Working out of Harris Bricken's Los Angeles office, Julie is a fearless advocate for businesses and organizations striving to master government processes, avoid litigation, and foster an environment that allows them to grow freely. Her experience working for federal and local governments and agencies has provided Julie with a unique perspective and an ability to foster cooperative relationships with public agencies on behalf of her clients.

california cannabis marijuana

Welcome back to “California Cannabis: Scams and Schemes of the Week.” We are publishing this series to shed light on the unscrupulousness of certain attorneys, consultants, and operators in the California cannabis industry, with the goal of establishing a more ethical and regulated industry in the state. You can find last week’s post here.

Scam #1: Attorneys Representing Buyer and Seller and Taking Commission

We continue to see attorneys representing cannabis entities on both sides of mergers and acquisitions, and in addition to taking an hourly rate, they’re taking a commission on the deal (from both parties)! We are seeing the same attorneys appoint themselves as counsel for the purchased corporation. We’ve seen some shocking deals that harm both parties and benefit only the attorney. Most often, troubling information about a business or property is concealed for the benefit of the seller and the attorney, to the detriment of the buyer. We often see good, trusting people get taken for a ride by attorneys with unethical motivations. The incentive to close a deal as quickly as possible to get a commission is at odds with the incentive to conduct careful due diligence. Make sure your agents and attorneys have your best interests at heart, and if a lawyer tells you he or she can represent “both sides” in a transaction, run!

Scam # 2: The $10 Million Plot of Empty Desert Land

We’ve seen some outrageous land deals in California. There are a number desert parcels without any improvements or utilities, in the middle of nowhere, being offered for millions of dollars. Due diligence is key in real estate transactions, especially in the speculative cannabis market. Just because cannabis activity is possible in a certain jurisdiction does not mean an empty plot of desert land there is worth $10 million. Supplying that land with water, electricity, and building out the structure is no small feat. Many remote desert areas lack the infrastructure to supply these parcels with necessary utilities, and the installation of such infrastructure takes many years and substantial cost. Beware.

Scam #3: Work for Equity in My Nonprofit! 

In California, no one “owns” a nonprofit. One cannot buy or sell a nonprofit corporation, and no stock can be issued or authorized by a nonprofit. We’ve discussed this before on the blog.

Still, we have people asking us to review equity agreements where their nonprofit employer is offering stock instead of salary. In some cases, the company offering these fake stock deals may not know any better because they’re being advised by incompetent attorneys. In other cases, however, these companies are knowingly taking advantage of employees who are blinded by the excitement of being part of a bourgeoning industry. Walk away.

Scam #4: Buy My License!

Under MAUCRSA, state licenses are non-transferable. According to 16 CCR 5023(c), if one or more of the owners of a state license change, a new license application and fee must be submitted to the BCC within 10 business days of the ownership change.

Most local cannabis permits are similarly non-transferable. And if they are transferable, most jurisdictions require you to obtain written approval from the local government prior to transfer. Keep this in mind if you’re looking to buy or lease a “cannabis approved” property, There is simply no guarantee you will be able to get a license to operate there.

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If you’ve come across a California cannabis industry scam, we would like to hear from you! Leave a comment below, or email us at firm@harrisbricken.com.

california cannabis scam

I’ve had it with the scams and schemes in the cannabis industry. I’ve never seen so much dangerously ignorant and downright criminal behavior. Since beginning work in the cannabis industry, I have yet to go a day without encountering some sort of scam. The unscrupulousness of some attorneys, consultants, and operators in this industry needs to be called out and eliminated so we can establish an ethical, regulated industry in California. Towards that end, I’ll be posting a weekly list of scams and schemes to help unsuspecting victims avoid getting taken for a ride.

Scam #1: We Turn Your Cash into a Check Through Real Estate Investment!

There is a group pitching a scheme to turn dispensary cash into checks that can be deposited in the bank. The method: fork your cash over to this group. They toss your cash in with other “investors” and buy real estate with it. They flip the property, and send the proceeds to you in a check. Folks, this is textbook money laundering. The pitcher of this scam is exhibiting at industry conferences across the country and handing out “attorney-approved” contracts. Brazen, stupid, and dangerous for all involved.

Scam #2: Cannabis Cryptocurrency

If you want a lesson on what the government thinks about combining anonymous cryptocurrency with a federally prohibited substance, look no further than the life sentence handed down to Ross Ulbricht, creator of the Silk Road. Ulbricht was convicted of money laundering, computer hacking, and conspiracy to traffic narcotics. Those are the exact same charges that could be brought against any cannabis cryptocurrency company. Don’t get me started on the value of cannabis cryptocurrency on the secondary market. It’s complete b.s.

Scam #3: You Must Cultivate Before Obtaining a Permit

Most people laugh out loud when they hear this. Unfortunately, there are a few attorneys who provide their clients with downright criminal advice, trying to convince would-be business partners or landlords to engage in unlawful behavior. The days of collectives and “creative” lawyering to get around the laws are over. We now have a robust regulatory system under MAUCRSA that makes it clear that you cannot engage in any sort of commercial cannabis activity before obtaining all local approvals and a state license.

Scam #4: Your DUI Attorney Can Handle Your Tax Audit

Just say no. You are a legitimate business, and you need to retain a legitimate and experienced lawyer to handle your legal matters See Seven Keys to Choosing Your Cannabis Business Law Firm.

Did San Mateo’s new ordinance moot the CEQA issue?

Last month, we blogged about the writ petition brought against the County of San Mateo by petitioners who alleged non-compliance with the California Environmental Quality Act (“CEQA”).

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

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

The County of San Mateo’s challenged ordinance allowed cannabis cultivation subject to ministerial approval of license applications. This means there was no deliberation or discretion involved, and the County could issue licenses over the counter, if an applicant checked all applicable boxes.

As we explained in our last post, the County issued a negative declaration with the challenged ordinance following an initial study, determining that there was not substantial evidence that the ordinance would have a significant effect on the environment. Petitioners disagreed, claiming the record contained substantial evidence supporting myriad arguments that the ordinance would adversely impact hydrology and water quality, sensitive species and habitat, air and light pollution, climate change, and other effects.

Further, as ministerial licenses, each cannabis cultivation project under the challenged ordinance would have been exempt from CEQA and none would require their own environmental analysis. That fact alone seems like an end-run around the law.

At the end of February, petitioners and the County held a settlement conference. Shortly thereafter, the County repealed and replaced their cultivation ordinance with one that subjects each cultivation project to discretionary approval. Now, each cultivation project will be subject to CEQA unless otherwise exempt.

MAUCRSA provides a temporary exemption to CEQA to cities and counties adopting a cannabis ordinance subject to specific conditions.  So long as a city or county ordinance requires discretionary review and approval of permits, licenses, or other authorizations to engage in commercial cannabis activity, and includes any applicable environmental review pursuant to Division 13 of the Public Resources Code, the adoption of the ordinance itself is exempt from CEQA. Bus. & Prof. Code, § 26055(h). This exemption expires July 1, 2019.

Arguably, the County of San Mateo’s new ordinance is exempt from CEQA pursuant to Business and Professions Code section 26055(h), and the petition is moot. There are no future hearings on calendar, but the writ petition is still pending. We will keep you posted on any developments: The viability of San Mateo’s approach could have a significant impact on the approach taken by other local jurisdictions with respect to California marijuana licenses.

Courts often invalidate unfair spot zoning ordinances.

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

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

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

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

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

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

california cannabis
Pro environment? Or just anti-cannabis?

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

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

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

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

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

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

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

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

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

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

California marijuana cannabis
ICYMI: We have answers to your marijuana retailer, distributor, and microbusiness questions from our MAUCRSA webinar

Last month, we hosted a webinar analyzing the emergency cannabis regulations released by the California state agencies in charge of administering the Medicinal and Adult-Use Cannabis Regulation and Safety Act (MAUCRSA). We had over 1,000 people sign up to find out what the California cannabis regulatory landscape will look like in 2018 for cultivators, manufacturers, distributors, retailers, and microbusinesses.

During the webinar, we took questions from attendees, but we couldn’t get to all of them due to the sheer number of questions asked. Alison Malsbury covered the webinar questions related to cannabis manufacturers, Habib Bentaleb handled the questions regarding cultivation, and I’ll cover the retail/distribution/microbusiness questions here.

Q: Please explain the logistics of distributors collecting excise tax from retailers. Is it collected at the time of invoice/delivery or can the retailer wait and not pay the distributor until up to 90 days later? If so, how the heck will distributors track all of this and what recourse do distributors have if a retailer doesn’t pay the excise tax?

A: The Distributor is the focal point in the California Cannabis and Excise Tax system. Cultivators and Retailers are prohibited from remitting Cannabis Taxes to the California Department of Tax and Fee Administration (CDTFA).  The law intentionally places a serious burden on the Distributor to pay up. Although only a Distributor may remit taxes to CDTFA, all licensees in the supply chain are subject to a 50% late payment penalty if the tax is not paid when due. Accordingly, Distributors should receive payment of the Cannabis Excise Tax from the Retailer at the date of sale. This will likely be a serious point of contention as the Retailer will want to defer payment until product is sold to a consumer, so be sure to cover it in your distribution agreements.

Q: Do retailer Exit Bags need to be labeled?

A: 16 C.C.R. § 5413 requires an “opaque exit package” for all product leaving a retail storefront going into a consumer’s hands, but the regs say nothing about having to have a specific label on that exit packaging.

Q: What are the child resistant packaging requirements for retail sales in the first few months?

A: During the transition period (January 1 through July 1, 2018), cannabis goods in a retailer’s inventory at the time of licensure that are not in child resistant packaging may be sold if the retailer puts them into child-resistant packaging at the time of sale. “Child resistant” means designed or constructed to be significantly difficult for children under five years of age to open, and not difficult for normal adults to use properly.

Q: Can licensed dispensaries purchase manufactured material from nonlicensed manufacturers during the transition period?

A: No. Licensees may only conduct business with other licensees, even during the transition period.

Q: What is a microbusiness?

A: A commercial cannabis business engaged in at least three of the following activities: cultivation (less than 10,000 square feet), manufacturing (non-volatile or no solvnets), distribution, and retail sale.

Q: Do microbusinesses activities need separate addresses?

A: No. In fact, microbusinesses must conduct all cultivation, manufacturing, distribution and retail activities on the same premises.

Q: Can you clarify what adult use licensees and medicinal licensees are allowed to do during the transition period? Can an adult use licensee purchase products from a medicinal licensee? Can a medicinal retailer sell to non-patients?

A: During the transition period, from January 1 through July 1, 2018, licensees can transact business with each other regardless of the “M” or “A” designation. However, a medicinal retailer cannot sell products to “adult use” customers and vice versa. In other words, medicinal retailers can only sell products to qualified patients and caregivers. A medicinal retailer cannot act as an adult use retailer during the transition period, or ever, without an adult use license.

Q: Can you talk more about the distribution license and if you will have to package, test, etc.?

A: It depends. You could be a “storage only” or a “transport only” distributor that does not handle packaging and testing. Otherwise, a distributor may package, re-package, label and re-label cannabis flower for retail sale. A distributor cannot, however, package, re-package, label or re-label manufactured cannabis products unless the distributor also holds a manufacturing license and is packaging, re-packaging, labeling or re-labeling its own manufactured cannabis products. Testing and quality assurance services are also on the table for distributors. Regarding testing, after taking physical possession of a cannabis goods batch, the distributor must contact a testing laboratory and arrange for a lab employee to come to the distributor’s premises to select a sample for testing. The distributor also has duties and obligations for which it is responsible during the testing sample retrieval process.

Q: Is self-distribution considered a “transport only” distribution license or can businesses wishing to self-distribute do all distribution activities package/label/testing/quality assurance review?

A: To be clear, a testing licensee is totally separate from all other licensees. A distributor is responsible for the coordination and verification of testing, but cannot do the testing itself. An entity with a distribution license, so long as it is not “transport only” or “storage only,” can engage in any of the activities that a licensed distributor is authorized to do.

Currently, the licensing fee schedule divides the distributor license into three categories: Distributor, Distributor Transport Only Self-Distribution, and Distributor Transport Only. Obviously, if you apply for the Transport Only Self-Distribution license, you will be limited to transport only (and even that has certain limitations regarding what you can transport and to whom).

Q: Would a cannabis yoga and meditation business be OK?

A: It depends on the local government. If onsite consumption is authorized, and the location is zoned for yoga and meditation (as well as onsite consumption of cannabis), then such activity would presumably be allowed pursuant to a retail or microbusiness license so long as the following are met: (1) Access to the area where cannabis consumption is allowed is restricted to persons 21 years of age and older, (2) Cannabis consumption is not visible from any public place or nonage-restricted area, and (3) Sale or consumption of alcohol or tobacco is not allowed on the premises. Appropriate permits/licenses from your local government would need to be obtained for yoga or meditation as well.

Q: Are you able to start a cannabis lounge, like a Hookah lounge?

A: The foregoing rules apply for cannabis lounges, too. Be sure to check on whether your local government authorizes onsite consumption.

Q: Can you have entertainment and onsite consumption?

A: See above regarding onsite consumption. Entertainment is often restricted by local zoning codes, but as long as it is locally authorized, live entertainment is expressly permitted by the regs so long as there is no nakedness, no live sex and no nipples (male or female)! Basically no strip club/consumption lounges are allowed in this context. See 16 C.C.R. § 5807 for more on that.

Q: Can you cover which of these licenses can be held concurrently? Or, if it’s a shorter list, which licenses have restricted concurrent licensing?

A: All licenses can be combined, with the exception of testing (and Type 5 cultivation licenses, which are not yet available). A testing licensee cannot hold any other cannabis licenses.

Q: Can distributors use professional employment organizations (such as ADP) and have these count as employees for the purposes of transport?

A: No. 16 C.C.R. § 5311 specifically states that transportation shall only be conducted by licensed persons or their employees. Further, Business & Professions Code § 26070(c) says “[t]he driver of a vehicle transporting or transferring cannabis or cannabis products shall be directly employed by a licensee authorized to transport or transfer cannabis or cannabis products.” Employees are expensive, but distributors need to budget accordingly if they want to comply with MAUCRSA.

Q: Can autonomous vehicles distribute cannabis or manufactured goods?

A: No. Unmanned vehicles are prohibited per 16 C.C.R. § 5311(c).

Q: If a product has been tested by a lab and deemed clean or cleared to go to market, why is the liability on the distributor and not the lab, cultivator or manufacturer if something ends up being wrong with that product?

A: Distributors are statutorily obligated to oversee the quality assurance process. A distributor is responsible for ensuring that the certificate of analysis from the lab correctly corresponds with the batch, that the label is consistent with the certificate of analysis, the packaging complies with MAUCRSA and is tamper-evident, the weight or count of the batch comports with that in the track and trace system, and that all events prior to receipt have been entered into the track and trace system. That does not mean that the distributor will be solely liable if something is wrong with the product, but we believe we will see a lot of distributors named in lawsuits involving product liability issues because of their statutory duty to do everything mentioned in the previous sentence. This does not mean cultivators, manufacturers, and testing labs are not also liable. As a result, insurance and indemnity agreements are key here.

Q: Does an indemnification contract remove the liability for the distributor? Or only possibly?

A: An indemnity agreement is a good tool to use to shift liability, but as I mentioned during the webinar, an indemnity agreement only works if the other party is well-capitalized and/or well-insured. If you have an indemnity agreement with a party that goes bankrupt and never carried insurance, you will not recover your losses. Nothing, not even a great indemnity clause, can guarantee full insulation from liability.

Q: What type of permitting or licensing do I need for a compassion program that is currently running is not a storefront. We do not sell cannabis at all, host our donation day at a brick and mortar and deliver to homes at no cost to patients that are low income, disabled or suffering from an acute illness.

A: For an answer to this question, please see California Cannabis Licensing and The Collective Model: How Long Will That be Going On? 

Q: Do I need to secure a location prior to applying for the license?

A: Yes. With your state application, you must submit the physical address of the premises, evidence of the legal right to occupy the premises, and a diagram of the premises, among other things.

Q: Is delivery considered a retail activity under the microbusiness license?

A: Yes. 16 C.C.R § 5500(e)(4) expressly contemplates non-storefront delivery as a retail element of a microbusiness.

Consolidation, Connection and Automation Differentiate Blockchain from Current Technologies

Following my last post about blockchain technology and the cannabis industry, a Canna Law Blog reader commented, “[m]aybe I’m missing something. How is this better than just scanning a barcode when the item changes hands like they do with FedEx?”

Great question. I asked similar questions early on in my work with blockchain technology. What differentiates blockchain from applications like DocuSign, DropBox and Google Drive which already provide a shared, instantaneous and relatively secure system.

Among other things, blockchain connects these isolated applications and consolidates them into one place — enabling faster, more secure, automated transactions. A barcode scan by FedEx is a single event trapped in the FedEx system. When shipping an item, FedEx, the shipper and the recipient can track the package by entering the tracking number on FedEx’s website. Blockchain, on the other hand, reveals all of the steps to all of the parties with permission to view the chain, such as the manufacturer, its suppliers, the seller, the various warehouses and intermediate sales channels (e.g., Amazon’s distributed sales network), the carrier (FedEx), the recipient, any inspectors at stages along the way, the paying bank, the receiving bank, the government taxing and other authorities. All are all linked. In a non-blockchain system, all of the various participants work on their own independent systems, which are arguably insecure and not linked into one, single, immutable ledger.

The FedEx scanning is, as you can see, only one small step in a larger chain of events and participants.

FedEx Scanning and Tracking Does Not Create Self-Executing Smart Contracts

In addition to the linking of participant networks as described above, blockchain technology can also be used to create self-executing “smart contracts,” where automatic and instantaneous responses are triggered by certain pre-defined events. Participants in a smart contract, for example, should get paid at the right time without the need for anyone to issue an invoice, receive an invoice, write a check, make a wire transfer, or execute a credit card transaction. Payment triggers would be written as code into the blockchain. According to Accenture, investment banks alone could save up to $12 billion per year by adopting blockchain and smart contracts. Gartner has estimated that by 2022, defined impact smart contracts will be in use by more than 25% of global organizations.

DocuSign is similarly just one small piece in a larger chain of events and participants. In a blockchain setting, a law firm would not be required to issue an invoice or to continually bug a client about paying a retainer as it would happen automatically. Submitting the engagement document to the blockchain with a digital signature would trigger a series of events. One event would be payment to the firm. The digital signature would be an authorization to the client’s bank to pay the bill automatically, with no additional approval needed from the client. If the payment is subject to conditions, then the “smart contract” would set out those conditions and the method for proving fulfillment. When fulfilled, the payment would be made. Consider the amount of time and friction that would save for a small entity. Then consider the amount of time and friction it would save for a large company and the economy as a whole.

Same with a DropBox type program. Once a document is accepted into a blockchain ledger, it does not just sit there inert as it does in DropBox. The entry into the ledger would trigger other actions: payment of a bill, issuance of a deed or registration of a deed of trust. Isolated transactions would be linked into the chain. If there is no need for this chain, e.g. if no network of participants exists, then blockchain is not required and the dead letter box of DropBox would be adequate.

 

The Downsides – Implementation Costs, Loss of Privacy and Intrusive Government Surveillance

Blockchain reduces time and friction, but what about the time and friction required to create a blockchain program, adapt old records into the system, program smart contracts with highly specific code language, and maintain the program over time? When blockchain’s benefits outweigh these downsides, we will see mass adoption of the technology.

As discussed in my previous article, blockchain technology has obvious benefits in the cannabis industry as a supply chain tracking mechanism. Regulators and technology companies have already shown interest in implementing a blockchain-based track and trace system. What has not been discussed, however, is how intrusive government participation could be if regulators are included as an authorized party in a blockchain system. Most would feel uncomfortable knowing the government could comb through all of their cannabis transaction histories with just one click. In fact, the Fourth Amendment protects United States citizens against such unreasonable searches. Further, the European Union’s incoming General Data Protection Regulation regarding consumer data privacy and ownership rights and the US Fair Credit Reporting Act, the Gramm-Leach-Bliley Act and the SEC’s “Regulation SP” all require personal financial data be redactable—something not possible on an immutable platform.

It remains to be seen how blockchain systems will strike a balance between privacy rights and the needs of government regulators. We will likely see mechanisms to allow government review of transaction history only upon demonstration of probable cause or upon consent of the participants. We should also expect to see opposition from the cannabis business community to the ability of government to participate in the blockchain ledger at all. I will monitor developments in this space as the technology and regulations evolve and continue to post about them here.

Cannabis, bitcoin and blockchain
Blockchain is coming to cannabis

IBM is getting into the cannabis business. On November 1, the US computer manufacturer submitted a proposal to the Government of British Columbia touting the benefits of its blockchain technology for supply chain management in Canada’s nascent cannabis industry. According to IBM, blockchain will allow B.C. to “transparently capture the history of cannabis through the entire supply chain, ultimately ensuring consumer safety while exerting regulatory control from seed to sale.”

What is blockchain, you ask?

Blockchain mania is taking over Silicon Valley — it’s the latest tech buzzword, described as world-changing technology. Essentially, blockchain is a shared, tamper-free public ledger that can be used for pretty much any kind of data organization that everyone can inspect, but which no single user controls. The participants in a blockchain system collectively update the ledger, and it can be amended only according to strict rules and by general agreement between the parties to the ledger.

The most famous applications of blockchain are bitcoin and Ethereum, cryptocurrencies built on blockchain technology. But blockchain is not limited to cryptocurrency — there are innumerable potential applications of this technology that industry leaders believe will revolutionize the way we do business. Namely, blockchain technology can help assure data integrity, maintain auditable records, render contracts into programmable software, and create self-executing agreements like “smart contracts.” Smart contracts and supply chain management are among the revolutionary applications of blockchain technology. For example, in the context of a supply chain, the secure records in a blockchain system help prevent fraud and provide a simple interface that enables businesses and regulators to inspect data regarding the flow of goods within a matter of seconds.

Blockchain technology can also minimize the sometimes nightmarish logistics of inventory management and tracking. IBM has been testing blockchain technology with various major corporations, including Walmart. Utilizing blockchain technology to manage the supply chain of mangoes, Walmart was able to reduce the time required to trace a mango’s journey from tree to consumer from six days to two seconds.

With the banking epidemic and the need for transparency in the robustly regulated (but mostly volatile) cannabis industry, blockchain can serve a number of functions; from assisting with track and trace systems for inventory, to mechanizing quality assurance reviews and data, to assisting licensees with their day-to-day sales and money transactions and transmissions.

Indeed, in its pitch to the B.C. government on integrating commercial cannabis activity with blockchain technology, IBM contends that the use of blockchain technology will enhance visibility of activities and identification of where an asset or product is at any point in time, who owns it, and what condition or state it’s in. According to IBM, this will bring “a new level of visibility and control to regulators and provides assurance to the multitude of cautious stakeholders regarding the way the management of a cannabis supply chain is rolled out.”

Specifically, IBM claims blockchain can help governments take control of sourcing, selling and pricing of cannabis products, thereby reducing or eliminating illegal sales, assist cannabis producers with real-time inventory management, improve projections of supply and demand, and elicit trends of consumption through data analytics. And that, for retailers of cannabis, an interconnected blockchain network can assist them to identify supply and demand gaps and ways to mitigate those gaps, provide feedback mechanisms to cannabis producers, and use data to create predictive insights.

So far, proposals to implement blockchain in the US cannabis market all appear intertwined with cryptocurrency, which resides in a questionable legal space and has attracted the scrutiny of federal regulators (see here). As demonstrated by IBM, cryptocurrency is not necessary to harness the underlying blockchain technology; one does not need to transact in cryptocurrency or purchase tokens to utilize blockchain. See also The Hazy Future of BitCoin and Marijuana.

We predict that blockchain systems untethered to cryptocurrency will begin to emerge in regulated cannabis markets in the US, especially if the benefits described by IBM come to fruition. For now, we will wait and see whether B.C. takes IBM’s advice.

Hollywood CannabisFive hours into a marathon council meeting, following robust discussion among City Council members and some fine-tuning by the City Attorney, West Hollywood introduced its new cannabis ordinance on first reading. The ordinance is scheduled for a second reading on November 20, and if adopted, will become effective just in time for the State’s implementation of MAUCRSA in January. The original ordinance is available here, but the revised version has not yet been published.

West Hollywood’s cannabis ordinance creates five types of cannabis business licenses, implements a merit-based system to select the top operators, and limits the number of licenses in each category to eight (except for delivery services).

The Ordinance Allows Adult Use Retail, Medical Use Retail, On-Site Consumption, Delivery, Testing, Manufacturing, and Cultivation

The ordinance provides for the following licenses:

  • up to 8 adult-use retail business licenses
  • up to 8 consumption areas (smoking, vaping, ingestion) with on-site adult-use retail (sales of products to be consumed on-site) business licenses
  • up to 8 consumption areas (edible ingestion only) with on-site adult-use retail (sales of products to be consumed on-site) business licenses
  • up to 8 medical-use dispensary business licenses
  • up to 8 business licenses for cannabis delivery services located in West Hollywood.
  • an unlimited number of business licenses for cannabis delivery services that are located outside the City limits and deliver cannabis to customers within the City of West Hollywood.

In addition to these licenses, the ordinance allows the following uses without a separate cannabis business license:

  • Testing laboratories
  • Manufacturing and indoor commercial cultivation as ancillary uses to licensed retail use

A business may hold a combination of licenses, but may not obtain two of the same type of cannabis license within the City. West Hollywood expects most operators will obtain multiple licenses.

A City Manager-Appointed Committee Will Rank Applicants Based on Weighted Criteria

Following an initial 30-day application period, the City Manager-appointed evaluation committee, comprised of at least three people with demonstrated experience in city government or the cannabis industry and with no business interests in West Hollywood, will review and score each application based on the general criteria listed below.

The City has not yet determined the specific criteria or weighting of points per criteria for each license type, but it will do so prior to the initial application period and it will publicly post this information.

At present, there is no tiebreaking mechanism in the ordinance, so it remains to be seen how the City will select the top 8 applicants in a particular category if, for example, 15 applications end up with the same high score.

The following general criteria will be used to rank applicants:

  • Previous adult-use retail, medical-use dispensing, or consumption area operation experience that was subject to state cannabis regulation, or experience in a similarly state-regulated activity (by way of example and not limitation, alcohol sales).
  • Ability to demonstrate the quality of cannabis strains and derivative product offerings.
  • Employee training, standard operating procedures, online ordering systems and procedures for providing cannabis to disadvantaged or disabled persons.
  • Social equity in terms of provision of providing a living wage and employee benefits and compliance with local, state, and federal employee non-discrimination policies.
  • Security program.
  • Pre-existing West Hollywood Cannabis Business that has no outstanding code violations with the City and is in compliance with local and state laws.
  • Ability to meet City of West Hollywood Urban Design Standards.
  • Additional information that demonstrates the ability to operate in a safe and responsible manner in the City, including without limitation a review of the quality and thoroughness of application materials, connection to West Hollywood, ability to serve the West Hollywood community, familiarity with West Hollywood, and innovative boutique business models consistent with the West Hollywood community.

Four Existing Cannabis Collectives Are Entitled to Relocation, Temporary Licenses, and Exemption from Ranking

The ordinance provides substantial priority to the four authorized cannabis collectives currently operating in West Hollywood. During the hearing, City Council amended the ordinance to automatically grant existing businesses the first four available medical dispensary licenses, so long as they satisfy certain criteria.

If any of the existing four want to take advantage of priority without having to go through the ranking process, they cannot make a permanent change to adult use. In other words, an existing business would have to remain medical only, and/or obtain only a temporary license to engage in any adult use. An existing business wanting to take advantage of this priority would not be able to obtain a consumption license because those are only compatible with adult use retail. It appears an existing business could potentially add delivery services, so long as the delivery involved medical use products only.

However, even if one of the existing four decided to add adult use and forgo the priority license, the ranking criteria includes a category for existing collectives in good standing, meaning the existing businesses are entitled to additional points that a new business could not obtain. Accordingly, the existing businesses have a significant advantage in obtaining licenses.

The ordinance further provides that any of the existing four collectives that do not meet location requirements of local or state laws can move to a compliant location and be considered an “existing medical cannabis location.” An existing business may also obtain a temporary use permit in its original, non-compliant location if the State will issue a license for the location. This language appears directed at an existing collective located within 600 feet of a school.

Under the ordinance, existing businesses may immediately apply for a temporary and annual state license and local business license to operate medical and adult use retail. A temporary use permit may be issued to the existing four collectives to engage in the sale of adult use on a temporary basis provided that the operator receives and maintains a valid temporary license from the State.

Further Changes to the Original Ordinance Include Eliminating the Double Driver Requirement, Expanding Consumption Areas, and Limiting Operating Hours

In addition to the changes discussed above, the City eliminated the requirement that at least two employees be present in a delivery vehicle at all times, expanded the maximum consumption space from 25% to 50% of the total floor area of the retail space, and added language expressly reserving the authority of the Business License Commission to limit operating hours and to institute a closing time earlier than 2:00 a.m.

Orientation Meetings Next Week; Ordinance Scheduled to Take Effect Before January 1, 2018

The City invited interested parties to an orientation meeting next week to discuss the ordinance and answer questions about specific requirements and the application process. If the second reading and adoption proceed as expected on November 20, the ordinance will become effective before January 1, 2018.