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 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.

california cannabis marijuana
State v. small growers: Who ya got?

The California Growers Association, which advocates for small and independent cannabis cultivators, recently sued the California Department of Food and Agriculture, the state agency charged with crafting and implementing cannabis cultivation regulations. The lawsuit stems from one of the biggest controversies in the state’s 2017 emergency regulations: a loophole in the licensing scheme that would effectively allow cultivators to set up mega farms by “stacking” unlimited small grow licenses. We discussed this precise issue at length at the end of 2017, and the matter is now the subject of legal challenge.

The gist of the lawsuit is that the CDFA’s failure to include a cap on small (5,001-10,000 square feet of canopy) cultivation licenses is inconsistent with MAUCRSA, the statute authorizing the CDFA to promulgate cultivation regulations. MAUCRSA generally prohibits large cultivation licenses (over 22,000 sq. ft. of indoor canopy or over 1 acre of outdoor canopy) until 2023, and limits medium cultivation licenses (10,001-22,000 sq. ft. of indoor canopy or up to 1 acre of outdoor canopy) to one per person for five years. The CDFA regulations contain no such cap on small cultivation licenses. Because the lack of a cap would essentially allow growers to do what they would otherwise be prohibited by statute from doing until 2023—i.e. cultivating more than 1 acre per person—the plaintiffs contend that the regulations are inconsistent with the statute, and that judicial intervention is needed to make them consistent by limiting total license issuance to one acre per applicant. It also bears mentioning that the state’s own environmental report recommended allowing no larger than one acre of cultivation per licensee.

Under California’s Administrative Procedure Act, one basis for challenging agency rules—and the grounds utilized by the plaintiffs here—is consistency, which is defined by the statute as “being in harmony with, and not in conflict with or contradictory to, existing statutes, court decisions, or other provisions of law.” If the CDFA regulations conflict with or contradict MAUCRSA, they are subject to challenge. However, the plaintiffs are not asking the court to invalidate the regulations altogether—only to limit small cultivation licenses to an aggregate of one acre per applicant.

Supporters of the CDFA’s approach would argue that MAUCRSA’s notable absence of a cap on small licenses, alongside explicit caps on other types of licenses, would suggest that the regulations’ reflection of that same approach is actually consistent with the statute and with legislative intent, and not the other way around. And in any event, it’s not clear what effect, if any, a short-term limitation on small grow licenses would have on market prices and competition. It remains to be seen how stringently the state will enforce regulations such as the track-and-trace program aimed in part at excluding illicit supply from entering the market (California already had an oversupply problem even before Prop 64 was passed). It’s also an open question as to how discerning consumers will be for variations in quality and speciality strains (i.e. how fungible farmed cannabis will be). It’s also unclear what effect excessive taxation might have on demand for licensed cannabis and whether consumers may be drawn to the illegal market (which is already rife with illicit mega farms).

Whichever way the CGA’s lawsuit goes, the outcome is sure to impact cultivation licensing in California and business planning for growers, but it’s not clear how much of an effect it will have on overall market demand for cannabis one way or the other. Regardless, this case is an interesting one to keep an eye on as the first substantial legal challenge to the state’s new cannabis regulations.

california cannabis
Pro environment? Or just anti-cannabis?

As we’ve discussed time and time again, California’s voter-passed cannabis legalization initiative, as well as all subsequent statutory and regulatory additions to that law, maintains local governments as the ultimate arbiters of whether and how commercial cannabis operations can take place within any given county or municipality in the state. The most prominent exercise of that authority exists through local permits and licenses (which are now a prerequisite for any state license), and land use laws, such as zoning ordinances. The starting point for any property owner considering a cannabis use on the property is the applicable zoning law and the local ordinance on cannabis, if any. Recently, property values in appropriately zoned places have appreciated accordingly.

But as the new laws are implemented, we are seeing the limits of local authority when it comes to zoning for cannabis operations. In one recent example, a group advocating for a moratorium on marijuana in San Mateo sued the County of San Mateo for opting to issue a “negative declaration” stating that its new cannabis ordinance would not have any significant impact on the environment, rather than engaging in the more rigorous option of preparing a full environmental impact report to study the effects of the proposed activity. The ordinance generally prohibits all cannabis activity except cultivation in greenhouses and transportation.

The petitioners in San Mateo brought the writ petition pursuant to the California Environmental Quality Act (“CEQA”), alleging that “the county prejudicially thwarted CEQA’s statutory goals, including environmental protection, informed decision-making and informed public participation.” According to NORML, the petitioners are an anti-cannabis group.

CEQA requires environmental review of discretionary projects to inform the public and government decision makers of the environmental consequences of their decisions and must be interpreted in such manner to afford the fullest possible protection to the environment within the reasonable scope of the statutory language. Unless exempted, all discretionary projects must receive environmental review pursuant to CEQA.

Under CEQA, the “lead agency”—the public agency principally responsible for approving a proposed project, in this case the County of San Mateo—is responsible for preparing the environmental documents for a project, including any negative declaration or environmental impact report (EIR). If a project is not exempt from CEQA, the lead agency must prepare an initial study to determine whether the project will have a significant impact on the environment, or skip the initial study and conduct an EIR if it is obvious that an EIR is required.

A negative declaration, as opposed to an EIR, is appropriate in two situations: (1) when there is no substantial evidence that shows that the project may have a significant impact on the environment, or (2) the initial study identifies potentially significant impacts, but revisions made to the project before public review of the negative declaration reduce impacts to a level of insignificance. Before approval of a negative declaration, the lead agency must find that there is no substantial evidence that the project may have a significant effect on the environment.

An EIR must be prepared if a project is not exempt from CEQA and does not qualify for a negative declaration. Generally, an EIR is required whenever it can be fairly argued that substantial evidence indicates that the project may have a significant impact on the environment. CEQA allows plaintiffs to sue public agencies for failure to comply. Plaintiffs can challenge a public agency’s decision to prepare a negative declaration instead of an EIR (like the San Mateo case), or a public agency’s determination that a project is exempt from CEQA, among other things.

CEQA litigation is rampant, and public agencies and developers alike are critical of its abuse by NIMBY groups and others who may bring an action for an improper purpose. For example, a competitor may file a CEQA lawsuit to delay or derail a competing project, or a labor union might file a CEQA lawsuit to secure an agreement that gives that union control over which project jobs will be allocated among which unions.

While public agencies, rather than private businesses, are ultimately responsible for determining how to proceed under CEQA, operators and developers should be mindful of the potential delays to their projects that could result from challenges brought by CEQA plaintiffs, and to pay close attention to any objections raised against the draft environmental document during the government approval process, which is a requirement for standing to bring a lawsuit under CEQA and could signal future legal challenges to the project. By the same token, cities and counties should be mindful of the high bar they will have to meet for any decisions involving potential environmental impact, and to plan accordingly by doing a thorough environmental review as part of the approval process for any cannabis-related proposals.

In some ways, CEQA challenges can be seen as part of the California cannabis regulatory regime’s rite of passage into public life, just as any other California industry has to contend with. But this is also an opportunity for California’s state regulators and local agencies to get it right and set an example for other states, and to show how the environmental damage caused by prohibition-era operations can be successfully mitigated with robust regulation and implementation of environmental standards. Until then, we expect to see more lawsuits brought by anti-cannabis and NIMBY groups using CEQA as a tool to challenge cannabis projects throughout California.

marijuana lease california
Leave yourself some room to maneuver with that cannabis lease.

The year 2018 began with a mixed bag. California, the nation’s most populous state and its most powerful economic engine, finally began issuing licenses to medicinal and adult use commercial cannabis businesses under the state’s new regulatory regime. Days later, the Attorney General issued a memorandum rescinding the 2013 Cole Memo enforcement guidelines, despite indicating to the contrary several months prior. There has since been bipartisan backlash against Mr. Sessions’ decision, and there are now numerous legislative proposals in congress as to how the federal government will move forward with respect to cannabis.

In the meantime, property owners still have to plan for the future, whether that means deciding how to use their property, or whom to rent commercial space to and under what terms. Operators and landlords alike are uncertain what to expect: on the one hand, state governments are issuing cannabis licenses freely; on the other, the federal government is telling its prosecutors to pursue any and all of them as they see fit–  regardless of any state’s laws. One strategy for approaching all this uncertainty is by building early termination contingencies into the lease. Below are a few of many contingencies that commercial cannabis landlords and tenants alike should consider including as part of a potential tenancy.

  1. Federal enforcement actions. This is what keeps state-legal operators up at night and what many legislators are currently trying to protect against. As long as cannabis remains federally illegal in all forms, however, this will remain a risk. One way to potentially mitigate that risk is by allowing for mutual early termination options in the event of any actual or specifically threatened enforcement actions, such as civil asset forfeiture. If the federal government’s goal is for cannabis operations on the premises to cease, then allowing each party an opportunity to force termination of the lease should be helpful.
  2. Changes in federal law and/or enforcement priorities. Similar to federal enforcement actions, the parties may want to include options to terminate the lease early if something changes at the federal level to an extent that both parties no longer feel comfortable with state law compliance alone. How significant that change would need to be is up to the parties’ negotiations and levels of risk tolerance. For example, while the Cole Memo has been rescinded, the Rohrabacher-Blumenauer amendment protecting state-compliant medicinal operations is still in effect (if only barely), so the recent federal action may not necessarily be cause for parties to end a tenancy.
  3. Cole Memo priorities as affirmative lease obligations. Just because the Cole Memo has been withdrawn does not make it irrelevant. The Cole Memo is essentially a well-thought-out list of the federal government’s highest priorities for enforcement against cannabis operators, such as preventing sale to minors, diversion to non-cannabis-legal states, and revenue to criminal organizations. Keeping these priorities in the lease as affirmative obligations that the tenant must comply with, and giving the landlord an early termination option if any one is violated, adds an extra layer of protection for both parties and helps further the state’s goal of elevating good actors and sorting out the bad. Also, we’ve already seen some federal prosecutors issue statements to the effect that existing enforcement priorities (i.e. the Cole Memo) will guide future enforcement decisions.
  4. Change in local laws/nonconforming use designation. Federal enforcement and changes in federal law are not the only things to pay attention to. California law gives cities and counties final say in whether and to what extent cannabis operations will be allowed in their jurisdictions. If something changes in local law, such as a zoning ordinance, and the proposed use becomes nonconforming and unlawful, then whether or not operations have commenced, the parties may want an option to exit the tenancy rather than fight the local government.
  5. Secured interests. Just as with residential mortgages, contracts supporting secured interests on commercial property often contain “compliance with all laws” provisions. In light of the recent federal action, lenders may be less comfortable with cannabis uses on the property securing their investment, and may be more prone to call the loan due in full, creating a problem for both landlord and tenant. In such event, the landlord may want an option to terminate the lease early without penalty.

We don’t know where the state-vs-federal conflict will go from here, and for now the cannabis industry will have to continue dealing with uncertainty. So far it seems the market is betting on the states to come out ahead. In the meantime, there are some meaningful items to include in a commercial cannabis lease that may mitigate some uncertainty and risk.

california cannabis marijuana lease
Put your lease on the list!

With the New Year upon us and California cannabis legalization in full swing, now is the time for industry players to make sure they are poised to thrive in the world’s biggest legalized cannabis market. A critical element of that strategy for commercial tenants, as well as landlords, is making sure the real property chosen for operation is properly tailored to the intended use, and is flexible enough to anticipate various adverse scenarios that can and will arise in a dynamic and rapidly changing legal landscape.

A smart and practical New Year’s resolution would be to make sure your lease is buttoned up and ready to go for commercial cannabis in 2018. Here are some points to consider towards that end:

  1. Stop using form leases. Yes, they’re easy and convenient, and checking boxes is certainly cheaper in the short term than writing a lease, but experience says one of two things will likely happen: either you will (1) end up spending just as much time writing addenda that cancel out, expand upon, or replace terms of the form lease, making it read more like a choose-your-own-adventure book that flips across chapters, or (2) you won’t, but you’ll be far more likely to run into costly problems down the road when you discover the lease is missing crucial pieces that would have helped you avoid a mess. Save yourself the trouble and plan ahead by working with an experienced real estate attorney who understands the proposed use and the industry in California, and can write a proper lease to fit the tenancy.
  2. Specifically describe the permitted use and define applicable law. There are important legal consequences under state and federal law for adult use cannabis operations vs. medical operations, and the state’s regulations require specific authorization from the landlord for whatever license the tenant will obtain. And of course, there remains the issue of federal illegality overhanging everything. To save everyone time and headaches down the road, make sure the parties are in clear agreement on exactly what categories of licensed activity will be allowed under the tenancy, specify that in the lease, and restrict it to that use. Simply writing “cannabis” or the evasive “any use not in violation of law” will not suffice. When it comes to applicable law, local law and state regulations should be front and center, and there should be a carve-out for inconsistent federal law, lest a tenant be in violation of the lease from day one.
  3. Keep it arm’s-length, or know the risks. Entanglement issues such as profit-sharing arrangements and equity-as-rent may be lucrative, but they require a higher risk tolerance. If a federal (or state) enforcement action occurs, the chances that the landlord will be considered part of the offending business may be higher than if the lease had been a traditional arm’s-length tenancy. Also, you might run into problems trying to enforce the lease if it amounts to asking the court to wade into cannabis business operations as opposed to enforcing an arm’s-length rent relationship.
  4. Clarify insurance obligations and anticipate increased operating expenses. Regardless of whether the landlord or the tenancy will be responsible for maintaining and paying for building and property insurance, the parties should realize that: (1) cannabis tenants will have a hard time finding quality property insurance policies right now, and (2) any new or existing policy will likely be much more expensive when a cannabis use is added to the property. In practice, this means that the parties need to decide who will be required to obtain and maintain which kinds of coverages, what the policy limits will be, what happens if that doesn’t happen, and who will bear the increased cost if it does. If it’s a multi-tenant building where common operating expenses will increase disproportionately due to the new tenant’s cannabis use, the lease should account for that and adjust accordingly.
  5. Do due diligence on the property first. Doing things like zoning and title analysis would more typically be associated with a new purchase than a lease. But with cannabis uses there are unique considerations that come into play, such as easements or CC&Rs that prohibit violation of “any laws”, water use rights (which will be a critical part of a state application, particularly for cultivators), and zoning restrictions. On that last item, it’s imperative that the proposed site not run afoul of local restrictions, and it behooves both the landlord and the tenant to have that issue ironed out before pen touches paper. The parties should consider including a due diligence period in the letter of intent, as well as including an early termination option for a variety of land use restrictions that could be triggered by cannabis use, including changes in zoning laws.
  6. Consider the neighbors. We’ve discussed at length how RICO lawsuits have found their way into cannabis land use disputes, as well as nuisance claims, and how NIMBYism will likely play a role in the California cannabis saga just as it has in other states. But similar to a zoning and title analysis, parties looking to start a commercial cannabis tenancy can and should factor the neighbors into the equation before deciding to commit to a lease. This is particularly relevant for business parks or multi-tenant buildings with non-cannabis tenants that might complain about the effect of cannabis (odors or otherwise) on their business operations. Better to know now than 3 years into a 10-year lease term. The parties can also consider including an early termination option in the event that neighbors bring a civil action.
  7. Consider the federal government. One of the most obvious reasons that form leases are wrong for cannabis tenancies is the failure to properly account for the fact that cannabis is still federally illegal, and the government can and does pursue civil asset forfeiture, putting the landlord at risk of losing the property over the tenant’s use. While there is no getting around the fact of federal illegality, one strategy is including early termination options for changes in federal law and/or enforcement guidelines, and for any forfeiture actions.
  8. Anticipate the license timeline. California has just started issuing temporary licenses to applicants who already have local approval. While those have had a relatively quick turnaround, full annual license application review could take longer, and in any event, there is the possibility that the tenant will be denied a state license and/or local approval. This uncertainty can be built into the lease in terms of rent abatement and an early termination option, depending how confident the parties are that approval will be successful.
  9. Make sure the occupancy plan stays legal. California’s new regulations dispensed with SB 94’s requirement that a licensee maintain “separate and distinct” premises for multiple licensed activities. However, licensed premises must still have a designated area dedicated to only one licensed activity at a time, with the exception of adult-use and medicinal operations being allowed to operate in the same place under certain circumstances. The new rules also contain a blanket prohibition on subletting of any licensed premises. This means that the parties should spell out in the lease exactly which activities will be conducted in which areas of the property. Whereas typical commercial tenants would have more or less free reign to use the leased premises however they choose as long as it’s within the permitted use, California’s new rules make this a more nuanced issue.
  10. Choose the right law, venue, and dispute resolution process. Limiting interpretation and enforcement of the lease to California law, restricting venue to state courts, and including a well-drafted arbitration clause are all important aspects of a cannabis tenancy that are typically missing from a form lease.

As we watch California’s regulatory and licensing process play out, landlords and tenants with properly tailored leases and well-researched land use analyses will be more likely to succeed and thrive. Many of the potential problems with the leasehold interest will have been considered and averted.

In 2018, resolve to make your leases better.