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Since joining Harris Bricken in 2010, Hilary has earned a reputation as a fearless advocate for local businesses. Hilary’s clients—start-ups, entrepreneurs, and companies in all stages of development—value her bold approach to business strategy.

california cannabis licensing
A California cannabis licensing backlog is imminent.

A backlog of cannabis license applications has no doubt happened in almost all of the other states that have medical and adult use licensing. You wouldn’t normally think this is such a big or concerning development, but in cannabis licensing delays can mean angry investors, a complete 180 for your business plans and even insolvency.

In California, a licensing logjam was bound to catch up with regulators, especially as cities and counties start to embrace the democratic experiment of legalization. And now we know that at least one state agency, California Department of Food and Agriculture (“CDFA”), which oversees cultivators, is feeling the pinch of hundreds and hundreds of license applicants.

On Friday, October 26, CDFA sent the following email to its stakeholder list serve:

ATTENTION, PLEASE!

FOR NEW TEMPORARY LICENSES ISSUED PRIOR TO DECEMBER 31, 2018

Due to the large number of applications being submitted for temporary cannabis cultivation licenses, the California Department of Food and Agriculture (CDFA) hereby notifies prospective applicants that any application for a temporary license received after December 1, 2018, may NOT be processed in time for us to issue a temporary license before January 1, 2019. After December 31, 2018, the authority for CDFA to issue temporary licenses expires. To provide sufficient processing time, please submit your temporary application to CDFA’s CalCannabis Cultivation Licensing Division by December 1, 2018.

Even though MAUCRSA makes clear that temporary licenses will no longer be around (or renewed) after December 31 of this year, CDFA is moving that timeline forward based on the sheer volume of applications for just temporary licenses its received. The kicker here is that you will NOT receive a provisional license (to continue to operate while you wait for your annual license) unless you’ve already had or have a temporary license for the same license type at your same location. And, in case you were living under a rock, provisional licenses are the new form of temporary licenses that the legislature okay’ed at the end of last month. Oddly enough, CDFA is the only agency so far that’s given its roadmap for how to get a provisional, but we imagine (based on statute) it will be pretty much the same protocol for the Bureau of Cannabis Control (“BCC”) and the California Department of Public Health (“CDPH”).

Why is all of this important? To date, temporary licenses (which are good for 120 days) represent the only means by which an operator can open and run its businesses before receiving its annual cannabis license. To get a temporary license, the licensee first has to secure local approval from its local government, which can be easy, somewhat challenging or extremely difficult, depending on the local jurisdiction. Importantly, temporary licenses can be renewed for 90-day increments so long as the license applicant is in pursuit of its annual license with the state. As a start-up business, it’s usually lucrative to be able to get operational very quickly because, in cannabis: 1) you likely already have an operational lease that you’re paying on; 2) you’ve completed a costly build out; and 3) you have to answer to your financiers or at least break even on your own contributions to keep going. If you can’t operate while you wait on your license, your fate is likely to just try to hang on while you bleed cash, and licensing can take months to get depending on the state.

The biggest wrinkle here in California is that many cities and counties are not really paying attention to, or cannot adequately address, this future gap in licensing–namely, if you can’t get your temporary license by the end of the year (which requires prior local approval from your city or county), you’re not operating at all in 2019 unless and until you receive your annual license, which is taking months to secure. (I have clients who applied for their annual license in April of this year and they still have no annual license.) A great example is West Hollywood, which for new license applicants for retail–by the City’s own admission–won’t even be done with its retailer selection process until the end of November. This affords successful applicants very little time, if any, to try and get temporary licenses from the BCC to be able to lock down their provisional licenses thereafter. And if you’re looking at Phase 3 general public licensing in the City of Los Angeles, you may not even get the chance to apply for local approval until 2019. This means you will miss the state temporary licensing deadline, and therefore the ability to get a provisional license altogether.

Indeed, many stakeholders will find that if they cannot get their city or county to give them some form of local approval by or before December 31 (or by December 1 if you’re applying to CDFA) so they can go get their temporary and eventually provisional license(s), they will be sitting on unusable businesses, likely paying rent, until they get their annual license from regulators. To us, this is nothing new as regulators constantly pump the brakes on licensing logistics across the board in order to make the situation more manageable for them. To that end, we’ll also likely see in the future prohibitions on being able to relocate your business while in the annual licensing process, prohibitions on changes of ownership while you’re in the annual licensing process, and prohibitions on changing your business plan or operational lay out in any way until you receive your annual license.

The foregoing all goes to show that regulators can and do shuffle the deck on licensing timelines all the time. Stakeholders have to have their heads on a swivel to survive, and failing to take into account how these licensing deadlines and expectations shift is a massive mistake that will inevitably foreclose the ability to participate for lots of would-be licensees. So, prepare accordingly!

california cannabis indemnity
Don’t skim over that indemnification clause!

Coming from Seattle to Los Angeles, I’ve already seen one state flip from being a “gray medical cannabis state” to a fully regulated licensing system and I understand how painful a process this can be. So much of what I saw in Washington State is now happening in California.

In California today, folks are jockeying for operational licenses on the state and local levels under MAUCRSA and “the cream” is rising to the top, just as it did in Washington. One-to-two-person shops and mom and pop operators are feeling the financial pinch of licensing costs and compliance woes. The secondary market for buying cannabis businesses is also beginning to open up as cities and counties solidify and stick with their local cannabis entitlement programs. Transactions between cannabis licensees are becoming increasingly sophisticated, from IP licensing agreements, to distribution agreements, to white labeling agreements, to purchase and sale agreements for inventory.

And just as happened in Washington State at the onset of legalization there, we are seeing many cultivators and manufacturers overpromising on what they can deliver, more often due to overconfidence as to dishonesty. In legal terms, this means we are also seeing cultivation and manufacturing licensees, and distributors agreeing to indemnify retailers and other licensees for everything under the sun, quite often to their own detriment. Even though the cannabis industry is maturing rapidly in California, many are still using boilerplate or Google-discovered or Legal Zoom and Rocket Lawyer contracts for these very serious transactions. This use of bad template documents (most of which are modified little if at all for the realities of the cannabis industry) has got to stop, or cannabis licensees will soon find themselves embroiled in costly and counter-productive disputes/litigation.

And that brings me to the crux of this post, which is one of the most important “boilerplate” contract provisions that absolutely must be tailored for a California cannabis contract: indemnification. What, exactly, is indemnification? It’s when one party (the “indemnitor”) agrees to hold harmless and compensate the other party (the “indemnitee”) for losses suffered by the indemnitee.

Many cannabis sellers in California are far too willing to indemnify third parties for things completely out of their control, like lab results, changes in regulations that may affect the other party’s operations, and unforeseen conduct by users of the cannabis product. These blanket indemnification provisions are creating liability and exposure.

In the past month or so, many cannabis companies have come to us (both in Los Angeles and in San Francisco) with poorly drafted, irrelevant or nonsensical indemnification provisions and agreements from cannabis sellers. So, what makes for a good indemnification provision in a cannabis contract?

A preliminary question should be the breadth of the indemnification. If you are the seller and you want to protect yourself, you should tailor your indemnification to what makes sense and to what you can afford. You do not want something like the following (which is being used fairly often in California these days by inexperienced lawyers and lawyerless companies):

“The Indemnitor agrees to indemnify, defend, and hold harmless the Indemnitee, its officers, directors, employees, owners, agents, assigns, and affiliates (collectively, the “Indemnified Parties”) from and against any and all claims, liability, loss, expenses, suits, damages, judgments, demands, and costs(including reasonable attorneys’ fees and expenses) (each a “Claim”) arising out of any accident, injury, or death to persons, or loss of or damage to property, or fines and penalties which may result, in whole or in part, by reason of the use or sale of any Product, or its packaging, except to the extent that such damage is due solely and directly to the gross negligence or willful misconduct of the Indemnified Parties and that the Indemnified Parties, or any of them, were acting in bad faith.”

This sort of provision is a bad idea for any cannabis seller. It means that seller will be liable to the buyer for just about anything that could go wrong–anywhere, for anyone–from the product. No one wants to be on the hook for things they cannot control.

Here are a few important things to consider when crafting a cannabis indemnification term:

  • Both the cannabis seller and buyer need to focus on what kinds of losses will or will not be covered by indemnification. If I’m the seller, I’m going to want to exclude incidental, punitive, and indirect damages even if foreseeable. If I’m the cannabis buyer, I’m going to want to include at least incidental damages and foreseeable indirect damages.
  • It is both unusual and risky for a seller to agree to indemnify a party indefinitely, and yet this too has become common in California. If you are the seller, make sure your indemnity agreement or provision has an end date.
  • Your indemnification agreement or provision should include a protocol for making indemnification claims to the indemnifying party. The boilerplate indemnification provisions and agreements we are seeing typically never even mention any claim deadline or claim notice requirements. As the cannabis seller you should, at minimum, address these two issues in your indemnification provision or agreement.
  • If the indemnification is mutual, and captures reciprocal indemnification obligations in the same paragraph or contract section, ask yourself “why?” Putting the same parameters around indemnification for both parties often makes no sense, because each party has a different role in the business relationship. Consider separating the indemnity obligations and applying tailored language for each party, as appropriate for that party’s role in the transaction.
  • Finally, can you just cross it out? If you have deal leverage, and someone presents you with an indemnification provision (particularly an onerous one), you may be able to get rid of it altogether. Sometimes, you can convince the other party to give you everything they need to feel comfortable through appropriate representations and warranties.

There are certainly very good and reliable stock indemnification provisions in most contracts, and there’s a reason for that boilerplate in that it’s time-tested and mostly appropriate for more standard business agreements. However, be sure that whatever you’re putting into your cannabis contracts on indemnification is tailored to your specific situation. If not, you could find yourself holding the bag on way more than what is fair — let alone what you expected or can afford.

california cannabis marijuanaIt’s not a normal day in California if there aren’t around 50 cannabis bills floating around Assembly halls. And this legislative session did not disappoint in getting certain much-needed cannabis legislation passed (though some important legislation also bit the dust). All in all, there is a lot of legislation and it can be difficult to keep track of. It can also be difficult to identify what’s going to have the greatest impact on California’s cannabis industry. We are still in an emergency rule period under MAUCRSA (with permanent regulations probably taking full shape and adoption in early 2019), so it’s comforting to see the legislature fill some of the gaps left over from the emergency rules.

Here’s my list of the most important/recent cannabis bills of 2018 for California:

Provisional licenses. Without a doubt, the industry would have gone into a tailspin and then come to a screeching halt after December 31 of this year without the advent of provisional licenses. We wrote about the provisional license bill, SB 1459, before its passage, and the bill is now law. The basic gist is that if your business holds or has held a temporary license and you’ve file for your annual license, you’re going to get a provisional license (which is good for only one year) in order to keep operating while you pursue your annual license. Temporary licenses will not be issued after December 31 of this year, so this is the new vehicle for continued operation in California while you wait on your annal license. Here’s a fact sheet from CDFA that details what you need exactly for a provisional cultivation license (the other agencies haven’t released anything yet as of the writing of this post).

Events. Finally, the legislature got on board with expanding the venues at which cannabis events can be held. AB 2020 now allows cannabis events to take place at “a county fair event, district agricultural association event, or at another venue expressly approved by a local jurisdiction for the purpose of holding temporary events of this nature. . .” Of course, local jurisdictions still have to approve of these events and only licensees can throw them, but this is a big move for the increased normalization of cannabis in California where we’re now beyond allowing licensees to have temporary events at only county fairs and district agricultural association events as was previously the case.

Cannabis convictions. AB 1793 represents the continued implementation of Prop 64. Namely, when it comes to cannabis-related convictions, Prop. 64 “authorizes a person to petition for the recall or dismissal of a sentence, dismissal and sealing of a conviction, or redesignation of a conviction of an offense for which a lesser offense or no offense would be imposed under [Prop. 64].” In turn, AB 1793 mandates that the State Department of Justice/Office of the Attorney General, before July 1, 2019, review all existing criminal records in the state’s database to identify past convictions that are eligible for recall, dismissal and sealing, resentencing and/or redesignation. The State DOJ then must notify all local prosecutors about the foregoing eligibility. The prosecutors must then, on or before July 1, 2020, review all of their eligible criminal cases to decide whether to challenge the recall, resentencing, dismissal and sealing, or redesignation. If no such challenge is made by that date, the subject court must automatically reduce or dismiss the conviction. Without a doubt, many people in California will have their lives and futures changed for the better due to the passage of this bill.

Social equity. I have long maintained that any meaningful social equity programs on the local level (like those in Los Angeles, San Francisco, and Oakland) likely wouldn’t survive unless supported by the state. Thankfully, California is on board with the success of local social equity regimes via SB 1294, also now known as the California Cannabis Equity Act of 2018 (the “CCEA“). The CCEA basically sets up the state to provide “technical assistance” not to social equity applicants directly, but to the local programs that govern them. The Bureau of Cannabis Control (“BCC”) “may, upon request by a local jurisdiction, provide technical assistance to a local equity program that helps local equity applicants or local equity licensees.” “Technical assistance” includes “providing training and educational sessions regarding state cannabis licensing processes and requirements to equity applicants or equity licensees that are coordinated with the local equity program.” Cities and counties will have to petition the BCC for a grant of assistance to get things going under the CCEA, and whether the BCC assists or not depends on various merit-based criteria set forth in the CCEA regarding the nature of the local social equity program.

Pets and pot. AB 2215 addresses veterinarians and their relationship to licensees under MAUCRSA. Under this new law, the Veterinary Medical Board can revoke or suspend a veterinarian license, or can assess a fine, for “accepting, soliciting, or offering any form of remuneration from or to a [MAUCRSA] licensee if the veterinarian or his or her immediate family has a financial interest [in the licensee].” Further, if a vet physician even discusses cannabis with a client (i.e., the pet’s owner) while the vet physician has any kind of an agreement with or is employed by a MAUCRSA licensee, or if the vet physician makes any kind of advertisement for cannabis, the Veterinary Medical Board can revoke or suspend a veterinarian license, or can assess a fine against the vet physician. This is the biggest kicker of all though–AB 2215 “prohibits a licensed veterinarian from dispensing or administering cannabis or cannabis products to an animal patient.” Still, the vet will not get into trouble for just discussing, on their own with the pet owner, the benefits or effects of cannabis on the pet.

Privacy. What companies can and cannot share about their customers seems to be ever changing and certainly constitutes an emerging area of law. And cannabis companies are no exception, and definitely not now in California. As we wrote in a previous post, “AB 2402 is significant in that it prevents licensed cannabis businesses from sharing expansive categories of customers’ personal information with third parties—except in limited circumstances in connection with payments, or where a customer has consented to sharing his or her data with a third party. Notably, AB-2402 prohibits licensed cannabis businesses from discriminating against or refusing service to consumers who do not consent to disclosure of their personal information to third parties.”

No CBD in your booze. For anyone who had dreams of making a cannabis-infused wine, cocktail, or beer, AB 2914. “prohibit[s] a licensee from selling, offering, or providing a cannabis product that is an alcoholic beverage, including, but not limited to, an infusion of cannabis or cannabinoids derived from industrial hemp into an alcoholic beverage.”  Yes, the nail is now officially in the coffin for hemp-derived CBD alcoholic beverages. And this doesn’t just apply to cannabis licensees–it also now applies to alcoholic beverage licensees licensed under the Alcoholic Beverage Control Act. Given that CDPH-FDB recently prohibited hemp-derived CBD in all food and regular drinks (via an FAQ), it was really only a matter of time until state government extended that prohibition to alcohol, too.

OSHA. AB 2799 is going to force licensees to get serious about employment laws in California; specifically, it will make cannabis businesses become Cal-OSHA compliant, which really isn’t a bad thing where it’s good public policy to promote and implement safe workplaces for employees. Now, when you apply for your annual license or you to go to renew that annual license, you’ll have to “[p]rovide a statement . . . that [you] will employ within one year of receiving or renewing a license, one supervisor and one employee who have successfully completed a Cal-OSHA 30-hour general industry outreach course offered by a training provider that is authorized by an OSHA Training Institute Education Center to provide the course.”

foreign investment california cannabis
Coming soon to California cannabis?

In addition to our California cannabis business attorneys’ work on corporate, finance, and transactional issues with marijuana-related businesses, we also work with our firm’s foreign direct investment group. As California has implemented MAUCRSA since January 1 of this year, we have been getting tons of interest and questions in and about foreign investment into California’s booming cannabis industry. As would be expected, much of this interest is from Israel, Canada, Spain, Turkey, South America, the Netherlands, the UK and Germany. These investors are interested in California because of the size of the market, but also because California has no residency or citizenship requirement to invest in cannabis businesses.

In general, foreign direct investment (FDI) refers to any type of cross-border transaction where a company or investor from Country A invests money in a company located in Country B. It generally doesn’t refer to dumping money broadly into stocks and bonds — it is specifically about a concentrated, single-enterprise investment.

FDI exists in several forms. Foreign investors can start a new company and can finance and build it from the ground up. They can participate in a joint venture with U.S. partners. They can wholly or partially acquire a U.S. business. They can also take a lighter touch, where they provide primarily branding and process support while having U.S. parties take on the bulk of the financial risk — the basic franchise model.

In the marijuana industry, we have already seen large FDI projects in cannabis ancillary services (i.e., the companies that provide the goods and services that support the actual marijuana traffickers). Foreign investors have opened up domestic companies for the manufacture and import of cultivation equipment like grow lights and hydroponic equipment, processing equipment like automated trimmers and extraction machines, and associated inputs including soil, fertilizer, vapor pen batteries and cartridges, and more. We have also seen large amounts of foreign money come in for cannabis real estate projects, especially in the Coachella Valley and certain desert cities. In addition to buying the real estate, the foreign investors put money into greenhouses, grow lights, storage facilities, and more to offer turnkey cultivation and processing facilities for lease to local businesses. These companies are largely unregulated at the state level, and their foreign investment issues are similar to non-cannabis businesses, dealing with things like registering as U.S. taxpayers for partnership taxed businesses, complying with FIRPTA, and dealing with immigration issues.

For firms directly involved in the buying and selling of cannabis, state-specific restrictions become more of a concern. States like Washington do not allow anyone who is not a state resident (much less not a U.S. resident) from having any profit interest in a marijuana business. California, similar to Oregon, is extremely liberal with its cannabis regulations regarding owners and “financial interest holders.” As mentioned above, there is no residency or even citizenship requirement to participate. Still, on the whole, state regulations and state laws are typically written with U.S. residents in mind. In turn, things like criminal and financial background checks on foreigners remain a bit of a gray area (though California’s Department of Public Health, which oversees manufacturers, has accommodated the situation somewhat with an “out of state owner” background check). Ultimately though, neither state officials nor the FBI are likely to have any real information on foreign nationals who haven’t had prior contact with the United States. How the Feds will react to foreign ownership in terms of the Department of Justice (rather than via immigration through the Department of Homeland Security) still remains to be seen, though nothing’s been publicly reported that’s a red flag against foreign marijuana business ownership in California.  

As far as federal laws go, the Controlled Substances Act doesn’t differentiate between activities that are international, interstate, or fully intrastate in nature. Possessing, manufacturing, and distributing marijuana are illegal federally regardless of where the company’s owners live. Still, there are a couple of criminal statutes that add fuel to the fire when interstate and international commerce are involved. 18 U.S.C. § 1952, for example, criminalizes traveling or using the mail in interstate or foreign commerce with intent to distribute the proceeds of marijuana sales.

More questions arise when considering foreign ownership in the context of the Department of Justice marijuana enforcement memoranda that cannabis-legal states are working under. The main takeaway from the August 2013 Cole Memorandum (which has been rescinded by U.S. Attorney General Jeff Sessions) was that if the states want to keep federal law enforcement away, they need to make sure their regulations prevent state licensees from violating the various federal enforcement priorities. One of those priorities was that state regulations need to prevent “revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels.” If the state and federal criminal background check databases don’t have extensive coverage on foreign crimes, how can a state, including California, have faith that the foreign investors don’t fall into one of those categories?

For now, with no broad pronouncements apparent, it appears that the federal government is taking a wait-and-see approach to foreign ownership of state cannabis businesses. That means it is up to state cannabis business participants and the states themselves to ensure that foreign owners do not violate federal enforcement priorities — starting with California.

california marijuana cannabis licensing
So many questions.

We’re still in the early days of the complete roll out of the Medicinal and Adult-Use Cannabis Regulation and Safety Act (“MAUCRSA”) in California. Currently, the only rules in play are the readopted emergency rules that are still full of ambiguities and unknowns, which will hopefully be addressed in the final permanent rules, which the state will likely release in coming months. We detailed the initial proposed permanent rules from back in July, the public comment period for which concluded at the end of last month. We assume the state is going to take into account a lot of that public comment before it pulls the trigger on adopting any permanent rules, which will likely happen by the end of the year.

While we’re in this interim emergency rules period, there are still a lot of unanswered questions for California cannabis businesses as they try to navigate an emerging, newly regulated industry. And some unknowns keep coming back again and again. I cover the top ones below.

1. Cannabis banking–when, when when. We’re all familiar with the cannabis banking epidemic. As a result of current federal laws, in certain states securing a bank account is nearly impossible (though in some states, banking is readily available because of the 2014 FinCEN guidelines). Unfortunately, California is still one of those “banking no-no” states because we don’t have a robust licensing scheme yet (that will certainly come though as regulators get down to business on permanent rules and enforcement). As a result of a lack of banking, there’s a lot of bad behavior out there, so beware of cannabis banking scams and fraudsters. And don’t count on any form of a public bank saving the day. However, if you’re lucky enough to find a financial institution in California that’s following the FinCEN guidelines, here are some useful tips on how to secure an account.

2.  Provisional licenses. There’s a sinister deadline looming for all temporary licensees. Namely, after December 31, 2018, no more temporary licenses will issue to any cannabis businesses. In addition, if you secure a temporary license on or around December 31 of this year, it will run its 120-day course and the governing state agencies will not renew it after that. To date, the agencies implementing MAUCRSA have renewed temporary licenses for 90-day stints (so long as a licensee is in pursuit of their annual license) to allow licensees to continue to operate once they secure local approval but before they get their full-blown annual license. Temporary licensure is without a doubt a big deal since it’s the only way to legal operate prior to receiving annual licensure, which is taking months at the state level to nail down. The silver lining is that the state legislature is contemplating creating provisional licenses under MAUCRSA to ensure that the industry doesn’t come to a screeching halt after December 31, but that bill is still pending.

3. Local control. Before you can receive a state temporary license, you must first show the state that you have the local approval of your city or county to operate within their borders. Once in pursuit of the state annual license, you can voluntarily provide evidence of your local approval, but the state will follow up with your local government regardless to make sure that you’re in compliance with local laws. The debate over local control and the fact that most California cities and counties ban commercial cannabis activity continues to rage in Sacramento. And the debate will ultimately play out in the permanent MAUCRSA regulations. For example, in the initial proposed permanent rules, state agencies, specifically the Bureau of Cannabis Control, proposed that retail delivery be borderless–meaning, licensees wouldn’t have to get local approval to delivery into/complete delivery in a given city or county. We are positive that such a decision made cities and counties cringe, but that likely won’t be the last time that the state and local governments butt heads over control over licensees.

4. CBD. CBD derived from industrial hemp in California is nothing short of a complete enigma. Why? Because, unless you’ve been living under a rock, you know that the California Department of Public Health Food and Drug Branch (CDPH-FDB) via an FAQ recently prohibited using hemp-derived CBD in food for pets and humans. Essentially, California is following the FDA lock-step on its treatment of hemp-CBD under federal laws. Other states have decided not to kowtow to the FDA in this area, but California surprised everyone by attacking hemp-CBD in this way. How enforcement will go and what it looks like remains a mystery. And since you’ll be hard-pressed to find a ton of juice bars, health food stores, breweries, coffee makers, and pet stores across the state not carrying hemp-CBD products meant for human or pet consumption, enforcement from CDPH-FDB could take a while.

5. Corporate versus cottage interests. The express intent of Prop. 64 was to hoist up and protect cottage interests in the cannabis industry. One of the biggest points of contention in Sacramento over MAUCRSA regulations has been the refusal of regulators to limit the number of cultivation licenses available to licensees. Namely, even though Type 3 medium sized cultivation licenses (I.e., 10,001-22,000 square feet of plant canopy) has been limited to one person/entity, anyone can still secure multiple and endless Type 1 and Type 2 cultivation licenses thereby getting around the limitation on medium sized grows. Combined with other regulatory barriers to entry and reporting and tax requirements, a lot of smaller cultivators and smaller business licensees are crying foul on MAUCRSA regulations being too corporatized. Whether regulators will really listen to this camp will be revealed in the permanent rules, and only time will tell.

6. DOJ and Jeff Sessions rescinded all DOJ marijuana guidance in January. As we all know, Jeff Sessions personally loathes cannabis. Sessions and whether you believe he’ll make good on his personal hatred or not, you cannot argue with the fact that the rescinding of the 2013 Cole Memo is unsettling if you’re a state-licensed cannabis business. Now that Sessions has take the position that U.S. Attorneys should prosecute cannabis crimes within their districts essentially according to the resources and priorities of the individual district, no one really knows what exactly enforcement will look like in each of the four federal California districts. So far though, to the best of our knowledge, the DOJ in California hasn’t been busting people for securing licenses under MAUCRSA.

7. Enforcement of rule violations. Temporary cannabis licenses began issuing in California on January 1, 2018. The program has been up and running for about a year and a half, and enforcement of rule violations against licensees has been varied at best. The state is mostly in the mode of getting people into the system and licensed in the first place. I’m confident that enforcement will finally begin to increase into next year as the dust settles on permanent licensing. And cities and counties are beginning to take the lead on enforcement anyway (see, for example, the latest from the City Attorney in Los Angeles). Still, exactly when the state will kick into higher enforcement mode is genuinely unknown.

marijuana california cannabis L.A.
Be careful! It’s easy to slip up under Proposition M.

I’ve written in the past about the precarious business of buying and selling existing dispensaries in Los Angeles, but that was under the now repealed Proposition D. In March of 2017, Angelenos voted in favor of Proposition M, which is a licensing and regulatory piece of legislation implemented and overseen by the City’s Department of Cannabis Regulation (“DCR”) and the Cannabis Regulation Commission. Under Prop. M, the City is licensing cannabis businesses in three phases, the first of which was exclusively for “Existing Medical Marijuana Dispensaries” (EMMDs). EMMDs are basically grandfathered Prop. D/Pre-ICO operators that met certain compliance criteria set forth by the City under Prop. M. As of the writing of this post, there are only 163 EMMDs in the entire City. This low number of dispensaries in potentially the largest cannabis market in the world makes the secondary market for these storefronts incredibly hot. So much so that our Los Angeles cannabis lawyers are receiving term sheets for the purchase of EMMDs on an almost bi-weekly basis. And based on that experience, it’s time to update readers on what to look for when contemplating the purchase of an EMMD, which is no small task under the City’s new laws.

Running due diligence on dispensaries in Los Angeles is massively important. The reason being (in addition to normal M & A due diligence) is that the City still has many, many illegal operators (though the City Attorney is doing his best to shut down those operations as fast as possible). Therefore, it’s not a stretch that an “LA dispensary” would try to take a buyer for a ride on a sale when, in reality, that dispensary is 100% illegal, making the purchaser a sitting duck.

In turn, here are the major bases to cover when buying an EMMD in the City of LA under Prop. M:

  1. Is the dispensary even on the City’s EMMD list? The DCR has done a fantastic job of continually updating its EMMD list on its website. Checking that list is the very first step for any reliable due diligence. If the dispensary is not listed, ask the sellers why that’s the case. At this point, with the window for EMMD licensing closed, failure to appear is going to be a huge and fatal red flag that’s fatal unless the selling dispensary can provide viable proof that they are in valid pursuit of EMMD status from the DCR or appealing a DCR denial of EMMD status,
  1. Licenses are not transferable. Many people don’t realize that commercial cannabis licenses are not transferable under California State law. The same goes for commercial cannabis licenses in the City of L.A.—they cannot be bought and sold as individual assets; only the entity that holds them can change owners (meaning, you’re looking at purchasing the company that holds the license). Therefore, any EMMD that’s trying to sell you one of its licenses (or one of its future licenses) is not recognizing that it can only sell its membership interests or stock, and not the licenses themselves, under state and L.A. laws and regulations.
  1. What entity type is the EMMD? Assuming your target EMMD is on the City’s EMMD list and the EMMD understands that it can only engage in an entity purchase and sale, the next question is whether the EMMD is organized as a non-profit or a for profit company. If the EMMD was in compliance with Prop. D, it’s most likely some form of a non-profit corporation (most often a non-profit mutual benefit corporation (“NPMBC”), stemming from 2008 State Attorney General guidelines regarding compliance with the Compassionate Use Act of 1996 under which the sale of medical cannabis for profit is not permitted). This obviously creates an issue where a non-profit has no equity that can be legally bought and sold, and individual NPMBC directors taking buyer purchase money undoubtedly violates the California corporations code in a multitude of ways. In turn, part of the EMMD purchase will entail some form of “conversion” to a for profit entity to ensure that future membership interests or stock can be sold off. Luckily, NPMBCs and non-profits in general in California can “convert” to for profit corporations and, from there, into whatever other for profit entity the controlling interests so decide. To “convert” though, unless the NPMBC’s bylaws specify otherwise, a vote of the entire “membership” (i.e., potentially all of the medical cannabis patient members) of the non-profit may be required in order to convert. And do not forget that a lot of dispensaries in L.A. may have made significant mistakes when putting together their bylaws so that a “conversion” vote may not even be possible without exposing the purchaser to significant successor liability from the NPMBC’s “members”. Also, don’t forget that the old corporate and tax sins of the NPMBC may haunt the new entity, so secure the appropriate representations, warranties, and indemnities accordingly.
  2. EMMD conversion is permitted outright in LA with a catch. Once you have the general conversion plan sorted in your term sheet, you have to deal with conversion under local law. In L.A., “. . . a change from non-profit status to for-profit status by an EMMD is exempt from [having to seek DCR approval] if no other ownership change is made in accordance with Proposition D’s ownership rulesand notice is provided to DCR within five business days. This exemption is not available after a License is issued.” This means that while EMMDs maintain a temporary license from the DCR to operate, EMMDs can convert from non-profits to for-profits without having to secure DCR approval so long as: 1) The original directors remain the “owners” and 2) The DCR gets 5 business days’ notice of the corporate change over. In turn, even if the entity can be converted, purchasers cannot immediately take over the EMMD unless the EMMD and the new owners are ready to complete all of the steps at point 6 below.
  1. EMMD status stopped in Phase 1. A lot of our clients have been pitched by several EMMDs on the alleged fact that EMMDs will get special treatment for the receipt of additional retail licenses in L.A.. This is not correct. All retailers in L.A. can receive and run up to three retail licenses total (including Type 9 delivery only retail). In phase 1 licensing, which was for EMMDs only and which has come and gone forever, if an EMMD only applied for a single retail license in that “Priority Processing” phase, they must wait until phase 3 for additional retail license application (which is the general public licensing phase). Regarding phase 3, the City has never said when it will open and it’s anyone’s guess as to when that window will commence, but it’s unlikely to happen in 2018 given the slower pace of licensing in LA. In any event, if EMMDs want more retail licenses (for which they did not apply when phase 1 was open), they’ll have to get in line like everyone else in phase 3.
  2. Phase 3 may be a dead end. Per point 5 above, if part of your purchase agreement is that the EMMD status will help you secure additional retail licenses in phase 3, you really need to be careful with that performance obligation. In phase 3, the City is already obligated under Prop. M to issue retail licenses to social equity applicants on a 2-to-1 basis relative to other general public (non-social equity) applicants. Since over 160 EMMDs already exist in L.A., this means that before even a single retail license issues to a general public (non-social equity) applicant, the City must first issue over 300 retail licenses to social equity applicants. Couple that with the fact that Los Angeles has undue concentration caps for retail licenses and the writing is on the wall that retail licensure may not be possible for non-social equity general public applicants in phase 3, and that includes for non-social equity EMMDs seeking additional retail licenses.
  1. This ain’t your daddy’s M & A. Mergers and acquisitions in regulated industries are a different animal because the transaction has to fit with regulatory vetting and approval before anything really becomes effective between the parties. Cannabis M & A is no different and, in fact, is probably worse since it’s an emerging industry and because commercial cannabis activity remains federally illegal. Once a California cannabis business has its annual license, if it wants to sell its membership interests or stock to bring in a disclosable “owner” (i.e., among other things, anyone or any entity that owns 20% or more in equity), it will first need to seek approval from the state agency that issued it its licenses. That’s not uncommon in states with robust cannabis regulations. What people may not know, though, is that the DCR also wants to know about changes in ownership and has full authority to reject the change request based on its scrutiny of the incoming owners. Specifically, in LA:

“A License is not transferable unless the change to the Licensee’s organizational structure or ownership is submitted to and approved by DCR. The Licensee shall complete a change of ownership application, pay all applicable fees and obtain the written approval of the change of ownership by DCR, pursuant to the Rules and Regulations . . .”

There are also specific increased requirements for changes of ownership for a social equity business set forth in the City’s Cannabis Procedures at section 104.20.

In any M & A term sheet and/or definitive purchase agreement for an EMMD in L.A., the parties have to take into account the requirement of first going through the DCR to have the transaction approved and they also need to address what happens in the event the new owners are, or the change of ownership request is, rejected by the DCR. The timeline for state and local government approval on these things is also both important and unpredictable, but should nonetheless be agreed to by the parties at the outset of the transaction to ensure success.

  1. Relocation is no picnic. In addition to their grandfathering, the EMMDs are not subject to undue concentration limits, and so long as they meet certain requirements they don’t have to comply with the Prop. M zoning and buffer requirements until 2022. However, if the EMMD relocates (which the DCR currently allows) or if it moves any of its other licenses from its original premises, it will lose the zoning and buffer exemptions. A good amount of the M & A we’re seeing includes a component that an EMMD with other licenses will either re-locate itself or some or all of its other licenses as part of the transaction. And a lot of that M & A completely fails to address the fact that upon such relocation the zoning and buffer grandfathering is lost. Be sure to address this grandfathering and/or the loss thereof if it’s part of your dispensary M & A goals in LA.

It’s not a stretch to say that selling and buying EMMDs in LA is not for the faint of heart. There are many important details that must be considered in any due diligence period and that must also be reflected in any viable purchase and sale agreement. So, do your homework and proceed with extreme caution.

l.a. social equity cannabis tier
Written agreement strongly recommended.

Applicants who qualify for commercial cannabis licensure during Phase II of the City of L.A.’s cannabis licensing process only have until September 13 to get their applications into the Department of Cannabis Regulation (“DCR”). This phase of licensing is reserved for existing, non-retail, social equity applicants. To get a license during this phase, the DCR requires proof of operation in the City prior to January 1, 2016, proof of service to an “Existing Medical Marijuana Dispensary” prior to January 1, 2017, and proof of eligibility as a Tier 1, 2, or 3 social equity applicant. For more on Phase II eligibility, see here and here.

I wrote earlier this month about the unusual business relationships our L.A. cannabis business lawyers are seeing born out of social equity in L.A. It’s pretty clear that lots of applicants will go for Tier 3 social equity status (i.e., where a Tier 3 incubates a Tier 1 or 2 social equity applicant). In that situation, the Tier 3 social equity applicant has to sign a social equity agreement with the City, but little to no detail on the content of that agreement exists in the law. In addition, licensees would be extremely unwise not to maintain social equity business agreements between themselves in order to ensure mutual performance and compliance. In turn, this post is dedicated to covering the details that should be included in social equity agreements between licensees:

  1. Mandatory Assistance.
    1. Capital. Under L.A. cannabis laws and regulations, Tier 3 social equity applicants must provide “capital . . . to Persons who meet the criteria to be a Tier 1 Social Equity Applicant. . .” L.A. does not mandate a minimum capital allocation. In turn, it is extremely important to specifically define in the private social equity agreement the amount of money and how often it will be paid to the Tier 1 social equity applicant. The contract should also address what occurs between the parties in the event the City mandates a higher amount to be paid from the Tier 3 to the Tier 1. This mandatory financing will also render the Tier 3 a “financial interest holder” of the Tier 1 under state law, so the disclosure process to the state of that fact should be addressed in the parties’ agreement.
    2. Leased Space. Tier 3s also have to provide certain amounts of leased space, rent-free as well as prorated utilities to Tier 1s. The amount of space the Tier 3 must secure for the Tier 1 is dictated by license and type and size as set by LA law. Current state law prohibits licensees from subleasing to each other (and state law dictates that only one license per “premises” is allowed), so any solid private social equity agreement will address the fact that the Tier 1 has to have its own lease for its own premises where the Tier 3 will pick up the rent and ensure prorated utilities. This situation opens all kinds of contingencies relative to the Tier 1 lease regarding default in rent payments by the Tier 3, indemnities, ongoing compliance with state and local laws by the Tier 1, and the list goes on and on. Additionally, if any build out or code compliance is necessary for the space, the question of who bears that cost and for how long and/or who has creative control over the process should also be negotiated.
    3. Business, Licensing and Compliance Assistance. A Tier 3 must also provide to both Tier 1s and 2s “business, licensing, and compliance assistance.” These terms are not defined by LA, so their meaning is currently up to the licensees and should be clearly defined in the private social equity agreement. For example, will the Tier 3 undertake the entire application process or just a portion of it on behalf of the Tier 1 or 2? Will the Tier 3 cover all licensing expenses on the state and local level? Will the Tier 3 allocate a certain amount of hours per week or month to ensure that the Tier 1 or 2 is in full compliance with both state and local law?
  2. There is no State Social Equity Program; Loss of Licensure. Where there is no state social equity program, the Tier 1 or 2 will still be personally responsible for compliance with MAUCRSA at all times. In turn, the parties need to discuss and agree on what will happen if the Tier 1 or 3 violates MAUCRSA in a way that jeopardizes the standing of their licenses. The same goes for material defaults of L.A. law and regulations.
  3. Social Equity Restrictions. Under L.A.’s social equity laws, a social equity applicant can’t really behave like a normal business. There are a slew of situations in which, before acting, the social equity applicant has to check in with the DCR. As a result, the private social equity agreement should force the Tier 1 or 2 into constant compliance with specific social equity reporting and vetting as required by local laws.
  4. Relationship of the Parties. Like any contract ever, the parties should be clear that their social equity relationship doesn’t otherwise create any partnership, joint venture, or agency relationship where one party can bind or create liabilities on behalf of the other.
  5. Term; Termination. The City of LA mandates that a Tier 3 “incubate” a Tier 1 or 2 for no less than a term of three years. On grounds for termination, the parties should contemplate a mutually beneficial code of conduct that goes to compliance with LA and state laws and regulations as well as maintaining respective social equity status.
  6. Taxes. Despite their local social equity relationship, each license is still responsible for the remittance of cultivation and/or excise taxes to the California Department of Tax and Fee Administration. Any contractual code of conduct between social equity applicants should make clear that each licensee bears the burden of tracking and paying its own taxes.
  7. Disputes. There are likely going to be many legal disputes between Tier 3s and their Tier 1 and/or 2 incubees. For one reason or another, it’s likely that either licenses won’t issue, construction will be stalled, and/or their will be material breaches to the detriment of either or both parties. We’ve already seen this occur in the Oakland social equity program. Therefore, Tier 3 social equity situations call for a clear protocol of what to do in the event of disputes. For more on the cannabis corporate disputes we’re seeing, see here.

Even though social equity is fairly heavily regulated in L.A., government cannot cover all the business details between parties (nor should it). That’s where a well thought out, written agreement becomes incredibly important in order to curb risk and get the parties in line for success or for a more orderly break-up in the event that things don’t work out.

california cannabis labeling prop 65
Don’t sleep on Prop 65!

Almost on a weekly basis, clients ask our California cannabis attorneys to review and provide advice and guidance on their packaging and labeling for their cannabis and cannabis products pursuant to California’s Medicinal and Adult-Use Cannabis Regulation and Safety Act (MAUCRSA). This means that our California cannabis attorneys have committed to memory the applicable packaging and labeling rules set forth under MAUCRSA and by the California Department of Food and Agriculture (CDFA) and the California Department of Public Health (CDPH). Between the two, CDFA deferred to CDPH on packaging and labeling for flower, and CDPH really only regulated packaging and labeling for cannabis infused products under the emergency rules. The packaging and labeling rules are not rocket science, but they’re immensely important for MAUCRSA compliance and consumer safety. However, none of the CDPH regulations or even MAUCRSA mention the applicability of Proposition 65 to California cannabis and cannabis products.

In addition to reviewing countless packaging and labeling content under MAUCRSA, our California marijuana business lawyers have also done a good amount of clean up of non-compliant packaging and labeling related to poor or uninformed legal advice regarding how Prop. 65 applies in the context of California cannabis. Failure to comply with Prop. 65 usually means disaster for the unwary business owner, ranging from costly and aggressive lawsuits to being shut down by the state.

The Safe Drinking Water and Toxic Enforcement Act of 1986 (a/k/a Prop. 65), requires the Office of Environmental Health Hazard Assessment (OEHHA) to publish a list of chemicals known to cause cancer, birth defects or other types of reproductive harm. The list now includes more than 1,000 chemicals. Effective June 19, 2009, marijuana smoke was added to the Prop. 65 list of chemicals known to cause cancer. OEHHA’s Carcinogen Identification Committee “determined that marijuana smoke was clearly shown, through scientifically valid testing according to generally accepted principles, to cause cancer.” Technically then, all cannabis flower is subject to Prop. 65 warnings since all flower contains/produces “marijuana smoke.” In addition, oils, wax, vapes, etc. usually contain at least one chemical on OEHHA’s list. Given this fact, there is hardly a cannabis business in California that won’t find itself subject to Prop. 65 warning requirements at some point. And none of the state agencies in charge of MAUCRSA are going to assist licensees in figuring out what they need to do to protect themselves under Prop. 65.

The first question cannabis businesses need to ask themselves in a Prop. 65 analysis is whether they’re subject to Prop. 65 at all. Who’s exempt? It’s a short list:

  1. Businesses with fewer than 10 employees and government agencies.
  2. Businesses are also exempt from the warning requirement “if the exposures they cause are so low as to create no significant risk of cancer or are significantly below levels observed to cause birth defects or other reproductive harm.” How low you ask? The exposure levels are different for each chemical type–for cancer causing chemicals, for example, no warning is required if the chemical exposure is calculated to result in “not more than one excess case of cancer in 100,000 individuals exposed over a 70-year lifetime.” You can find the Prop. 65 allowable exposure levels here.

Availing yourself of this second exemption is going to be very difficult, complex, and expensive to prove. It likely isn’t worth it if you even think you’re close to exceeding the allowable exposure levels.

Once you determine that Prop. 65 applies to you, you then need to identify the type of warning you need based on your product(s) and the relevant chemicals. And to really throw in a twist, you should know that new Prop. 65 regulations take effect on August 30, 2018. In turn, only the new safe harbor warnings should be used for products manufactured on and after August 30, 2018 (though you can still use the old September 2008 safe harbor warnings for product made before that date).

One of the most important changes with the new regulations is that you now need to actually identify at least one triggering chemical depending on the type of harm caused by that chemical. Specifically, OEHHA mandates that:

If, for example, there are five possible chemical exposures from a given product, and all five chemicals are listed only as carcinogens, then the business would only be required to name one of those five chemicals in the warning. . . If there are exposures to both carcinogens and reproductive toxicants, a business would be required to name one of the chemicals that is a carcinogen and one of the chemicals that is a reproductive toxicant, but the business could choose to identify more chemicals in the warning.

In turn, your new Prop. 65 warning will look like one of the following (plus the required symbol at the beginning and to the left of the warning):

  • For carcinogens: “WARNING: This product can expose you to chemicals including [name of one or more chemicals], which is [are] known to the State of California to cause cancer. For more information go to www.P65Warnings.ca.gov.”
  • For  reproductive toxicants: “WARNING; This product can expose you to chemicals including [name of one or more chemicals], which is [are] known to the State of California to cause birth defects or other reproductive harm. For more information go to www.P65Warnings.ca.gov.”
  • For exposures to both listed carcinogens and reproductive toxicants: “WARNING; This product can expose you to chemicals including [name of one or more chemicals], which is [are] known to the State of California to cause cancer, and [name of one or more chemicals], which is [are] known to the State of California to cause birth defects or other reproductive harm. For more information go to www.P65Warnings.ca.gov.”
  • For exposures to a chemical that is listed as both a carcinogen and a reproductive toxicant: “WARNING: This product can expose you to chemicals including [name of one or more chemicals], which is [are] known to the State of California to cause cancer and birth defects or other reproductive harm. For more information go to www.P65Warnings.ca.gov.”

In certain circumstances, short-form warnings for consumer products are allowed so long as minimum font requirements are met. Specifically, in addition to other content requirements, the short-form warning must be “in a type size no smaller than the largest type size used for other consumer information on the product and in no case in a type size smaller than 6-point type.”

Unfortunately, I still see cannabis products floating around that completely ignore or bungle Prop. 65 requirements, making these businesses sitting ducks for bounty-hunter plaintiffs and their attorneys. You’ve really only gone halfway in your MAUCRSA packaging and labeling analysis if you haven’t considered whether Prop. 65 applies to your business and what you need to do to duck in under the safe harbors. So, double check whether Prop. 65 applies to you and what you need to do to protect your business to ensure that you’re not on the wrong end of any Prop. 65 litigation.

Oftentimes in the marijuana industry, licensees forget or don’t believe that existing federal, state, and local laws apply to their cannabis operations. For example, things like ADA and OSHA compliance get overlooked where the thinking can be, “I’m already violating one federal law, so I don’t have to comply with other, existing federal or state laws.” Of course, that line of thinking is incorrect and is only going to lead to pain and suffering when it comes to legal violations, fines, and penalties.

Our California cannabis business lawyers are seeing many licensees in these early days of legalization continue to ignore existing state and federal laws, though we see that many are also striving to keep up both with the state’s rules and all other existing federal and state laws. On that note, one of the stickiest areas of compliance in California hasn’t really had anything to do with cannabis–it’s been whether distributors, specifically those who self-distribute, need a motor carrier permit (“MCP”) from the Department of Motor Vehicles. And the answer is: It depends.

California cannabis motor carrier permitGenerally, California requires any “motor carrier of property” transporting goods with a “commercial motor vehicle” to obtain and maintain a MCP from the state. California’s Medicinal and Adult-Use Cannabis Regulation and Safety Act (MAUCRSA) and the Bureau of Cannabis Control (BCC) regulations specifically provide that “[a]ll vehicles transporting cannabis goods for hire shall be required to have a motor carrier permit pursuant to . . . the Vehicle Code.” What the term “for hire” means is not defined either by MAUCRSA or the BCC (which oversees distributors).

California’s Vehicle Code provides that “a motor carrier of property shall not operate a commercial motor vehicle on any public highway in this state, unless it . . . holds a valid motor carrier permit issued to that motor carrier by the department.” For purposes of that statute: “‘motor carrier of property’ means any person who operates any commercial motor vehicle,” and “‘commercial motor vehicle’ means:

  1. Motortrucks of three or more axles that are more than 10,000 pounds gross vehicle weight rating;
  2. Truck tractors;
  3. Vehicles transporting hazardous materials;
  4. Any motortruck of two or more axles that is more than 10,000 pounds gross vehicle weight rating; and
  5. Any other motor vehicle used to transport property for compensation.

Whether a vehicle operator must obtain a MCP basically depends on: (1) the type and size of vehicle, and (2) whether the vehicle is “used to transport property for compensation.”

Distributors transport cannabis in three main scenarios: between licensees before testing, for testing purposes, and between licensees post-testing (including for remediation in the event of a failed cannabis quality assurance test). If a distributor is using vehicles it owns to conduct transport activities that it pays for and that benefit the distributor, with no form of compensation, that distributor will not need a MCP. However, if the distributor, let’s say, hires another distributor to move the cannabis around, that distributor is going to be a “for-hire motor carrier of property,” and the first distributor isn’t responsible for obtaining MCPs because the vehicles in that scenario are not owned by that first distributor. And if a distributor is getting paid for its transportation of cannabis goods, even to cover the costs of transportation, a MCP is in order.

Ultimately, in almost all scenarios, whether a distributor has to get a MCP in California will come down to the transportation terms and conditions between licensees.  If a distributor obtains any kind of compensation for transporting products, this triggers the MCP requirements. If the distributor is performing transportation services gratis though, no MCP is necessary.

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

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

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

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

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

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