California cannabis cooperative
California cannabis cooperatives are still going strong.

Our firm’s cannabis practice group represents licensed cannabis cultivators of all sizes, ranging from the small artisanal grower to the medium/large farm with a country farmhouse to the mega farm jumbo operation. Common problems permeate cannabis cultivation operations of any size in this state: California’s cannabis taxes are high; traditional financing is unavailable; licensing and environmental compliance fees are burdensome; and the black market is still too strong a competitor. However, those challenges hit the little guys much harder, which is why we see stories about legacy farmers being forced out of business or back underground because they’re just unable to compete in the regulated environment. Then came the new emergency state regulations, which paved the way even more for mega farms through a loophole that allowed growers to “stack” small cultivation licenses to get around the 1-acre cap per licensee.

The little guys fought back, and sued the state arguing that the emergency regulations were contrary to the intent of voter-approved Prop 64 in 2016, which was intended to limit grows in the short term to allow smaller farmers to get back on their feet after expending initial capital investments and having to come into compliance with state environmental laws. But earlier this year, the plaintiffs dropped their lawsuit against the state, soon after the final regulations came out affirming the state’s position would not change.

But now the farmers are starting to explore a new tactic: joining forces as cannabis cultivation cooperatives to better compete with the bigger players. But didn’t cooperatives get phased out by the new regulations? The short answer is that yes, the traditional cooperative model that existed under the Compassionate Use Act is now gone, but a new model exists under current law, the Medicinal and Adult-Use Cannabis Regulation and Safety Act (MAUCRSA). Generally speaking, under MAUCRSA a cannabis cooperative association is a group of 3 or more cultivator licensees, each farming no more than 10,000 square feet of outdoor canopy, and collectively not farming more than 4 acres total. But cooperatives have advantages and disadvantages as a potential vehicle for ownership and operation.

Advantages

When cannabis cultivators join a cooperative association, the members are able to spread fixed costs from the services that the association is able to provide, such as access to land and financing, equipment leasing, bulk purchase of supplies, group insurance plans, hiring and recruitment services, security and property management services, and marketing and advertising resources. Associations are also allowed to merge or consolidate with other cannabis cultivation associations, allowing even greater economies of scale.

Members are able to enter into collective marketing agreements, which allows them to offer purchasers a steadier and larger supply of more uniform products. This creates a more competitive market position than growers could attain on their own, while still allowing them to devote the time and attention required for producing high-quality appellations and artisanal strains. The cooperative model also eases the pain of licensing and regulatory compliance through group access to consultants, accountants, and attorneys familiar with the group’s operating model.

Disadvantages

To be a member or stockholder in a cannabis cooperative association, a person or entity must be a licensed cannabis cultivator, meaning that opportunities for outside investment in the cooperative itself are lacking. Members also cannot hold cannabis licenses in any other state or country, and their operations are limited to 4 acres in total. And if you’re thinking that members could get around that by contracting to operate as a single entity, think again: members shall not “conspire in restraint of trade, or serve as an illegal monopoly, attempt to lessen competition, or to fix prices in violation of” California law.


Whether or not it makes sense for a small grower to join a cooperative association depends on the risks and benefits it has to weigh for each of its options, and each grower has unique circumstances it must consider. But as long as the black market continues to thrive in California, even with the cost savings and other advantages available under a cooperative model, the state will have to continue coming up with creative solutions for incentivizing illegal operations to join the licensed community.

hemp cbd report congressThe House Appropriations Committee (the “Committee”) publishes reports to accompany annual spending bills. One such report, released on June 3, provided insight on hemp-derived CBD (“Hemp-CBD”). The Committee’s report on didn’t get much coverage in the media, outside of some ace reporting from the folks at Marijuana Moment. Despite that, it’s kind of a big deal because it outlines Congress’ expectations for the Food and Drug Administration (“FDA”) when it comes to Hemp-CBD.

The Committee’s passage on Hemp-CBD starts by focusing on its concerns:

Cannabidiol Regulatory Pathway—The Committee is concerned about the proliferation of foods and dietary supplements marketed in violation of the Federal Food, Drug & Cosmetic Act (FFDCA), including products containing cannabis and cannabis-derived ingredients. Non-FFDCA-compliant products pose potential health and safety risks to consumers through unsubstantiated and misleading claims such as treating a wide-range of life-threatening diseases and conditions; excessive cannabidiol (CBD) concentrations that can result in harmful drug-drug interactions, somnolence, and elevated transaminases or liver toxicity; and the presence of significant levels of intoxicating compounds such as tetrahydrocannabinols (THC).

First, the Committee lays out its concerns over unregulated Hemp-CBD. These concerns echo the FDA’s statements on Hemp-CBD, especially the reference to unsubstantiated and misleading claims about CBD. Second, the Committee focused on the safety of CBD itself. This includes how CBD interacts with other drugs, somnolence (which according to Wikipedia is a fancy way to say sleepiness or drowsiness), and liver toxicity.  FDA-approved Epidiolex, the epilepsy medication that contains CBD, includes a warning about liver damage. A recent study conducted and the University of Arkansas and published in Molecules found that large dosages of CBD damaged the livers of mice. Third, the Committee raised the issue of elevated significant levels of THC in products. Though hemp only has 0.3% THC, the Committee seems concerned about hemp-derivatives containing excess amounts of CBD or consumers ingesting large doses of THC. The 0.3% threshold is relative, after all and the Committee might be concerned about intoxicating effects in large doses.

The Committee went on to outline its expectations of the FDA:

The 2018 farm bill expressly preserves FDA’s public health authority to take appropriate actions regarding cannabis, including hemp and its derivatives. The Committee recognizes the FDA is considering a public regulatory process to evaluate the appropriateness, and possible parameters, of a regulatory pathway that would permit CBD in certain foods and dietary supplements. The Committee expects the FDA to assert its commitment to identifying lawful federal regulatory pathways for CBD foods and dietary supplements if such pathways are consistent with protection of the public health. Such pathways may include necessary public health and safety parameters that will protect the public health, such as labeling requirements and limits on CBD or other cannibis-derived ingredients in products, based upon anticipated total exposure levels. The Committee also expects the FDA to preserve the integrity of its drug development and approval processes, which ensures that products marketed for drug uses have undergone a rigorous scientific validation process demonstrating quality, safety and efficacy. It is also imperative that any FDA regulation of foods and dietary supplements containing CBD or other cannibis-derived ingredients preserve incentives to invest in robust clinical study of cannabis, so its therapeutic value can be more fully understood.

The FDA’s marching orders are to figure out a safe way to allow CBD in foods and dietary supplements if that is possible to do while protecting public health. The Committee floats the idea of labeling requirements and limiting cannabinoids based on anticipated exposure levels. Remember that the FDA is a creature of statute. It exists because Congress wanted it to exist. Though the FDA is part of the executive branch, it must operate within the laws passed by Congress. The Committee doesn’t represent the entire legislative body, but it does seem to be in favor of a world where CBD is available in food and dietary supplements. That being said, the Committee also wants CBD in drugs. The FDA must also preserve incentives to research CBD’s health benefits. That research happens when companies go through the FDA’s drug approval process. The Committee doesn’t want to forego the medical benefits that come with CBD being approved for use in drugs.

The FDA has work to do. It recently held a listening session which allowed stakeholders to comment on the FDA’s approach to regulating Hemp-CBD. This latest report from the Committee only reiterates the prevailing expectation that Hemp-CBD will be available both as a drug and as a food/dietary supplement. It remains to be seen how the FDA will get to that point.

For more analysis on this “two-track” theory and the FDA’s position on CBD, check out the following posts:

fda vape marketingLast week, the Food and Drug Administration issued final guidance for vape manufacturers to submit premarket tobacco product applications (PMTA), which are required to obtain official authorization to market their products. These guidelines will invariably affect manufacturers of vape products that can be used with both tobacco and cannabis.

In order for any new tobacco product to be legally marketed, the FDA must issue an order permitting the marketing of that product. To issue a PMTA marketing order, the FDA must first evaluate the product “based on a public health standard that considers the risks and benefits of the product to the population as a whole, including tobacco product users as well as non-users.”

The guidance, which is non-binding and can be found here, and can assist anyone submitting PMTAs for electronic nicotine delivery systems (ENDS) under section 910 of the Federal Food, Drug, and Cosmetic Act (FDCA). In addition to this guidance, the FDA will designate a single Regulatory Health Project Manager so that applicants have a single point of contact in Center for Tobacco Products (CTP) office to answer questions regarding PMTAs, and applicants will have access to an appeals process in the event that the FDA denies their application.

For a bit of quick background, the Family Smoking Prevention and Tobacco Control Act (Tobacco Control Act), which was enacted in 2009, amended the FDCA to give the FDA authority to regulate tobacco products. In 2016, the FDA issued a final rule, “Deeming Tobacco Products to Be Subject to the Federal Food, Drug, and Cosmetic Act, as Amended by the Family Smoking Prevention and Tobacco Control Act; Restrictions on the Sale and Distribution of Tobacco Products and Required Warning Statements for Tobacco Products” (81 FR 28973). In the final deeming rule, the FDA clarified that all ENDS (including, but not limited to, e-cigarettes, e-pens, e-cigars, e-hookah, vape pens, personal vaporizers, and electronic pipes) are subject to the FDA’s authority. These products are subject to most of the same FDCA provisions to which cigarettes, cigarette tobacco, roll-your-own tobacco, and smokeless tobacco are subject, including premarket review requirements and adulteration and misbranding regulations.

The FDA lays out a number of important definitions in its guidance, including that of an “e-cigarette,” which may be either open (i.e. a refillable e-cigarette that includes a reservoir that a user can refill with an e-liquid of their choosing), or closed (i.e. an e-cigarette that includes an e-liquid reservoir that is not refillable, or that uses e-liquid contained in replaceable cartridges or pods that are not intended to be refillable).

Acting FDA Commissioner Dr. Ned Sharpless noted in his statement regarding the guidance that:

[t]here are no authorized e-cigarettes currently on the market and [FDA oversight] is critical to our public health mission and, especially, to protecting kids from the dangers of nicotine and tobacco-related disease and death.”

The guidance outlines how the agency will review ingredients and additives to ENDS, how they are packaged, labeled and marketed, and how the devices themselves are designed and made.

The FDCA requires that the FDA deny any PMTA where it finds “there is a lack of a showing that permitting such tobacco product to be marketed would be appropriate for the protection of the public health.” This determination will be made with respect to the risks and benefits to the population as a whole, taking into account the following:

  1. the increased or decreased likelihood that existing users of tobacco products will stop using such products; and
  2. the increased or decreased likelihood that those who do not use tobacco products will start using such products.

It will be important for manufacturers of all vaporizer products to review and understand this guidance, particularly those that are engaged in the manufacture and distribution of products intended or used for both cannabis and tobacco.

alabama hemp lawsThe Agriculture Improvement Act of 2018 (“2018 Farm Bill”) legalized hemp by removing the crop and its derivatives from the definition of marijuana under the Controlled Substances Act (“CSA”) and by providing a detailed framework for the cultivation of hemp. The 2018 Farm Bill gives the US Department of Agriculture (“USDA”) regulatory authority over hemp cultivation at the federal level. In turn, states have the option to maintain primary regulatory authority over the crop cultivated within their borders by submitting a plan to the USDA. This federal and state interplay has resulted in many legislative and regulatory changes at the state level. Indeed, most states have introduced (and adopted) bills that would authorize the commercial production of hemp within their borders. A smaller but growing number of states also regulate the sale of products derived from hemp.

In light of these legislative changes, we are presenting a 50-state series analyzing how each jurisdiction treats hemp-derived cannabidiol (“Hemp-CBD”). Each Sunday we will summarize a new state in alphabetical order.

Without further ado, we start with Alabama.

2014 Farm Bill Industrial Hemp Program. In 2016, Alabama enacted the Alabama Industrial Hemp research Program Act, (“Act”), which gave the Alabama Department of Agriculture and Industries (“ADAI”) the authority over the production of industrial hemp and hemp products. In Alabama, industrial hemp is defined as “[a]ll parts and varieties of the plant Cannabis sativa, cultivated or possessed by a licensed grower, whether growing or not, that contain a delta-9 tetrahydrocannabinol concentration of not more than 0.3 percent on a dry weight basis.” The term “industrial hemp” excludes marijuana. “Hemp products” are “[a]ny and all products made from industrial hemp, including, but not limited to, cloth, cordage, fiber, food, fuel, paint, paper, particleboard, plastics, seed, seed meal and seed oil for consumption, and seed for cultivation if the seeds originate from industrial hemp varieties.” (Emphasis added).

ADAI rules do not explicitly address hemp processing or issue hemp processor licenses. Therefore, it is unclear whether a license or a permit is required to manufacture and sell Hemp-CBD products. The rules are also silent on the sale of Hemp-CBD products manufactured in Alabama or elsewhere.

However, shortly before the enactment of the 2018 Farm Bill, Alabama’s Attorney General issued a Public Notice stating that “CBD derived from industrial hemp, with a THC concentration of not more than 0.3% on a dry weight basis, can be legally produced, sold, and possessed in the State of Alabama.” Accordingly, there seems to be no direct limitation regarding the sale and possession of Hemp-CBD products in the state, so long as the products contain no more than 0.3 percent THC on a dry weight basis.

2018 Farm Bill Plan. On May 30, 2019, state lawmakers passed SB 225, which tasked ADAI with developing a plan to monitor and regulate the commercial production of hemp under the 2018 Farm Bill. ADAI will need to review and amend its existing rules, adopted pursuant to the Act , to comply with the requirements of the 2018 Farm Bill. In addition, ADAI will need to promulgate rules that account for the commercial sale of Hemp-CBD products. According to its FAQs, ADAI anticipates releasing these rules within a year.

Bottom Line. This may come as a shock due to Alabama’s general hostility towards cannabis in the past, but when it comes to policy, it is one of the most hemp-friendly states in the country. The state Attorney General has expressly allowed the production, sale and possession of Hemp-CBD products and under Alabama’s new legislation, the ADAI will oversee these commercial activities. The future looks bright for hemp in Alabama.

california cannabis beverage label
CA keeps adding to the file…

The California Department of Public Health (“CDPH”) has, to say the least, some very strict cannabis labeling regulations.  Earlier this year, I wrote about how the CDPH’s new rules were likely to create a mess in California and then how the California cannabis agencies sought to relieve some of the burdens on the industry by pushing back their expectations on compliance. While this gave cannabis companies a bit of wiggle room, it didn’t change any of the non-cannabis labeling requirements out there, like Proposition 65 (which we’ve written about recently here, here, and here).

One of the more obscure labeling issues concerns certain cannabis-containing beverages. Earlier this year, the CDPH released this FAQ for cannabis labeling, which states in part:

CRV Recycling (for beverages, if applicable) – Beverage manufacturers are responsible for labeling qualifying beverage containers with recycling information. For more information, visit https://www.calrecycle.ca.gov/bevcontainer.

The California Department of Resources Recycling and Recovery—also known as CalRecycle—administers the California Beverage Container Recycling and Litter Reduction Act (“Beverage Act”), which for relevant purposes creates a California Redemption Value (“CRV”) for certain covered beverages. The CRV is 5 cents for containers under 24 oz., 10 cents for containers 24 oz. or greater (for people recycling the cans, not cannabis manufacturers). Containers that are eligible for CRV include:

  • Beer and Malt Beverages
  • Wine Coolers
  • Carbonated Fruit Drinks,
    Water, or Soft Drinks
  • Noncarbonated Fruit
    Drinks, Water, or Soft
    Drinks
  • Coffee and Tea Beverages
  • 100% Fruit Juice less than 46 oz.
  • Vegetable Juice 16 oz. or less

The Beverage Act imposes numerous obligations on beverage manufacturers and distributors, including include on labels of certain qualifying beverages the terms “CA Redemption Value”, “California Redemption Value”, “CA Cash Refund”, “California Cash Refund”, or “CA CRV”.

Requirements for cannabis beverage manufacturers, distributors, and sellers can be complex—both under the Beverage Act and California cannabis law generally.  It’s important for cannabis beverage companies to consult with counsel when creating packaging and labeling for any kind of cannabis product.

One-page MOU for $7.5 million deal?!?

We frequently write on hemp litigation and the ways farmers and purchasers can mitigate the risks inherent in this new industry. Along with others, we have stressed the importance of strategic and careful thinking before entering into a hemp-related contract.  Our cannabis lawyers frequently write and speak on these and related topics.

A couple of my recent posts have highlighted litigation arising after harvest. This post discusses a federal lawsuit filed last week in the District of Oregon, Jupiter Pharma, LLC et al. v. Lafayette Land Company, LLC, et al. that arises from a pre-harvest dispute between the parties. (Feel free to email me if you’d like a copy of the complaint.)

The lead plaintiff (Jupiter) is a Delaware limited liability company building a “Soil to Oil” industrial hemp/CBD operation in Oregon that includes the cultivation, processing and marketing of industrial hemp. The lead defendant (Lafayette) is a farmer residing in Oregon.

The parties entered into a contract in March 2019 to farm and cultivate industrial hemp for the 2019 season that included, at Jupiter’s option, the 2020 and 2021 seasons. Lafayette agreed to farm and cultivate approximately 950 acres of hemp and agreed to assign to plaintiffs its interests in two specific parcels of land to be used for cultivating industrial hemp. In exchange, Jupiter agreed to pay defendants $7.5 million for delivery of at least 2 million pounds of biomass and to transfer to Lafayette farming equipment purchased by the plaintiffs, which equipment would be credited against the $7.5 million payment obligation. Jupiter also agreed to pay Lafayette certain incentives based on hemp production and a monthly stipend during the growing season.

After entering the contract, Lafayette allegedly failed to provide the required documentation concerning the assignment of interests for the two parcels of land. Jupiter then made several trips to the farm to discuss the project and operations. During these visits, Lafayette allegedly made representations that he would provide the land and farm it for plaintiffs. Meanwhile, Jupiter has allegedly entered into contracts with third parties worth $15 million to build a CBD processing facility and purchase equipment per the contract as well as invested over $1 million into the project.

The gravamen of the complaint is that Lafayette repudiated the alleged hemp production contract in late May 2019 and in early June 2019 began planting hemp seed for a third party in violation of the contract with Jupiter. The complaint is quick to note that the Oregon hemp growing season begins in June and if not planted, Jupiter’s season will be lost. The complaint alleges this will cause Jupiter to lose its significant investments in the project and that Jupiter cannot secure alternative farm lands for the 2019 season.

The complaint seeks declaratory relief (a ruling that the contract is enforceable) as well as injunctive relief and specific performance (forcing Lafeyette to assign the rights in the land). In the alternative, Jupiter alleges Lafayette defrauded it by inducing it to enter a contract for the production of hemp and seeks no less than $1 million in damages.

So is there an enforceable contract? The contract is titled a “Memorandum of Understanding” (MOU).  This could be better for Jupiter—one Oregon appellate decision, citing Farnsworth’s treatise, notes: “On the problem of determining whether contracting parties intend to bind themselves either in the presence or absence of terms such as ‘letter of intent’ and ‘memorandum of understanding,’ it has been said, ‘It would be difficult to find a less predictable area of contract law.’” The title of the document does not control, however, the ultimate question being whether there was a meeting of the minds as to the terms of the deal supported by consideration. In this regard, the MOU seems reasonably definite.  But litigation sure is an expensive way to get an answer to the question of enforceability.

A few other comments on the MOU. It is a short, one-page document for a purported $7.5 million deal with kickers for a biomass harvest exceeding 2 million pounds. (Maybe the defendants believed they found a better deal elsewhere?) The MOU says nothing about THC content or CBD content of the hemp. Nothing about the risk of the USDA deciding not to approve Oregon’s hemp production plan. Nothing about state record-keeping requirements or who is responsible for testing of hemp for human consumption – presumably the goal of this Seed-to-(CBD)Oil business or about the chain-of-custody of documentation to ensure nothing is seized during shipment or what happens if Oregon suspends or revokes Lafayette’s license to grow hemp. Notably, the MOU contains no express deadline by which Lafayette must deliver evidence of the purported assignments of agricultural land. I hate to be too critical of the MOU, but there seems much here that could have been done differently and, perhaps, better.

Stay tuned for updates.

California’s illicit market for cannabis is booming—not just out in remote grows deep in the wilderness, but also in delivery and even brick-and-mortal retail stores in big cities all over the state. Our California cannabis attorneys regularly receive questions from licensed cannabis companies about what they can do to stay competitive in the face of unlawful operators who charge lower prices and operate (sometimes) 24 hours a day, seven days a week. There isn’t always a clear or easy answer since the illicit market is so rampant and even state and local authorities are having a hard time eradicating it.

When it comes to tamping down the illicit market, there is often little that legitimate, licensed cannabis companies can do besides out-market and sell a higher quality product. Instead, the ball is largely in the state’s court. And to date, the state has not really made a noticeable dent in that illicit market.

california black market marijuana
Unlicensed cannabis is still pervasive.

This may lie in the fact that the state’s biggest (and sometimes only) method to combat the illicit market is through enforcement of cannabis laws rather than using the legislature to deal with certain illicit-market problems (though, to be sure, there have been some attempts which I’ll get into below). In fact, trade groups in the City of Los Angeles are threatening to sue the city for not enforcing against local operators enough. This is a tricky issue, and it’s not always so clear. The limited resources at the state and local level mean that there is only so much enforcement that government agencies can do, and enforcement alone is not likely to do anything unless the cities and state can better incentivize lawful operations.

The biggest problem with enforcement over legislation is that it’s not a whole lot different from the prohibition era. Shutting down illegal pot shops is sort of like a game of whack-a-mole, which doesn’t get to the root of the problem. Creating comprehensive legislation that makes sales easier for licensed operators and eliminates barriers to entry for new operators could reduce incentives and opportunities for illicit-market sales and make the lawful market more competitive. I’ll take a look at some ways the state could do that below.

#1 Allow More Licenses

It almost goes without saying that the number one way to tamp down the illicit market is to just allow more licenses. I’m not just referring to retail sales, but to all license types. The more licensed operations there are, the less of a likelihood that there will be illicit-market sales.  As our Washington and Oregon cannabis lawyers can tell you, it’s harder for the illicit market to survive in a state with high supply and lower prices, and having more licensed cannabis companies is certainly a way to accomplish that.

As readers of this blog are likely aware, there was recently an effort under way in the state legislature to force certain cities to allow retail licenses if more than 50 percent of their populace voted in favor of legalizing adult-use cannabis a few years back (the bill was AB-1530, which I wrote about here). Unfortunately, in April, the bill failed to pass. It could be re-introduced, but that will probably take significant time and even then, it may not be likely to muster sufficient votes to ever become law.

The bottom line is that prohibition doesn’t defeat the illicit market. It didn’t for decades while cannabis was 100% illegal, and it won’t now in the regulated market. Cities that don’t allow lawful cannabis sales aren’t going to block pot from entering their limits, they are just going to miss out on taxable sales, permitting fees, and job creation, and ensure that criminal activity continues to proceed. Another possible remedy for these cities is to allow even delivery, but as I’ll talk about below, there is resistance to even that across the state.

#2 Allow More Deliveries

Allowing deliveries is perhaps the best compromise for cities that want to eliminate the illicit market but get queasy when it comes to the idea of having a pot shop on main street. Allowing deliveries from other cities that license delivery retailers is a win-win for cities like this. Cannabis will still be available, and they won’t have to deal with it head on.

But many cities, again, oppose this concept. In fact, more than 20 cities banded together earlier this year and sued the California Bureau of Cannabis Control when the Bureau passed a rule allowing pot deliveries into any jurisdiction in the state. So far, not much has happened with that lawsuit and it may be quite a while before it’s resolved. But the point is that cities here are doing everything in their power to resist this compromise, and the result may be a bigger illicit market.

#3 Speed Up the Licensing Process

Even if the state can’t force cities to accept permit applications just yet, it can expend additional resources on assisting current state licensees with their applications. Earlier this year, it was reported that businesses across the state were losing their licenses because certain state agencies couldn’t process them fast enough. Our California cannabis attorneys see the same thing—cannabis companies press on to file applications and the applications seem to just sit there for a long time. There are obvious budget issues and the agencies are clearly under a lot of pressure, but the state can act to better fund the agencies to ensure that they can process licenses more quickly.

It’s true that the state has now begun issuing provisional licenses more quickly, but those are currently only available for cannabis companies that once had temporary licenses (see this update from the BCC).  In other words, for any cannabis company that didn’t get a temporary license in 2018 (they can no longer be issued), provisional licenses aren’t currently available, and those companies will have to sit in line for who knows how long.

If licenses aren’t issued and companies can’t operate, then the same problem that I identified in points 1 and 2 above exists. The illicit market will continue to flourish where there’s a lack of competition.

#4 Broaden Hours of Operation

Cannabis stores across the state have very restrictive permissible hours of operation. The Bureau of Cannabis Control allows retailers (including delivery drivers) to make sales only between 6 AM and 10 PM. Cities can’t allow broader sales, but many of them restrict those hours even further. This is a problem, when illicit sales are available 24/7. If a customer wants to purchase cannabis at 10:30 PM, they may just look to the illicit market rather than wait. There is no great reason for cutting sales off at 10 PM or earlier and expanding the permissible sales hours could reduce the illicit market.

#5 Lower Taxes

Probably one of the bigger reasons that the illicit market can survive is the price of cannabis. Illicit-market sellers probably aren’t paying taxes or charging sales tax, and therefore can charge much lower prices. Even taxes on cultivators here in California will ultimately drive up the price of cannabis sold at retail. So, California lawmakers introduced a bill recently to lower the excise tax and temporarily suspend the cultivation tax, but that bill effectively died last month. It looks like, for now, we’ll still have high taxes on cannabis here.

#6 Enforcement

I know I said above that enforcement isn’t the answer to the illicit market, and that’s generally true. Enforcement alone will never be the solution to illicit-market sales, if there is also prohibition. We’ve already seen enforcement efforts across the state, but they’ve generally been few and far between and not too successful given the flourishing illicit market. Simply increasing them isn’t likely to do very much unless the state can ramp up its efforts to get more cannabis businesses licensed.

However, enforcement combined with active and broad licensing will be a way for states to eradicate the illicit market. If the state and local jurisdictions adopt policies that make it easier for a sufficient number of legitimate cannabis companies to survive and operate, while going after the companies that don’t follow the rules, that’s the best thing they can do to ensure the viability of the legal market.

cannabis securities secSince 2014 we’ve cautioned investors about publicly traded marijuana stocks. Back then we cautioned would-be investors about “pot companies that are trading at frothy levels that are not well-positioned to compete in the marijuana marketplace.” More recently, we’ve written about the scale of mergers, acquisitions, and cross border work, how to “raise money right,” and how Canadian public companies invest in U.S. cannabis. Other posts have examined the challenges of cannabis startups in complying with securities laws and highlighted pending cannabis-related securities litigation.

A significant player in the burgeoning hemp industry is Hemp, Inc. , (“Hemp”) a publicly traded company that trades between 50 and 100 million shares a day, according to its website, which also notes that its CEO, Bruce Perlowin, has been in the cannabis industry since at least 1978. Unfortunately, Hemp and others, including Perlowin, are the subject of a civil enforcement action filed in 2016 by the Securities and Exchange Commission (“SEC”) that is pending in the District Court of Nevada.

This post concerns a recent order (“Order”) in the SEC civil enforcement action by the federal magistrate which decided two motions for sanctions brought by the SEC against four of the defendants — Perlowin, Barry K. Epling and two entities he controls, Ferris Holdings, Inc. and Hobbes Equities, Inc. The SEC alleged these defendants fabricated evidence and gave false testimony at their depositions.

What is the lawsuit about? The SEC alleges that the defendants “engaged in a comprehensive, years-long scheme to defraud investors and evade securities law by selling restricted shares of Hemp without registering the sales.” They did so, says the SEC, by selling hundreds of millions of unregistered and purportedly unrestricted shares of Hemp to public investors and by exchanging gifts and entering into sham consulting agreements. Specifically, Epling—through entities he controls, Ferris and Hobbes—sold $9.8 million in securities, of which $1.8 million was used to pay expenses on behalf of Perlowin and Hemp. The defendants have claimed these payments were personal loans from Ferris to Perlowin.

The first motion concerned allegedly falsified evidence produced by Epling and false testimony given by Epling and Perlowin. To determine whether the consulting agreement were bona fide, the SEC asked Epling for copies of his filed tax returns between 2011-2015, including schedules and forms. Epling did not initially produce the requested documents and later produced tax documents that were unsigned and undated printouts bearing the watermark “DO NOT FILE.” The SEC then sought copies of his returns from the IRS and learned that Epling had filed returns for several years on the same day – May 5, 2017, nearly three months after the SEC made its discovery request, and after Epling had told the SEC he had just found his returns.

The SEC argued that the tax returns never existed and were in fact created by Epling in response to the SEC’s discovery request. The SEC characterized the returns as falsified evidence and sought to exclude them from trial. The SEC asked the court to impose an adverse inference and adverse jury instruction that the consulting agreements were not bona fide (effectively deciding this issue for trial). The SEC also sought sanctions against Perlowin and Epling for giving false deposition testimony. Both testified there were no documents memorializing the $1.8 million in loans. Yet several weeks later they produced copies of documents they claimed memorialized those same loans. The SEC asked the court to exclude all evidence related to the claimed loans and for an adverse instruction that there were no loans.

The second motion alleged that Ferris provided false evidence (tax returns) that were never actually filed with the IRS but were produced by Ferris to the SEC in response to a request for “as-filed” returns. For this offense and Epling’s other offenses, SEC sought the drastic sanction of terminating sanctions against Epling and the two defendant-companies he controls, Ferris and Hobbes. (This means the SEC believed the discovery violations so egregious that it asked the Court to enter default judgment against these defendants, effectively terminating the case as to these defendants without a trial.)

The Order is thorough, concluding that the defendants’ conduct was “egregious” and a waste of a “huge amount of judicial and party resources.” Nonetheless, the Court denied the SEC’s request for terminating sanctions, despite finding Perlowin and Epling’s testimony at the motions hearing not credible and that Epling deceived the SEC (and his own) counsel with respect to his tax returns. The defendants’ deception and discovery violations warranted sanctions, but were not enough to interfere with Epling and Ferris’s right to a trial on the merits, said the court.

Although these defendants may have escaped default judgment, I do not envy their counsel’s task at trial because the Court ruled that:

  • Defendants are precluded from offering any evidence at hearing, in motion practice, or at trial related to the loan documents produced after Epling and Perlowin’s depositions;
  • The jury should be instructed that the defendants failed to comply with their discovery obligations;
  • The jury should be instructed that Epling deceived counsel for the SEC and defense counsel by falsely representing that his personal tax returns he produced for 2012-2014 were “as-filed” copies; and
  • The jury should be instructed that they may consider evidence of the defendants’ discovery violations and Epling’s deception about his personal tax returns along with all other evidence in the case in reaching their verdict.

The moral of the story is here is plain: Don’t play fast and loose with the facts should you or your company find yourself the subjects of an SEC investigation. The chances of you succeeding at doing so are minimal. One wonders how long defense counsel—some of whom were deceived by their own clients—will continue this representation. A better strategy is to retain legal counsel and be forthright about the strengths and weaknesses of the SEC’s case (and your own) so that you and your legal team can implement the appropriate strategy.

(The defendants have since filed an objection to the magistrate’s order, which will now be reviewed by the trial judge.)

cannabis law and policy law schoolFor the past three years, I have taught a class called “Cannabis Law & Policy” at Lewis & Clark Law School here in Portland, Oregon. It’s a seminar that meets for two hours a week for upper level students. Per the syllabus, learning objectives for that class are: 1) students should be able to understand and explain the legal and policy framework of cannabis regulation federally and in Oregon, and its related effects; 2) students should develop practical proposals and strategies for dealing with degrees of cannabis prohibition; and 3) students should gain an appreciable understanding of the manner in which attorneys work with cannabis industry businesses. All in all, we cover a lot of ground each semester and I enjoy teaching the class.

One of the things I like best about teaching a graduate level course is the challenge of articulating difficult concepts to smart people. Good students will not let you off the hook on hard problems, and there are plenty of vexing issues when it comes to cannabis. It’s fascinating in an almost bottomless sense, and the further you go with it, the more you appreciate the breadth and scope of the problem. Below are a few observations on things that have been especially interesting, and which I did not expect.

The old laws are worse than you think.

Most people who have followed the story of cannabis in the United States understand the racially disparate impact cannabis laws have had, by design, and particularly on black and Latino populations. They will cite to the corrupt motivations behind President Nixon’s support of the federal Controlled Substances Act, and maybe to the disturbing crusades of Henry Anslinger before that. But people are often oblivious to actions and policies endorsed by states for the past 50 years, including profoundly harmful legislation like the Rockefeller Drug Laws instated in New York in 1973. Those laws were the toughest drug laws in the nation at that time and served as a model for many other states on issues like mandatory minimum sentencing, elimination of plea bargaining, elimination of suspended sentences, elimination of parole possibilities, etc. Today and historically, most arrests and imprisonment for cannabis crimes happen under state laws. The federal laws may set a trend, but state actions have been more impactful and more damaging overall.

The new laws are pretty lousy too.

States continue to adopt cannabis licensing regimes that preclude individuals convicted of crimes from participating in cannabis business ownership. Generally speaking, there are no exemptions for prior felonies related to cannabis, and none of the early recreational cannabis programs contained restorative justice or social equity dimensions. The federal laws aren’t any better. The 2018 Farm Bill, for example (and with limited exceptions) expressly bars “any person convicted of a felony relating to a controlled substance under State or Federal law” from growing hemp under a USDA certified program. There is no reasonable justification for this type of exclusion and it is disappointing that our legislators continue to leave people behind.

Cannabis law is vexing; policy is harder.

You can tie yourself into knots with legal arguments as to why state cannabis programs may be defensible under the 10th Amendment, or why state-legal marijuana does not cause the United States to violate its international treaty obligations on controlled substances. That stuff is pretty fun. But as a sheer intellectual exercise, policy is harder.

Every semester, we do about two hours on the optimal way to tax cannabis production, distribution and sale. We could do 20 more. Every semester, we spend an hour or two talking about how to build a social equity program to benefit disenfranchised people and populations. No one has come close to figuring that one out, either. The list goes on and on.

This area is highly dynamic.

I realize this fact every year when I resurrect the syllabus and half (or more) of the readings need to be replaced. Students realize it over the course of the semester, too, when readings become obsolete– sometimes from week to week. By way of example, here is what happened in each of the past three Januaries, as we kicked off the semester.

  • In January 2017, President Trump took office and appointed Jeff Sessions as Attorney General. Many of the states that voted to legalize a few months prior (including California) began to recalibrate their efforts and proposals.
  • In January 2018, the Cole Memo, Wilkinson Memo and other federal guidance were abruptly revoked. Industry as well as state attorneys general like Bob Ferguson were gearing up for litigation and raids.
  • In January 2019, the Farm Bill had just passed, legalizing industrial hemp. At the international level, the World Health Organization recommended total descheduling of hemp/CBD and a reschedule of marijuana.

Developments like these can be incredibly disruptive to a fixed curriculum! As with lawyering in the cannabis space, or simply running a cannabis business, everyone has to roll with it.

People love this stuff.

We end up with a long waitlist every year, and every year I get emails from students the first few weeks trying to wriggle in. The legal and policy mechanics of peeling back layer after layer of prohibition is compelling, especially to students who are accustomed to studying comparatively settled bodies of law. I’ve been fortunate to see a few of the students go on to get jobs as cannabis business lawyers in Portland and elsewhere, which may be the best part of all.

l.a. cannabis phase 3
L.A. is not making things easy.

A lot of attention has been paid recently to brick and mortar retail licenses in the City of Los Angeles for Phase 3 licensing, which is set to commence in early September of this year. While L.A. is trying its best to champion social equity with its Phase 3 storefront licensing, it’s also going to develop a Delivery Pilot Program for social equity applicants in the City.

As a recap of Phase 3 in L.A., the first 100 Type 10 (brick and mortar retail) licenses will go to social equity applicants on a first-come, first-served basis (specifically, the first 75 Tier 1 applicants and the first 25 Tier 2 applicants will get licenses if they meet all eligibility requirements) in Round 1. For Round 2, which will be for 150 Type 10 retail licenses, this will also be on a first-come, first-served basis. The Round 1 window is going to be extremely short–only 14 calendar days (preceded by a 15 calendar day notice from the DCR). Businesses are only eligible to apply if they have a verified Tier 1 or 2 social equity “Owner” (with the mandated equity share in the business). Importantly, an individual can’t be the Tier 1 or Tier 2 social equity Owner for more than one applicant in Round 1, and existing medical marijuana dispensary (“EMMD”) owners can’t act as social equity Owners in this round either. The Round 2 window is 30 calendar days for 150 licenses that will also go to pre-verified Tier 1 and 2 social equity applicants (without any processing priority between those two groups). Note that the Department of Cannabis Regulation (“DCR”) began the pre-vetting process for social equity applicants for Round 1, Phase 3 licensing very recently– on May 28th, 2019. This window is open until July 29, 2019 (see here for how to demonstrate your social equity status to the City).

Specifically regarding Type 9 non-storefront, delivery only licenses, the DCR will, on a date to be determined in the future, begin accepting applications for delivery (there will be a 15-day notice before this particular window opens, too). Eligibility for a Type 9 license hinges on submitting at the time of filing: 1) a copy of an executed lease agreement with proof of a deposit or property deed for the business premises (yes, even as a delivery service, you have to have a physical facility to store your inventory); 2) a premises diagram; 3) proposed staffing, security, and delivery plans; 4) a dated radius map including horizontal lines and labeling of any sensitive uses relative to a Type 9 License; 5) an indemnification agreement with the City; 6) a current Certificate of Occupancy for retail use for the business premises; and 7) all business records and agreements necessary to demonstrate that a Tier 1 or Tier 2 social equity applicant owns the minimum equity share in the Type 9 applicant (i.e., a Tier 1 must own at least 51% and a Tier 2 must own at least 33%). Criteria number 7 is “as applicable” in that the City must also issue on a 2 to 1 basis Type 9 licenses to general public, non-social equity applicants.

Regarding order of priority for Type 9 applicants, the DCR will process a total of 60 Type 9 applicants in Round 1 of licensing (delivery actually has three rounds). 40 of these licenses will go to first Tier 1 and 2 social equity applicants, and 20 will go to the first general public applicants that don’t have any social equity component (to satisfy the 2:1 licensing ratio required under LA law). These licenses represent the City’s Delivery Pilot Program, and these applicants must submit 1-7 (7 as applicable) per the above at the time of filing.

For Round 2 of delivery licensing, importantly, if you applied but were rejected for a Type 10 license in Rounds 1 or 2 because your proposed storefront location was in a geographic area of undue concentration limits or within a 700-foot radius of another Type 10 application, you get priority processing for a Type 9 license relative to all other applicants except those in the Delivery Pilot Program.

And Round 3 of delivery licensing is for those non-retail applicants that applied for licensure in Phase 2 licensing. Those applicants can, at a time TBD by the DCR, amend their Phase 2 annual applications to include delivery.

Very importantly, even though we don’t have a set date yet for when delivery licensing will open in Phase 3, if you want social equity delivery licensing in Phase 3 as part of the Pilot Program, you still need to get vetted now during the social equity vetting window that’s open until July 29th. See here for that online application.

The bottom line is this: The same directives we’ve preached before apply for delivery licensing in LA–start now in gathering your business and real estate documents to ensure that you make a timely submission to the City when the delivery window opens, and do not forget to right now (through July 29th only) get pre-qualified as a social equity candidate with the City if you want in on the Pilot Program.