We recently wrote about the new Oregon Liquor Control Commission (OLCC) rules for marijuana businesses, and observed that those rules were issued with the stated intent to stave off diversion of cannabis. In addition to its public-facing actions, we have seen an apparent shift in internal OLCC review policies and procedures. A few weeks ago, we covered the apparent adoption of new settlement policies. Today, we cover what appears to be increased scrutiny for each of the following: new license applications (those submitted prior to June 15th), license renewal applications, change in business structure applications, and change-in-ownership applications. OLCC investigators are looking at all of these submissions more carefully than ever.

It was never easy to get an OLCC license. It only felt that way, given the stricter and more tedious requirements faced by cannabis program applicants in other states. In Oregon, the application process was somewhat cumbersome initially (remember the narrative-based forms, released in 2015?), but the state quickly progressed to “check the box” paperwork in combination with its online data entry system. Today, there are a few interesting quirks in that protocol, but it’s navigable and sensible and clean overall.

So what changed? Generally, the administrative environment is different these days. Licensing has existed for a couple of years, OLCC has refined its processes, and investigators are better trained than before. Specifically, investigators have raised the bar for the content of application submissions, are they are looking under rocks that previously would have been left unturned. In many cases, they are finding things.

OLCC marijuana cannabis license
OLCC investigators are taking a harder look.

Gone are the days when an applicant could submit a business document in the belief that, regardless of that document’s contents, the inspector would summarily tuck it into her file essentially unread, and pass the application along to “final review.” OLCC investigators are now actively requesting and reviewing legal documents, and doing a really good job of it. Here is a sampling of investigator questions we have seen in the past month or so, that never would have surfaced even a year ago:

  • “Does this lease’s rent reconciliation provision mean that the landlord is entitled to a percentage of profits? Explain that.”
  • “Was this asset purchase agreement ‘deposit’ escrowed? Or have these funds used in the business operations already?”
  • “Why does this business structure form contain an LLC member who is not listed on the state business registry?”
  • “At what point did the seller transfer these utility bills into the buyer’s name?”

Etcetera. We have seen businesses tripped up (badly) in the both the change-in-ownership and renewal processes by questions like these. In the worst case, these inquiries can result in proposed license cancellation and/or non-renewal by OLCC. Those situations can be incredibly frustrating and stressful for a business, especially one with sunk costs and accumulating obligations. They should be avoided if legitimately possible.

In all, the new licensing paradigm leaves us with a couple of key takeaways going forward. The first is really simple: Run your business like a real business and ensure you have everything in place prior to OLCC submission. This means writing things down, to start, and using appropriate forms to do so. The second takeaway is to enlist help when needed. That doesn’t mean you need to pay an attorney or a consultant thousands of dollars to process your application. In our Portland office, for example, we have experienced marijuana licensing paralegals who process OLCC applications literally all day every day, and who talk with OLCC investigators on the regular. Our cannabis business lawyers only enter the picture to draft documents, or deal with nuanced or delicate matters.

Going forward, we expect OLCC to continue to ratchet up standards for both applicants and licensees on everything from rulemaking to license review to site inspections. That’s a good thing for compliant operators and for businesses that want to do things correctly. Really, it’s exactly how it should be.

marijuana cannabis employment discrimination
Nice job by the court.

As a general rule of thumb, employers are not allowed to discriminate against employees with disabilities. Both federal and state laws provide this protection. This means that an employer cannot take an adverse employment action against an employee because of the employee’s disability. Again, this is a “general” rule of thumb: In the cannabis context, things are always a bit different.

Some states have passed legislation protecting medical marijuana users off work marijuana use. Employers in those states cannot terminate an employee or refuse to hire an applicant because of their off-work medical marijuana use. Historically, however, the big problem with these laws is that state and federal courts have readily determined the Controlled Substance Act (CSA) preempts state law, and that employers may terminate medical marijuana patients for off-work use. Recently, for the first time, a federal court sided with an employee who brought a claim against her employer for termination for off-work use of marijuana.

According to the lawsuit filed in Connecticut, Katelin Noffsinger is a registered medical marijuana user. In 2016, Noffsinger applied for a job with Bride Brook Nursing & Rehabilitation (“Bride Brook”). Bride Brook offered her the job contingent on passing a pre-employment drug test. Noffsinger informed her potential employer that she was a medical marijuana patient and likely would not pass the drug test. Noffsinger took the drug test which confirmed the presence of THC. Bride Brook rescinded its job-offer. Noffsinger brought a claim against Bride Brook alleging Bridge Brook had violated the anti-discrimination provision of the Connecticut Palliative use of Marijuana Act (PUMA). Bride Brook attempted to dismiss the case, asserting the claim was preempted by the CSA, the Americans with Disabilities Act (ADA) and the Food, Drug and Cosmetic Act (FDCA).

The federal court first addressed the CSA preemption claim. The Court held that the CSA did not prohibit employers from employing marijuana users. Meaning, if state law prohibited employers from discriminating against medical marijuana users, it would control.

The Court next determined that the ADA did not preempt PUMA because the ADA explicitly allows employers to prohibit illegal drug use at the workplace but does not authorize employers to take adverse employment action based on drug use outside of the workplace. Finally, the Court determined the FDCA does not regulate employment and therefore was inapplicable in the current case.

The Court did not rule on the substance of Noffsinger’s claim–meaning it has not determined if Noffsinger was discriminated under PUMA. That decision is still pending a jury trial.

The Noffsinger case is important. It’s the first case of its kind to determine that marijuana’s illegality under federal law does not bar an employment claim based on state law. State courts, such as the Oregon Supreme Court, have expressly held that the CSA preempts state medical marijuana laws—meaning employers in the State of Oregon, for example, may still terminate an employee for off-work marijuana use.

The decision in the Noffsinger case is not binding in other jurisdictions, but it could indicate a significant shift in federal courts’ view on medical marijuana. Perhaps this court’s sound reasoning will influence other federal judges to provide equal protections to medical marijuana patients until marijuana is de- or rescheduled under the CSA.

RICO cannabis landlord
RICO suits are not just busting up gangs these days.

The Racketeer Influenced and Corrupt Organizations Act (RICO) is a federal Nixon-era law originally intended to combat drug cartels and organized crime. Among other features, it allows average citizens claiming a loss in property value to bring suit for triple damages plus attorney’s fees against any “person” or “enterprise” that has a part in any neighboring “racketeering activity” which includes—you guessed it—“dealing in a controlled substance.” Currently, federal law continues to classify cannabis as a Schedule I controlled substance—meaning it has no medicinal value, and is supposedly more dangerous than methamphetamine, methadone, hydromorphone, and oxycodone, among other things.

RICO has been read broadly enough by its patrons to include operators, as well as landlords, lenders, and even government licensing agencies and customers, as co-conspirators in licensed cannabis operations, meaning angry neighbors have found their deliverance when it comes to trying to shut down state-legal cannabis businesses. The painful irony of all this is that anyone with an aversion to cannabis in a state where voters democratically decided to legalize it has unique power to be an American Gangbuster because of an almost-half-century-old relic of the federal War on Drugs; yet, meanwhile, companies that would be investing in local communities are looking north to do five-billion-dollar Canadian Blockbusters. The bottom line is that as long as federal law remains unchanged, it does not matter how state voters decide to govern themselves, or even how sensibly the federal government decides to enforce federal laws prohibiting cannabis. RICO provides a private right of action for any would-be provocateurs that can plausibly claim they have been damaged by a neighboring cannabis business.

So how can landlords and tenants approach this issue when designing a cannabis tenancy? The short answer is that RICO will continue to be a real issue for as long as federal law allows it to be, but the parties can take some proactive measures in drafting the lease to mitigate that threat:

Build in an early termination option for third-party lawsuits. Just as the lease can include early termination options for a variety of cannabis-specific occurrences, it can provide an opportunity for one or both parties to address an undismissed third-party lawsuit by terminating the tenancy. This can include RICO actions as well as standard nuisance actions, which often have longer legs than RICO lawsuits. It can also include indemnification obligations if, e.g., the tenant causes the problem by failing to comply with the lease terms, or if the landlord misrepresents neighborhood sentiment (more on that below).

Vet the neighbors. Just as a tenant would analyze the zoning laws applicable to a proposed use, a cannabis tenant should take some time to see what the neighborhood is all about. Does the community support the use? How are the neighboring areas zoned? Is there any kind of history of bad actors in this space that’s left a bad taste? The tenant will have to make sure the site isn’t within any prohibited buffer zones of schools or youth centers as part of its state license application anyway, and what better opportunity to get to know your potential neighbors? Even some casual exploring is better than nothing, and can save loads of trouble down the road. Depending on how the parties negotiate the lease, it can include, e.g., landlord warranties of no known neighbor objections after diligent inquiries, or a term that puts the responsibility on the tenant to figure out how the use would go over in the community.

Tighten up those compliance obligations. Compliance with state and local law is the key to avoiding enforcement actions, and is equally important when it comes to neighbor relations. State regulations contain strict requirements about security protocols, waste management, hours of operation, and product transportation. Local rules will typically dictate things like parking requirements, odor management, and noise. The stronger and more specific the lease is with regard to complying with these various rules, the better chance you will have that the tenant (i) knows them, and (ii) follows them. Simply indemnifying yourself in the lease makes little difference if you end up losing an otherwise good tenant because they were uninformed.

Research the local politics and get to know local law enforcement. California’s cannabis regulatory regime is unique in that local jurisdictions are still king when it comes to who gets to operate and where. And we’ve already seen a repeat of what’s happened in other states that have legalized: jurisdictions sometimes change their minds and declare previously allowed cannabis operations to be non-conforming uses. Having your finger on the community pulse and knowing the level of support for your local cannabis ordinance when it passed is going to put you in a better position to know whether your cannabis tenant or your cannabis operation is more likely to be a welcome neighborhood feature or a walking lawsuit.

For more on California cannabis leasing, check out the following:

california cannabis marijuana development
Development agreements are a unique process.

This is the second post in our three-part series on California development agreements. In our first post we provided an overview of the use (and misuse) of development agreements in the cannabis industry. This post breaks down the basics of development agreement laws.

California’s development agreement statutes are located in Government Code sections 65864 – 65869.5. According to the legislative findings and declarations, the lack of certainty in the approval of development projects can result in a waste of resources, escalate the cost of housing and other development to the consumer, and discourage investment in and commitment to comprehensive planning which would make maximum efficient utilization of resources at the least economic cost to the public. Cal. Gov’t Code § 65864(a).

Providing assurance to development project applications that, upon approval of a project, the applicant may proceed in accordance with existing policies, rules and regulations, and subject to conditions of approval, strengthens the public planning process, encourages private participation in comprehensive planning, and reduces the economic costs of development. Cal. Gov’t Code § 65864(b). In other words, the California State Legislature has determined that providing certainty and predictability in the development process is good for everyone.

Government Code section 65865(a) provides that anyone with a legal or equitable interest in real property may enter into a development agreement with a city or county for the development of the property.

“Development” is not defined in the development agreement statutes, but “development project” is defined in a subsequent chapter as any project undertaken for the purpose of development, including a project involving the issuance of a permit for construction or reconstruction, but not a permit to operate. Cal. Gov’t Code § 66000. Accordingly, a cannabis business that obtains permits for tenant improvements would fall under this definition, but a development agreement would likely not be appropriate where a cannabis business enters a turn-key facility that requires no construction. In practice, this does not seem to be the case, and we’ve seen cities require development agreements where no construction is contemplated.

The development agreement process begins with the local agency’s procedures for development agreements. If none exist, a city or county must adopt procedures upon the request of an applicant, at the applicant’s expense. Cal. Gov’t Code § 65865(c).

The development agreement statutes provide minimum standards for local procedures and requirements, including periodic review of the agreements at least once every twelve months, specification of the duration of the agreement, the permitted uses of the property, the density or intensity of use, the maximum height and size of proposed buildings, and provisions for reservation or dedication of land for public purposes. Cal. Gov’t Code §§ 65865.1-65865.2

A development agreement is a legislative act that must be approved by ordinance and is subject to referendum. Cal. Gov. Code § 65867.5(a). A noticed public hearing by both the planning agency and by the city council are required before a development agreement is approved. See Cal. Gov’t Code § 65867. A development agreement cannot be approved unless the legislative body finds that the provisions of the agreement are consistent with the general plan and any applicable specific plan. Cal. Gov. Code, § 65867.5(b). Like all other ordinances, the ordinance approving the development agreement must go through a two-reading process, with at least a five-day intervening period. See Cal. Gov’t Code § 36934. A development agreement cannot legally take effect until after the 30-day period for a referendum expires. See Cal. Elect. Code § 9141; Referendum Committee v. City of Hermosa Beach, 184 Cal. App. 3d 152 (1986); Midway Orchards v. County of Butte, 220 Cal. App. 3d 765 (1990).

In practice, all of this means that the development agreement approval process takes a substantial amount of time. First, the developer and local government need to negotiate essential terms. Once the terms have been negotiated, the agreement is placed on the planning commission calendar for hearing, followed by two separate city council meetings. Only after the referendum period has expired can the agreement become effective. In a best case scenario, this process may take 90 days. It often takes much longer.

Development agreements in California are rarely challenged, and when challenged, development agreements are usually upheld because the statutes are liberally construed to encompass agreements that substantially comply with their specific terms and conditions and achieve their essential objectives. Santa Margarita Area Residents Together v. San Luis Obispo County (2000) 84 Cal.App.4th 221, 228.

However, given the popularity of use of development agreements in the California cannabis industry, we anticipate seeing an increase in legal challenges, especially where the agreements are mandatory, require substantial fees, have short terms, and lack any connection with construction.

Stay tuned for our next post in this series regarding key terms to fight for in development agreement negotiations related to California cannabis use.

If you have purchased marijuana in Washington State, you’ve probably noticed the packaging can be difficult to open and is adorned with warnings, bar codes, and lots of other information that appears in tiny font. This is by design, as the state has created robust regulations intended to protect the public from contaminated cannabis and to limit access by children. Though these regulations are important, one has to ask what impact these packaging requirements have on the environment.

Washington’s packaging and labeling requirements can be found in WAC 314-55-105. Note that this section of the Washington Administrative Code was recently amended meaning that there are two separate packaging standards. Licensees can abide by the old rules until January 1, 2019 when the new version of WAC 314-55-105 go into full effect. Until that date, licensees have the option to comply with the new rules. This post will focus on the newer version of WAC 314-55-105.

All containers that carry marijuana must protect the substance from contamination and harmful substances. Marijuana-infused products, such as edibles, and marijuana concentrates must come in child-resistant packaging. For packages containing more than one serving (a serving is capped at 10 milligrams of THC) of a solid edible product, each serving must come in child resistant packaging. For liquid products, the packaging must include a measuring device such as a cap that you would find accompanying a bottle of NyQuil. Hash marks on the side of a package are not enough.

In addition, Washington imposes substantial labeling requirements. All products must clearly show the following warning:

Warning – May be habit forming. Unlawful outside Washington State. It is illegal to operate a motor vehicle while under the influence of marijuana.

Per the recent rule change, all marijuana products must also include Washington’s marijuana universal symbol (pictured below). In addition, the label must include the business or trade name and UBI number of the licensed producer and processor, the traceability identifying number, the number of servings (if applicable), the net weight, and THC and CBD concentrations.

Washington’s universal marijuana symbol.

The state also requires the following labeling on specific products:

  • Useable marijuana flower must include the additional warning, “smoking is hazardous to your health.”
  • Marijuana concentrates or infused products intended for inhalation must list the solvents used to create product, state the method of extraction, and disclose whether any other chemicals or compounds were used.
  • Marijuana infused products intended for consumption must also list information about extraction methods and solvents, in addition to listing food allergens and the following sentence: “CAUTION: intoxicating effects may be delayed by 2+ hours.” Additionally, edible marijuana products must include the “Not for Kids” logo, shown to the right.
  • Marijuana topical products must contain the statement: “DO NOT EAT” in bold, capitol letters.

All of this means that products come with a significant amount of packaging. Even small,

Required on edibles in Washington State.

single-serving edibles must come with enough packaging to include the two logos, written warning, and information on the licensees and product. In addition, businesses making the product also want to include their branding and marketing material, which also takes up space. That branded packaging is important for producers and processors who are trying to stand-out and earn valuable shelf-space in retail stores. Unfortunately, all of that packaging has to go somewhere and it often ends up on the street or sitting in a dump.

Last month, journalist Kristen Millares Young wrote about the waste generated by Washington’s cannabis market in an article for the Washington Post. Young highlighted that environmental groups are increasingly finding cannabis packaging on the streets, something I can personally attest to living here in Seattle. The article also highlights the problem with “doob” (as in doobie) tubes, the plastic tubes used to package pre-rolled joints. These tubes cannot be recycled, even when made of recyclable plastic, because they fall through the grates of recycling machines.

Washington’s waste problem doesn’t have a simple solution. As Young points out, a potential “fix” would for Washington to require that producers and processors use recyclable material for the purpose of packaging. However, that would add increase costs to producers and processors who are already struggling to operate in a fiercely competitive market where the number of producers and processors far outweighs the number of retailers.

Perhaps it’s time to reconfigure Washington’s labeling requirements. The newest version of WAC 314-55-105 allows producers and processors to provide some information that used to be required on the physical package online. This may allow for more streamlined packaging, putting less of a burden on Washington landfills. After all, a QAR code can provide a vast amount of information without taking up much space.

If you’re a consumer you have some options. First, you can contact the Washington State Liquor and Cannabis Board about its rules, either online or during their monthly board meetings; and you can call your state representative to voice your concerns. Second, you can purchase products that have less packaging, such as marijuana flower rather than pre-rolls packaged in tubes, and you can reward companies that do use recyclable materials by purchasing their products. Third, you can make an increased effort to recycle your discarded packages and reuse non-recyclable packages. For example, maybe save the doob tube and use it to transport your hand-rolled joint in the future.

What’s in YOUR employee handbook?

Even if your company is fully compliant with all OLCC-mandated marijuana laws and regulations, you can still expose yourself to legal pitfalls if you aren’t just as strict keeping up with state and federal employment laws. While the rapid evolution of corporate cannabis is evident in the news alone, you may not realize that state employment laws are just as volatile — and there are a lot of them.

As a business owner, you should know how to navigate this multitude of regulations. We saw one company face the consequences of violating Oregon’s sick leave law earlier this year. OSHA could be just as serious if they find marijuana producers are not adhering to state agricultural safety standards. What can you expect with an employment audit? How does Oregon and Portland’s “ban-the-box” ordinance effect who and how you hire?

Harris Bricken employment lawyer Megan Vaniman will be leading a free presentation on employment law for cannabis businesses on October 11, 2018 from 4 to 5 PM PST, followed by a reception. OSHA and BOLI are the tip of the iceberg; Megan will dive deep into state and federal legislation that can prevent your business from succeeding if you don’t proceed with caution.

Both the event and reception will take place at Harris Bricken’s Portland office. Can’t be there in person? The content in this presentation will be recorded and distributed as a webinar at a later date. Further questions about the event can be sent to firm@harrisbricken.com.

RSVP for this event at our EventBrite today!

Want to study up before the event? In addition to the articles linked above, check out these past articles by Megan:

california marijuana cannabis SB1459
Provisional licensing would benefit state AND industry.

The California legislature is currently finalizing a bill (SB-1459) which would establish a provisional licensing regime for California cannabis businesses. The bill moved into “enrolled” status late last week, which means that SB-1459 has been approved by both houses of the state legislature and is being proofread to ensure all amendments were properly inserted. Once SB-1459 is “correctly engrossed”, only a signature from Governor Brown is needed for the bill to take immediate effect. In all, provisional licensing seems imminent.

These pending, provisional licenses would provide holders with a year-long, non-renewable, provisional license to operate after filing completed license applications. These provisional licenses would alleviate pressures on licensing agencies caused by the backlog of pending applications. Provisional licenses would also allow holders to continue operating, rather than potentially ceasing operations later this year. On that point, the SB-1459 legislative findings are compelling:

The significant number of cultivation license applications pending with local authorities that do not have adequate resources to process these applications before the applicants’ temporary licenses expire on January 1, 2019, threatens to create a major disruption in the commercial cannabis marketplace.”

Cannabis licensing in California is a relatively recent phenomenon and is a requirement for any cannabis business operating in the state. Under current law, licensing authorities may issue temporary licenses pending the approval of final licenses. Temporary licenses can be issued for 120-day periods, with certain allowable extensions. According to the Senate Floor Analysis of SB-1459, the temporary license was intended as an intermediary step while local and state regulatory bodies themselves came into compliance with California’s new law. Notably, under the current law, temporary licenses cannot be issued after December 31, 2018.

Perhaps as expected, thousands of cannabis businesses submitted license applications this year. Many of these licenses were sought in Humboldt, Monterey, and Santa Barbara counties, where regulators were not prepared to (and have not been able to) address the flurry of applications. As noted in the Senate Analysis accompanying SB-1459, the barrage of environmental disasters in California—particularly in Santa Barbara—have contributed to the delay in the process. Thus, of the thousands of applications that have been submitted to date, many have yet to be completed.

Originally introduced in February 2018 as a method to bill concerning agricultural reporting issues, SB-1459 underwent substantial revisions during the legislative process. SB-1459 is now almost an entirely new piece of legislation and contains the provisional licensing scheme intended to alleviate the pressures identified above. If the current SB-1459 is codified into law, it would permit licensing authorities—in their sole discretion—to issue provisional licenses for a non-renewable period of 12 months. These licenses could be issued to applicants that hold or even held a temporary license for the same premises and same commercial cannabis activity sought to be licensed, have submitted completed license applications, and in connection with those completed license applications have submitted evidence that compliance with the California Environmental Quality Act (or “CEQA”) is underway. Notably, the Senate Analysis accompanying SB-1459 notes that a provisional license applicant could obtain a license without proof of full CEQA compliance.

SB-1459, if passed, would remain in effect only until January 1, 2020. This would both provide an additional year of breathing room for already swamped regulators and would prevent cannabis businesses from potentially having to cease operations. Not surprisingly, numerous public bodies, private entities, and industry groups (including our California cannabis business lawyers) have supported the bill. Barring unforeseen circumstances, it’s a safe bet that SB-1459 will become law.

marijuana north dakota missouri utahLast week, we discussed New Jersey, Oklahoma, Michigan, and Virginia’s recent legislative and/or referendum developments in ending marijuana prohibition.

Today, we look at the three other states that will decide the fate of recreational and medical marijuana locally during the November election.

North Dakota

Last month, North Dakota’s recreational pot measure, Measure 3, was approved for bringing the matter to a public vote. Legalize ND, the committee that introduced this measure, managed to submit more than the 13,452 valid petition signatures which are required to get a measure on the November ballot.

Measure 3 aims to legalize marijuana use by people 21 and older and seeks to seal the records of anyone convicted of a marijuana-related crime.

In May, the North Dakota Sheriff’s and Deputies Association introduced a measure opposing Measure 3 as it believes legalizing recreational marijuana would create more problems for law enforcement, such as more impaired drivers and fatalities. Another anti-legalization organization, Smart Approaches, is also working to oppose the ballot measure.

In response, Legalize ND is planning to bring in members of Law Enforcement Against Prohibition, better known as LEAP, a pro-legalization organization composed of former and current police officers, federal agents, judges and prosecutors, that are critical of existing drug policies.

Utah

Although Utah is a rather conservative state, state voters are ready to decide the fate of medical marijuana ballot measures.

Proponents of Utah Proposition 2 collected about 200,000 signatures, which is roughly 80,000 more signatures than is required for ballot inclusion.

If the measure were approved, patients suffering from qualifying medical conditions with medical cards would be able to buy up to 2 ounces of unprocessed marijuana with no more than 10 grams of tetrahydrocannabinol (THC) or cannabidiol (CBD) every two weeks. The measure would continue to ban smoking marijuana, driving under the influence of marijuana, or using marijuana in public view except in a medical emergency.

Missouri

Missouri voters will get to choose from three medical marijuana measures in the November ballot. Two of the ballot measures are constitutional amendments; the third one is a statutory change. Although the details of the three measures vary, all would provide legal protection to patients and would regulate the production, processing and retail sales of cannabis.

New Approach Missouri championed one of the proposed constitutional amendments, which would allow doctors to recommend medical cannabis for any medical condition they see fit. Registered patients would be allowed to grow up six marijuana plants and purchase up to four ounces from dispensaries each month. A four percent tax would be imposed on the sales of medical cannabis.

The other proposed constitutional amendment, backed by Find the Cures, would let doctors recommend medical marijuana to patients who suffer from one or more of the listed qualifying conditions. The retail sales tax, which would be set at 15 percent, would be used to support research to develop cures and treatments for cancer and other diseases.

Lastly, the proposed statutory change, sponsored by Missourians for Patient Care, would also afford access to medical marijuana to qualifying patients who suffer from specific conditions. Under this measure, sales would be taxed at 2 percent.

Undoubtedly, it will to be a busy election season for the legal marijuana industry. We will keep you posted on any other legislative or referendum developments between now and the November 6 election.

marijuana california cannabis L.A.
Be careful! It’s easy to slip up under Proposition M.

I’ve written in the past about the precarious business of buying and selling existing dispensaries in Los Angeles, but that was under the now repealed Proposition D. In March of 2017, Angelenos voted in favor of Proposition M, which is a licensing and regulatory piece of legislation implemented and overseen by the City’s Department of Cannabis Regulation (“DCR”) and the Cannabis Regulation Commission. Under Prop. M, the City is licensing cannabis businesses in three phases, the first of which was exclusively for “Existing Medical Marijuana Dispensaries” (EMMDs). EMMDs are basically grandfathered Prop. D/Pre-ICO operators that met certain compliance criteria set forth by the City under Prop. M. As of the writing of this post, there are only 163 EMMDs in the entire City. This low number of dispensaries in potentially the largest cannabis market in the world makes the secondary market for these storefronts incredibly hot. So much so that our Los Angeles cannabis lawyers are receiving term sheets for the purchase of EMMDs on an almost bi-weekly basis. And based on that experience, it’s time to update readers on what to look for when contemplating the purchase of an EMMD, which is no small task under the City’s new laws.

Running due diligence on dispensaries in Los Angeles is massively important. The reason being (in addition to normal M & A due diligence) is that the City still has many, many illegal operators (though the City Attorney is doing his best to shut down those operations as fast as possible). Therefore, it’s not a stretch that an “LA dispensary” would try to take a buyer for a ride on a sale when, in reality, that dispensary is 100% illegal, making the purchaser a sitting duck.

In turn, here are the major bases to cover when buying an EMMD in the City of LA under Prop. M:

  1. Is the dispensary even on the City’s EMMD list? The DCR has done a fantastic job of continually updating its EMMD list on its website. Checking that list is the very first step for any reliable due diligence. If the dispensary is not listed, ask the sellers why that’s the case. At this point, with the window for EMMD licensing closed, failure to appear is going to be a huge and fatal red flag that’s fatal unless the selling dispensary can provide viable proof that they are in valid pursuit of EMMD status from the DCR or appealing a DCR denial of EMMD status,
  1. Licenses are not transferable. Many people don’t realize that commercial cannabis licenses are not transferable under California State law. The same goes for commercial cannabis licenses in the City of L.A.—they cannot be bought and sold as individual assets; only the entity that holds them can change owners (meaning, you’re looking at purchasing the company that holds the license). Therefore, any EMMD that’s trying to sell you one of its licenses (or one of its future licenses) is not recognizing that it can only sell its membership interests or stock, and not the licenses themselves, under state and L.A. laws and regulations.
  1. What entity type is the EMMD? Assuming your target EMMD is on the City’s EMMD list and the EMMD understands that it can only engage in an entity purchase and sale, the next question is whether the EMMD is organized as a non-profit or a for profit company. If the EMMD was in compliance with Prop. D, it’s most likely some form of a non-profit corporation (most often a non-profit mutual benefit corporation (“NPMBC”), stemming from 2008 State Attorney General guidelines regarding compliance with the Compassionate Use Act of 1996 under which the sale of medical cannabis for profit is not permitted). This obviously creates an issue where a non-profit has no equity that can be legally bought and sold, and individual NPMBC directors taking buyer purchase money undoubtedly violates the California corporations code in a multitude of ways. In turn, part of the EMMD purchase will entail some form of “conversion” to a for profit entity to ensure that future membership interests or stock can be sold off. Luckily, NPMBCs and non-profits in general in California can “convert” to for profit corporations and, from there, into whatever other for profit entity the controlling interests so decide. To “convert” though, unless the NPMBC’s bylaws specify otherwise, a vote of the entire “membership” (i.e., potentially all of the medical cannabis patient members) of the non-profit may be required in order to convert. And do not forget that a lot of dispensaries in L.A. may have made significant mistakes when putting together their bylaws so that a “conversion” vote may not even be possible without exposing the purchaser to significant successor liability from the NPMBC’s “members”. Also, don’t forget that the old corporate and tax sins of the NPMBC may haunt the new entity, so secure the appropriate representations, warranties, and indemnities accordingly.
  2. EMMD conversion is permitted outright in LA with a catch. Once you have the general conversion plan sorted in your term sheet, you have to deal with conversion under local law. In L.A., “. . . a change from non-profit status to for-profit status by an EMMD is exempt from [having to seek DCR approval] if no other ownership change is made in accordance with Proposition D’s ownership rulesand notice is provided to DCR within five business days. This exemption is not available after a License is issued.” This means that while EMMDs maintain a temporary license from the DCR to operate, EMMDs can convert from non-profits to for-profits without having to secure DCR approval so long as: 1) The original directors remain the “owners” and 2) The DCR gets 5 business days’ notice of the corporate change over. In turn, even if the entity can be converted, purchasers cannot immediately take over the EMMD unless the EMMD and the new owners are ready to complete all of the steps at point 6 below.
  1. EMMD status stopped in Phase 1. A lot of our clients have been pitched by several EMMDs on the alleged fact that EMMDs will get special treatment for the receipt of additional retail licenses in L.A.. This is not correct. All retailers in L.A. can receive and run up to three retail licenses total (including Type 9 delivery only retail). In phase 1 licensing, which was for EMMDs only and which has come and gone forever, if an EMMD only applied for a single retail license in that “Priority Processing” phase, they must wait until phase 3 for additional retail license application (which is the general public licensing phase). Regarding phase 3, the City has never said when it will open and it’s anyone’s guess as to when that window will commence, but it’s unlikely to happen in 2018 given the slower pace of licensing in LA. In any event, if EMMDs want more retail licenses (for which they did not apply when phase 1 was open), they’ll have to get in line like everyone else in phase 3.
  2. Phase 3 may be a dead end. Per point 5 above, if part of your purchase agreement is that the EMMD status will help you secure additional retail licenses in phase 3, you really need to be careful with that performance obligation. In phase 3, the City is already obligated under Prop. M to issue retail licenses to social equity applicants on a 2-to-1 basis relative to other general public (non-social equity) applicants. Since over 160 EMMDs already exist in L.A., this means that before even a single retail license issues to a general public (non-social equity) applicant, the City must first issue over 300 retail licenses to social equity applicants. Couple that with the fact that Los Angeles has undue concentration caps for retail licenses and the writing is on the wall that retail licensure may not be possible for non-social equity general public applicants in phase 3, and that includes for non-social equity EMMDs seeking additional retail licenses.
  1. This ain’t your daddy’s M & A. Mergers and acquisitions in regulated industries are a different animal because the transaction has to fit with regulatory vetting and approval before anything really becomes effective between the parties. Cannabis M & A is no different and, in fact, is probably worse since it’s an emerging industry and because commercial cannabis activity remains federally illegal. Once a California cannabis business has its annual license, if it wants to sell its membership interests or stock to bring in a disclosable “owner” (i.e., among other things, anyone or any entity that owns 20% or more in equity), it will first need to seek approval from the state agency that issued it its licenses. That’s not uncommon in states with robust cannabis regulations. What people may not know, though, is that the DCR also wants to know about changes in ownership and has full authority to reject the change request based on its scrutiny of the incoming owners. Specifically, in LA:

“A License is not transferable unless the change to the Licensee’s organizational structure or ownership is submitted to and approved by DCR. The Licensee shall complete a change of ownership application, pay all applicable fees and obtain the written approval of the change of ownership by DCR, pursuant to the Rules and Regulations . . .”

There are also specific increased requirements for changes of ownership for a social equity business set forth in the City’s Cannabis Procedures at section 104.20.

In any M & A term sheet and/or definitive purchase agreement for an EMMD in L.A., the parties have to take into account the requirement of first going through the DCR to have the transaction approved and they also need to address what happens in the event the new owners are, or the change of ownership request is, rejected by the DCR. The timeline for state and local government approval on these things is also both important and unpredictable, but should nonetheless be agreed to by the parties at the outset of the transaction to ensure success.

  1. Relocation is no picnic. In addition to their grandfathering, the EMMDs are not subject to undue concentration limits, and so long as they meet certain requirements they don’t have to comply with the Prop. M zoning and buffer requirements until 2022. However, if the EMMD relocates (which the DCR currently allows) or if it moves any of its other licenses from its original premises, it will lose the zoning and buffer exemptions. A good amount of the M & A we’re seeing includes a component that an EMMD with other licenses will either re-locate itself or some or all of its other licenses as part of the transaction. And a lot of that M & A completely fails to address the fact that upon such relocation the zoning and buffer grandfathering is lost. Be sure to address this grandfathering and/or the loss thereof if it’s part of your dispensary M & A goals in LA.

It’s not a stretch to say that selling and buying EMMDs in LA is not for the faint of heart. There are many important details that must be considered in any due diligence period and that must also be reflected in any viable purchase and sale agreement. So, do your homework and proceed with extreme caution.

washington residency marijuana constitutional
Could definitely be unconstitutional.

We think it is worth taking another look at whether Washington’s strict residency requirement is constitutional. Since Washington first licensed marijuana businesses in 2014, we have wondered if anyone would be willing to bear the expenses of that particular challenge. And to date, there are no Washington appellate or federal legal decisions determining the constitutionality of the residency requirement. If there were a challenge, Washington would have a tough time defending the constitutionality of the law.

There are two important constitutional concept here: the Dormant Commerce Clause (the DCC) and the Privileges and Immunities Clause (the PIC). We first wrote about one of these, the DCC, three years ago. The DCC is a body of law (all made by judges) that seeks to enforce free-trade rules among the states. The idea is that Congress has the sole authority to regulate interstate commerce, and state laws that blatantly interfere with interstate commerce are potentially unconstitutional. Our analysis of this issue is largely the same as it was in that blog post three years ago. To determine if a law violates the DCC, one first determines whether the law interferes with interstate commerce. Washington’s residency restriction likely does so because it stops out-of-state participants from engaging in commerce in Washington. If a state law discriminates against out of state residents, it is very likely unconstitutional. It can only survive if the state can show that the law is the least restrictive means by which it can achieve a non-protectionist purpose. In the case of Washington’s marijuana residency requirement, there are lots of other states without such a requirement, and they are doing fine.

It looks like the book could be open and shut with the DCC, but people are still hesitant to bring that case. The DCC is tough to understand in practice: It’s a constitutional restriction by inference and counterfactual. So if law by logical proof isn’t your thing, the PIC provides an alternative compelling constitutional argument that Washington’s residency restriction would lose a court battle. The PIC —  Article IV, Section 2, Clause 1 of the U.S. Constitution — says: “The Citizens of each State shall be entitled to all Privileges and Immunities of Citizens in the several States.” The PIC seeks to prevent discrimination by one state against another state’s residents. In addition to protecting civil liberties, the PIC also protects fundamental economic interests.

The weakness in the PIC arguments is that the right to own a marijuana business may not be considered a fundamental economic right that the PIC protects. In past cases, the PIC has successfully knocked out state residency requirements for attorney bar licensure and for employment, but the PIC has failed to stop a state from only giving hunting licenses to its residents. Cases seem to say that commercial activity, as opposed to recreational, is fundamental, but it would be reasonable for the discriminating state to argue that the right to own a federally illegal marijuana business cannot, by definition, be fundamental enough to get this constitutional protection.

The federal illegality of marijuana, of course, is the elephant in the room. There seems to be a misconception that federal courts would never protect a would-be marijuana business owner in a legal battle with the state. That fear, however, is a misreading of constitutional law. Marijuana’s illegality does get in the way of a lot of general legal enforcement. Contracts with an illegal subject matter can be found void as a matter of law. Federal bankruptcy courts will not process marijuana company filings because they cannot appoint a trustee to manage marijuana assets. And in cases where parties seek injunctive relief, courts can use the “clean hands” doctrine to say that they will not issue injunctions to help marijuana businesses because those businesses have not come to the court with sufficiently “clean hands” to receive the benefit of equitable rulings.

However, the Constitution is not a contract or an equitable ruling. The Constitution protects us from state and federal overreach in all circumstances, regardless of what we have done and regardless of what we are doing. To put it another way, let’s say that Washington had a law that said women not allowed to own a marijuana business. Does anyone think that a federal court would not overturn that law? Of course it would. It doesn’t matter that marijuana is federally illegal; the state cannot violate the Constitution with illegal preferences. Similarly, both the DCC and the PIC are constitutional protections. A litigant against the state of Washington seeking to overturn the residency requirement would win or lose on the merits. Even a federal court would not throw out a case simply because marijuana businesses were involved.