Oregon marijuana cannabis
OLCC audit results were nothing to write home about.

Earlier this month, the Oregon Secretary of State’s office released a formal audit report (“Report”) of the Oregon Liquor Control Commission’s (OLCC) information technology systems as they relate to Oregon’s recreational cannabis regulatory enforcement. The Report, titled “Oregon Liquor Control Commission: Cannabis Information Systems Properly Functioning but Monitoring and Security Enhancements are Needed“, focused on two separate but related issues: 1) the OLCC’s Marijuana Licensing System (MLS) and Cannabis Tracking System (CTS), and 2) general IT security concerns and disaster recovery procedures. The Report and the OLCC’s formal written response (“Response”) paint a picture of an underfunded agency doing its best to establish appropriate procedures and processes in the face of a unique emerging marketplace, unexpected demand for licenses, strict statutory deadlines, an an ever-changing regulatory framework. It is also apparent that the Secretary of State and the OLCC worked well together during the audit process, as each party complements the other on transparency, professionalism, and common courtesy.

The audit was initiated to determine whether:

  • the OLCC has sufficient technical controls in place to ensure that the MLS and CTS are supporting effective regulation of the recreational cannabis industry; and
  • the OLCC has implemented sufficient security procedures to protect against known technical and physical threats.

Today we will focus only on issues raised relating to the MLS and CTS.

Marijuana Licensing System (MLS) and Cannabis Tracking System (CTS)

The Report and the Response provide an interesting look at how these two independent but related systems came to exist. When Oregon passed Measure 91 and then HB 3400 (2015), the OLCC was charged with creating and enforcing a regulatory framework for an entirely new industry with tight deadlines and insufficient resources. The OLCC reasonably decided that the only practical solution was to hire third-party contractors to provide Software as a Service (SaaS) solutions. The OLCC hired the company that created Colorado’s seed-to-sale tracking system to customize Colorado’s system to serve Oregon’s needs, resulting in the CTS, an online portal that allows OLCC licensees to input data about harvests, sales, etc. The OLCC hired a separate company to create its license application and renewal software, the MLS.

After hiring these vendors, OLCC was forced to repeatedly overhaul these systems in response to extensive legislative rewrites to the recreational program in 2015, 2016, and 2017. In recognition of these difficulties, the OLCC requested funding for a full time Chief Information Officer in the 2017 legislative session, but was denied. The Report and the Response both highlight the importance of filling this position, and the OLCC will be asking for additional funding from the legislature again this session.

In a nutshell, the CTS is Oregon’s licensee portal where licensees are required to self-report information about inventory, transfers and sales. The MLS is the OLCC’s online system for tracking license applications and licensee status.

We identified several weaknesses associated with OLCC’s new IT systems used for marijuana licensing and tracking. They include data integrity and maturity issues, and insufficient processes for managing marijuana computer programs and vendors. Until these issues are resolved, the agency may not be able to detect noncompliance or illegal activity occurring in the recreational marijuana program. – The Report

The Report identifies five general weaknesses in the CTS and related enforcement:

  1. the CTS relies on self-reported data that is inherently susceptible to inaccuracies;
  2. the CTS allows users to enter measurements in either metric or imperial resulting in additional errors;
  3. existing licensees are potentially abusing a policy that allows new licensees to introduce cannabis into the recreational regime from any source;
  4. inadequate data quality hampers the OLCC’s ability to monitor the Oregon market as a whole;
  5. the OLCC lacks sufficient trained staff for regular on-site inspections.

Even with the additional staff, OLCC may not be able to ensure an appropriate amount of scrutiny for marijuana businesses. Both Alaska and Nevada have approximately one inspector for every 18 recreational marijuana licenses. Currently, Oregon only has one inspector position for every 83 recreational marijuana licenses. – The Report

The Report also notes that the OLCC doesn’t take sufficient steps to monitor their third-party SaaS providers, has inadvertently stored test data in the active MLS database, and has insufficient controls over user accounts. Finally, the Report notes that the MLS and CTS are not set up to automatically update each other. For example, a licensee with revoked status in MLS could still have active status in CTS.

In its Response, the OLCC generally agrees with all of the Report’s findings and states that, subject to obtaining additional funding from the legislature, it will work diligently to implement the Report’s recommendations. The OLCC refers to the MLS and CTS as “state-of-the-art imperfection” and notes that while issues exist, the CTS system has already identified thousands of discrepancies that have led to investigative and enforcement actions, and that even bad data is meaningful.

Citizens and policy makers need to know that as important as the issues identified in this audit are, the OLCC is not dependent on the CTS system alone to identify licensees that are attempting to use the state system as a cover for diversion. The CTS system is one fundamental tool for successful enforcement and compliance . . . the audit recommendations focus on improving the overall effectiveness of the system which the audit acknowledges is properly functioning. – The Response

The take away here is that the CTS system is not broken. It is currently helping to limit diversion and promote public safety, but like any system, it can and should be improved. On the whole, the public and licensees should expect that the OLCC will be implementing regular, random on-site inspections to support the CTS, and refining the CTS system to eliminate opportunities for confusion or deliberate deception. Hopefully the legislature will recognize the importance of a robust and technically effective OLCC to the industry as a whole, and will provide the OLCC with sufficient funding to retrofit its systems and hire a Chief Information Officer.

San Luis Obispo California cannabis
SLO is thinking through its options for cannabis.

California has 58 counties and 482 incorporated cities across the state, each with the option to create its own rules or ban marijuana altogether. In this California Cannabis Countdown series, we cover who is banning cannabis, who is embracing cannabis (and how), and everyone in between. For each city and county, we’ll discuss its location, history with cannabis, current law, and proposed law to give you a clearer picture of where to locate your California marijuana business, how to keep it legal, and what you will and won’t be allowed to do.

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

Today’s post is on the City of San Luis Obispo (not the County). We’ll provide an update on what the County is up to next week.

Welcome to the California Cannabis Countdown.

LocationSan Luis Obispo (affectionately referred to as SLO) is a city in San Luis Obispo County and is home to California Polytechnic State University (well sort of, since Cal Poly’s campus sits just outside the City limits and is part of the County). SLO is located in California’s Central Coast at about the halfway point if you’re driving from San Francisco to Los Angeles. If you need to spend the night or make a pit stop, check out the quirky Madonna Inn.

History with Cannabis: San Luis Obispo currently prohibits all commercial and industrial cannabis business activities. The City, like a many number of other California jurisdictions, enacted its ban prior to January 01, 2018 (SLO enacted its cannabis prohibition ordinance in March of 2017). The City’s prohibition wasn’t meant to be permanent as nearly sixty-eight percent of SLO voters approved the Adult-Use of Marijuana Act (a/k/a Prop 64). Instead, the purpose of the City’s ban was to act as a temporary stopgap while the City sought community feedback for a long-term cannabis solution. This “prohibit while we study the issue dance” is currently playing out throughout California. Since its moratorium, the City held a number of hearings and workshops in order to engage the community so that it could begin to develop a cannabis regulatory structure. To that end the City’s Community Development Director (CDD) prepared a report for the City Council to discuss today, February 20th.

Proposed Cannabis Laws: The CDD report is the first step in enacting a cannabis ordinance. When drafting the report, the CDD used community feedback and cannabis regulations in other jurisdictions as guideposts. The goal of the report is to propose an ordinance that will regulate the cannabis marketplace and that is acceptable to the City Council and the community. Here are some of the report’s highlights:

  • It authorizes both medical and adult-use cannabis activities.
  • Authorizes up to three retail licenses.
  • Delivery is allowed.
  • Outdoor cultivation is prohibited.
  • There will be three types of indoor cultivation license types: Special Cultivator (up to 5,000 square feet), Small Cultivator (up to 10,000 square feet), and Nursery (up to 10,000 square feet).
  • Special and Small cultivators can include processing.
  • There will be a citywide cultivation cap of 70,000 square feet.
  • Only non-volatile cannabis manufacturing is allowed.
  • Distribution and testing are allowed.
  • Onsite consumption and cannabis events are prohibited.
  • Applications would be reviewed and ranked by a third party consultant (the City is still working on a criteria for ranking applications).
  • The CDD asked whether cannabis products with high concentrations of THC should be banned.
  • The CDD asked whether persons under the age of 21 (regardless of medical recommendation) should be prohibited from dispensaries.

The CDD report is by no means a finished product, as further direction from the City Council and input from the community can drastically alter (for better or worse) what the final cannabis regulation will look like for SLO. If all goes well, the City will hold another hearing in front of the Planning Commission on March 28 and potentially adopt a resolution on May 01. We’ll be sure to keep you posted.

california cannabis events
Coming soon to a cannabis friendly town near you?

We receive calls on a weekly basis from clients and prospective clients who want to know what steps they must take to host a cannabis event. We’ve heard plans for cooking classes, dinner parties, shows at art galleries with on-site consumption, and the list goes on. And while the Medicinal and Adult Use Cannabis Regulation and Safety Act (“MAUCRSA”) does provide for state temporary event licenses, those licenses are unfortunately extremely limited.

Pursuant to MAUCRSA, a state licensing authority may issue a state temporary marijuana event license to a licensee authorizing onsite cannabis sales to, and consumption by, persons twenty-one years of age or older at a “county fair or district agricultural association event, provided that certain other requirements are met.” No other venue is allowed.

The hypothetical events I listed above do not constitute a “county fair” or a “district agricultural event,” and so technically, even if a local jurisdiction were entirely willing to issue a special event license for one of these types of events, it would not be permissible under state law. Assembly Bill 2641, introduced on February 15th, seeks to remedy this problem.

AB 2641 would authorize the Bureau of Cannabis Control (“BCC”) to issue the temporary event licenses, and would authorize a state temporary event license to be issued for “an event to be held at any other venue expressly approved by the local jurisdiction.” The BCC would not be authorized to approve a state temporary cannabis event license for a given event unless the local jurisdiction in which the event is to be held has approved.

The bill would also authorize the BCC to issue a temporary cannabis retailer license to a licensed cannabis manufacturer or a licensed cannabis cultivator for the retail sale and deliver of cannabis or cannabis products to customers at a licensed temporary cannabis event, and the license would be valid only for the duration of that particular temporary cannabis event.

Temporary cannabis retailer licensees would need to be valid manufacturing or cultivation licensees. A temporary cannabis retailer licensee would only be authorized to sell cannabis or cannabis products manufactured or cultivated by that licensee. And of course, temporary cannabis retailer licensees must comply with all other requirements imposed on retailers.

Perhaps because cannabis events are such a desirable option for many people, AB 2641 is not the only bill of its kind. Last week, we covered Assembly Bill 2020, which also gives local jurisdictions the right to approve and permit events. The bills are quite similar, with AB 2641 slightly more detailed on requirements that event licensees sell only cannabis that they themselves have cultivated.

Given the demand for a wide array of cannabis events, we see the overlapping proposals of AB 2641 and AB 2020 as a welcome moves that would grant local jurisdictions flexibility in determining what types of special events they wish to approve. And it may mean that soon, our clients will finally be able to host all those creative events they’ve been planning.

California marijuana packaging and labeling
What are the packaging and labeling requirements for new marijuana products?

California is just starting to get its cannabis packaging and labeling regulations right under MAUCRSA. The state has a mandated transition period from January 1 to July 1, 2018, during which time adult use and medical marijuana licensees can do business with each other, and temporary and annual state licensees can transport and sell cannabis products already in their possession in the newly regulated market. This means there are two packaging and labeling standards during this transition period: one for products that licensees bring into the marketplace from before January 1, 2018 and another for products cultivated or made on or after January 1, 2018. I covered transition period product packaging and labeling in a previous post. This post will cover the packaging and labeling requirements for those products made or cultivated on or after January 1, 2018 (collectively, “New Products”).

Retailers

For New Products, retailers won’t package or label anything. Instead, all New Products will come to retailers already packaged and labeled by either cultivators, processors, manufacturers, or distributors. The only packaging requirement retailers have for New Products is exit packaging. Specifically, per section 5413 of the Bureau of Cannabis Control Emergency MAUCRSA rules, “[c]annabis goods purchased by a customer shall not leave the retailer’s premises unless the goods are placed in an opaque exit package.”

Distributors

While distributors have lost a lot of power via MAUCRSA, they may still package, label, re-package, and re-label flower for retail sale (in line with cultivation packaging and labeling rules). That said, they cannot package, label, re-package, and re-label manufactured products unless they also own a manufacturing license and they’re dealing with their own manufactured products. The lone exception for manufactured products is if lab testing shows that the tetrahydrocannabinol (THC) content, per package or serving, was labeled incorrectly but is still within allowable THC limits. In that case, the distributor may then re-label the package with the correct amount of THC. Lastly, “transport only” distributors can’t package, label, re-package, or re-label any cannabis goods at all.

Manufacturers

For manufactured New Products, manufacturers (and Type Ps that label, package, re-label, and re-package cannabis products) must ensure that the label is in English and that all required labeling is “unobstructed and conspicuous” so that it can be “read by the consumer”. Moreover, all required labeling must go on the outside of the package or container (supplemental product information and “side effects” information can go on the inside of the packaging through inserts). There are two mandatory panel labeling requirements for manufactured New Products: the primary label and the informational label.

The primary label must contain the following items, in no less than 6-point font and in relation to the size of the primary panel and container/package:

  1. the identity of the product in a text size reasonably related to the most prominent printed matter on the panel;
  2. the net weight or volume of the contents of the package; and
  3. the THC content and cannabidiol (CBD) content for the package in its entirety (even if the CBD content is zero), expressed in milligrams per package.

If the manufactured New Product is an edible, the following requirements also apply:

  1. the words “cannabis-infused” must go immediately above the identity of the product in bold type and a text size larger than the text size used for the identity of the product; and
  2. the THC content and CBD content per serving, expressed in milligrams per serving; and
  3. this crazy symbol must be included:

You can include additional product information on the primary panel, but the foregoing MUST be on the outside label as relevant.

The informational label must also contain (in no less than a 6-point font in relation to the size of the primary panel and container/package, with limited exceptions depending on how much room you have with the label):

  1. the licensed manufacturer and its contact number or website address;
  2. the date of the cannabis product’s manufacture;
  3. the following statement: “GOVERNMENT WARNING: THIS PRODUCT CONTAINS CANNABIS, A SCHEDULE I CONTROLLED SUBSTANCE. KEEP OUT OF REACH OF CHILDREN AND ANIMALS. CANNABIS PRODUCTS MAY ONLY BE POSSESSED OR CONSUMED BY PERSONS 21 YEARS OF AGE OR OLDER UNLESS THE PERSON IS A QUALIFIED PATIENT. THE INTOXICATING EFFECTS OF CANNABIS PRODUCTS MAY BE DELAYED UP TO TWO HOURS. CANNABIS USE WHILE PREGNANT OR BREASTFEEDING MAY BE HARMFUL. CONSUMPTION OF CANNABIS PRODUCTS IMPAIRS YOUR ABILITY TO DRIVE AND OPERATE MACHINERY. PLEASE USE EXTREME CAUTION;
  4. if the product is intended for the medical market, the statement “For Medicinal Use Only”;
  5. a list of all product ingredients in descending order of predominance by weight or volume;
  6. if an edible product that contains an ingredient, flavoring, coloring, or an incidental additive that bears or contains a major food allergen, the word “contains,” followed by a list of the applicable major food allergens;
  7. if an edible product, the names of any artificial food colorings contained in the product and the amount, in grams, of sodium, sugar, carbohydrates, and total fat per serving; Instructions for use, such as the method of consumption or application, and any preparation necessary prior to use (which is completely up to the manufacturer); and
  8. the product expiration date, “use by” date, or “best by” date, if any; and, when available from the state, the UID and, if used, the batch number.

For the required packaging of all manufactured New Products, manufacturers must have packaging that is:

  1. capable of protecting the product from contamination and that shall not expose the product to any toxic or harmful substance;
  2. tamper-evident, which means that the product shall be packaged in packaging that is sealed so that the contents cannot be opened without obvious destruction of the seal;
  3. child-resistant, which means the package shall be designed or constructed to be significantly difficult for children under five years of age to open or otherwise obtain access to the product contained therein within a reasonable time, and shall not be difficult for normal adults to open or obtain access to the product contained therein;
  4. not imitating any package used for products typically marketed to children;
  5. if an edible New Product, opaque; and
  6. if the package contains more than one serving of cannabis product, re-sealable so that child-resistance is maintained throughout the life of the package.

Cultivators and Processors

Cultivators can grow and process their own flower. Processors only trim, dry, cure, grade, package, and/or label flower or non-manufactured cannabis: they don’t grow anything. Both are charged with the following packaging and labeling requirements for cultivated New Products headed for retail sale (including the same font, conspicuous placement, and English language requirements as manufacturers):

  1. all cannabis has to be labeled and placed in a resealable, tamper-evident, child-resistant package and must include, once available, a unique identifier for the purposes of identifying and tracking cannabis and cannabis products;
  2. the following statement in bold print:  “GOVERNMENT WARNING: THIS PACKAGE CONTAINS CANNABIS, A SCHEDULE I CONTROLLED SUBSTANCE. KEEP OUT OF REACH OF CHILDREN AND ANIMALS. CANNABIS MAY ONLY BE POSSESSED OR CONSUMED BY PERSONS 21 YEARS OF AGE OR OLDER UNLESS THE PERSON IS A QUALIFIED PATIENT. CANNABIS USE WHILE PREGNANT OR BREASTFEEDING MAY BE HARMFUL. CONSUMPTION OF CANNABIS IMPAIRS YOUR ABILITY TO DRIVE AND OPERATE MACHINERY. PLEASE USE EXTREME CAUTION.”;
  3. the net weight of cannabis in the package;
  4. identification of the source and date of cultivation, the type of cannabis, and the date of packaging;
  5. the appellation of origin, if any;
  6. list of pharmacologically active ingredients, including, but not limited to THC, CBD, and other cannabinoid content, the THC and other cannabinoid amount in milligrams per serving, servings per package, and the THC and other cannabinoid amount in milligrams for the package total; and
  7. information associated with the unique identifier issued by the state Department of Food and Agriculture.

Additionally, a flower label may specify the county of origin only if 100% of the cannabis or nonmanufactured cannabis product contained in the package was produced within the designated county, as defined by finite political boundaries. For more on cannabis appellations in California, see here.

In all, the packaging and labeling requirements for California cannabis products are extremely detailed and must be followed to a T by any business that wishes to maintain its medical or adult use license. All prospective licensees should begin preparations today.
Stay tuned for Part 3 of this series on California cannabis packaging and labeling, where I’ll cover the warnings and disclaimers that should go on your products (not covered under or mandated by MAUCRSA), including how to handle new Prop. 65 rules.
marijuana employment cannabis
This might not be true in California anymore.

Thirty states and the District of Columbia have laws that legalize marijuana for adult recreational use and/or medical use. Many of those states also protect employees’ off-work use of medical marijuana. However, some of those states, including California, Oregon and Washington, have statutes or case law allowing employers to terminate employees for off-work use of marijuana– even employees legally using it under the state’s medical marijuana laws. Oregon recently tried to pass legislation protecting off-work use of marijuana, but the bill failed to gain traction and fizzled at the committee level. California is the latest state to attempt to pass legislation to protect employee’s off-work use of medical marijuana. Let’s hope it happens!

California Assembly Bill 2069 (AB 2069), introduced last week, proposes to protect medical marijuana patients’ off-work use of marijuana. AB 2069 would amend California’s anti-discrimination statute by expanding the list of protected classes to include medical marijuana patients. This means that if an employer discovered that an employee or potential employee was a medical marijuana patient, or that the employee had tested positive for marijuana, it would be illegal for the employer to:

“refuse to hire or refuse to select the person for a training program leading to employment, or to bar or to discharge the person from employment or from a training program leading to employment or to bar or to discharge the person from employment or from a training program leading to employment or to discriminate against the person in compensation or in terms, conditions, or privileges of employment”.

California’s proposed bill is similar to other states that have successfully passed legislation to protect off-work use. AB 2069 also includes an important provision to protect employers who would lose money or licensing related benefits under federal law or regulations. Because marijuana remains a Schedule I substance under the federal Controlled Substances Act, companies that contract with the federal government must ensure a drug-free workplace. Under the proposed bill, such companies would not violate AB 2069 for terminating employee’s off-work marijuana use. This important safe harbor makes it seem more likely the bill will pass.

Note that AB 2069 would not provide protections for employees who use medical marijuana on the premises, or employees who are intoxicated while working, if company policy prohibits these things. Regardless of whether AB 2069 becomes law, it is important to be clear with your employees when it is acceptable to use marijuana and when it is not. Those rules, along with other employment-related requirements, must be spelled out in the cannabis business’s employee handbook.

Marijuana will continue to be legalized across the country in 2018. California has been on forefront of medical marijuana policy since Proposition 215 over 20 years ago, so it’s fitting that the Golden State may be next to protect off-work medical marijuana use by patient employees. AB 2069 is to be heard in committee next month, and we expect this bill to get some traction. Make sure to write your representative. And if you want to track this bill going forward, go here.

In the meantime, for more on employees and off-duty cannabis use, check out the following posts by our attorneys:

 

A growing number of startups in the cannabis space are engaging brokers and online platforms to assist in their fundraising. This makes sense: as we’ve written previously, most investors (particularly institutional capital) are staying on the sidelines and taking a wait-and-see approach to the cannabis industry. Thus, cannabis startups will always target a smaller, more dispersed, more specialized investor base, and going through experts is a logical way to reach them. Note that 506(c) is one of the relatively new options for company financing, implemented as part of the JOBS Act of 2012. It allows for companies to engage in a more public “general solicitation”—but with strings attached, as we’ll detail below.

From a securities law perspective, the engagement of a broker-dealer or online platform converts the offering exemption from the ever-popular 506(b) offering to a 506(c) offering – changing this one letter has a number of significant consequences:

1 – You must ensure that the broker-dealer is registered, or else.

Section 3(a)(4)(A) of the Securities Act generally defines a “broker” broadly as “any person engaged in the business of effecting transactions in securities for the account of others.” This broad definition includes any “finder,” “fundraising consultant,” or anyone else receiving any transaction-based bonus or commission in return for introducing or engaging an investor. You should always consult your securities counsel when a third party is assisting the company on fundraising. Once it is established whether broker-dealer registration is required, FINRA provides an online Broker-Dealer Check. The penalties for using an unregistered broker-dealer are extremely harsh, so it’s always wise to err on the side of caution.

2 – You are limited to accredited investors, and you must take additional steps to confirm an investor’s accredited status.

In a 506(b) offering companies have the flexibility to raise from an unlimited number of accredited investors, as well as up to 35 unaccredited investors. Only around 2% of the US population would meet the accredited investor conditions (in short: at least $1 million of assets not including one’s home, or a recurring annual income of at least $200,000 (or $300,000 if married)). The loss of the unaccredited investor option may eliminate some of the classic “friends and family” seed investors, that write smaller—but often critical—checks to keep the company afloat in the early going.

Further, raising under 506(c) puts a higher burden on the company to complete its own diligence to confirm an investor’s accredited status. Under 506(b) you can essentially take the investor’s word for it. The SEC has laid out the types of records one would examine under a “principles-based verification method” and they include the investor’s bank statements, brokerage statements and records of securities holdings, tax returns and tax assessments or appraisal reports prepared by third-parties. Looking at these records may not seem like such a big deal, but the hurdle of developing this method and implementing for each investor can be a significant undertaking for startup company.

3 – You can engage in a general solicitation under 506(c), but with greater visibility comes…greater visibility.

The advantage of expanding your potential investor base beyond those with whom you have a “substantial pre-existing relationship” (which is required under 506(b)) may seem to open a world of possibilities. But putting your company out in the open may have drawbacks: any proprietary info in your investor materials will get passed around, you may pick up shareholders that cause you problems down the line, you may attract attention from the not-in-my-backyard types, and some investors prefer their cannabis investments to keep a lower profile.

Finally, it bears repeating: seek an experienced corporate and securities attorney. With these choices you need principled and consistent counsel, because there is a final consideration: once you’ve engaged a broker-dealer or otherwise engaged in a general solicitation, you are committed for the entirety of your financing round. Any unaccredited “friends and family” are out—they can’t write checks under any circumstances—and you cannot revert to the more relaxed requirements of 506(b).

blockchain cannabis california

We have previously discussed blockchain technology and the effect it can have on the cannabis industry here and here. This post serves as a more detailed analysis of how blockchain can and may disrupt the tracking of cannabis from seed to sale, specifically within the new California adult use market.

Currently, cannabis businesses are spending significant amounts of money to implement track and trace systems compatible with Franwell’s Metrc. Metrc is a government-designed software that many states have elected to use, including California, that allows regulators to ensure that cannabis products are not being diverted to illegal markets. Cannabis products are given a radio frequency identification (“RFID”) tag, which licensees along the supply chain must input into their systems. This allows regulators to track the chain of custody of marijuana products. Under this system, however, licensees and regulators spend significant time ensuring compliant transfers.

Enter blockchain. In its simplest form, blockchain is a dispersed ledger. Transactions, or “blocks,” are added in a linear fashion, or “chain”, after they have been verified by other members of the blockchain as valid. All transactions on the chain are trackable to the initial entry. A blockchain platform can have various levels of supply chain information gathering, such as record keeping, tracking, assigning verifications, linking products together and sharing information.

Using blockchain technology, cultivators can input details about each crop: e.g., the date the flower was harvested, pesticide levels throughout the growth cycle, and information about cross-pollinated plants. The data can be stored and verified via blockchain, and instantaneously shared with all parties on the blockchain platform. These parties can be other members of the cultivation team, cultivators in different facilities, potential retailers or producers, and even end-use consumers. This data will travel with the flower from seed to sale.

When the product is ready for pick-up from a grow site, the blockchain platform can verify that a distributor is licensed. Implementing blockchain can therefore prevent unlicensed distributors with fabricated paperwork from stealing goods. The platform will also maintain all records of a transaction or series of transactions: e.g. shipping manifests, receipts, purchase orders, lab results, etc. Blockchain can also help ensure that products are being properly labeled. When a label is created, a photograph or file of the label can be uploaded to the blockchain. Members of the blockchain can verify that the label is correct before it reaches the product.

Because all information recorded in blockchain is verifiable by other members on the platform, blockchain will remove the need for tedious paperwork at each step in the supply chain. Cannabis will be able to move freely from licensee to licensee without any added hassle. Regulators will gain a streamlined audit tool, and customers will be able to ensure that they are only getting the best and safest products. Ultimately, blockchain can improve the overall integrity of the track and trace system, and minimize the time it takes for the product to get from seed to sale.

The million dollar question with all of this is whether and when blockchain will burst through and finally become mainstream enough for adoption by a state regulatory body, like California in the case of cannabis. There are a range of opinions on the inevitability and timing of blockchain (for just a few of the many examples, see here, here and here). In our view, blockchain and cannabis are a perfect marriage of emerging trends. We will continue to partner with individuals and businesses interested in this technology, and we foresee a bright future for blockchain and cannabis once the implementation and educational hurdles are cleared– hopefully, in a few years at most. In the meantime, California businesses and regulators will have to muddle along with Franwell’s Metrc product.

oregon cannabis processor
Licensees and employees only: them’s the rules!

Our Oregon marijuana processor clients often approach us with requests to draft agreements that will allow third-parties to process cannabis in the client’s licensed premises. Typically, the processor is not operating at capacity and would like to supplement income by charging fees to keep the premises open around the clock. Previously, we have explained that this arrangement only really works if the third-party is also a licensed OLCC processor, pursuant to Oregon’s new alternating proprietor rules (OAR 845-025-3255). However, we are most often approached with proposals to have non-licensee third-parties enter the kitchen and physically create cannabis products that will be owned and sold by the licensee.

Here is a more concrete example: Kelly’s Kitchen is an Oregon Liquor Control Commission (OLCC) licensed processor. Kelly meets Cindy, who has developed a recipe, labels, and packaging. Cindy doesn’t want to go through the OLCC application process, she just wants to make her Bud Brownies. Kelly invites Cindy to personally make her brownies on Kelly’s property, and Kelly agrees pay Cindy for each unit sold. The prevalence of these arrangements suggests that the industry has been treating this as a grey area. However, we recently reached out to the OLCC and received confirmation that this is black and white: The OLCC will view Cindy as illegally processing cannabis without a license, even if Kelly always retains ownership of the cannabis and resulting product. This arrangement can also put Kelly’s license at risk. No arrangement that allows non-licensees to personally process cannabis within a licensed premises is allowed under the rules.

The OLCC’s view should not come as a surprise when you consider the significant restrictions in the new alternating proprietor rule that allows multiple OLCC licensed processors to share kitchen space:

  • The kitchen must have a pre-approved schedule posted on its front door showing when each processor will be using the kitchen.
  • The kitchen must have a separate secure area for each processor to store its cannabis products.
  • Any concentrates produced under an alternating proprietor arrangement can only be used within that processor’s edibles or topicals.

In effect, Cindy and Kelly are trying to bypass these restrictions, and the processor licensing regime as a whole.

The only viable alternative to alternating licensed proprietors appears to be a standard intellectual property licensing agreement, whereby Cindy would license her recipe, branding, and packaging to Kelly as co-packer. Kelly or her employees then process the brownies and sell them retailers or wholesalers without Cindy’s involvement. Cindy will likely expect to be paid based on the number of brownies that Kelly manages to sell. However, anyone considering this arrangement needs to carefully look at the OLCC’s financial interest disclosure requirements.

The definition of financial interest is fairly broad and includes anyone “having an interest in the [licensed] business such that the performance of the business causes, or is capable of causing, [an individual or entity] to benefit or suffer financially.” The OLCC will view Cindy as a financial interest holder because her compensation depends on Kelly’s success in moving the product. This isn’t the end of the world, but it does mean that Kelly must submit a Change in Financial Interest form and receive approval from the OLCC before Kelly begins making Cindy’s brownies. All this means is that Cindy will likely need to be fingerprinted and pass a background check.

We expect that we will continue to be approached by clients that want to invite non-licensees into their licensed premises to make products, but now we can confidently say that this common industry practice violates OLCC rules. Be warned!

cannabis subordination loan
Best if landlord, tenant and lender talk out that cannabis loan ahead of time.

Commercial cannabis leases are different than other commercial leases in many important ways. In other respects, however, they can be quite similar. One item that tends to fall into the latter category is the creation of a landlord’s lien on the tenant’s personal property in the event of an uncured tenant default. For example, if a marijuana producer fails to pay rent, the landlord acquires an ownership interest in that producer’s lights, fans, security equipment, and even the cannabis itself. If the lease is drawn up correctly, the landlord would then be able to seize these assets and liquidate them, in accordance with state law.

When representing landlords, this type of provision makes it into every type of cannabis lease we draft. When representing tenants, we often try to narrow this right, especially in situations where the tenant may be taking on debt. Why? Because lenders often insist on priority rights in the event that a pot business cannot repay a loan. In many cases, the lender will come prepared with a “Waiver and Consent Agreement” or a “Subordination and Consent Agreement.” The tenant is tasked with acquiring its landlord’s signature on this contract, so that if there is a default under the lease, the landlord does not preempt the lender’s rights in the tenant’s property (which serves as collateral for the loan).

From the landlord’s perspective, subordinating its lien on the tenant’s personal property is preferred to a total waiver of the lien. The lender won’t care either way, so long as it receives a primary security interest in the cannabis and everything else. For that reason, most of the time the parties will end up with the landlord agreeing that its lien is subordinate to the lender’s right, but not totally extinguished (“waived”). That way, the landlord is assured that its tenant will receive the cash needed to operate, and will retain the right to hop in line behind the lender and lien on any assets, as needed.

Landlords should be aware that the waiver or subordination agreement will typically allow the lender to enter the leased premises and remove the trade fixtures and even the marijuana itself, subject to state rules. On this point, the landlord will want to require that the lender minimize disturbance with respect to any other tenants on site, and require that removal occur prior to the end of the lease term. Once the lender is in the space, the landlord will want to ensure that the lender is required to comply with state marijuana rules, provide evidence of insurance, and keep the premises open for inspection, among other items.

There are a host of other concerns that a boilerplate consent or subordination document will create in the context of a cannabis loan to a tenant operator. These range from specific items, like the landlord’s obligation to notify the lender of a tenant’s default, to general items, like restrictions on the ability of a landlord and tenant to amend the lease agreement. Depending on which chair you are in—landlord, tenant or lender—these items will have different repercussions and should be negotiated with that in mind.

Each party’s goal, as always, will be to minimize risk and to maximize the ability to make and receive payments, in accordance with state and local rules. If you understand the basics of cannabis leases, lender subordination agreements, and your state’s disclosure requirements for cannabis lenders, you should be able to propose a contract solution that works for everyone. That way, in the event of a default under a loan or lease, the parties won’t have to fight over what happens next.

California marijuana businesses Culver City
Cannabis businesses are finally coming to the Heart of Screenland.

Culver City plans to release its commercial cannabis applications before the end of March. On monday, the City Council voted to adopt its proposed cannabis business permit application process. Based on the released draft application documents, getting a commercial cannabis permit in Culver City is not going to be an easy process.

Here is a breakdown the application processes per license type:

Storefront Retail Applications:

In the first phase of the application process, applicants must submit live scans, zoning verification documents, and their cannabis business application. City staff and the Culver City Police Department will review that information and, if sufficient and complete, applicants will move on in the process. A three-person panel of City staff members will review and rank the applications; reviewers will read business plans, security plans, and design/location documents and rank each application on a point scale.

The panel will then choose a minimum of three and a maximum of six applicants with the highest average ranking to proceed. Other applicants will be put on hold pending the outcome of the permitting process. A five-person review committee composed of City staff members will then interview the ranked applicants. At least two of the largest equity holders and the day-to-day operations manager of the applicant must be present for the interview. The three applicants with the highest average scores will then proceed in the licensing process. In the event of any tie amongst applicants, a lottery will be used to choose who moves on.

Only after interviews or the potential lottery will these 3-6 applicants finally apply for a Conditional Use Permit (“CUP”) and other required Los Angeles County permits. Upon applying for the CUP, applicants will present their building and operational proposals at a public City Council meeting, and the Council will either approve or deny the permits accordingly. If the Council approves, the applicants will then apply for their Culver City Business Tax Certificate (“BTC”), all required City permits, and begin moving forward with their build-outs. Applicants will then pay permit fees, complete their build-outs, and City staff will perform on-site inspections. If everything checks out, the CUP and BTC will finally issue to the applicant.

Non-Storefront Retail Applications (i.e., Manufacturing, Distribution, Delivery-only retail, Cultivation, and Testing Labs):

In the first phase of the application process, applicants must submit live scans, zoning verification documents, and part one of their cannabis business application. City staff and the Culver City Police Department will review that information and, if approved, applicants will move forward. If more than the maximum number of permits allowed (6 manufacturing, 6 distribution, 3 cultivation, and 4 testing laboratories) qualify, then the City will use a lottery to determine the applicants that will ultimately receive a permit.

Successful applicants will then apply for a BTC, all applicable permits from LA County Department of Public Health, all required City permits, and submit part two of their cannabis business application.

Without a doubt, Culver City will be one of the most competitive jurisdictions in L.A. County. In such a setting, potential operators need to prepare themselves by organizing their business and operational plans as well their communal impact and outreach plans and methods, which will take significant preparation. Because the City plans to release its cannabis permit applications as soon as the middle of next month, would-be operators should start organizing themselves now: it’s going to be an uphill (and expensive and time-consuming) process in the Heart of Screenland.