marijuana cannabis Oregon packaging labeling
Don’t worry, your favorite symbol isn’t going anywhere.

Last year, the Oregon Legislature passed Senate Bill 1057, which transferred cannabis labeling authority from the Oregon Health Authority (“OHA”) to the Oregon Liquor Control Commission (“OLCC”). The new rules, which became operational on August 15, 2018, merged the OHA rules with those of the OLCC and further clarified the labeling and packaging regulations. Overall, this is a good thing.

Although the new regulations do not drastically differ from those under the old rules, OLCC licensees (i.e., recreational marijuana producers, processors, wholesalers, and retailers, including those processing and selling hemp products) and OHA registrants (i.e., medical marijuana growers, processors, and retailers) will need to familiarize themselves with these revisions and update their labels to be in compliance by April 1, 2019. At that point, all marijuana items transferred to dispensaries or retail shops will have to be packaged and labelled pursuant to the new rules.

To comply with these new standards, existing licensees will need to resubmit their label and package applications for pre-approval before the April 1, 2019 deadline. Also note that all new label and package applications submitted for pre-approval as of August 15th will be reviewed and evaluated by the OLCC under these rules. Typically, pre-approval takes 2 to 4 weeks but can occasionally last longer.

The most noticeable changes and clarifications to the labeling and packaging rules are as follows:

  • The word “consumer” now excludes “a patient or designated caregiver.”
  • The new rules explicitly provide that they apply to marijuana items and industrial hemp products sold to consumers, patients, or designated primary caregivers. Consequently, the new rules require a clear label of whether the product contains marijuana or hemp. If it contains both, then the label must identify the item as a marijuana item.
  • Marijuana items and industrial hemp products must be packaged in a container that is “resealable and continually child-resistant.”
  • If the product is an industrial hemp commodity or product processed by a licensee, the principal display must include the hemp symbol in place of the marijuana universal symbol.
  • The new rules define “added substances” to mean “any additional component or ingredient added to usable marijuana, cannabinoid concentrate or cannabinoid extract during or after processing that is present in the final product. This includes added flavors, terpenes, and any substances used to change viscosity or consistency of the cannabinoid product.”
  • The new rules no longer provide a distinction for “flag labels.” Instead, the new regulations refer to “small container labels and “tiny container labels,” which have their own requirements.
  • The new rules no longer require test batch numbers on labels.
  • The new rules replaced the font size and font type requirements (at least 8 point Times New Roman, Helvetica, or Arial font) with a provision that the labels display a “legible font that is easy to read and contrasts sufficient with the background and is at least 1/16th of an inch in height based on the uppercase ‘K’.”
  • The new rules rephrased some of the warning requirements to read as follows: “Do not drive a motor vehicle while under the influence of marijuana.” And, “Keep out of reach of children.” (You are no longer required to mention animals.)

Note that while labels must comply with the new rules by April 1, 2019, marijuana items on dispensary or retail shelves that meet old packaging and labeling rules under the OHA will be allowed for sale until December 31, 2019. However, as of January 1, 2020, all marijuana items will have to meet the OLCC packaging and labeling rules and all items with labels that meet the pre-August 15, 2018 rules will be removed from the market.

So, if you are licensed to produce, process or sell marijuana or industrial hemp products in Oregon be sure to review the new rules now to have ample time to update your labels by the April 1, 2019 deadline and avoid any civil penalty, which can go up to $500 per day—Ouch!

cannabis hemp CBD
Don’t miss this one!

Cannabidiol (“CBD”) products are suddenly everywhere. But as much as opportunity and possibility have opened in the hemp-derived CBD industry, so too have legal pitfalls and snares that can confuse just about anyone breaking into this new market. When it comes to navigating the trails that are still being blazed, many are left wondering, “Is it legal or not?”

At a time when the popularity of CBD and hemp products meets legalization, the importance of this question cannot be overstated. Unfortunately, the answer is not an easy one. Individuals and companies alike are stepping forward with innovative ideas and using these products in health supplements, topical ointments, and even food and beverages. What they often find at all stages of production (manufacturing, distribution, and marketing), is that the law can be ambiguous and varied, especially when divided by state lines and the unavoidable intersections with federal law.

Our attorneys have been at the forefront of the struggle to effectively interpret and understand these challenging legal circumstances. Tomorrow,  August 16th, at 11 am PST, Harris Bricken attorneys Daniel Shortt and Alison Malsbury will present a webinar entitled “CBD Legal or Not: How State and Federal Laws Govern the Manufacture, Marketing & Distribution of CBD Products.”

Whether you are an individual or part of a company, working with U.S. or foreign grown products, an attorney or a government official, this webinar will equip you with the knowledge you need to successfully untangle the legal knots that may be preventing you or your clients from realizing the full potential of this industry. Our attorneys will discuss current state and federal laws, marketing do’s and don’ts, trademark protections, and FDA regulations. They will also address audience questions throughout the presentation.

To register, please go here.

In the meantime, for more on CBD law, check out the following:

marijuana cannabis loan
This industry is different, you know.

Many cannabis businesses are funded with debt. Sometimes, the debt is owed to one of the business’s owners, who pursued a debt structure for tax reasons. Other times, the debt is owed to a third party. That party could be a friend or family member, an investor keen on the industry, or even a professional hard money lender. Our marijuana business lawyers have papered a large number of loans in the industry, on behalf of both businesses and lenders. This blog post identifies some considerations for lenders making plays in the industry.

Do Your Diligence.

Before making a loan of any type to a cannabis business, do your diligence. Like so many things related to cannabis businesses, this exercise is different than with standard businesses. There are several reasons for this: 1) cannabis businesses often have short or non-existent operating histories; 2) by extension, cannabis businesses often have limited financial information at hand (tax returns, P&Ls, etc.); 3) the financial projections for cannabis businesses are more speculative than for other businesses, due to market dynamism; and 4) regarding operations, cannabis businesses may be “license pending” and thus offer little to vet.

Altogether, these factors make it supremely important to vet the actual owners of the business, as well as whatever you can get on the enterprise. This means having a look at personal financials and assets, credit reports, asking for personal references and calling around, etc. And when it comes to diligence on the business, make sure you do more than simply run a UCC search and review financials. Ask for company agreements. After all, a business may have an oppressive lease or licensing agreement which makes it less likely to succeed, or it may have similar documents with contingent or springing security interests that diminish your repayment prospects.

Prepare to Be Vetted.

The cannabis business will look into you, of course. But the real vetting is likely to happen by the licensing authority. In Washington, for example, the two groups that must report to the Liquor Control Board are “true parties of interest” and “financiers.” In California, it’s “owners and financial interest holders.” And in Oregon, it’s anyone with a “financial interest.” Each of these terms is defined in each state’s ever-evolving administrative rules, but it’s very likely that as a lender, you will need to be disclosed and vetted by the licensing authority. This may entail submission of information on your business, if you have one, and/or its owners and spouses. It also usually means fingerprints, background checks, and having your name on file as a part of the public record.

Demand Security.

Arms-length loans are almost never unsecured, so this one is a no-brainer, and if a marijuana business pushes back, it should be a dealbreaker. The best type of collateral is something tangible, like real property (land) that is unencumbered by senior interests, or where foreclosure by a senior noteholder would not wipe out all available equity. But there are other types of collateral, too, like personal property (including intellectual property); and there is always the option for a convertible note. Finally, lenders often get creative with deposit control agreements and other collection levers.

In the personal property category, the noteworthy asset when lending to plant-touching businesses is the cannabis itself. Most states have procedures for secured creditors to take control of a cannabis business under provisional licensing authority, for liquidation purposes. But, before you sign up for this, ask yourself: Could I really see myself chopping down cannabis plants one day? Or paying a receiver to do that? If not, and if the business has no other valuable assets, this loan may not be right for you.

Demand Personal Guarantees.

This ties into the diligence and security categories. A personal guaranty is just an extension on whatever security you can otherwise acquire as a part of the loan. Make sure these guarantees are uniformly integrated into the loan documents, and that each guaranty is more than a cursory sentence appended to a promissory note. The personal guaranty should cover various contingencies, e.g.: What happens if the guarantor dies? Are there any allowances for its termination, aside from repayment of the loan? Etc. Also, consider whether your borrower resides in a community property state like Washington or California, where the guaranty may not attach to marital property.

Do Market (and Legal!) Research.

Lenders to the cannabis industry are getting better rates than almost anyone else. They are taking on more risk, and feeding an insatiable capital market. We have seen loans with interest rates up to 50%(!) for relatively quick turns, but we have also seen loans that do not conform with licensing rules, or with state lending and usury laws. The exercise here is to ascertain market norms, look at your prospective borrower’s situation, and consider these factors in the greater context of lending statutes and marijuana licensing program rules. Finally, balance what you think you can get against the decreasing odds of collection that inevitably come with higher interest rates and compact repayment schedules.

Hacking back isn’t the answer, unfortunately.

As I have discussed for the last two weeks, cannabis businesses have become increasingly vulnerable to cyberattacks. It is natural for a company victimized by data breaches to want to retaliate by hacking back. However, under current U.S. law, which is codified under the Computer Fraud and Abuse Act (“CFAA”), it is strictly prohibited to intentionally access another’s computer without authorization.

Legislators have given some thought to this problem. Most recently, the re-introduction in October 2017 of the Active Cyber Defense Certainty (“ACDC”) Act, a bill sponsored by Congressman Tom Graves (R-Ga) and Congresswoman Krysten Sinema (D-Az), raised questions about the legality of counter attacking. Indeed, the ACDC Act proposes to amend the CFAA and enable victims of cyberattacks to adopt active defensive measures to identify the hackers, destroy information originally stolen from the victims’ networks, and attack the intruders’ servers to interrupt the ongoing attack. Although an eye-for-an-eye form of justice is appealing, unauthorized access to networks is not a good idea. Here is why.

First and foremost, the ACDC Act has not be enacted. This means that the CFAA remains the law of the land, and accessing others’ computer systems without their permission is a criminal offense. Every state law punishes hacking under the computer crime statutes. These crimes carry serious penalties ranging from a class B misdemeanor (punishable by up to six months in prison, a fine of up to $1,000, or both) to a class B felony (punishable by up to 20 years in prison, a fine of up to $15,000, or both).

Second, even if retaliation were legal, most companies would lack the expertise required to safely conduct an offensive cyber operation. It is incredibly difficult to identify individuals and entities behind cyberattacks. Most intruders cover their tracks very carefully by using encryption and by routing strikes through others’ computers. Given this, counter hacking would most certainly result in attacking computer systems and destroying data belonging to innocent third parties.

Then, there is the issue of whether victim companies have the technical proficiency required to effectively take counter measures against cyber intruders. Indeed, the internal tools needed to effectively hack back represent a major undertaking: a high level of expertise, constant vigilance, and huge financial resources. Moreover, it is highly unlikely that companies that could not prevent the intrusion of their networks would manage to take on their attackers on their own digital turf.

Lastly, retaliation by companies that fell victim of a data breach would most certainly impede law enforcement investigations and delete or temper with evidence that could be useful in a prosecution. Unlike law enforcement agencies, companies do not have the relevant technical expertise or diplomatic tools to pursue hackers. Most companies ignore how to preserve a chain of custody that would enable the introduction of untampered evidence at trial. In addition, counter hacking is an incredibly dangerous endeavor because it is very difficult, if not impossible, to see what a company would be up against. In retaliating, a company would run the risk of escalating the situation and of further injuring itself.

As I have discussed before (here and here), no one and no company is immune to cyberattacks. It is understandable that companies, including cannabis companies, are getting tired of being passive and of merely defending against these breaches. However, hacking back is not a feasible option given its illegality and the negative consequences it could have on the retaliating company. When faced with a data breach, don’t let your emotions dictate your actions; instead, stick with a comprehensive plan of action that will help you minimize your damages and let skilled, experienced law enforcement agents do the job of tracking and investigating your attackers.

marijuana federal employment cannabis
Will the laws change for federal worker marijuana use?

Could the federal government protect the rights of federal employees to use marijuana in states where its legal?

Possibly. A bipartisan bill was introduced in Congress on July 28 proposing to protect federal employees’ personal and private use of marijuana in states where it is legal. Congressmen Charlie Crist (D-Fl) and Drew Ferguson (R-Ga) jointly introduced the “Fairness in Federal Drug Testing Under State Laws Act”, which would prohibit federal employers from denying employment or subjecting federal employees to adverse personnel action if they test positive for marijuana and live in a state where it is legal.

Today, because marijuana remains an illegal substance under the Controlled Substance Act, federal employees can be terminated or denied employment if they test positive for marijuana on a drug test (and many federal agencies require regular or periodic testing). The bill would not apply to individuals occupying or seeking positions requiring top-secret clearance (meaning, they could still be tested), and the bill would allow federal employers to terminate employees for being impaired at work.

The bill, while incredibly important for federal employees, could also significantly impact private employers in states with legal cannabis. A majority of states have some form of legal marijuana, either medical or recreational. However, many of those states still allow employers to terminate employees for off-work use of marijuana, even medical marijuana patients. Several states, including Oregon and California, have attempted to pass legislation protecting employees’ off-work marijuana use, but the bills have failed in committees or did not garner enough votes to pass. Thus, both Oregon and California currently have statutes and/or case law allowing employers to terminate employees for off-work use.

So why are the state proposals failing? One big reason is that they have not made exceptions for private employers who contract with the federal government. Private employers who contract with the federal government are required to have drug-free workplace policies in place—meaning they have to terminate employees for positive drug tests to maintain their federal contracts. If the Fairness in Federal Drug Testing law passes, it likely would extend to private employers contracting with the government. And if the federal law passes, states may have a clearer path to protecting off-work use.

It is also important to note that the state laws and cases permitting employers to terminate employees for off-work marijuana use rests on marijuana’s continued classification as a Schedule I controlled substance under the federal Controlled Substance Act. While the Fairness in Federal Drug Testing act would not change marijuana’s status as controlled substance, states would at least be able to rely on the federal government’s position that it will not fire employees for off-work use. It seems more likely that the states where marijuana is legal in some form would be successful in passing legislation protecting employees’ off-work use of marijuana.

It will certainly be interesting to see if the Fairness in Federal Drug Testing bill gains momentum in committee and in front of Congress. We will be sure to keep you posted for any movement on the bill after Congress returns from their August recess.

vape marijuana cannabis
Is the vape industry in real trouble?

Like so many other U.S. industries, the U.S. vaping industry is now in the crosshairs of a 25% tariff on products imported from China. The first two waves of President Trump’s proposed tariffs against China covered about $50 billion worth of Chinese products but they did not include any vaping products. After China retaliated and proposed its own equivalent tariffs on an estimated $50 billion worth of U.S. products imported into China, President Trump proposed a much bigger third list of China products to cover an additional $200 billion in imports from China. This third list targets vaping devices, vaping parts, and batteries from China. Because our law firm’s marijuana business lawyers represent so many companies involved in various aspects of the vaping industry, we are hearing a earful about how these tariffs will “decimate” the nascent industry.

The U.S. vaping industry is indeed particularly exposed to these tariffs. Though much of the e-liquid used for vaping is made in the United States, almost all of the vaping hardware is imported from China. Just as Gillette makes the most money selling razor cartridges and not razors, many U.S. vaping companies chose to focus on the higher margin e-liquids, rather than lower margin vaping devices. Some have noted that there are no U.S. companies that produce any vaping hardware products. We are hearing of how many vape and cannabis retail shops will be unwilling or unable to pay the extra 25% tariffs because they do not believe they will be able to pass these extra costs on to their customers. If this does prove true, the vaping industry will indeed be decimated.

Fortunately, there is still time for vaping companies to seek a tariff exemption for certain vaping products. The U.S. Trade Representative will accept comments until September 6 on whether entire categories of products listed on the third wave of proposed tariffs — the $200 billion in imports from China — should be exempted. There likely will be yet another chance to make more product-specific exclusion requests later in the fall.

For an exclusion request to have any realistic chance at being granted, marijuana and related vaping companies should address the following factors:

  • A description of the physical characteristics (dimensions, material composition, etc.) of the particular vaping products and the 10 digit subheading of the HTSUS tariff category applicable to those products.
  • Whether the particular vaping product is available only from China. In addressing this factor, requesters should address specifically whether the particular vaping product and/or a comparable product is available from sources in the United States and/or in third countries.
  • Whether imposition of additional duties on the particular vaping product would cause severe economic harm to the requester or other U.S. interests.
  • Whether the particular vaping product is strategically important or related to “Made in China 2025” or other Chinese industrial programs.
  • Requesters must provide the annual quantity and value of the Chinese-origin product the requester purchased in each of the last three years. If precise annual quantity and value information are not available, USTR will accept an estimate with justification.
  • Requesters may also provide any other information or data they consider relevant to evaluating their request.

The process for reviewing and deciding on these exclusion requests will not result in any immediate decision but the hope is that a favorable decision eventually will allow for refunding the tariffs paid.

The goal is to have the USTR review the comments and grant exclusions, particularly for products that are not made in the United States and can only be sourced from China. The last time similar tariffs were applied on steel products back in the early 2000s, many exclusions were granted that helped ease the impact of the tariffs on downstream users.

There have already been many opposing comments and exclusion requests submitted for the first two waves of proposed China tariffs. Many of the opposing comments have noted how the proposed tariffs on the Chinese products have nothing to do with  Chinese practices of stealing or extorting intellectual property from U.S companies, which are the reasons claimed for invoking the China tariffs in the first place. Many have also objected to how these tariffs are not likely to change how China respects intellectual property  rights, but will have a catastrophic effect on certain American companies.  What was a booming U.S. vaping industry now faces going bust with the proposed tariffs. If you are in the vaping industry, now is the time to do what you can to prevent this.

Editor’s Note: A version of this post previously appeared on our law firm’s China Law Blog. It focuses on the vaping industry but much of it holds true for a host of other U.S. industries caught up in the tariffs as well. The bottom line is that the situation for products and companies that will be hurt by these tariffs is not good and the chances of overturning the tariffs are in most cases less than 50 percent. But in many cases the situation is not yet hopeless and it behooves you to try.

california marin county marijuana 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 cannabis 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 San Jose, and before that the City of Cotati, the City of San Luis Obispo, the City of Redding, the City of San Rafael, the 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 the City of Emeryville and the City of Antioch.

In addition to the above, we have previously written about commercial cannabis regulations in Marin County here, here, and here. Today’s post is an update on those regulations, as requested by one of our faithful readers.

Welcome to the California Cannabis Countdown.

What commercial cannabis activity is allowed in Marin County?

In unincorporated Marin County, medicinal cannabis delivery-only retailers (MCDORe) are allowed pursuant to a licensing ordinance approved on November 14, 2017. These locations must be closed to the public– only delivery is allowed.

How many retailers are allowed?

A maximum of four MCDORe locations are authorized in the C1 (Retail Business), CP (Planned Commercial), AP (Admin and Professional), OP (Planned Office) and IP (Industrial Planned) zoned districts. MCDORe locations must be located at least 600 ft from schools, day care centers, youth centers and playgrounds.

What about delivery?

Delivery of medicinal cannabis into unincorporated Marin County by licensed retailers located outside of unincorporated Marin County is also allowed. All other commercial cannabis activities are prohibited in unincorporated Marin County.

Is Marin County accepting MCDORe license applications?

The deadline for applications was July 12, 2018 and Marin County is not accepting additional MCDORe applications at this time. According to County staff, there may be an opportunity for additional licenses in the future if the program expands. After implementation of MCDORe licensing, Marin County will be evaluating program expansion into other potential licensing regulations.

What about non-medical?

Currently, Marin County does not allow any adult-use commercial cannabis activities, including cultivation, manufacturing, testing, distribution or retail sales. This is unfortunate, because in 2016, 69.6 percent of Marin voters supported Proposition 64. For this to change, citizens and industry should make it known to the County Board of Supervisors that an additional licensing ordinance is needed.

cannabis marijuana term sheet

When I receive a summary of a cannabis business deal–the first emails, calls, LOIs, and term sheet in any form–with 90% accuracy I can say whether the transaction will be a difficult one or not. Note that “difficult” does not correlate with complex: Often the more complex deals, with multiple entities and asset transfers, end up being much easier, whereas a simple secured loan can be more difficult. And in the context of a transaction, “difficult” = “time consuming” = unnecessary expense. Everyone would like to avoid that.

The number one differentiating and determinative factor in assessing the difficulty of a marijuana business deal is the term sheet. If a deal is a building, think of the term sheet as both the architect’s blueprint and the physical foundation on which the deal is built. Deals that are smooth are built with a clear plan and on a solid base; these come in on time and under budget. Deals that are built based on a vague understanding of the final goal but with no firm, documented plan, will be typified by stops and starts, walls built, torn down and rebuilt, and a final product that stands but doesn’t resemble what either parties had in mind (“in mind” being a key phrase here, as often what was in the parties’ mind was never exchanged in an agreement). Oh, and the dreaded cost overruns.

Engage your attorney before you sign a term sheet. 

Having a final term sheet is necessary for a smooth transaction, but agreeing that a half-baked term sheet is “final” may prove worse than having no term sheet at all. Do not make the mistake of thinking you cannot engage your attorney until you have a term sheet signed: In fact, an hour with your attorney before you finalize the terms, could save you many hours down the line. Your experienced business attorney will know how the terms will fit in the documents, and in turn what terms you may not have addressed fully, or at all.

Do not have your attorney draft the transaction documents until after you sign a comprehensive and binding term sheet. 

Speed in transactions is defined by certainty. Term sheets that say “market standard” terms for X is likely a proxy for “we didn’t take the time to discuss X.” This can work if the parties have a common reference point or an external reference. For example, in the context of an equity financing, “standard NVCA language on Registration Rights” is OK. “Standard anti-dilution” is not OK: There are at least three flavors and they are wildly different, so the drafting attorney with that term sheet is guessing–or likely talking only to his side–on the issue. The stops, starts, and re-drafts is what eats up time.

Continuing with the building analogy: Every couple building their dream home wants the house built quickly and correctly, and on budget. But they had better get all the critical details decided and in the plans before the first brick is laid. In other words, if you don’t agree on the location and number of bathrooms, you wouldn’t tell a contractor to “start building now and we’ll decide on the bathrooms later.” The decisions won’t get easier if you put them off, and having a full plan in place from the beginning will make the process more enjoyable for all.

cannabis marijuana patent litigation

In previous posts, we’ve puzzled about why no one has filed a cannabis patent infringement case, despite the large number of patents granted for cannabis plants and compounds. See here, here, here, and here.

That all changed last week. United Cannabis Corporation (“UCANN”) has now filed what is believed to be the first cannabis patent infringement complaint. The case is United Cannabis Corporation v. Pure Hemp Collective, Inc., case no. 1:18-cv-01922-NYW, in the United States District Court for the District of Colorado.

The patent asserted is U.S.P. 9,730,911, “cannabis extracts and methods of preparing and using same.” The claims in the patent generally cover liquid cannabinol formulations using tetrahydrocannabinol (THC), cannabidiol (CBD), and various terpenes. See, for example, claim 10: “A liquid cannabinoid formulation, wherein at least 95% of the total cannabinoids is cannabidiol (CBD).”

Although the UCANN complaint does not specify which claims are being asserted, it appears that the plaintiff may focus on CBD-related claims, e.g., claims 10-15, rather than claims for THC. The complaint devotes several paragraphs to discussing FDA’s recent approval of Epidiolex, a CBD-based drug, as we discuss here and here. The complaint suggests that FDA will reclassify CBDs generally as Schedule II or Schedule III drugs. While it is clear that FDA will do a reclassification, it is not clear that it will reclassify all CBDs, rather than just the Epidiolex compound.

In any event, we expect to see more cannabis patent litigation soon, perhaps in Colorado, California, Oregon or elsewhere. Whether it will be a trickle or a flood remains to be seen, but we will be following the UCANN case closely and providing regular updates.

For more on cannabis patents, see our series here:

cannabis marijuana L.A. social equity
Looks good. Might get messy.

Phase II cannabis licensing in the City of Los Angeles (for only non-retail activity) kicked off on August 1 at 12 p.m. (and it will conclude on September 13th). To qualify for a City of Los Angeles cannabis license during this timeframe, an applicant must, among other things, be eligible for the City’s cannabis social equity program. This qualification factor has propelled a search for business partners who will make them eligible for Phase II cannabis licensing. Though this momentum is spurring business marriages all over the City many of these “partnerships” are little more than ruses for circumventing the social equity requirements.

It’s not unusual in the cannabis industry to see people rush into half-baked, hasty business marriages for fear that some grand opportunity will pass them by if they don’t. This is why the cannabis litigation lawyersat my firm spend so much time litigating cannabis business ownership disputes. LA’s social equity component has created a new breed of business “relationship” ripe forscamsand potential applicants on both sides of the social equity aisle need to be aware of the tricks being used to game this new system.

The below are some examples of what our Los Angeles cannabis lawyers have been seeing and are likely to see from social equity cannabis business unions in L.A.:

  1. The Tier 1 and Tier 2 Straw Men. To qualify for social equity in Los Angeles you need some combination of “low income” status, a “cannabis conviction,” or having lived in a “disproportionately impacted area” in the City for a certain amount of time. (For a detailed explanation of LA’s social equity qualification requirements go here.) Based on what you can prove as a social equity applicant, your cannabis business will be categorized as a Tier 1 or a Tier 2 business. To be Tier 1, the social equity applicant must have at least 51% of the equity in the cannabis business. To be Tier 2, the social equity applicant must have at least 33.3% of the equity in the cannabis business. Government rules that require sharing equity make even hardened business people nervous about losing voting control and search for ways around this rule. We expect to see Tier 1 and 2 cannabis businesses claim on paper (via operating agreements, bylaws, or subscription agreements) that they have the requisite equity spread while utilizing a “side letter” or a handshake to ensure that the actual social equity applicant has little to no real economic or control rights.
  2. The Incubator Terminator. L.A.’s social equity program has a Tier 3 cannabis business category that does not involve equity sharing. To qualify as a Tier 3, you must provide space, utilities, capital, business assistance, and licensing help to a Tier 1 or 2 business for no less than two years. Los Angeles is a very competitive cannabis market and I would not expect many will want to assist their competition and certainly not for free. This means we are bound to see Tier 3 businesses seek to sabotage their Tier 1 or 2 “roommates” so as to strengthen the competitive landscape for their own business. Oakland has shown what can happen when an incubator drags its feet during the entitlement process to the detriment of the social equity applicant, and unless Los Angeles mandates reporting requirements from Tier 1s and 2s to ensure Tier 3s are actually providing the help required by law, we can expect to see a Tier 3s working for the death of “their” Tier 1s and 2s during the mandatory assistance term.
  3. “Show Me the Money” Tier 1s and 2s. We have already seen Tier 1 and 2s essentially selling their status to multiple parties for a quick pay out without any actual plans to compete in the Los Angeles cannabis market. These sorts of deals go against the purpose of the social equity program, which wasto ensure those most negatively affected by The War on Drugs get a meaningful share of Los Angeles’s legal cannabis market.
  4. Is Your Partner Really a Tier 1 or 2?Many in Los Angeles wrongly believe one cannabis conviction is automatically enough to qualify for Tier 1 or 2 status. If you’re looking to partner with a Tier 1 or 2 be sure to do your due diligence to ensure they actually do meet the required criteria.
  5. Predatory Matchmakers. There aren’t many ways for legitimate Tier 1s and 2s to meet legitimate and willing Tier 3s, and our Los Angeles cannabis lawyers have been seeing more than a few questionable 11th hour brokered deals rushed to finish by the September 13th deadline. Many of  “brokerage” agreements we’ve seen have been inadequate and many deals are going through with little to no due diligence conducted by either party. These agreements are mostly boilerplate forms pulled down from the internet and badly re-purposed for social equity in L.A. Though satisfying L.A.’s requirements to qualify for Phase II is clearly important, you should not forget that these agreements will also serve as your legal foundation for a real business relationship with real obligations and liabilities and it is important thatt your agreement get the details right on things like company financing, leasing, voting, and managing day-to-day operations. Most of the “social equity brokers” putting these deals together care only about getting paid their percentage.
  6. Tier 3 Management Companies. There’s no such thing as a free lunch and many Tier 3s giving space, time, money, and assistance to Tier 1s and 2s will be expecting a lot back in return. We are already hearing of Tier 3s insisting they become management companies to the Tier 1s and 2s they plan to assist. L.A. is planning to address the issue of management companies generally in the City and that means we will likely see regulations aimed at preventing management companies from cannibalizing the opportunities intended for Tier 1s and 2s.

Los Angeles’s cannabis social equity program is a complicated undertaking and if just a handful of Tier 1 and Tier 2 cannabis businesses thrive in Los Angeles that will constitute a significant victory for the cannabis industry as a whole.