what and when. In many cases, these disputes would never occur if the parties could had a clearly worded set of bylaws, an operating agreement or services agreement. And if the dispute must go to litigation, it is often cheaper to argue over the meaning of a written contract, than to argue over what the parties orally agreed to in the first place.

Cannabis businesses need to take the same ordinary business steps as other business do to properly memorialize their business relationships. Please, take it from our lawyers who have operated in other highly regulated cannabis states–just get it in writing. You won’t regret it.

Sincerely,

Our Oregon and Washington cannabis lawyers

 

Buying a Los Angeles Cannabis dispensary
Buying a Los Angeles cannabis Dispensary? Due diligence is key.

With California’s recent passage of the Medicinal and Adult Use Cannabis Regulation and Safety Act (“MAUCRSA“), we finally know California will be combining its regulatory oversight of medical and adult use cannabis. We also know potential licensees no longer need to prove prior compliance with local laws to receive a state cannabis — which was the case under MCRSA, which has been repealed. This does not mean state licensees get to violate local laws. Instead, MAUCRSA lays out a sort of local vigilance program where the state notifies local governments of incoming licensees and the local governments then have to let the state know whether those licensees are complying with local cannabis laws. Local law is still king in California.

If you’ve been following the situation in Los Angeles, you know LA has an embattled history with its medical marijuana dispensaries. In addition to other enforcement measures, one of the City’s biggest battles has been enforcing Proposition D (a mere immunity-from-prosecution ordinance), which was essentially replaced this past March with ballot initiative Measure M that will finally regulate cannabis businesses within the City’s borders. Among other directives, Measure M ensured that Proposition D-compliant dispensary collectives would receive “priority” status for whatever local approval mechanism the City would design under Measure M. Despite the passage of Measure M, the question remained as to whether the City would increase the number of dispensaries and how exactly the City would regulate its cannabis operators.

Last month, Los Angeles released proposed Measure M regulations. Under those regulations (which are in a 60-day comment period), dispensaries that can prove “substantial” compliance with Proposition D will receive priority processing in the first round of the City’s issuance of “certificates of approval.” Though there has already been a fair amount of stakeholder dissent surrounding the use of certificates of approval and backlash against the proposal of a non-retail registry for cultivators and manufacturers, what has not been discussed as much is whether Proposition D-compliant dispensaries can essentially “flip,” or partner with third parties on, one or more of their certificates of approval (which include delivery and cultivation).

Even before institution of Measure M, folks were looking to “buy” Proposition D-compliant dispensaries, but ever more so now that owning such a dispensary gets priority processing from the City and because L.A. may not actually increase its number of dispensaries based on some restrictions in the proposed Measure M regulations.

If you are looking to get in on a Los Angeles cannabis dispensary you need to be thinking about due diligence. Due diligence on Los Angeles dispensaries is difficult because California’s existing MMJ laws under Prop. 215 do not require much operational or corporate accountability or tracking on either the state or local level. Also, because most of these entities are non-profits, there’s no equity to buy or sell. So you need to check the entity’s bylaws to make sure you can either take over the entity by paying a membership fee or that you can do some kind of director swap with an attendant asset purchase and that the entity will not need to give notice to thousands of patient members for you to do so. Given the unregulated nature of existing operators on a state level, you also need to make sure that the dispensary has been paying its taxes to the IRS (under 280e) and that it has been paying the Board of Equalization. Lastly, many Los Angeles dispensaries are not compliant with Proposition D and this too could cause you all sorts of problems. What makes for a compliant Proposition D dispensary? This is not entirely clear. Some believe that being on the 2013 City-issued list (which shows 134 dispensaries) proves compliance. Others believe the June 2017 map of dispensaries issued by the City Controller (which shows 139 dispensaries) is the proof you need. Proposition D says that to prove compliance, a Los Angeles dispensary must show the following:

1. Was operating as a medical marijuana dispensary in the City by or before September 14, 2007;
2. Had a business tax registration certificate (“BTCR”) or tax exemption from the City by or before September 13, 2007;
3. Was registered as a medical marijuana dispensary with the City Clerk by November 13, 2007. pursuant to the then existing pre-interim control ordinance number 179027;
4. Notified the City Clerk by February 18, 2011 of its intention to register under the city’s Medical Marijuana Ordinance 181068, as amended by temporary urgency ordinance 181530;
5. Has not ceased operations at its identified location for any of the following reasons: (1) court or government enforcement order to shut down or (2) lack of a lease or utilities (in the name of the dispensary or one of the managers/directors of the dispensary for the benefit of the dispensary) to the property. There are exceptions to this requirement if the dispensary ever relocated (which they were allowed to do) or if it temporarily closed down because of a shutdown letter from the Feds or the City prior to the temporary urgency ordinance 181530 but then re-opened;
6. Obtained its BTRCs for 2011 and 2012 (and has continued to renew those BTRCs with the City);
7. Has no outstanding or unpaid tax liability with or to the City (including any fines, penalties, etc.). There are some exceptions here on payments during the 2011 and 2012 tax years, and settlement agreements with the City are also exempt;
7. Has continuously complied with the various operational requirements in Proposition D;
8. Has had all dispensary managers over the years submit to the City livescan checks; and
9. From property line to property line, is at least 1,000 feet away from any schools and at least 600 feet away from any parks, churches, child care facilities, public libraries, youth centers, rehab facilities, and other dispensaries.
Under Measure M proposed regulations, the City will allow the dispensaries to explain any mitigating factors for non-compliance with Proposition D, but that’s definitely not a guarantee the dispensary will receive a certificate of approval.
If you are contemplating buying into or joining as an owner in any Los Angeles dispensary business, due diligence will be key. Proposition D compliant-dispensaries are valuable as they may end up being the only dispensaries in Los Angeles for a number of years. But don’t get sucked into investing in a Los Angeles dispensary that will not be able to prove its immunity under Proposition D–avoid this problem by doing proper due diligence.

California cannabis lawyers California may take its cannabis advertising restrictions to the next level if Senate Bill 162 makes it through the Assembly Appropriations Committee. SB 162, which the Senate passed unanimously last month, would prohibit future cannabis licensees from advertising their cannabis products “through the use of branded merchandise, including, but not limited to, clothing, hats, or other merchandise with the name or logo of the product.”

This legislation would fill some of the gaps in the proposed rules for the implementation of both Proposition 64 and the MCRSA, now known cumulatively as the Medicinal and Adult-Use Cannabis Regulation and Safety Act (“MAUCRSA”). Many opponents of Proposition 64 raised concerns that legalization would lead to increased public consumption due to the measure’s “lax rules on marketing.” Well, if there was any concern over allegedly lax marketing standards, California’s legislature is now swinging in the extreme opposite direction by essentially eliminating any branded merchandise for cannabis businesses.

Originally, Prop. 64 limited ads in broadcast, cable, radio, print and digital mediums to placements where at least 71.6% of the audience is reasonably expected to be at least 21 years old, based on reliable, up-to-date audience data. This restriction was not included in any of the proposed rules for the MCRSA (which has now been repealed), but it is included in SB 162.

Prop. 64 required any advertisements or marketing by a state-authorized marijuana licensee satisfy the following:

  1. Accurately and legibly identify the licensee responsible for the content;
  2. Use a method to confirm age if involving direct, individual communication by the licensee; and
  3. Be truthful and appropriately substantiated.

Prop. 64 also specifically prohibited licensees from advertising or marketing marijuana in the following ways;

  1. On a billboard located on an Interstate Highway or State Highway that crosses the border of any other state;
  2. In a manner intended to encourage people under 21 to consume marijuana;
  3. With symbols, language, music, gestures, cartoon characters or other content known to appeal primarily to people under 21;
  4. On an advertising sign within 1,000 feet of a day care center, K-12 school, playground, or youth center; and
  5. Through free giveaways of marijuana or marijuana accessories as part of a business promotion.

SB 162 includes these restrictions, but takes things one huge step further with its extremely broad ban on branded merchandise. Ostensibly, the ban could extend to employee t-shirts or uniforms bearing the brand of the licensee, and would prohibit merchandise produced by an unlicensed third-party if that merchandise were created on behalf of a licensee (or if that third-party company was owned by a licensee in their individual capacity).

These advertising restrictions in SB 162 are more restrictive than we’ve seen in any of the other adult-use states in which our cannabis lawyers worked, and we’re pretty shocked California is trying to kill this kind of creativity because they truly believe that if kids see branded merchandise they’ll start using cannabis. Washington State, for example, prohibits licensees from selling branded merchandise in their stores or facilities such as hats and t-shirts, but allows separate or affiliated ancillary companies to sell this merchandise on a licensee’s behalf. And Washington does not prohibit the sale of branded paraphernalia, which would likely be included under the definition of “branded merchandise” in SB 162.

We think this piece of legislation goes way overboard in its attempt to regulate advertising. These types of onerous restrictions will not allow licensed businesses under the new regulatory regime to thrive, and it will definitely kill the swag game at all cannabis-related events in The Golden State, undermining cannabis business’ ability to grow, compete, and spread their brands. We will be keeping tabs on the progress of SB 162, and will provide an update on its final fate, but we really hope the California legislature comes to its senses and stops this form of modern reefer madness.