Continuing our discussion from last week, we received a few follow-up questions on whether patent litigation is really worth the trouble and what can be potentially recovered. In short, the amount of damages you can recover for patent infringement is outlined by statute. Here is a cursory discussion of the different types of damages that are available in such a case:

Compensatory damages

35 U.S.C.A. § 284 provides: “Upon finding for the claimant the court shall award the claimant damages adequate to compensate for the infringement but in no event less than a reasonable royalty for the use made of the invention by the infringer, together with interest and costs as fixed by the court.”

The major, underlying theory of damages in patent litigation is to deny the infringer the fruits of his illegal act, AND to restore to the patent owner the benefits which he would have derived from his monopoly had he not been denied the infringing sales. Another way to think about this is the distinction between “damages” and “profits.” Profits refers to what an infringer makes. Damages refers to what a patent owner lost by the infringement. A patent owner’s monetary award equals the amount adequate to compensate him for the infringement (usually, for the patent owner’s lost profits), but in no event less than a reasonable or established royalty.

Measured by patent owner’s lost profits

For a patent owner to recover lost profits, he must demonstrate that “but for” the infringement, he would have made the sales that the infringer made. To recover under the lost profits approach, the patent owner must prove two things:

  • The patent owner would have made the sale of the product but for the infringement (which is an inquiry made based on the demand for the patented product in the market, the patent owner’s ability to meet this demand, and the absence of acceptable substitutes); and
  • Computation on the loss of profits by proper evidence.

Unlike copyright or trademark infringement, patent infringement does not provide for an accounting for an infringer’s profits (except in the case of a design patent). However, the infringer’s profits may properly be considered, for comparison purposes with the patent owner’s proof of his lost profits, in estimating the patent owner’s damages.

Lost profits may be in the form of diverted sales, eroded prices, or increased expenses. It should be noted that an infringer’s foreign sales are not included in this calculation because protection only extends to infringement in the United States.

Measured by a reasonable royalty

In the event a patent owner cannot prove the above, his damages are limited to a “reasonable royalty.” A reasonable royalty is generally the amount at which a person desiring to manufacture and sell a patented product would be willing to pay as a royalty to the patent owner. The factors considered in this analysis are called the Georgia-Pacific factors (from Georgia-Pacific Corp v. United States Plywood Corp.):

  • The royalties received by the patent owner for the licensing of the subject patent.
  • The rates paid by the licensee for the use of other patents comparable to the subject patent.
  • The nature and scope of the license, as exclusive or non-exclusive.
  • The licensor’s established policy and marketing program to maintain his patent monopoly by not licensing others to use the invention or by granting licenses under special conditions designed to preserve that monopoly.
  • The commercial relationship between the licensor and licensee.
  • The effect of selling the patented specialty in promoting sales of other products of the licensee; the existing value of the invention to the licensor as a generator of sales of his non-patented items; and the extent of such derivative or convoyed sales.
  • The duration of the patent and the term of the license.
  • The established profitability of the product made under the patent; its commercial success; and its current popularity.
  • The utility and advantages of the patent property over the old modes or devices, if any, that had been used for working out similar results.
  • The nature of the patented invention; the character of the commercial embodiment of it as owned and produced by the licensor; and the benefits to those who have used the invention.
  • The extent to which the infringer has made use of the invention; and any evidence probative of the value of that use.
  • The portion of the profit or of the selling price that may be customary in the particular business or in comparable businesses to allow for the use of the invention or analogous inventions.
  • The portion of the realizable profit that should be credited to the invention as distinguished from non-patented elements, the manufacturing process, business risks, or significant features or improvements added by the infringer.
  • The opinion testimony of qualified experts.
  • The amount that a licensor (such as the patent owner) and a licensee (such as the infringer) would have agreed upon (at the time the infringement began) if both had been reasonably and voluntarily trying to reach an agreement.

Indirect damages

Generally, indirect or consequential damages (such as lost supply sales) are not recoverable.

Interest on damages award

35 U.S.C.A. § 284 provides as follows regarding interest: “Upon finding for the claimant the court shall award the claimant damages … together with interest and costs as fixed by the court.”

Both pre-judgment and post-judgment interest are included.

Exemplary (or, punitive) damages

35 U.S.C.A. § 284 provides as follows regarding exemplary damages: “When the damages are not found by a jury, the court shall assess them. In either event, the court may increase the damages up to three times the amount found or assessed.”

A patent owner can win exemplary damages, up to and including three times the actual damages, where the infringer has knowingly, deliberately, intentionally, willfully, or wantonly infringed the patent. While “willful infringement” is a nebulous fact inquiry, the primary question is whether the infringer, acting in good faith, had reason to believe that it had the right to act in the infringing manner. The In re Seagate Technology test is comprised of two parts:

  • Did the infringer act despite an objectively high likelihood that his actions would constitute infringement of a valid patent? (Note, the infringer’s actual state of mind is irrelevant).
  • Was this risk either known or so obvious that it should’ve been known to the infringer?

In mid-October, California Governor Gavin Newsom approved a bill (SB-153) that dramatically changed California’s hemp cultivation laws. The bill was clearly intended to bring California closer into harmony with the 2014 and 2018 Farm Bills, in anticipation for the state’s ultimate submission of a statewide hemp production plan to the U.S. Department of Food and Agriculture (“USDA”) following the USDA’s issuance of interim hemp regulations. Unfortunately for the California legislature, those USDA interim rules (you can read the full text here) were released a few weeks later, and are very, very different from California’s new hemp cultivation regime.

The difference between California law and the USDA interim rule matters because the USDA interim rules require that any state hemp production plan be at least as restrictive as the USDA interim rules. In practice, that means that many of the existing California laws and regulations that are less restrictive than the USDA interim rules will need to be changed when California’s hemp production plan is submitted to the USDA (most likely sometime in early 2020). And there are a few key areas where the USDA interim rules and California law differ , including:

  • Testing Times: Under SB-153, required sampling for testing must occur “no more than 30 days before harvest”. The USDA interim rules require that sampling be done within 15 days prior to the anticipated harvest. This 15-day gap is significant because THC levels tend to rise the closer plants get to harvest.
  • Total THC Testing: Under SB-153, testing is only required for delta-9 tetrahydrocannabinol.  Under the USDA interim regulations, labs will have to test for “total THC“, which is the molar sum of delta-9 THC and delta-9 tetrahydrocannabinolic acid (“THCA”). This generally increases the THC concentration in hemp sample and pushes it over the 0.3 percent limit, and in effect limits what kinds of hemp breeds that cultivators can use or which harvests can move down the stream of commerce. Not surprisingly, the USDA has faced some pretty heavy backlash. What this means for California is that hemp that may otherwise be legal under SB-153 may no longer be if total THC testing is required.
  • DEA Registrations: The USDA interim rules require testing laboratories to register with the DEA. This is not a requirement under current California law and could pose problems for testing labs who want to work in both the cannabis and hemp space.

For the next year or so, while states are compiling and submitting plans to the USDA, the USDA interim rules make clear that hemp may still be produced under the 2014 Farm Bill. The 2014 Farm Bill really only applies to narrow hemp cultivation by state departments of agriculture or institutions of higher education. And it’s arguable that in many cases, California allows much broader hemp cultivation than the 2014 Farm Bill. To date, the California Department of Food and Agriculture (the agency that oversees hemp cultivation in the state) has not commented on the interplay between SB-153 and the 2014 Farm Bill given the new USDA interim rules. It will certainly be interesting to see what the agency’s position is, and how it instructs registered cultivators in the future.

One thing that’s important to note is that the USDA interim rules really only relate to cultivation. While they make a few references to processing, they don’t explicitly require a license or authorize it in every state. Notably, the USDA interim rules allow states to prohibit hemp cultivation, so the fact that they don’t really mention processing should not be viewed as any kind of implication that states are no longer authorized to prohibit hemp processing or the sale of hemp-derived cannabidiol (“Hemp CBD”) products. The FDA has not changed its nearly year-long position that some Hemp CBD products are unlawful, and California legislation aimed at legalizing Hemp CBD as an additive to foods (AB-228) stalled out in a legislative committee earlier this year. So for the time being, nothing has really changed regarding CA laws (or the lack thereof) on processing or the California Department of Public Health’s position on Hemp CBD sales.

As always, stay tuned to the Canna Law Blog for more updates on the interplay between federal laws and regulations and California’s complex hemp rules.

On October 31, the U.S. Department of Agriculture (USDA) published its interim final rules for the production of hemp under the 2018 Farm Bill. Our firm has provided a broad overview of the rules and written about the potential impact of the testing rules on the hemp industry. Today we address disqualifying criminal history for the purpose of participating in the hemp industry.

The interim rules outline the requirements for States and Indiana Tribes hemp production plans, which must be approved by the USDA.  Among these requirements is that if the producer is a business entity, the State or Tribe must collect and submit information that includes:

  • The full name of the business,
  • Address of the principal business,
  • The location, full name and title of the “key participants”,
  • An email address if available, and
  • The EIN number of the business entity

Applications for a producer license – whether submitted to the USDA, a State, or a Tribe – must be accompanied by a completed criminal history report for each key participant. This is because the 2018 Farm Bill prohibits persons convicted of a felony related to a controlled substance under State or Federal law from producing hemp for 10-years following the date of conviction. An exception applies to persons who were lawfully growing hemp under the 2014 Farm Bill before December 20, 2018 (the date that the 2018 Farm Bill was signed into law), and whose conviction occurred before that date.

Who is a key participant? A key participant is:

  1. A person or persons who have a direct or indirect financial interest in the entity producing hemp, such as an owner or partner in a partnership;
  2. Persons in a corporate entity at executive levels, including chief executive officer, chief operating officer and chief financial officer.

The rules expressly state that “key participants” do not include other management positions like farm, field or shift managers.

USDA is requiring a criminal history records report for key participants because those persons are likely to have control over hemp production, whether production is owned by an individual, partnership, or a corporation. What does this mean? It means that the USDA considers those persons as responsible for ensuring compliance with the regulatory requirements. For a corporation, if a key participant has a disqualifying felony conviction, the corporation may remove that person from a key participant provision – failure to do so will result in a denied application or license revocation.

What is unclear from the interim rules is how far into a web of corporate relationships the requirement of identifying and providing criminal history reports for key participants’ extends.  Consider a scenario in which Company X is applying for a hemp production license. Company X is owned in equal parts by two individuals and Company Y. Company Y’s ownership is comprised of three individuals and a trust.  Read broadly, the requirement to identify key participants and submit criminal history reports would apply to C-level employees of Company X, five individuals and the beneficiaries of the trust and may include the trustee.  This is a basic example of the kinds of corporate structures that we often see and which can create burdensome headaches when it comes to identifying “key participants.”

Those of us operating in states that have legalized recreational marijuana are used to reading the identification as extending through the entire corporate family.  For example, here is a recent post on this issue California. And here is a post about considerations for foreign companies when investing in US cannabis. As these articles explain, financial interest disclosure requirements can be incredibly difficult to comply with and it may not always be clear who has an “indirect” interest.  The goal of such regulations is to ensure that the government knows the identity of every person who may profit from the recreational marijuana business.

It appears that may also be the case for hemp and there is much more to say on this and other topics. So stay tuned as we delve further into the interim rules governing hemp production in the coming weeks and please register for our webinar this afternoon at 12:00 PM.

 

Tomorrow is our free webinar discussing the USDA’s interim hemp rules released on October 29th and published in the Federal Register on Halloween. The new rules may seem intimidating (spooky even given the publishing date), but a thorough understanding is crucial for anyone with a vested interest in the hemp and CBD industries for the foreseeable future. The rules provide clarity regarding hemp cultivation and production, but ambiguities remain. To understand the meaning, impact, and consequences of these changes, join attorneys Daniel Shortt and Nathalie Bougenies tomorrow, Thursday, November 14, at 12:00 PM PST.

The agenda for tomorrow will include:

  1. THC Testing
  2. Interstate Transport
  3. State and federal licensing
  4. Immediate legal impacts on hemp farmers
  5. Ambiguities in the regulations and areas of concern
  6. Steps for hemp farmers to take now to best prepare for compliance with the interim rules once they’re finalized
  7. The effect of the USDA regulations on hemp-CBD and hemp-derived products

We encourage you to register here prior to the webinar if interested. Those who are not able to attend live, but still sign up, will receive a copy of the webinar following the presentation.

On November 13, our own Jesse Mondry will present a primer on hemp law at the Farm Journal’s “Hemp College” in Las Vegas, Nevada. Jesse also will participate in a Market & Regulations Panel along with Michael Bowman, Co-Founder of First Crop, Dion Oakes, a farmer from Monte Vista, Colorado, and Adrienne Snow from Western States Hemp.

During this one-day event, speakers will discuss the best agronomic practices for hemp production and will also touch upon marketing, legal considerations and policy news. Sessions will include How to source high-quality seed; Hemp nutrient needs from A to Z; Pest, weed and disease management; In-season management and harvest practices; Steps to developing a marketing plan; and Legal considerations for hemp production.

As the hemp industry continues to grow, we anticipate the laws and regulations to grow more complex. Jesse has been a leading voice on hemp production contracts and hemp/CBD litigation and he regularly helps companies navigate this promising market.  For more information on Harris Bricken’s team of Hemp/CBD regulatory and litigation attorneys, click here.

You can register for the Hemp College here.

Every state that’s legalized cannabis for adults 21-and-up has faced that moment or even series of moments that threatened to really derail or seriously stymie market development. California is at that crossroads and has been almost from the outset of the first issuances of cannabis licenses back in January 2018. California will, of course, eventually and sufficiently deal with its myriad of cannabis issues, but right now there are a select few that are really affecting licensed businesses and the success of this important democratic experiment. In no particular order, my top six (current) threats/growing pains to the development and success of California’s cannabis marketplace are:

  1. State licensing woes and low licensing numbers.  Every state at some point experiences what seems to be either too much licensing (see Oregon) or just too little to satisfy demand. Right now, California is probably in the latter category. And with too few licenses comes lack of access for consumers and the growth and continued operation of illegal operators. The state has done its best to mitigate the licensing log jam (see, for example, the new and improved provisional license concept), but even that hasn’t done much to spur huge licensing numbers. Right now, according to the AP, “California has 7,392 licensed cannabis businesses. The [Bureau of Cannabis Control] oversees 2,630 companies with either provisional or annual licenses, while the state Department of Public Health oversees an additional 932 manufacturers. The state Department of Food and Agriculture oversees 3,830 farmers.” Whether it’s based on local control issues (see below) or the fact that licensing, itself, is just too onerous for stakeholders, California just doesn’t have a swell of legal operators with licenses at this point. In fact, just last week, the state suspended 394 licensee applications, representing 5% of the licensed market, because those applicants weren’t progressing with the mandatory track and trace training requirements, which is a cornerstone of legalization (being able to monitor the inventory at all times).
  2. Local control. Most people don’t realize that the majority of California cities and counties still completely ban commercial cannabis activity. And the majority of cities and counties that do allow for it only limit that activity to medical cannabis production and sales. Of course, the local control pitch was a big part of getting Prop. 64 and the Medicinal and Adult-Use Cannabis Regulation and Safety Act (“MACURSA”) through into actual law, and cities and counties have inherent police powers anyway to ensure the protection of the health and well-being of their citizens. Still, in California, to secure a state license of any kind, you must have local approval to operate from your city or your county. And in local jurisdictions that have bans, this means that licensing is impossible; it also means that these communities are hotbeds for unaccountable illegal cannabis activity, which of course undermines legal operators at every turn.
  3. Illegal market actors. Every state continues to deal with the illegal cannabis market, and it will always exist in some capacity regardless. At the same time, when barriers to entry are too high or intense or taxes are way too high and/or there’s too much red tape, regulators may be helping to spur the illegal market they seek to eliminate. In California, the illegal market is alive and well in certain communities for a number of reasons. The usual culprits are municipal bans, lack of enforcement by the state or locals, the fly-by-night nature of these operators, egregious taxation that makes legal operation too expensive, and constant changes to or inconsistent regulator interpretations of state and local rules that can bankrupt operators. Moreover, the brazen attitudes and recklessness of illegal actors (especially in California) know no bounds–a perfect example is the vaping crisis, which is almost entirely attributable to illegal cannabis vapes and cartridges, for which the legal cannabis industry has suffered from reactionary state and local bans and new restrictions on lucrative vapor products at the state and local levels.
  4. Lack of transparency and consistency from regulators. Being a cannabis regulator is no easy task. To wrangle and control a new industry unlike any other is incredibly difficult and many challenging policy and legal decisions have to be made by these regulatory bodies without any assistance (or budget) from other branches of state and federal governments. At the same time though, and in my experience, the best cannabis regulators are those that are consistent, transparent, and responsive to stakeholders, and especially those that do not engage in “business as usual” politics, only dealing directly with paid lobbyists and trade groups. In California, my personal experience with the three governing bodies at the state level has been mixed. At the outset of licensing, it seemed it was easier to secure more comprehensive, direct responses to questions or concerns about various regulations (and there are A LOT of regulations). Now though, depending on the agency and depending on the analyst with whom you may be dealing, you would be lucky to even get a substantive response to important regulatory questions within a couple weeks of submission, if at all. Some of that delay or lack of response is understandable as regulators wear many hats and are on the constant go relative to enforcement and maintaining the regulatory structures surrounding licensing. And maybe some of the delay or non-responsiveness is due to the size of California and the massive undertaking that is licensing, but I can say that in almost a decade of practice in this area it is not yet simple or easy for stakeholders to consistently communicate with state regulators, which puts at risk business practices and a solid understanding of regulatory compliance in order to avoid regulatory violations.
  5.  Taxes. In my opinion, no state has figured out the gold standard for cannabis taxation that isn’t so high as to hinder business but isn’t so low as to incentivize extreme consumer cannabis use. In California, there are multiple levels of cannabis taxation–a 15% excise tax on retail sales (on top of state and local sales tax), a varying cultivation tax depending on the type of product that enters the commercial market, and then applicable local cannabis-specific taxes and fees. In July, the SF Chronicle estimated that “Californians are paying up to 45% tax rates on cannabis purchases — nearly 40% higher than the standard 6% state sales tax.” When taxes are unflinchingly high like this, the illegal market is energized and consumers tend to turn that way to avoid paying too much for their cannabis even if that cannabis isn’t tested or quality assured. Since MAUCRSA’s inception there’s been little to no tax reform to provide any kind of relief to cannabis businesses, including on the local level (with very few exceptions from cities that want the tax revenue to justify the social cost).
  6. Lack of access to banking. If you’re motivated and capitalized enough to secure local approval and a state license, and you can bear the significant tax burdens, you still likely will have difficulty securing a bank account in California. Because California’s regulations aren’t the tightest in the cannabis union, on the whole (and especially regarding the vetting of owners and financial interest holders), financial institutions have not openly banked the industry pursuant to the 2014 FinCEN guidelines (which are still alive despite the rescinding of the 2013 Cole Memo). The lack of access to banking forces the classic public safety threat of all-cash, which is also a logistical nightmare for cannabis businesses that must taxes and run payroll. While other states with stricter regulatory regimes, like Washington State and Colorado, have options for cannabis banking, California still lags in this area, but I’m hoping that will change as cannabis regulations progress.

None of the foregoing are new or novel cannabis industry issues on a state-by-state basis. However, since California has had cannabis legal reform since 1996, you wouldn’t be out of bounds to think that such a state could quickly and effectively deal with these issues, but that’s not been the case (despite the fact that they are now several state legalization blueprints from which to borrow). Nonetheless, I remain confident that California will eventually come out on the other side with successful and long-lasting licensees in tow after it makes through these growing pains.

It is trite of me to say so, but the current “gold rush” in the U.S. has prospectors dreaming of double-fisting cannabis buds and greenbacks, and that makes for fertile fraud soil. In this green rush, investors are voraciously putting money into cannabis ventures that are, in some instances, producing vast amounts of cash and garnering valuations at 10x (and more) EBITDA when potential purchasers come knocking (and they are knocking) (see here and here for posts on cannabis business valuations). But this frothy business market means the fraudsters are also salivating en masse about would-be investors, and securities regulators are keeping close tabs on these securities transactions. Regardless of which side of the investment equation you are on, you do not want your company, yourself, or someone you care about to be involved in securities fraud. This post focuses on Utah, which is infamous (pronounced IN-fame-us) for being one of the fraud capitals of the U.S., but the principles are widely applicable to cannabis ventures in established cannabis markets like Colorado, Washington, Oregon, California, Maine, and beyond.

I recently attended Utah’s annual securities law workshop with some heavy-hitting headliners: Ben McAdams from Utah’s Congressional delegation; the chief accountant for the SEC’s enforcement division; and the head of Utah’s Division of Securities, Tom Brady (the slightly less famous one). Mr. Brady confirmed for me that Utah has more than its fair share of fraud and that the fraud has a particular Utah flavor, with confidence schemes dominating the landscape, often perpetuated by fraudsters who work their church, neighborhood, and family connections in a state that rivals China for its interconnectedness (in Chinese it’s called guanxi (gwon shee) – 关系). Many of Mr. Brady’s examples of fraud perpetuated in Utah began with a hot tip provided by a well-regarded businessperson who was extremely likeable and therefore seemed trustworthy. Utah has a very trusting population, and it also has a growing elderly population, both of which are vulnerable to fraud. Although it is currently only appearing as an intermittent blip on the radar of Utah’s Division of Securities, the Utah cannabis scene is ripe for fraud opportunities. Caveat investor.

Utah is on the cusp of rolling out its medical marijuana program. The Utah Department of Health will begin issuing medical marijuana cards no later than March 1, 2020. Even before Utah voters passed the ballot initiative on November 6, 2018, the green rush had already started in Utah, with would-be investors looking at getting in on the ground floor in Utah’s new marijuana marketplace. Heavy cannabis investments are happening in all the states where we have attorneys: Washington, Oregon, California, and Utah, which means that bogus investments (not just bad investments) are also being shopped to would-be investors as an alternative to the evergreen oil-and-gas venture fraud in the West. How can prospective investors in a Utah cannabis venture avoid losing their money in a fraudulent scheme? It helps to ask the right questions and to know what the right answers sound like.

Is the company or individual raising funds using a law firm to help with the transaction? Does that law firm know both securities and cannabis?

These questions are partially self-serving, but I put this point first because you do not want to dabble in securities law, whether you are a company, an individual businessperson, an investor, or a lawyer. Whatever your role in business, if money is changing hands between investors and a business venture, the investor is investing in securities being offered by the company. Even if it is “just” a promissory note or you are “just” loaning some funds to a friend or family member, unless you do not care about getting your money back, make sure there is a qualified securities attorney involved. There are a lot of great attorneys in Utah. There are at least two good cannabis attorneys in Utah. I am not aware of any other lawyers in Utah who know both securities and cannabis. You need good securities attorneys representing the company and each investor.

If the company is using an intermediary to solicit investments, is that intermediary licensed to solicit investments? Are they registered with the SEC, FINRA, or the State of Utah? Has the intermediary been disciplined by any of these entities?

Intermediaries or “finders” are (by definition) not involved with the day-to-day operations of the company that is soliciting investment, and they must be registered with state and federal regulators because they are in the trusted position of soliciting funds for investment. If the intermediary is not registered as a broker or investment advisor, they should not be soliciting investments unless they have a direct and substantial role with the company. If the company thinks the intermediary is registered but the intermediary is not registered, you should think twice about investing with the company. If the company does not know that their intermediary needs to be registered, you should also think twice about investing with the company.

What type of investment registration statement is the cannabis venture required to file?

The company either has to register its investment securities or qualify for an exemption from registration. If the company owners do not know what a securities offering is, you should think twice before investing with the company unless the company is willing to get competent advice from a securities lawyer. If the company or its attorney has not heard of Reg D, Rule 4(a)(2), or Rule 506, you should probably walk away or insist a qualified securities attorney get involved.

What parts of a cannabis business can be invested in, or what are the limits to the company’s business purpose?

Some states (like Arizona) allow full integration of marijuana business activities; others (like Washington) do not. If, for instance, the company seeking investment plans to develop a cannabis testing facility and have a fully integrated cannabis business (cultivate, manufacture, distribute/transport, and retail sales), but you know that the company can only do what its license permits, then you may want to look for another company to invest in. In Utah, only eight companies have been authorized to grow medical cannabis: Dragonfly Greenhouse, Harvest of Utah, Oakbridge Greenhouses, Standard Wellness Utah, True North of Utah, Tryke Companies Utah, Wholesome Ag, and Zion Cultivars. There will initially be only up to 14 privately-operated medical cannabis pharmacies licensed by the Utah Department of Health, and the RFP is available at the Utah Division of Purchasing’s vendor website to view the application (search for RS20006). The RFP application window closes December 2.

What can be found out about the principal owners and operators of the business by (1) word of mouth, (2) a simple Google search, and (3) checking with state and federal securities regulators?

I cannot tell you how many instances of investment fraud could have been avoided by doing a simple Google search. This was stressed recently in another conference I attended with the Washington State securities regulators. Do your homework or pay someone else to do your homework. In the legal world, that homework is called “due diligence,” which is a crucial part of any business transaction.

When it comes to investing in cannabis, know your counterparts, know their business, and know their flaws and weaknesses. Know all of this before you invest.

The 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 summarize a new state in alphabetical order. Today we turn to Massachusetts.

The Massachusetts Department of Agricultural Resources (“MDAR”) oversees the state’s “Hemp Program.” The Hemp Program offers the following services:

  • Licensing for Growers and Processors through an application process
  • Inspection of growing sites and processing facilities
  • Education and outreach to interested parties and hemp program participants
  • Certification of Industrial Hemp through regulatory testing to ensure THC levels < 0.3%

MDAR test the THC percentage in hemp using high-performance liquid chromatography (“HPLC”) to test for total THC, including both delta-9 THC and THCa. This appears to be required pursuant to the recently issued interim hemp rules but is going to likely create problems for hemp growers nationwide.

An MDAR license is required to plant, grow, harvest, process or sell industrial hemp in Massachusetts. MDAR issues three different license types for growers, processors, and for those engaged in both growing and processing. A grower is a person who cultivates Industrial Hemp, and a processor converts Industrial Hemp into a marketable form through extraction or manufacturing. A processor is only allowed to process hemp that was grown in Massachusetts as part of the Hemp Program. However, according to MDAR’s Frequently Asked Questions on hemp, there is an exception to this general prohibition:

The only exception to this is if such hemp to be processed was obtained lawfully under federal law from an approved source. We are still waiting on guidance from USDA as to how domestically grown, unprocessed hemp may be transported over state lines and as such no unprocessed hemp grown in the United States may be brought into Massachusetts for processing at this time.

MDAR’s FAQs also state that Massachusetts was “waiting for additional guidance from USDA before developing a plan to ensure compliance with the 2018 Farm Bill[.]” Now that the USDA has provided guidance through its interim hemp rules, it appears to be only a matter of time before Massachusetts submits a hemp production plan to the USDA pursuant to the 2018 Farm Bill.

When it comes to the sale of hemp-derived products, the MDAR states that it does not regulate the retail market and is limited to the wholesale market. According to the MDAR, the wholesale market includes the following transactions:

  • Wholesale of industrial hemp from Massachusetts Grower to Massachusetts Grower
  • Wholesale of industrial hemp from Massachusetts Grower to Massachusetts Processor
  • Wholesale of industrial hemp from Massachusetts Processor to Massachusetts Retailer
MDAR does not require a license for the retail sale of hemp-derived products.
MDAR states that the following hemp-derived products can and cannot be wholesaled in Massachusetts:
Allowed Not Allowed
Hemp seed and hemp seed oil Any food product containing CBD
Hulled hemp seed Any non-food product containing CBD derived from hemp that makes therapeutic and/or medicinal claims on the label, unless it has already been approved by the FDA
Hemp seed powder Any product containing CBD that is being marketed as a dietary supplement, unless already approved by the FDA
Hemp protein Animal feed that contains any hemp products, including CBD
Clothing Unprocessed or raw plan hemp, including flower that is meant for end use by a consumer.
 Building material
Items made from hemp fiber
Non-food CBD products for human consumption that DO NOT make any medicinal/therapeutic claims on the label and  are not marketed as a dietary supplement, unless the product has already been approved by the FDA.
Flower/plant from a Massachusetts licensed Grower to a Massachusetts licensed Grower or Processor

The Massachusetts Department of Public Health (“MDPH”) has also posted FAQs on CBD and hemp in food.  Unlike MDAR, the MDPH does have the ability to regulate retail sellers of food. Therefore, the sale of Hemp-CBD food and dietary supplement products is not allowed in Massachusetts. In addition, Massachusetts issued a temporary ban on “all non-flavored and flavored vaping products, including mint and menthol, including tetrahydrocannabinol (THC) and any other cannabinoid.”

In summary, Massachusetts allows for the cultivation and processing of hemp and appears to be working on a plan in light of the 2018 Farm Bill and USDA’s interim hemp rules. Massachusetts currently bans the sale of Hemp-CBD in food, dietary supplements, and unapproved drugs, following the FDA’s state position on these products. Massachusetts also prohibits the sale of hemp flowers and has a temporary ban on vaping products, essentially eliminating the smokable hemp market as well.

For previous coverage in this series, check out the links below:

Is your cannabis business ready to protect online consumer data?

We’ve been writing a lot lately about recent major changes in federal hemp laws that will likely affect every hemp company in the United States (see here, here, and here). While we’re on the topic of dramatic legal changes, it’s probably a good idea to talk about a California privacy law that’s about to take effect and require many cannabis and hemp companies across the nation to dramatically change their business practices—the California Consumer Privacy Act (or “CCPA”).

CCPA takes effect January 1, 2020. If you haven’t heard of it yet, you will soon. It is comparable in scope and breadth to the EU’s General Data Protection Regulation (or “GDPR”) which is a real nightmare for businesses to comply with. CCPA is by far the most significant and expansive U.S. privacy law to date. Just keeping up with the law has been difficult—there have been a dozen attempts to amend the law, many of which have been successful (some privacy organizations have even created amendment trackers), and the California Attorney General recently issued proposed regulations that add another layer of complexity to the already complex law.

One of the first (and more complicated) aspects of CCPA is figuring out to whom it even applies. CCPA applies to (a) for-profit businesses who (b) do business in California and (c) collect consumers’ personal information themselves or through others or determine the purposes and means of processing consumers’ personal information and (d) meet one of the following three criteria:

  1. A business generates more than $25 million in annual gross revenues (this number will be adjusted over time).
  2. A business “Alone or in combination, annually buys, receives for the business’ commercial purposes, sells, or shares for commercial purposes, alone or in combination, the personal information of 50,000 or more consumers, households, or devices.”
  3. A business derives at least 50 percent of its annual revenues from selling consumers’ personal information.

This is a mouthful. Here are some of the particularly important notes:

  • There is no requirement that the business is located in California.  A cannabis or hemp company in any other state or country could be forced to comply so long as it hits the above criteria.
  • “Doing business” is not defined and could be construed very broadly to include seemingly minor relations to the state of California.
  • CCPA can apply to certain parents or subsidiaries of companies to whom CCPA applies. In other words, if an out-of-state cannabis or hemp company owns a company to whom CCPA applies, then CCPA may apply to both companies even though the parent is based elsewhere and otherwise wouldn’t need to comply.
  • For many companies, points 1 and 3 may not apply. However, point 2 should give any company pause. In recent guidance, the California Attorney General interpreted this provision by stating that “[A]ny firm that collects personal information from more than 137 consumers or devices a day will meet the 50,000 threshold. To provide an upper bound on the number of firms potentially affected by the CCPA regulations, we consider two alternative assumptions. We assume that either 50% or 75% of all California businesses that earn less than $25 million in revenue will be covered under than CCPA.” In other words, if a business obtains personal information (which is defined in an extremely broad way) from just 137 consumers or “devices” per day, then CCPA could apply. And of course, this is not limited to online collection.

If CCPA applies to a cannabis or hemp business, compliance will be no small undertaking. Below are some of the key aspects of CCPA that businesses should be aware of:

  1. CCPA creates numerous rights for consumers with respect to businesses who hold their personal information, including the right to find out what information about the consumer a business possesses, the right to deletion of certain information, the right to opt out of the sale of information, and so on. Businesses must be able to comply with customer requests and doing so can be complex. Is the average cannabis or hemp business able to drop everything and identify to a consumer within a short window exactly what information the business has about the customer?
  2. To really be able to comply with CCPA, businesses should be able to identify how they collect information from any source, and what they do with it. This can be a tremendously complicated task, especially for larger businesses or businesses that have an online presence.
  3. Companies need to have privacy policies that explain to customers what information they have, how they obtained it, and what they do with it. While California already required businesses with websites to have privacy policies, CCPA-type privacy policies will be much more broad and will not just apply to information collected through websites. Moreover, pursuant to the proposed regulations recently released by the California Attorney General, those policies must be accessible to consumers with disabilities, which can be a huge challenge to comply with for covered businesses.
  4. If businesses sell (or in some cases even provide) customer information to third parties, that will need to be explained to customers up front, and customers will have the ability to opt-out of such information sharing. In fact, per the Attorney General regulations, websites should even include a special opt-out button.
  5. Businesses who provide consumer information to third-party “service providers” to process the information on behalf of the business must enter into contracts with the service providers that obligate them to adhere to certain standards under CCPA.
  6. Businesses must train their employees and agents concerning certain privacy practices.
  7. CCPA creates a private right of action for consumers and allows them to seek statutory or actual damages in the event of certain breaches where companies failed to adopt reasonable security measures. This means that there will likely be an onslaught of class-action suits against all kinds of companies in the future, including cannabis companies. Even companies who do believe they have reasonable security measures in place will have to essentially prove that through expensive litigation. The one saving grace is that there may be a cure period for some businesses, but in all likelihood, lawsuits will be coming.

This is just a short list of some of the more important requirements of CCPA. As any reader can see, compliance will not be easy. Cannabis and hemp companies that don’t start thinking about CCPA now may be at risk later.

cannabis insurance litigation

Recently, Jonathan Bench wrote about the importance of insurance coverage for your hemp or recreational marijuana business. His first article provided the basic anatomy of such policies and his second discussed the importance of product liability insurance. This post highlights recent litigation in which insurance is at issue, or ought to be.

Hemp insurer seeks declaration of no coverage

Regular readers may recall the Big Bush Farms case —in which Big Bush brought a $57 million lawsuit arising from a hemp production contract against Boones Ferry Berry Farms and others. (See here for more detail). That lawsuit has now given rise to a coverage lawsuit by Boones Ferry Berry Farms’ insurer.

Recently, American Family Insurance filed a lawsuit in the federal district court of Oregon seeking a declaration from the court that it has no duty to extend to a defense to co-defendants Boones Ferry Berry Farms, LLC and its principals the Snegirevs (together the “Insureds”). American Family sold the Insureds a farm/ranch policy in which it agreed to provide the Insureds “a defense against liability for pay damages because of ‘property damage’ caused by a covered ‘occurrence.”  The policy excludes coverage for “‘property damage’ expected by, directed by, or intended by any ‘insured.’” I expect your eyes are glazing over so I’ll cease quoting language from the insurance policy!

The gist of the federal lawsuit is that American Family contends the claims against the insureds in the underlying state-court lawsuit do not give rise to a duty to defend or indemnify the insureds.

Oregon retailer sued for damages allegedly caused by exploding vape pen

As I noted, Jonathan also wrote about the importance of product liability insurance. (See here). He described is as a non-negotiable priority. A recent lawsuit filed in Oregon state court demonstrates why.

The plaintiff alleges personal injury resulting from a vaping device exploding while touching his mouth, causing part of the device to shoot through his teeth and into his face. The plaintiff alleges he bought this device from an OLCC retailer based in Bend, which device was manufactured by Korean company. The plaintiff sued both the Oregon-based retailer and the Korean company. The plaintiff alleges claims for strict liability, negligence, breach of the implied warranty of fitness for a particular purpose and breach of the implied warranty of merchantability and seeks $1 million in economic and non-economic damages.

For those thinking this lawsuit arises from the recent ban on flavored vape products, it does not. The events at issue occurred in October 2017 but the lawsuit was not filed until October 2019. Questions for the Oregon retailer include: Do you have product liability insurance? Did you have coverage during the applicable period (occurrence v. claims-made)? When, if at all, did you tender the claim to your insurer?

What ought you do?

First—have insurance.

Second—at the outset of any business dispute consider whether the loss may potentially be covered by insurance. This is not usually an enjoyable experience, as Jonathan pointed out, given the labyrinth of policy language, endorsements, exclusions, and exceptions to exclusions. As someone who has represented numerous insureds in disputes with their commercial general liability and other policies, my advice is to tender any potentially covered claim to your insurer ASAP. And I mean do it immediately after the loss or as soon as you become aware of the potential of a claim so that your insurer cannot argue you did not timely tender the claim. Your policy will spell out the how and when of tendering.

Third—review the insurers coverage position with a coverage attorney if the insurers denial or reservation seems at all tenuous. After you tender a potential claim, the insurer will provide its own coverage analysis and either accept coverage, decline coverage, or accept coverage subject to a reservation of rights. The insured then has the option of disputing the insurer’s coverage analysis and this is where a careful reading of your policy is just the first step. Determining whether to challenge an insurer’s coverage position requires insureds to evaluate policy language in light of general insurance law principles of the insureds jurisdiction as well as relevant case law interpreting terms within different kinds of policies. Insureds should remember that the duty to defend is broader than the duty to indemnify and that ambiguities in policies are resolved in favor of the insured. Nonetheless, insurers often find reasons to decline coverage and your coverage attorney may help you gain leverage and reach an agreement with your insurer regarding defense and/or indemnity.

Fourth—consider commencing a declaratory judgment action. The purpose of the action is to have the court “declare” whether or not the facts alleged in a complaint give rise to a duty to defend and/or whether or not the insurer must indemnify its insured’s loss. This is usually a last resort but it may be necessary in some circumstances.