Photo of Daniel Dersham

Located in Harris Bricken's San Francisco office, Daniel's practice focuses on commercial and real estate disputes. His success in Federal and State trials, arbitrations, and mediations has made him a sought-after legal adviser not only for cannabis corporate clients, but also for individual owners and landlords seeking representation on a variety of real estate issues and disputes, such as leasing, land use, and regulatory compliance.

california cannabis remediation nuisance lease
Don’t get left with a mess on your land!

For California landlords leasing to cannabis businesses, we’ve previously discussed how compliance with state and local law, perhaps even more so than the specter of federal enforcement, should be a top concern when structuring the tenancy and drafting the lease. As the state ramps up its efforts to transition the industry to a robust regulatory regime, one result of those efforts that is playing out across the state is that cultivator tenants, particularly outdoor grows, are abandoning their cultivation operations rather than paying for cleanup or dealing with state or local enforcement actions.

Sometimes this is due to a lack of wherewithal to become a licensed operation and pay the costs of compliance. Other times it’s due to a change in local law that renders the operation a nonconforming use. And still other times it’s the result of a private or government-initiated nuisance action (although these actions can sometimes create other problems). But the result is often the same: The property is left abandoned and trashed, cannabis growing material such as dangerous fertilizers are left spread across the site, and, often, illegal stream diversions or alterations have been illegally constructed, posing a threat to wildlife, water quality, and natural water drainage systems. The result is an environmental disaster and a landlord left holding the bag, often with a hefty administrative fine or nuisance abatement assessment to boot. Below are some of the many considerations that should go into structuring a cannabis lease when it comes to preventing these types of situations from happening in the first place.

  1. Reviewing tenant SOPs as part of the vetting process. Before even putting pen to paper on a lease, landlords should consider requiring potential tenants to produce their standard operating procedures (SOPs) and other relevant cultivation planning documents to demonstrate what materials they will be using to cultivate, where they will be obtaining their water, how they will be disposing of waste, and how the site layout will be organized. Much of this information will have to be provided to local and state agencies anyways in order for the tenant to obtain its cultivation licenses and permits. The lease can also include tenant obligations to list all hazardous materials it intends to use at the site and to provide material safety data sheets (MSDS) for each. If the tenant doesn’t have a proper site use plan in place before they sign a lease, then chances are things will not end well for the landlord.
  2. Maintaining strict control over tenant improvements in the lease and allowing for discretionary inspection. Commercial cannabis is a strictly regulated industry (for good reason), and the lease should afford similar control for the landlord over how a tenant uses the leased premises. Indoor cultivation leases may require discretionary landlord approval at multiple stages for any alterations to the building, and outdoor cultivation leases may also require the same level of approval for changes to the land, however insignificant. The lease can give teeth to these restrictions by allowing for landlord and government inspections, and affording the landlord early termination options for a tenant’s failure to comply.
  3. Including strong tenant indemnifications for remediation. Indemnity clauses provide a guaranty that a tenant will hold the landlord harmless and defend it against certain types of claims. A common such clause pertains to remediation of hazardous substances on site, where the tenant promises to pay for any costs associated with spills or contamination. Cannabis cultivation leases can add to that by including cleanup costs for any damages caused or messes left behind by cultivation operations, and defense costs for any governmental remediation actions or private nuisance actions requiring abatement.
  4. Including early termination options for government enforcement actions and third-party lawsuits. If the government or a private actor sues the landlord or the tenant because the tenant is causing a nuisance by creating a mess (and not just by conducting the permitted use—another example of a carve-out that tenants will want to include), the landlord will want to be able to abate the problem quickly by terminating the tenancy and enforcing the tenant’s indemnity obligations. To that end, the lease can include a landlord early termination option to end the tenancy and evict the tenant on short notice, should the landlord opt not to deal with convincing the tenant to comply.
  5. Adjusting the security deposit to the size of the cultivation operation. While commercial security deposits are normally one or two months’ rent, there’s nothing requiring them to be. Because the stakes for noncompliance are so high in this industry, landlords may consider upping the deposit to an amount sufficient to properly deal with a cleanup of the tenant’s operation, should tenant fail to comply and abandon the premises. The lease can also be written so that the security deposit essentially acts as a bond for performance of the indemnification obligations, though in California there are necessary statutory waivers to be included in the lease.

California is serious about dragging its cannabis industry into regulatory compliance, and that includes a lot of cultivation site cleanup and forward-looking maintenance. California is also extremely serious about compliance with its environmental laws, as the world already knows, and we are fortunate for that. Landlords should be aware of the consequences of the leased premises turning into a nuisance or environmental violation, and consider how to build the tenancy to protect against such problems from the get-go by drafting a proper lease agreement. When everyone’s on the same page about strict compliance and good environmental stewardship, everybody wins.

california cannabis lease
…with your California cannabis lease.

The current state of enforcement in California tends to be dominated by headlines about the Department of Justice, Jeff Sessions, the DEA, and the Controlled Substances Act. And for good reason—under the constitution, federal law is the law of the land, and commercial landlords and tenant alike should study federal enforcement guidelines closely. Lease agreements should account for those guidelines by mandating clear tenant compliance obligations as well as providing for appropriate remedial measures in the event those obligations are not followed.

But California’s commercial cannabis legal regime does not exist under or because of federal law—rather, it is a creature wholly of state and local law. California statutes, state agency regulations, and city and county ordinances, zoning plans, and land use restrictions are what form the flesh and bones of California cannabis law. As a result, most risks affecting commercial tenancies materialize not from threatened federal action, but from issues surrounding compliance with state and local law, and related enforcement actions. Commercial cannabis leases in California should therefore primarily account for and address these risks. Following are examples of some specific issues that should be addressed in the marijuana business leasing process.

     1.     State and local enforcement actions. 

After twenty years of a mostly hands-off approach to the medicinal cannabis industry, it has proven difficult for the state to properly incentivize cannabis businesses to apply for licenses and comply with California’s new cannabis regulatory regime. And the ones that have done so are currently at a relative disadvantage in that they cannot deduct business expenses for tax purposes, must pay the costs of acquiring permits and licenses, and must maintain compliance with all applicable laws (which continue to change not infrequently). With the exception of a legislative budget dispute on how to fund it, the state is set to ramp up enforcement efforts against unlicensed entities. What this means for cannabis tenancies is that leases should include, among other things: strict compliance obligations that track the status of local and state regulation; a clear licensing and permitting timeline with built-in contingencies for failure to acquire, maintain, or comply with any relevant government approvals; and early termination contingencies for enforcement actions brought by local or state agencies. While these are similar to federal enforcement contingencies, they can go further by tailoring to locality-specific requirements, and referencing specific provisions of tenant permits when available. Whereas the industry is rife with speculation about federal enforcement priorities, there is a voluminous amount of information about state and local laws applicable to the cannabis industry in California, and tenancies should take advantage of that knowledge to minimize risk of adverse enforcement actions.

     2.     Change in local law rendering tenant’s operation a nonconforming use.

Interestingly, this is often something that I have had to convince clients is actually a real risk to consider: a locality passing a commercial cannabis ordinance, and then following it with a ban, but not before issuing cannabis permits and happily accepting the fees. This first became an issue in states such as Washington where legalization occurred early on, and it’s now becoming an issue in California, inevitably leading to enforcement of those post-hoc bans and ensuing criminal charges and civil litigation. Whether or not a ban is ultimately upheld in court, it creates uncertainty and immediate enforcement concerns for landlords and tenants. Leases should account for this risk by building in early termination contingencies for changes in local law, or, depending on what the parties negotiate, indemnification and attorney’s fees provisions in the event one of the parties decides to challenge the change in law.

     3.     Zoning, land use, and water rights.

No matter what the federal government might say or do in the future, every locality will always have laws that govern how land within its borders may be used, and how water may be used on that land. While such laws are not unique to commercial cannabis, laws that apply to cannabis in California are, and they vary between every city and county. Of course, there are also private land use restrictions such as CC&Rs and easements that may affect a cannabis use. In every commercial tenancy there are risks that such laws and restrictions would prevent the tenant from performing the permitted use, perhaps due to an overlooked setback requirement, or a property that’s zoned for one cannabis use but not another, or a conservation easement on farmland whose terms require compliance with “all laws” (including federal), or an inability for the tenant to divert enough water or property discharge waste. These issues should be part of a tenant’s due diligence process prior to singing the lease, and responsibility should be allocated accordingly in the lease. But it doesn’t hurt for the landlord to conduct its own analysis during the tenancy vetting process, and the lease can also be structured to allow for early termination if any such unanticipated issues arise, including in the event that any such laws or restrictions change during the tenancy.

What is unique about state and local laws is that they will likely remain active concerns for commercial cannabis leasing no matter what the federal government does in the future. More so than typical commercial tenancies, cannabis landlord and tenants alike will have to continue to account for state and local issues that present risks to the tenancy, and all parties will have to stay abreast of laws and regulations as they continue to change.

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

california marijuana cannabis

The year 2018 has been confusing so far for California’s commercial cannabis industry in terms of the conflict between federal and state legal regimes. It began with California formally opening its doors for licensed cannabis activity. That was soon followed by the U.S. Department of Justice rescinding its 2013 Cole Memo that deprioritized enforcement against state-legal cannabis operations — a move that sparked considerable concern among operators who had invested substantial resources to become legitimate, licensed cannabis businesses. Then we discovered that the former Republican speaker of the House, previously having been “unalterably opposed” to cannabis, had now become a board member of a cannabis investment company.

Next, we heard about a massive enforcement effort against cannabis grow operations in Sacramento involving one of the largest residential civil asset forfeiture efforts in U.S. history. Meantime, California continued to struggle with its persistent black market problem, as the vast majority of operators have declined to come into regulatory compliance, due in no small part to the enormous market advantage of not paying licensing fees or the extremely high taxes levied on legitimate cannabis businesses.

The uncertainty and apparent inconsistency begs the question, what are the current state and federal policies on cannabis enforcement in California? We don’t have a crystal ball, but we can glean some information based on what the state and federal government are saying and doing as of late. It’s good news.

We’ve previously observed how state and federal enforcement incentives have started to converge based on common interests. That convergence has continued and has actually become somewhat solidified through public statements of federal and state law enforcement officials. Recently, the U.S. Attorney for the Eastern District of California, McGregor Scott, issued informal guidance on his office’s cannabis enforcement goals: “The reality of the situation is there is so much black market marijuana in California that we could use all of our resources going after just the black market and never get there … So for right now, our priorities are to focus on what have been historically our federal law enforcement priorities: interstate trafficking, organized crime and the federal public lands.” To that end, the federal government will allocate $2.5 million towards enforcement against illegal grows on public land, a concern arising largely due to an increase in the use of banned pesticides on federal land in California.

It has not been lost on careful observers that Mr. Scott’s announced enforcement priorities align closely with those of the 2013 Cole Memo. Mr. Scott also appeared to distinguish the illegal operations he seeks to target from the legal cannabis regime that California is working to implement: “[California’s black market] is of biblical proportions and what we’re talking about here today is a classic example of that market—people who have no intent of ever entering the legal system that has been created and California has attempted to establish.” In other words, a top federal law enforcement authority in California seems to be conveying that the federal government will not prioritize licensed commercial cannabis operations that comply with California laws and regulations.

On the state side of things, the Bureau of Cannabis Control is working on finalizing its regulations and is continuing to process state licenses, and Governor Brown has sought to put teeth behind those regulations, requesting $14 million “to crack down on tax evasion, conspiracy and other financial crimes by the black market cannabis industry as well as stem the flow of illegal cannabis in the mail and parcel delivery systems.” At the same time, licensed cannabis businesses have started to speak out more forcefully against illegal operators, and rightfully so: black market businesses have an enormous market advantage in that they don’t pay taxes or licensing fees, and follow no advertising or distribution restrictions. While the cannabis industry was largely united behind Prop 64, which legalized cannabis in 2016, those alliances have diverged as some businesses have taken the legal route while others have remained in the shadows. In fact, we’ve now reached a point where licensees are filing formal complaints against illegal operators and local prosecutors are encouraging them to do so.

Given the federal government’s desire to protect public lands, eliminate organized criminal operations, and prevent interstate trafficking of cannabis, and given California’s desire to give meaning to its regulatory regime and prop up those operators that have spent the time, effort, and resources to become licensed citizens of the California cannabis industry, it’s no wonder that the previously unthinkable is now materializing: the federal government is now teaming up with the State of California to crack down on unlicensed cannabis operations. What comes next is uncertain, but one thing is clearer now than ever: commercial cannabis businesses in California are now exponentially better off from an enforcement standpoint if they can demonstrate compliance with California laws and regulation. That includes spending the time and effort to obtain a state license.

california cannabis leasing
Again and again and again.

Last Friday, California released another round of emergency regulations that essentially renewed the existing emergency rules, but with some updates, a fair amount of which affect commercial cannabis leasing. Here are some of the notable ones.

“Premises” distinctions defined. SB 94 and AB 133, the statutes enacted in 2017 to implement and refine Prop 64, both defined a licensed “premises” as a “designated structure” that is held “under the control” of the licensee for commercial cannabis activity, and must be contiguous and held by only one licensee. The statutes did not, however, define what those terms meant with regard to physical segregation of licensed spaces, which is an important factor for places like warehouse spaces where multiple tenants want to operate concurrently, or any rental space with common areas. The new emergency regulations address this issue by clarifying that for the areas of a licensed premises required to be under a licensee’s exclusive control for operations, actual walls and locked doors will be required, but that common or shared spaces will be allowed for multi-tenant spaces without violating that requirements. This may seem like common sense, but until now it was not codified. This means that landlords and tenants alike will have more certainty in planning out the leased premises.

Potential for shared entrances. On a related note, the new rules contemplate the use of a shared entrance, so that each licensed premises need not have its own exclusive access to the outside world. The catch, however, is that if neighboring licensees share a common entryway, and state inspectors are prevented from accessing a licensed premises due to a neighboring licensed premises preventing passage, then both licensees shall be responsible for the access violation and subject to discipline. Be warned!

No change to license stacking. Sometimes a lack of change is more significant than a change. The prior emergency regulations caused some controversy by allowing for stacking of small cultivation licenses and the potential proliferation of cannabis mega-farms. In fact, the state had to defend a lawsuit over this very issue. But despite all the controversy, the new regulations do not change the situation: a single licensee can still hold an unlimited amount of cultivation licenses each for up to 10,000 square feet of canopy, with no requirement that those licenses each have a separate and distinct premises.

Strict separation of residential and commercial buildings. It’s very common for commercial cannabis cultivation property purchases, especially in California’s Emerald Triangle, to include a residential home on the property. We’ve previously written about the pitfalls of these farmhouse purchases. The new emergency regulations reflect the state’s concern with mixing home and work when it comes to cannabis. The rules now require that the premises diagram in the license application clearly define which buildings on site are residential and which are commercial, and prohibit any licensed premises from being located within a private residence or from requiring a person to pass through a private residence to access the licensed premises.

Expanded access to shared utilities. An update to the rules last month created a new opportunity for manufacturer co-tenants to sublease shared space under certain circumstances, similar to a time-share arrangement. The new emergency regulations provide additional opportunities for tenants in a multi-tenant building or shared space to pool resources, including security camera systems, security guard services, and alarm systems. The catch, however, is that if multiple licensees decide to share such resources, each licensee is responsible for the violation of any regulations by any other licensee as it pertains to the shared resource.

It remains to be seen what other changes the state might make to its cannabis regulations when it issues its final rules, but it does seem that the rules are tending towards economies of scale in some respects. It will be interesting to see how strictly the state decides to enforce its rules as it continues to deal with black market stragglers that have thus far declined to join the regulated community.

california cannabis insurance
In California, it just got easier for landlords.

One of the most important elements of a commercial tenancy is insurance. Generally, the landlord maintains property insurance for damage to the building, existing improvements, and surrounding property, as well as liability insurance for bodily injury and property damage occurring on the premises. The landlord will typically pass the cost of that coverage on to the tenant as an operating expense, proportionally according to the tenant’s share of space in the building. The tenant will typically be required under the lease to carry, at its own expense, property insurance on all tenant improvements and tenant personal property, as well as its own liability policy covering injury and property damage occurring on the premises.

Because marijuana remains a Schedule I controlled substance that is federally illegal to produce or sell, most traditional insurance companies have declined to write insurance policies for the commercial cannabis industry. This relates to the federal illegality of marijuana itself, and also the increased risk associated with commercial cannabis as a result of such illegality, e.g. increased rate of loss from theft or burglary. As a result, landlords and tenants alike have often had to look to non-admitted carriers or surplus lines insurers to write a rider on a policy to cover cannabis activity. Such coverage is often extremely limited in scope, rife with exclusions, and very expensive. That said, rolling with a general liability policy that is not specific to cannabis is often even worse.

In industries other than cannabis, buyers tend to disfavor non-admitted carriers. This is due to the risk of losing out on various benefits offered through admitted carriers. Such benefits include: the certainty of financial stability and good business practices that comes with the state’s stamp of approval, the right to appeal claims that are denied, and the guarantee that the state will pay certain claims if the insurance company goes bankrupt. Cannabis businesses have had none of these benefits, until now.

Last week, the California Department of Insurance announced that it has approved a Lessor’s Risk policy issued by California Mutual, a traditional carrier with an “A- excellent” rating, for landlords renting to commercial cannabis tenants. Lessor’s Risk coverage is typically a comprehensive landlord insurance package that includes both the property and liability coverages often carried by commercial landlords. Specific commercial cannabis activities and businesses services by this announced coverage would include cannabis labs, product manufacturing, cultivation, and dispensary operations.

In the bigger picture, this is an important development for at least two reasons. First, it signals to other large insurers that the water is warm to start writing policies for cannabis businesses, and increased competition will mean lower prices, which will encourage more landlords to lease to cannabis tenants. Second, it is a huge step towards further legitimizing the cannabis industry by treating it like any other industry that requires business and government services. And it also highlights the need for perhaps the most important business service, banking, which is currently headed in the right direction as well.

All in all, when you have the Insurance Commissioner for the fifth largest economy on earth organizing cannabis facility tours for insurance executives, you can’t help but notice how seriously the state is taking this industry. That’s a good thing for landlords and tenants alike.

california marijuana lease
…of about a million frequently asked questions.

We’ve previously written a lot about commercial leasing issues in the California cannabis space, including some basic concepts, some key things to consider in getting leases right, and some ways to improve your leases. But there are certain common questions that tend to come up in a leasing transaction, and whether you are the landlord or the tenant, getting yourself up to speed on these issues now will save you loads of trouble down the road. Here are five examples of questions that frequently come up in cannabis leasing.

I’m a commercial landlord, what are my risks if I decide to rent to a cannabis tenant?

In a federal law enforcement scenario, the consequences could be serious. Marijuana is still (as of this writing) a Schedule I controlled substance, meaning that on the books, the federal government views cannabis as being on par with fentanyl-laced heroin. That may sound absurd—and it is—but in terms of federal drug enforcement it means that civil asset forfeiture actions are a real risk for landlords that knowingly rent to cannabis tenants. Making matters worse, the Department of Justice rescinded Obama-era enforcement guidance that deprioritized prosecution of state-legal cannabis businesses that comply with state law and don’t involve themselves with things that the federal government really cares about, like organized crime, growing on federal land, advertising to minors, or exporting to non-legal states.

So that was the scary part. The good news is that with each passing day, the federal government is getting closer to adjusting federal law to align with public opinion on legalization, whether it’s the administration apparently abandoning the federal crackdown on cannabis, or the Senate minority leader introducing a bill to decriminalize, or the former Republican Speaker of the House joining the board of a cannabis investment fund and saying his views on cannabis have “evolved.” While the Department of Justice is still prosecuting cannabis operations and filing asset forfeiture actions, in the last few years it has continued to follow the Cole Memo priorities, even post-rescission, a fact that may actually prove to help California establish and enforce its regulatory regime.

The key to this equation for commercial landlords is requiring a tenant’s strict compliance with state law as an affirmative obligation of the lease agreement, and building in termination contingencies for changes in law or federal enforcement actions.

My prospective tenant says she needs a signed lease before she can get a permit to operate, but I don’t want her in without a permit. How do I protect myself?

In most jurisdictions, both the local permit and the state license are tied to the property, and are non-transferable, so both parties almost always run into this chicken-and-egg problem. A common solution is to build in a licensing timeline and contingencies for failure of permits to issue. A bit like a tenant improvements build-out plan but with fingerprint scans and background checks, cannabis permits and licenses are no sure thing. But the uncertainty of getting government approvals can be built into the lease, sometimes with abated rent in the meantime.

My property insurance seems like it might increase, should I pass that cost onto the tenant?

Trick question: You need to start shopping for new insurance. You will likely lose your existing building insurance coverage when your carrier finds out you’re bringing on a cannabis tenant, and if you wait until you have to submit a claim to let them know, you could have a rude awakening when the carrier declines to pay on the policy due to breach of the insurance contract. While landlords can charge a premium for rent to cannabis tenants, so too can insurance companies charge a premium for premiums on commercial cannabis tenancies.

I have a mortgage on my building, will that be affected if I take on a cannabis tenant?

It depends on the contract, but probably. And that also applies if you want to refinance down the road. Most loan agreements and deeds of trust securing a loan with real property contain some sort of language requiring compliance with “all laws” regarding use of the property for the duration of the loan. Absent a smart carve-out for federal law inconsistent with state cannabis laws, such phrasing presents a problem for potential cannabis uses. Any decision to take on a cannabis tenant must consider existing security interests on the property and compliance with the terms of the contracts. That may mean shopping for hard-loans, but it’s certainly a problem better dealt with prior to the new tenancy rather than midway through when you find out your lender is calling your loan due for violation of contract terms.

My potential cannabis tenant wants to sublease to other operators. Is that a problem?

It depends what kind of subleasing we’re talking about. The general rule is that the state prohibits a tenant from subleasing all or part of a licensed premises. But as of last month, the state is now allowing manufacturers, under certain circumstances, to operate in shared spaces under a sort of timeshare arrangement. Depending on the nature of the space and the terms of the proposed subtenancies, a landlord may want to prohibit subleasing in the lease terms and work backwards from there.

At the current rate, we could soon see a sea change in federal policy such that cannabis tenancies become less risky and less expensive very quickly. But even if some of the more modest proposals take hold, it will still be imperative to mandate strict compliance with state cannabis laws as part of a tenant’s lease obligations as a means to protect the landlord, as well as the viability of the tenancy. Only time will tell.

For more on cannabis leasing generally, see:

california cannabis marijuana
California and the Feds are an odd couple in canna law enforcement.

When the Cole Memo was rescinded in January, uncertainty was rife on all sides of the state-regulated cannabis industry. Neither the regulators, the regulated, nor the unregulated knew what to expect from the federal government. The U.S. Department of Justice told each of its 93 United States Attorneys to exercise his or her own discretion when it comes to enforcing the federal prohibition on cannabis. While some indicated that they would more or less continue to follow the Cole Memo, the nature and status of enforcement priorities suddenly became an open question. Through the recent budget bill, thankfully, we learned that Congress would continue to prohibit the DOJ from enforcing against state-legal medicinal cannabis operators, but case law interpreting that law is relatively undeveloped.

On the other side of the equation, California regulators continue to struggle with the still-unlicensed operators who have decided that it’s better to continue operating unregulated and unlicensed—and tolerate the ongoing risk of a crackdown—than it is to incur the costs of compliance. That calculus depends largely on the robustness of the state’s enforcement efforts, which, like the federal government’s priorities, has also been somewhat of an open question. Two recent developments in California suggest what direction the Department of Justice may be headed on the question of cannabis enforcement. Perhaps even more interesting, however, is how the interests of the federal government and the state of California have apparently converged—if only for a moment—on the issue of cannabis enforcement.

Recently, hundreds of federal agents and local law enforcement officers conducted raids at 74 houses in and around Sacramento, in the Eastern District of California, and filed more than 100 civil asset forfeiture actions against residential properties. The houses, many gutted to make room for indoor grow rooms, were reportedly part of a Chinese organized crime operation for the secret cultivation and export of cannabis, and may have been purchased with funds of dubious origin. But the U.S. Attorney in charge of the enforcement action made clear that it had nothing to do with California’s cannabis regulatory regime, as the authorities weren’t conducting actions interfering with state cannabis laws, and that the alleged actions would be “illegal under anybody’s law.” Needless to say, the suspects did not have state or local licenses to conduct any cannabis activity.

In United State v. Gilmore, a case on appeal from the Eastern District of California, the court held that the operators of an El Dorado County cannabis garden on federal land were not entitled to the protections of the Rohrabacher-Blumenauer amendment, which restricts DOJ funds from being used to prosecute medicinal cannabis in states where it is legal. The court reasoned that nothing in federal or California law purports to allow anyone to grow cannabis on federal lands: In other words, there is no set of circumstances under which this operation would be compliant with state law. (Of particular note was the court’s rejection of the appellants’ claim that they were unaware they were growing on federal land—a good plug for the value of due diligence in a real estate transaction).

In both the Sacramento and El Dorado County cases, the federal government carried out or continued enforcement actions against operators who were neither licensed nor in compliance with state law. Also in both cases, the exit of unlawful operators from the marketplace furthered the state of California’s regulatory priorities; local law enforcement even assisted with the Sacramento raids. It is not clear what DOJ’s cannabis enforcement priorities will be going forward, but it cannot be ignored that at least in these two cases, the interests of both governing bodies were served, and under circumstances consistent with Cole Memo priorities to boot. It begs the question of what might result from future alignments of priorities, but the reality is that California has an unregulated black market cannabis problem, and at least in these two cases, that problem was alleviated to some degree.

California marijuana manufacturer
Finally, a boost for small manufacturers.

This past Friday, the California Department of Public Health—the agency charged with regulating commercial cannabis manufacturing—issued new emergency rules to allow certain types of manufacturers to operate in shared use facilities and on shared equipment, under essentially a sort of timeshare sublease arrangement. The move is a win for small, medium, and artisan manufacturers that don’t have the budget to buy commercial property or take on an expensive lease, and who have the ability to run a lean operation without large space requirements.

The new rules require an existing “primary licensee” with a Type 6 (nonvolatile extraction), Type 7 (volatile extraction), or Type N (infusion) license that either owns or leases suitable manufacturing space. If the locality approves of the arrangement and issues the appropriate permits, the primary licensee can then enter into a use agreement with multiple “Type S” licensees— manufacturers that can engage in packaging and labeling, food infusion, and some butter and oil extraction operations required for the infusion process, all in the same space, as long as they have less than $500,000 in annual revenue.

Each Type S licensee must have their own designated space to store their cannabis and cannabis products, and the shared-use facility must have a security plan as with any other licensee. Under this new arrangement, however, Type S licensees can have exclusive access to the shared-use facility and equipment at their own designated times, like a time share. The California Bureau of Cannabis Control’s existing rules prohibit licensees from subletting all or part of a licensed premises. But under the new Type S rules, the use agreement creating the shared-use arrangement satisfies the requirement of lessees to demonstrate the legal right to occupy a space and obtain landlord approval for the proposed cannabis activity, implying that the relationship is akin to a sublease and thus seemingly creating a limited exception to the prohibition.

What this means for manufacturers looking to break into the market is that even in high-priced areas, there is an opportunity to cut costs by sharing rent and equipment—two of the largest recurring expenses for manufacturing operations. Companies with shared space can also potentially take advantage of group savings on expenses like insurance, maintenance and service contracts, utilities, security services, and distribution. On the other side of the equation, the new rules also present an upside for landlords and master tenant “primary licensees,” whose owned or leased space will now be able to command more overall rent, much like a dated 3-bedroom apartment in San Francisco can command $6,000: more tenants to spread the cost.

The next question will be what other actions the state might take to benefit small and medium commercial cannabis operations, as it faces challenges claiming that it has benefitted large scale operators at the expense of the still-growing artisan industry. Time will tell, but at the moment, small-scale manufacturers have cause to celebrate.

marijuana bankruptcy lease
Bankruptcy cases have been hard, when cannabis is involved.

A recent unpublished decision out of the Ninth Circuit Bankruptcy Appellate Panel presents an interesting set of facts and a decision that may leave one questioning which direction the bankruptcy courts might be headed in the era of legalized cannabis. An elderly Nevada resident owned some commercial property at a shopping mall in South Lake Tahoe, and had been leasing it for several years to a medicinal cannabis dispensary (the lease specifically authorized the tenant to operate a “dispensary”). After several years of state-legal operations, an argument arose over an alleged option agreement to purchase the property, and the tenant sued to force a sale of the property. The bank holding the mortgage recorded a default shortly thereafter and began foreclosure proceedings.

The owner then filed for Chapter 13 bankruptcy, which is a form of debt reorganization that allows a debtor to pay creditors on a court-approved payment plan. Her proposed plan called for her to sell off the commercial property occupied by the dispensary but continue renting it in the meantime, so she filed a motion to reject the lease and the option agreement, and proposed a payment plan that included giving the bank rental income from the dispensary. The city also joined in, asking the court to reject the lease on the grounds that the tenant’s permit to operate the dispensary had expired due to the owner’s failure to provide written consent (a good plug for including a landlord cooperation clause in commercial cannabis leases).

The tenant fired back with an interesting approach: he moved to dismiss the bankruptcy petition altogether on the grounds that the owner’s acceptance of his cannabis dispensary’s rent payments violated the federal Controlled Substances Act (CSA). None of the motions were heard, though, because the lower bankruptcy court decided to dismiss the petition on its own, declaring that the owner had “committed a crime” by accepting rent from the dispensary while the bankruptcy case was pending.

On appeal, the bankruptcy appellate panel vacated the lower court’s decision and remanded, because the court had failed to articulate any findings or legal basis justifying the conclusion that the owner was violating the CSA and that violation was grounds for dismissal. The appellate panel in its opinion discussed the importance of establishing knowledge and intent to lease the property for marijuana cultivation in order to prove a CSA violation by an owner, and in turn to use that violation as a basis for rejecting a bankruptcy petition. In sum, the appellate panel highlighted the high bar that a court must clear to be able to use accepting cannabis rents as a reason to deny a property owner’s bankruptcy petition, even were the rents are accepted after the petition was filed.

While the owner’s bankruptcy case may have lived to fight another day, nothing about the case invalidates the CSA or even precludes using it as grounds for dismissing a bankruptcy petition. But the case highlights the ongoing conflict that federal courts are confronting due to the status of state-legal cannabis as being federally illegal. The lesson of the case is nicely framed in the concurring opinion: “With over twenty-five states allowing the medical or recreational use of marijuana, courts increasingly need to address the needs of litigants who are in compliance with state law while not excusing activity that violates federal law.”

Courts often invalidate unfair spot zoning ordinances.

We recently discussed the California Environmental Quality Act as a limitation on local zoning authority through environmental regulation. Another important limitation on local authority when it comes to cannabis ordinances is spot zoning, which is the act of singling out specific parcels of land to benefit specific owners at the expense of others in the surrounding areas. Spot zoning can exist in the form of restricting activities from occurring on specific parcels, or by providing exclusive use benefits to specific parcels—such as allowing licensed marijuana operations in select places. It is essentially the practice of creating zoning “islands” that are decidedly dissimilar to their surrounding areas, and is often the subject of legal challenges.

Recently, a San Bernardino County Superior Court judge invalidated Measure O, a voter-approved ballot initiative that eliminated a city-wide ban on medicinal cannabis and required the City of San Bernardino to allow commercial cannabis operations in certain parts of the city. The court found that although Measure O provided a variety of areas in which cannabis cultivation, manufacturing, testing, transportation, and distribution could occur, it limited the possible dispensary sites to just two addresses, one of which was the Flesh Showgirls strip club.

The court noted that not all spot zoning is invalid per se, but spot zoning is impermissible if there is no rational basis for it—i.e. if it is arbitrary or capricious. An example of potentially permissible spot zoning would be restricting a portion of land within a commercial development to residential use, because doing so might benefit the public interest by maintaining dedicated housing. Similarly, a city might allow an island of land within a residential neighborhood to obtain commercial licenses for retail and light manufacturing, in order to preserve a neighborhood commercial district for the benefit of the local community.

In the San Bernardino case, however, the court found no such rational basis. The court opined that no justification was provided for why two particular parcels were singled out as the only locations in the city that could have dispensary use. According to the court’s ruling, “these two addresses are separated from each other by several miles and are surrounded on all sides by similarly situated yet non-qualifying properties,” and that there was no rational basis for doing so, nor was there any discernible public interest served. The court determined that Measure O effectively created a zoning duopoly in the two dispensary addresses “with the owners of these two locations the sole beneficiaries.” Accordingly, the court concluded that unlawful spot zoning had occurred, and held that because it was not feasible to sever the dispensary zoning from the overall initiative, Measure O was invalid in its entirety.

We have heard rumblings of special interest groups organizing to pass initiatives in California jurisdictions that currently prohibit commercial cannabis activity. Any groups pursuing such a path should be mindful of the Measure O case and the invalidity of spot zoning without rational basis. While the idea of eliminating competition by drafting a ballot measure favoring select parcels of land may seem like an attractive business proposition, even if an initiative passes with support of the voters, it can still be overturned by a court of law if it is legally defective.

While San Bernardino County may have to go back to the drawing board on its cannabis zoning, the lesson is clear: if you’re going to limit the places where cannabis businesses can operate, there has to be a rational basis for doing so that serves a legitimate public interest, and it cannot create an unfair monopoly over the market for select participants. Otherwise, you risk a court invalidating the ordinance altogether.