California cannabis manufacturing
California cannabis manufacturing

We wrote about cannabis edibles regulations under the proposed manufacturing rules issued pursuant to the MCRSA, but clients have been asking about what, if anything, has changed due to passage of Senate Bill 94. Here’s what SB 94, aka “MAUCRSA,” has to say, generally, about edibles:

MAUCRSA mandates edible cannabis products must meet the following requirements:

  1. Not be designed to appeal to children, or be easily confused with commercially sold candy or foods that do not contain cannabis;
  2. Produced and sold with a standardized concentration of cannabinoids not to exceed 10 mg of THC per serving;
  3. Delineated or scored into standardized serving sizes if the cannabis product contains more than one serving;
  4. Homogenized to ensure uniform disbursement of cannabinoids;
  5. Manufactured and sold under sanitation standards that comport with California State Department of Health regulations;
  6. Provided to consumers with sufficient information to enable informed consumption of the product, including the potential effects of the cannabis product and directions for its consumption; and
  7. Marked with a universal symbol that will be set by the California Department of Health.

But as for the other rules promulgated by the California Department of Health pursuant to the MCRSA? They are no longer applicable, and we will have to wait for another set of proposed rules to drop before we know exactly what the regulations will look like. If you weren’t happy with the first set of rules under the MCRSA, you shouldn’t get your hopes up for big changes as the odds are good that most of these rules will remain the same under MAUCRSA as it is widely expected the California Department of Health will issue a new set of rules very similar to the first. As a refresher, here are some of the cannabis products NOT allowed under the first set of rules that could change, but probably won’t:

  1. Cannabis-infused alcoholic beverages;
  2. Cannabis products containing any non-cannabinoid additive that increases potency, toxicity or addictive potential, or that would create an unsafe combination with other psychoactive substances, including nicotine and caffeine;
  3. Cannabis products that must be held below 41 degrees Fahrenheit to be safe for human consumption;
  4. Vacuum packed cannabis products;
  5. Canned cannabis products;
  6. Cannabis-infused juice;
  7. Perishable bakery products that must be held at temperatures below 41 degrees Fahrenheit, including cream or custard-filled pies, pies or pastries which consist in whole or in part of milk or milk products, eggs, or synthetic fillings, or meat-filled pies or pastries;
  8. Dairy products of any kind (yes, this appears to include butter);
  9. Meat products;
  10. Seafood products.

Also note that the initial set of proposed rules prohibited licensees from manufacturing cannabis products by applying cannabinoid concentrate or extract to commercially available snack candy or food items, also known as “re-manufacturing.” Though MAUCRSA (SB94) does not speak to this issue, the California Department of Health will likely take the same stance as they redraft the next set of proposed rules. Those hoping to secure manufacturing licenses pursuant to the MAUCRSA will need to stay tuned, and pay close attention to the revised rules as they develop.

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. Hilary Bricken from our Los Angeles office will moderate two of our San Francisco-based attorneys (Habib Bentaleb and me) in a discussion on the major changes between the MCRSA and MAUCRSA, including on vertical integration and ownership of multiple licenses, revised distributorship standards, and what California cannabis license applicants can expect more generally from California’s Bureau of Cannabis Control as rule-making continues through the remainder of the year. We 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!

Bay Area Cannabis LawyersWith California’s recent passage of its Medicinal and Adult Use Cannabis Regulation and Safety Act (“MAUCRSA” a/k/a the Governor’s Trailer Bill, a/k/a SB 94), California has combined government oversight of its medical and adult use cannabis industries into one master regulatory regime. MAUCRSA is almost guaranteed to make California’s cannabis industry more business friendly and less bureaucratic and protectionist, but questions remain about how the California Bureau of Cannabis Control (and its sister agencies) will fill in the gaps posed by the MAUCRSA legislation. Though we have 200 plus pages of proposed regulation under the now repealed MCRSA, those rules will need to go back to the drawing board to accommodate MAUCRSA’s changes stemming from Proposition 64 (one of San Francisco attorneys attended a state stakeholder meeting this past Monday, and that was pretty much confirmed). The big question is whether California will significantly revise the rules already proposed under MCRSA.

The short answer is nobody really knows, but there’s a good chance that many of the operational standards from MCRSA will remain.

We say this because regulators knew it was pretty much inevitable MAUCRSA would pass. We also say this because California’s regulators are on a tight timeline to begin accepting applications for licenses in January 2018 and slashing and burning MCRSA proposed regulations is not a good way to finish by that date. We expect the proposed MCRSA rules will not change much regarding the application process, except where necessary to make them better line up with MAUCRSA.

In turn, here are the top ten issues (among many others) we see with which California regulators will have to grapple when revising MAUCRSA rules:

  1. “Premises” and Multi-Tenant Operations. MAUCRSA defines premises as “the designated structure or structures and land specified in the application owned, leased, or otherwise held under the control of the applicant or licensee where the commercial cannabis activity will be or is being conducted. The premises shall be a contiguous area and shall only be occupied by one licensee.” MAUCRSA’s definition of premises is pretty much the same as in the proposed MCRSA rules, but it is not clear whether MAUCRSA rules will permit multi-tenant operations on the same parcel of land. Proposed MCRSA cultivator rules explicitly allowed for multi-tenant cultivation, but the MCRSA retail and manufacturing rules were silent on it. We’ll now have to see if the revised draft MAUCRSA rules will continue to permit multi-tenant operations.
  2. Local Approval Process. Under MCRSA, proof of a “local permit, license, or authorization” was required before you could receive your California state operational license. Though this has changed under the MAUCRSA, you still must be in compliance with local laws to secure your California state cannabis license. Among other things, the state of California will notify relevant local governments when a license applicant applies from within their borders. California’s cities and counties will then have 60 days to tell the state whether the applicant is in compliance with local laws. If the applicant is not in compliance, the state will reject the license application. If the local government stays silent, the state will presume the license applicant is in compliance with local laws, but will still not renew the license if the local government at any time notifies the state that the licensee is out of compliance with local laws. What we don’t know is how active local governments will be in communicating with the state about local law compliance. We expect litigation will emerge against local governments that “allow” cannabis operators to proceed via their silence, but then later object to those operations because of changes in local laws.
  3. Prohibited Products and Potency. The California Department of Health’s proposed manufacturing rules had a pretty aggressive list of prohibited products and everyone wants to know whether that list will change. Under MCRSA, California was not going to allow cannabis-infused alcohol, caffeine, or nicotine products and no cannabis product made of “potentially hazardous food.” Potentially hazardous food means any food “capable of supporting the growth of infectious or toxigenic microorganisms when held at temperatures above 41 degrees Fahrenheit.” This would mean products that must be refrigerated at less than 41 degrees and any dairy or meat products would not be allowed. MCRSA edibles also can’t contain more than 10 milligrams of THC per serving or more than one hundred 100 milligrams of THC per package of finished product. And, for non-edible manufactured cannabis, no finished package can contain more than 1000 milligrams of THC. Unfortunately, the consensus among our California cannabis attorneys is that it is unlikely MCRSA regulations will ease up on these restrictions.
  4. Advertising. Though MCRSA said nothing about cannabis business advertising other than that state agencies would generally regulate it, MAUCRSA heavily restricts it — there’s also bill in the California legislature to kill off cannabis business branded merchandise of all varieties.  What we don’t know is if regulators will further tighten advertising rules now that they have a roadmap from the state to do so. Specifically, under MAUCRSA both medical and adult use cannabis operators must:
    • Accurately and legibly identify the licensee responsible for advertising content.
    • Use a method to confirm age if involving direct, individual communication by the licensee.
    • Be truthful and appropriately substantiate their factual claims.
    • Not advertise or market cannabis in any of the following ways:
      • On billboards located on an Interstate Highway or State Highway that crosses the border of any other state;
      • In a manner intended to encourage people under 21 to consume marijuana;
      • With symbols, language, music, gestures, cartoon characters or other content known to appeal primarily to people under 21;
      • On an advertising sign within 1,000 feet of a day care center, K-12 school, playground, or youth center; and
      • Through free giveaways of marijuana or marijuana accessories as part of a business promotion.
  5. Non-Storefront Retail Delivery. Pursuant to MAUCRSA, “delivery” means the commercial transfer of cannabis or cannabis products to a customer and the retailer’s use of any technology platform it owns and controls. The MCRSA retailer rules required retailers to have brick and mortar storefronts from which to deliver cannabis product to patients. MAUCRSA on the other hand allows California cannabis retailers to “conduct sales exclusively by delivery” from a physical location that doesn’t have to be open to the public. Since the MCRSA regulations didn’t contemplate such a model, California cannabis regulators will need to craft rules regarding such operations, which will have huge ramifications for those delivery-only retail operators.
  6. Anti-Competitive Behavior. MAUCRSA zeroes in on preventing anti-competitive behavior between licensees, probably because, unlike MCRSA, MAUCRSA currently allows for near total vertical integration for almost all licensees and doesn’t yet limit the number of licenses a person can have in a given category (outside of Type 3s, see below). Specifically, MAUCRSA states that, it “shall be unlawful for any person to monopolize, or attempt to monopolize, or to combine or conspire with any person or persons, to monopolize any part of the trade or commerce related to cannabis. The Attorney General shall have the sole authority to enforce the provisions of this subdivision.” Though the Attorney General’s office will be the one to enforce here, there’s nothing to stop California’s regulating agencies from creating additional rules to prevent exclusive or long term contracting between licensees or to prevent cannabis licensees from exerting undue influence over each other. We have yet to see those rules, but they’re bound to arise as they have in other states with highly regulated cannabis regimes.
  7. State Due Diligence on “Owners.” MAUCRSA slightly changes and consolidates the definition of owner. “Owner” now means a “person with an aggregate ownership interest of 20 percent or more in the [entity] applying for a license or a licensee, unless the interest is solely a security, lien, or encumbrance; the chief executive officer of a nonprofit or other entity; a member of the board of directors of a nonprofit; and an individual who will be participating in the direction, control, or management of the person applying for a license.” MAUCRSA requires owners go through increased vetting (as opposed to those considered “non-owners”), but the consensus among our California cannabis attorneys is that the state will up the ante on background checks during the application process for those considered non-owners.
  8. Self-Distributorship. The MCRSA mandated cannabis cultivators and manufacturers go through separately owned third party distributors to get their products to market with retailers. MAUCRSA undoes this standard, for better or worse as I told L.A. Weekly, by allowing cannabis licensees to be their own distributors — with the exception of Type 5 licensees (i.e,. large scale growers), which won’t exist for the first five years of the program. The proposed MCRSA rules thoroughly covered how distributors could interact with licensees and operate. We don’t yet know whether those comprehensive regulations (like being able to take title to cannabis products and mandating separate storage facilities for inventory) will remain under MAUCRSA regulations now that almost all licensees can distribute their own products.
  9. Continuing Operations. The proposed MCRSA rules all had the following “continuing operations” standard: “All applicants that were in operation prior to January 1, 2018 . . . may continue to operate while their application is pending if a completed application is submitted to the Department no later than 5:00 p.m. Pacific Standard Time on July 2, 2018, and the continuing operations of the applicant are the same activities in which the applicant is seeking licensure.” MAUCRSA does not have this standard, which is somewhat problematic for those securing local permits, licenses, and approvals right now–though it does have a temporary licensing standard that will likely fill the gap here to make sure there is no shortage of product or access to cannabis when 2018 rolls around, but the procedures around securing those temporary licenses need to be fully created.
  10. Limitation on Type 3s and Total Plant Canopy. The MCRSA required the California Department of Food and Agriculture (“CDFA”) to limit the number of Type 3 cannabis licenses. Type 3s are mid-size grow facilities between 10,001 and 22,000 square feet of plant canopy. MAUCRSA has this same limitation requirement. Under the proposed MCRSA cultivation rules, the CDFA limited “a person … to one Medium Outdoor, or one Medium Indoor, or one Medium Mixed-Light license., and all cultivation licensee applicants to no more than 4 acres of total plant canopy statewide. It is not yet known whether the CDFA will keep these limitations in place.

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. I will moderate San Francisco-based Alison Malsbury and Habib Bentaleb in a discussion on the major changes between the MCRSA and MAUCRSA, including on vertical integration and ownership of multiple licenses, revised distributorship standards, and what California cannabis license applicants can expect more generally from California’s Bureau of Cannabis Control as rule-making continues through the remainder of the year. We 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 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