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.

sonoma county cannabis RICOFor a while, criminal conspiracy lawsuits against cannabis operations looked like a potentially promising strategy for cannabis prohibitionists to try and use litigation to reverse the trend of legalization. The idea is to use the Racketeer Influenced and Corrupt Organizations Act (“RICO”), a federal statute intended to combat organized crime–and which allows private rights of action for lost property value resulting from criminal operations–to enjoin cannabis operations and recover damages to force the operators out of business. The typical set of facts is that a residential neighbor plaintiff claims that his or her property value is damaged by the existence of a nearby cannabis operation, usually outdoor cultivation, and names as a defendant every single person and business that had any conceivable connection to that operation.

There were a handful of relative successes with this strategy early on, culminating in a 10th Circuit Court of Appeals decision allowing a RICO claim against cannabis cultivators to move forward on a theory of diminished property value. However, that victory was soon followed by a resounding defeat in a jury verdict finding no such diminution of property value. Subsequent U.S. District Court decisions from Oregon continued the backward slide, finding that although the residential neighbor plaintiffs might have potential personal injury claims for nuisance, they were unable as a matter of law to demonstrate a plausible claim for injury to the value of their property.

That trend has now found a secure foothold in California, where a San Francisco federal court recently dismissed a lawsuit by residential plaintiffs in Sonoma County alleging RICO claims against a neighboring cannabis cultivator. While the court acknowledged that the plaintiffs could potentially move forward with their claims for “diminished sense of serenity” and various “cleaning, medical, legal, and other expenses,” it found those damages would have to be pursued though traditional state law nuisance claims, not federal RICO claims, noting that “RICO was intended to combat organized crime, not to provide a federal cause of action and treble damages to every tort plaintiff.” Ouch.

Furthermore, California law added another unique element to the court’s decision. Although California recognizes claims for diminution in the market value of their homes, including prospective future losses, and such losses could potentially be compensable under RICO, under California law, “a plaintiff in a continuing nuisance case may not recover diminution in value damages because the plaintiff would obtain a double recovery if she could recover for the depreciation in value and also have the cause of that depreciation removed.” And in this case, the court found that the alleged cannabis cultivation issues would be better classified as a continuing nuisance and that the defendants had already abated the nuisance while the lawsuit was pending. Therefore, the plaintiffs’ property loss claims were effectively moot.

In the end, although the defendants prevailed on the motion to dismiss, the case was more of a pyrrhic victory because the defendants had to shut down, as they were not properly permitted by the county or licensed by the state, and the court granted leave to amend the complaint to still allow the nuisance claims to proceed. But at least in terms of the viability of RICO lawsuits as a tool to reverse cannabis voter initiatives, this was another nail in the coffin.

For more on RICO cannabis litigation, check out the following posts in our series:

california marijuana leaseWe’ve previously written about some of the pitfalls for landlords to avoid when leasing to commercial cannabis tenants in California. We’ve also recently discussed some relevant issues for landlords created by the state’s near-final regulations. And we’ve also looked at some of the biggest uncertainties remaining after the state issued those regulations. Now that we have a clearer picture of what the regulatory regime will look like in 2019, here are some issues we’ve encountered in practice that both landlords and tenants should consider before finalizing a commercial cannabis lease in California.

Status of Cannabis Enforcement in California

As of today, the cannabis plant (which includes hemp), including any parts of the cannabis plant and all derivatives therefrom, remains a Schedule I controlled substance that is illegal under the Controlled Substances Act, except to the extent it contains a THC concentration of not more than 0.3% on a dry weight basis (i.e. not psychoactive), in which case it is now legal under federal law thanks to the 2018 Farm Bill. This confusing result follows a year in which the federal government, despite some early drum-beating about a resurgence of the drug war, made clear time and time again that its priorities when it comes to cannabis enforcement are illegal grows on federal land and organized crime. There has been no crackdown on state-licensed cannabis businesses in California (or elsewhere, as far as we know), and on the other side of the equation, the legalization and decriminalization movement has forged ahead to now include several more states, Canada and Mexico, and an incoming Democratic House leadership that has pointedly prioritized the issue in line with surging public support nationwide. Still, however unlikely federal enforcement efforts against state-legal cannabis businesses may seem, until full federal legalization occurs, landlords and tenants alike should consider building contingencies into the lease to anticipate enforcement actions and how they will affect the tenancy.

Structuring the Tenancy Relationship

Even before California came out with its new regulations, it was still a risky proposal for landlords to accept ownership in or profits of a cannabis tenant in lieu of rent. That concern has become even more salient under the state’s new regulations, since landlords can unintentionally become undisclosed “owner” or “financial interest holders” of the tenant cannabis business, thereby subjecting themselves to unanticipated and burdensome disclosure and vetting requirements. The parties to the lease should consider the unintended consequences of anything other than an arms-length tenancy and pay careful attention to the new regulations on point.

Licensing and Permitting Contingencies

The easily obtainable temporary state cannabis license is a thing of the past; now applicants must submit the full annual license application, which is far more robust and demanding (although applicants can now obtain provisional licenses if they previously held a temporary license, they can only do so after submitting a full annual application). Similarly, it can take months for an applicant to obtain a conditional use permit in localities that require one, which is common. Understandably, neither landlord nor tenant will know quite how they feel about the tenancy–and how much they want to invest in tenant improvements–until there is more certainty on licensing. A common solution has been to build into the lease an anticipated licensing timeline with benchmark contingencies that allow the parties to evaluate progress and decide whether to terminate if there is not enough.

Operating Expenses

Cannabis tenancies often involve unexpected costs that neither party fully anticipated, which can create a problem especially for multi-tenant properties. For example, you can expect that the landlord’s building insurance policy will not allow for a cannabis tenant and that the replacement policy will be more expensive. Cannabis businesses in California have to comply with strict security protocols that require security cameras, fencing, and security guards on site, and depending on what the existing uses are at the leased premises and the needs of other tenants, adding a cannabis tenant could create unique requirements that upset the existing proportional allocation of operating expense, and this should be addressed up front in the lease. If a cannabis tenant is a manufacturer or an indoor cultivator, it’s also likely that utility usage will not only increase beyond that of other tenants on a multi-tenant premises, but that additional water or electricity infrastructure will need to be installed to accommodate the increased usage, thereby creating additional capital improvement costs that need to be amortized and proportionally allocated. Another issue that comes up is cannabis waste management: for one, cannabis licensees—especially cultivators—must have strict waste management protocols in place that include securing waste on site or hauling it away under strict requirements. The regular building garbage service will likely not be a good match for a cannabis tenant.

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

hemp cbd vape californiaLast week, the 2018 Farm Bill became law. Included in that law is a milestone provision that removes hemp from the Controlled Substances Act (CSA), and another that prohibits states from preventing transportation or shipment of hemp or hemp products across state lines– even if a state has itself outlawed hemp or hemp products. However, following passage of the Farm Bill, the Food and Drug Administration (FDA) issued a statement virtually ensuring that regardless of changes to the CSA, the FDA will effectively maintain the prohibition on most uses of CBD until further notice, because it retains control over the safety of foods and dietary supplements that include cannabis or cannabis products.

A quick review of some relevant terminology for context: The cannabis plant (Cannabis sativa L.) is cultivated in many strains, with varying levels of the psychoactive ingredient tetrahydrocannabinol (THC) and the non-psychoactive ingredient cannabidiol (CBD), along with hundreds of other constituent ingredients. The Farm Bill amends the CSA to define “hemp” (formerly referred to as “industrial hemp”) as the cannabis plant, any parts of the cannabis plant, and all derivatives therefrom, to the extent they contain a THC concentration of not more than 0.3% on a dry weight basis (i.e. not psychoactive). Any cannabis plant or derivative with more than 0.3% THC remains a Schedule I controlled substance that is illegal under the CSA.

The FDA’s statement clarifies that with respect to foods and dietary supplements, absent further action by the FDA, CBD-infused food or dietary supplements still cannot be legally sold in interstate commerce, even if the Farm Bill mandates that interstate transport and shipment of hemp and hemp CBD must be allowed. The FDA has also taken the position that if CBD-infused products of any kind are marketed as having medical uses or disease-curing properties, they will be subject to FDA regulation as “drugs” under existing law.

But a question that has not yet been answered is how these recent developments affect the legality of hemp-derived CBD extract oil used as an additive in vape products, which is a common application for CBD, but which is not within the realm of foods or dietary supplements. Electronic nicotine delivery systems such as vape pens are regulated separately by the FDA as tobacco products, but it’s unclear how a hemp CBD-only (i.e. containing no tobacco-derived or cannabis-derived products) vape pen would fare under federal law post-Farm Bill. It’s also not clear how the FDA would view hemp CBD as a standalone additive to vape products, and whether it would fall within FDA regulatory purview.

Here in California, it’s also unclear how the Department of Public Health (CDPH), the agency charged with regulating manufactured cannabis products in the state, will view hemp CBD use in vape products. We’ve previously looked at the muddy state of California hemp CBD regulation. Although current CDPH regulations allow cannabis-derived CBD as an additive in licensed manufacturing of cannabis vape products, they also mandate that “[a] manufacturer licensee shall only use cannabinoid concentrates and extracts that are manufactured or processed from cannabis obtained from a licensed cannabis cultivator.” This would seem to foreclose hemp CBD altogether as an option for manufacturing licensees. However, California cannabis statutes make clear that regulated cannabis does not include hemp, and that hemp is an entirely separate regulated substance for which only cultivation is currently regulated by state law.

We already know that the CDPH has determined that hemp CBD will not be a permitted food additive until either the FDA says it is or the CDPH determines it is safe for human consumption, even though cannabis-derived CBD is already allowed as a food additive under state law. And although it may seem reasonable for CDPH to seek to prohibit licensees from using any CBD (including hemp CBD) derived from unlicensed sources, as well as to prohibit unlicensed persons from manufacturing at least cannabis-derived CBD from any source given that existing regulations restrict it, we will not know for sure how the state is going to deal with hemp CBD use in vape products until CDPH issues guidance as it did with respect to hemp CBD as an additive to foods.

So what does all of this mean? Despite passage of the 2018 Farm Bill legalizing hemp, it may not have helped much with the confused state of regulation in California and other states. Use of hemp CBD in vape products is still a grey area at best, and use of hemp CBD as a food additive is still prohibited in California. There appears to be interest in passing California legislation regulating the sale of hemp CBD, and perhaps this legislation will also address the use of CBD in manufacturing in a way that reconciles potential inconsistencies with existing state cannabis regulations as well as federal deregulation. For now, this might be the first time in modern history that a cannabis substance appears to be treated more permissively by the federal government than California—at least for now.

california cannabis licensing rulesThis past Friday, California’s three agencies charged with writing and enforcing cannabis regulations—the Bureau of Cannabis Control (BCC), the Department of Public Health (DPH), and the Department of Food and Agriculture (DFA)—made public their respective proposed final regulations, which are currently pending a 30-day review by the Office of Administrative Law before becoming law. Some of the most significant and controversial changes appear in the BCC’s proposed final regulations, which govern a variety of licensees such as retailers, distributors, testing laboratories, and microbusinesses, and which we will be writing about in the coming days.

As for the DFA, which issues and enforces rules for cannabis cultivators, the proposed final rules are substantially the same as the modifications the agency proposed back in October. While “substantially the same” might sound innocuous, it amounts to acceptance of the October modifications, many of which were significant. Below are some initial takeaways.

Cultivation license “stacking.” It looks like the “stacking” work-around for the acreage cap is going to be permanent. Remember the controversy surrounding the state’s decision not to limit accumulation of small cultivation licenses by a single licensee so as to essentially create a loophole to the 1-acre cap, to the benefit of big farms. However…

Shared facilities limitations. It also looks like the DFA’s proposed modifications regarding shared spaces between licenses are also going to be permanent, creating a challenge for license “stackers”. As we explained here, what the DFA was proposing (and which now appears likely to become final) was restricting the ability of a single licensee holding multiple licenses from being able to use shared facilities for its various licenses. And whereas the areas excluded from shared use under the October modifications included immature plant-growing areas, processing or packaging areas, and administrative holding areas, it looks like we can now add to that list areas used for storage of harvested cannabis, which is an item that was removed from the allowable list of shared usage areas this time around (although there is some ambiguity in how that particular regulation could be interpreted).

What this means overall is that things are going to be more difficult for licensees holding more than one license (especially of the same type), as they will now have to arbitrarily create various dedicated areas on the cultivation premises to serve each specific license, even if they’re the same kind of license with the same kind of operation in every respect.

Structures on site.  There is an interesting difference in the BCC proposed final rules compared to the DFA rules when it comes to the permanency of structures on the licensed premises. The BCC is aiming to require that all structures included as part of a BCC-licensed premises would have to be permanently affixed to the land, and this would specifically exclude things like shipping containers, mobile trailers, and non-affixed modular structured. We had suspected that the DFA might follow suit in its final proposed rules, especially because such structures are popular for cannabis farms, but it has not—no such explicit restriction appears in the DFA’s proposed final regulations.

Ownership, Financial Interests and Disclosure. There is also an interesting difference between ownership and financial interest holder disclosure requirements between the BCC and DFA proposed final rules. We previously wrote about how the BCC’s proposed final rules could sweep some landlords into the definition of “owner” or “financial interest holder” depending on the landlord’s relationship with the tenant. But another important difference between the BCC and DFA rules that we thought would be reconciled in the final rules but apparently will not be is the extent to which entities (as opposed to persons) that qualify as “owners” or “financial interest holders” of BCC licensee must undergo vetting and disclosure all the way up the chain of entity ownership, whereas there is no such explicit requirement for DPH or DFA licensees. We will be writing more on this specific difference in the coming days. Stay tuned.

california cannabis lease
May be required of certain California cannabis landlords.

We’ve previously written about some of the pitfalls for landlords to avoid when leasing to commercial cannabis tenants in California. We’ve also written about how the state’s recently proposed modifications to its final cannabis regulations could affect licensees and the industry writ large (see here, here, and here). The comment period for those rule changes is now over and we expect to see final rules from the state agencies within the next couple of weeks. This post focuses on a few examples of how those proposed modifications would affect cannabis landlords specifically.

One of the biggest proposed changes in the new rules has to do with who qualifies as an “owner” or a “financial interest holder” of a cannabis licensee that must be disclosed and vetted as part of the cannabis operator’s license application. Under the current proposed final rules and existing statutes, all “owners” of a cannabis business licensee must be listed in a licensee’s annual license application, including each owner’s contact information, social security number and tax identification number, employment information, disclosure and description of all past convictions, and a live scan fingerprint analysis for a background check with the Department of Justice. All “financial interest holders” in a licensee business must also be disclosed, though disclosure requirements are lesser than for owners and vary slightly across agencies, ranging from a simple list of financial interest holders to the name, and type and number of government identification for individuals; business name and tax ID for entities.

Under the most recently proposed rule modifications, a “financial interest holder” in a cannabis licensee such as a retailer, distributor, testing laboratory, or microbusiness would now include “[a] landlord who has entered into a lease agreement with the commercial cannabis business for a share of the profits.” And if that agreed share is 20 percent or more of the tenant’s profits, then the landlord would qualify as an “owner” of the cannabis licensee. (Landlords already qualify as “owners” under prior versions of the rules if they own 20 percent or more of the cannabis tenant business).

While we have previously written about the problems associated with landlords entering into anything other than an arms-length relationship with cannabis tenants for payment of rent in exchange for leased space, you can now add to that list the regulatory burden of disclosure and vetting of the landlord. However, if the landlord is an entity such as a holding company or an investment fund, the disclosure burden is amplified exponentially: if an entity landlord is an “owner” or a “financial interest holder” in certain kinds of cannabis licensees, then the same disclosure requirements apply for various layers of ownership to all individuals and entities that are owners or financial interest holders in that landlord entity, along with board members, CEOs, etc., all the way up the chain until only individuals remain.

What this means is that if cannabis landlords agree to accept a share of the tenant’s profits in lieu of rent—and this is not an uncommon arrangement especially for smaller or undercapitalized cannabis tenants—the landlord and its owners and investors could unknowingly be exposing themselves to unexpectedly high burdens of regulatory disclosure and vetting that would not normally apply if the tenant was anything other than a cannabis licensee.

It remains to be seen what the state agencies’ final rules will look like, especially in light of the widespread effect such disclosure requirements would have on investment in the cannabis industry in California, but in the meantime landlords considering profit-sharing arrangement with their cannabis tenants would be wise to consider the full regulatory implications of doing so, even if on an anticipated basis during pendency of the rulemaking process.

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

BCC california cannabis marijuana
We’ve got a lot of questions for the BCC right now.

Last month, California’s regulatory agencies charged with writing commercial cannabis rules released new modifications to the final rules proposed in July. The Bureau of Cannabis Control’s (BCC) proposed modifications contained some of the most dramatic changes, including what would effectively be an outright ban on intellectual property licensing for cannabis products—something we are still trying to wrap our heads around due to the seismic effect it would have throughout the industry. The comment period is now closed on the proposed modifications, so now we must wait and see what the BCC decides to do with its final rules in the next few weeks. (To see at our law firm’s comments to BCC on this, go here.)

The proposed rule banning IP licensing agreements is the result of the BCC’s attempt to redefine what constitutes “commercial cannabis activity.” Existing California statutes—which allow the BCC to create and modify cannabis rules—already require that “all commercial cannabis activity shall be conducted between licensees.” So, if you are conducting “commercial cannabis activity” you must have a license to do so. But what truly is “commercial cannabis activity,” and where should the state draw the line?

Current state law defines “commercial cannabis activity” as “includ[ing] the cultivation, possession, manufacture, distribution, processing, storing, laboratory testing, packaging, labeling, transportation, delivery or sale of cannabis and cannabis products.” That much makes sense—activities that touch the plant or its products fall squarely within a common sense understanding of what activities should require a license from the state. But under the BCC’s new proposed rules, the following would now also constitute commercial cannabis activity:

  • Procuring or purchasing cannabis goods from a licensed cultivator or licensed manufacturer on behalf of, at the request of, or pursuant to a contract with a non-licensed person;
  • Manufacturing cannabis goods according to the specifications of a non-licensee;
  • Packaging and labeling cannabis goods under a non-licensee’s brand or according to the specifications of a non-licensee; and
  • Distributing cannabis goods for a non-licensee.

Distributing cannabis goods for an unlicensed operator seems straightforward. But for the other additions, such a broad reading of the statute would undoubtedly sweep many activities within this prohibition that in fact have little or nothing to do with actual cannabis activity. For example:

  • Some types of cannabis licensees are not prohibited from conducting certain types of non-cannabis activity (e.g. manufacturing, distributing, and selling cannabis accessories). To prohibit any of those non-cannabis contracts from having any interaction with cannabis contracts would add an unnecessary restraint on trade. Perhaps a non-licensee makes vape batteries and as part of its distribution agreement wants to require its licensed retailer partner to only purchase cannabis oil from a certain licensed manufacturer to preserve its brand integrity. Under the new rules, that would be prohibited.
  • Imagine that same battery manufacturer wanted to require that same manufacturer by contract to produce vape oil to certain specifications, to ensure the device functions as designed. Under the new rules, that would be prohibited.
  • The third point is perhaps the most concerning, as we have already discussed previously and written directly to the BCC. It means that anyone with a brand, whether they already associate it with cannabis products or not, would now be prohibited from selling licensees the right to use that brand on packaging or labels for cannabis goods. This would mean that if you want to have a brand you also have to have a license, which means you also have to be a cannabis operator of some kind. And the entity that holds the license to operate must also own the rights to the brand – holding the intellectual property in a separate entity for liability purposes would not be allowed. Such an arbitrary barrier to the use of intellectual property is an unnecessary restraint on trade.

It’s not clear exactly why the BCC believes these rule modifications are necessary or justified; it only states in its notice of modifications that it had been made aware “that licensees may be engaging in such conduct” as would now be prohibited by the new rules. It’s also unclear whether the BCC will stick with these changes or discard them based on feedback received during the comment period—only time will tell.

federal court cannabis marijuana
Federal courts are finding ways to enforce cannabis contracts nationwide.

We’ve written previously about how courts, especially U.S. District Courts charged with applying and interpreting federal law, are wrestling with inconsistencies between state and federal law when it comes to state-legal cannabis. A little over a year ago, the emerging solution when it comes to enforceability of contracts involving cannabis was to apply the legal principle that “even where contracts concern illegal objects, where it is possible for a court to enforce a contract in a way that does not require illegal conduct, the court is not barred from according such relief.” Mann v. Gullickson (N.D. Cal. 2016). Fast forward to today, almost a year after California’s new cannabis regulations have been percolating into the world’s fifth largest economy, and that permissive, mostly hands-off approach to state cannabis contracts seems to have not only solidified, but appears to have been applied in other states that have recently legalized cannabis.

In an Oregon case, the plaintiff sought to recover economic damages in a personal injury case stemming the future earnings of a cannabis company. The defendant argued that because cannabis is federally illegal, the court cannot award future earnings from what amounts to an illegal business. In denying the defendant’s motion for summary judgment, the court found that “Marijuana’s legal status is unique. It is neither fully legal nor illegal. Because [plaintiff’s] family cannabis business is allegedly legal under Washington law, I conclude that . . . Plaintiff may recover economic damages based on projected profits from that business.” Tarr v. USF Reddaway, Inc. (D. Or. 2018). In so doing, the court also favorably cited a 2017 Oregon federal case holding that an employee of a marijuana testing laboratory could bring a claim under the federal Fair Labor Standards Act despite the federal illegality of marijuana. Id., citing Greenwood v. Green Leaf Lab LLC (D. Or. 2017). Key to both decisions was that in order to grant the requested remedies (allowance of future economic damages for personal injury; allowing a claim to proceed for violation of labor standards), the court did not need to order either party to directly violate the federal controlled substances laws that otherwise prohibit cannabis. Rather, the remedies were ancillary to the fact that the parties happened to be engaged in cannabis business activity.

In Nevada, a state that legalized cannabis in 2016, a plaintiff wanted to enforce certain promissory notes against a cannabis cultivation business. Some terms of the notes required defendants to use the loan money to pay off debtors and purchase certain real estate in Nevada—both things the court found to be lawful objects of a contract. Other terms of the notes, however, required the defendants to use some of the funds as operating capital in their cannabis business, and to grant the plaintiff a right of first refusal to purchase part of defendants’ business, both things the court found to be unenforceable because they would require defendants to violate federal law. The court, citing favorably to the Mann principle, found in favor of the plaintiff and denied the motion to dismiss, and noted that Nevada law allows courts to interpret contracts so as to sever unlawful or unenforceable provisions while retaining and enforcing the lawful parts. Bart Street III, Inc. v. ACC Enterprises, LLC, et al. (D. Nev. 2018). The significance of Bart Street is that the court expanded the use of the Mann decision, which merely dealt with nonpayment of promissory notes, and narrowly interpreted cannabis contracts so as to allow plaintiff to proceed in its suit to enforce the lawful terms, even where other terms clearly violated federal law and the contracts as a whole involved a federally illegal business purpose.

Finally, in a Texas case applying the law of Illinois, a state that recently legalized medicinal cannabis, a plaintiff sought payment for certain promissory notes involving cannabis businesses, similar to the situations in Mann and Bart Street. The defendant raised the defense of illegality of the contracts as justification for not performing. The court, collecting cases from all over the country in support, found that the defense of illegality under federal contract law was more equitable than remedial, and more presumptive than absolute, instead requiring a balancing of factors such as “the avoidance of windfalls or forfeitures, deterrence of illegal conduct, and relative moral culpability.” Ginsburg v. ICC Holdings, LLC (N.D. Tex. 2017). The court also noted the importance of “creating stability in contract relations and preserving reasonable expectations” as counterbalances to the “costs in forgoing the additional deterrence of behavior forbidden by the statute” that renders the contract illegal. The court concluded that the defendant had not met the standard for a motion to dismiss if its sole argument was for illegality of purpose in the contracts. Ginsberg is remarkable in that the court continued the whittling down of federal law as an invalidating presence upon state contracts involving state-legal cannabis activity, and did so in a way that frames the decision as a culmination of established principles of contract law.

It remains to be seen what will become of the absolute federal illegality in cannabis, but in the meantime, federal courts continue to find ways around invalidating contracts simply because they happen to involve cannabis, and sometimes even when they include terms that require parties to violate federal law, so long as those provisions are severable.

On Friday, the three California agencies charged with issuing and enforcing rules for cannabis business licensees issued a stack of proposed changes to the final rules it had previously proposed in July. Many of the most dramatic changes came from the BCC and will likely motivate more than a few comments during the rulemaking process (deadline for comments on these proposed changes is Nov. 5, FYI).

The Department of Food and Agriculture, which administers the cannabis cultivation licensing program, issued its own set of proposed rule changes that, while not as jaw-dropping as some of the BCC’s proposed changes, are still noteworthy.

Most importantly, the rules for cultivation plans just got a lot more onerous for licensees that plan to “stack” small licenses for use on one premises. Recall California’s controversial decision last year not to cap the total cultivation acreage per licensee to one acre, and the resulting benefit to mega farms that were then free to “stack” multiple smaller licenses to get a larger total cultivation area that they would otherwise be prohibited from getting due to the one-per-licensee limit of 1-acre outdoor licenses and the prohibition on Type-5 “large” cultivation licenses until 2023. A key element to that loophole’s benefit to large growers was AB 133, which clarified that a licensee could maintain one big “premises” upon which to operate all of its licenses, and was not required to make each license have its own “separate and distinct” premises. This would allow for economies of scale, as it would be arbitrary and inefficient to require every single chunk of canopy on a parcel to have its own fencing, security, etc.

Cue the DFA, which through its new proposed rule modifications, now says there are certain categories of a licensed premises that categorically cannot be shared among licenses owned by a single licensee.  Permissible shared areas must be contiguous, and they are limited to areas designated for pesticide storage, composting, cannabis waste storage, and harvested cannabis storage, in addition to traditional common areas such as hallways, bathroom, and break rooms. However, areas that cannot be shared among multiple licenses held by one licensee include: (i) areas outside of the canopy where only immature plants are grown (i.e. nursery-type areas); (ii) processing or packaging areas (i.e. “drying, curing, grading, trimming, rolling, storing, packaging, and labeling”); and (iii) areas designated for physically segregating cannabis during an administrative hold pending resolution of a notice of violation from the state. While it is not clear exactly how the DFA would interpret this proposed new rule language in practice, a likely result could be that cultivation licensees holding multiple licenses (either of the same type or a variety) for use on a single premises would no longer be able to take advantage of the same economies of scale for processing and packaging or for cultivation of immature plants, and that each separate license would require its own dedicated room for each such activity. We also know that the BCC requires separate walls and sealed doors when it calls for premises to be separate. Time will tell how this rule will look in a few months, but as it stands now it could harm companies with limited access to space and resources for building additional rooms, and would certainly add to costs of compliance.

Other notable small changes that could add to licensing costs include requirements that each license applicant must now agree to put one supervisor and one employee through a standard 30-hour Cal-OSHA course for workplace safety; and beginning in 2020, all cannabis and nonmanufactured cannabis products packaged or labeled by a licensed cultivator must come in child-resistant packaging, which conforms to the requirements of BCC and DPH for packing of other cannabis products.

Finally, one proposed change in the BCC rules that may end up having more of an effect on cultivators is that all structures included as part of the licensed premises must now be permanently affixed to the land for an indefinite period of time. Off-the-grid type operations are notorious for using RVs, mobile homes, lightweight moveable greenhouses, etc., so this rule change might also serve to prevent what would otherwise be a quick fix to the first issue identified above.

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

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

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

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

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

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

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

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

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

california marijuana cannabis enforcement
Home of fewer illegal grows.

Federal enforcement of the Controlled Substances Act in states that have legalized cannabis has been a huge question mark for years, but especially so in California since the 2016 passage of Prop 64, which legalized medicinal and adult-use cannabis and laid the framework for a new regulatory regime. Almost two years later, that question remains, but certain trends have emerged, were reinforced, and now seem to be forging full speed ahead. Those trends suggest that (1) the Department of Justice is not engaging in a crackdown against cannabis businesses that are in compliance with state and local law, and (2) the state and the federal government have agreed to coordinate on enforcement actions where it furthers the priorities of both entities. So far, those priorities have been organized crime and illegal cultivation on public lands, and this week the latter priority got a big boost from both sides of the equation.

On the state side of things, a proposed state law extending the statute of limitations from one to three years for state enforcement actions against unlawful “conversion of timberland to nonforestry-related agricultural uses”—a move that targets illegal cannabis cultivation on public lands—has passed the state legislature and is now before Governor Brown for signature. The bill also clarifies that the limitations period does not begin to run until the state discovers the violation.

On the federal side of things, the Department of Justice issued a formal statement about the results of its summer-long collaborative project with the state and local governments to target and eradicate illegal cultivation operations on public lands, aka Operation Forest Watch, which we now know has been underway since at least October 2017 and also included the California National Guard. One important reason behind this effort was an unprecedented level of illegal toxic pesticides being used in unlicensed cannabis cultivation, some so powerful that a “quarter-teaspoon can kill a 300-pound bear.” Because cannabis grown using these dangerous pesticides cannot pass California’s stringent quality standards, it has been mostly shipped illegally to the Midwest and the East Coast, undermining both California and federal laws prohibiting diversion out of state.

The big-picture takeaway from this joint operation is that “federal authorities are concentrating their efforts on hazardous illegal grows on public land instead of targeting California’s new recreational marijuana industry, although marijuana remains illegal under federal law.” Another take on it is that federal and state cooperation on cannabis enforcement as it has been structured to date benefits both entities when priorities are aligned: The federal government furthers its goals of protecting public lands and public safety and targeting organized crime; while the state furthers those same goals in its own interests, and at the same time reinforces the state’s regulatory regime by incentivizing licensing and compliance and cracking down on the state’s illegal markets.

It remains to be seen what effect these joint enforcement actions, as well as California’s continued crackdown on unlicensed operators, will have on the state’s cannabis market writ large, but to date they have unquestionably proven beneficial to both parties, as well as all Californians who enjoy and want to preserve our forests.