Photo of Robert McVay

Robert is a partner at Harris Bricken focusing on corporate, finance, and transactional matters for clients both inside and outside the cannabis industry.

Properly managing marijuana supply is the single most challenging aspect of state-level marijuana regulation. In an op-ed published January 12th in the Oregonian, Billy Williams, U.S. Attorney for the federal district that encompasses Oregon wrote about what he calls Oregon’s “massive overproduction problem.” According to Williams, postal agents in Oregon seized 2,644 pounds of marijuana in outbound parcels in 2017 alone. Decreasing wholesale prices in Washington and Colorado indicate oversupply as well based on the inverse correlation between supply and price. We hear anecdotes in Washington all the time from marijuana producers that are finding it more and more challenging to survive with the current market prices.

If this were any other market, data points indicating falling prices and oversupply would be wholly unremarkable. Free markets tend to find an equilibrium point between supply and demand that support relatively stable wholesale and retail prices. Free markets also tend to self-correct, if given the opportunity to do so. If businesses in a market are all extremely profitable, new firms are induced to enter the market. The entry of those new firms tends to increase competition and decrease profits across the board, signaling to other would-be market participants not to enter. Similarly, if things are not going well and competitors exit the market, surviving businesses are given a little bit more room to maneuver and succeed.

cannabis marijuana supply
Managing cannabis supply is a tightrope for state regulators.

But standard markets differ from cannabis markets. They have a longer history from which to draw conclusions and base expectations. The legal cannabis markets in Washington and Colorado didn’t really start until 2014. It is challenging to determine what effects outside forces have on those markets when there isn’t historical data to draw on. How elastic are cannabis markets– meaning, how price-sensitive are they? We are learning a lot now, but the cannabis data we have pales in comparison to, for example, the alcohol market with data going back to prohibition.

The cannabis market’s short life span can also explain why market participants often act differently than one might expect. People investing in the cannabis market see it as a once-in-a-lifetime opportunity to get in on the ground floor of something. Whether it’s the original dotcom bubble, bitcoin, or marijuana, new markets create hope of potentially boundless returns. Because of that hope, firms tend to stick around longer than one might expect — you don’t want to be the person that exited the industry right before it took off and made everyone in it a billion dollars.

And that hope is part of the reason that oversupply issues exist in legal marijuana states. Oversupply by itself wouldn’t be a problem if not for cannabis’s federal illegality. Because even in the cannabis market, forces will eventually correct oversupply and get us to equilibrium. Companies aren’t going to stay in business losing money year after year into eternity. But whereas other markets get the benefit of time to find that equilibrium, cannabis oversupply issues bring threats of federal enforcement. If there is too much supply in the legal market, the incentives remain for certain unscrupulous and desperate cannabis businesses to cut their losses and sell their overage in the black market.

Which brings us back to state regulations. If we could have had Eric Holder as attorney general for ten more years, the Department of Justice may have understood that legal cannabis markets need time to adjust, and that the adjustment period would be occasionally rocky. But under Jeff Sessions and the U.S. Attorneys that share his views, these periods of market adjustment provide ample opportunity to criticize state cannabis programs and claim that federal law enforcement is necessary due to black market leakage.

Ending the cannabis black market is the one shared goal that prohibitionists and legalization proponents have in common. No one thinks that empowering an underground illegal cannabis market is a good idea. But if states move too far in controlling supply because they are worried about black market leakage inviting in federal law enforcement, legal cannabis prices will rise too high within those states. And those high prices will incentivize black markets to continue selling outside the eye of any state regulatory system.

This tightrope is why managing supply is such a tough nut to crack for state regulators. If U.S. Attorneys and the Department of Justice really want to see the end of cannabis sales in black markets, though, they will provide room for the legal markets to stabilize and find their natural supply, demand, and price points on their own.

marijuana cannabis
What will the future bring for marijuana markets?

The end of one year and the beginning of another presents a good opportunity to look ahead at the long-term goals of the marijuana legalization movement. In the near term (next year or two), nationwide legalization or even decriminalization of marijuana is unthinkable. The current Congress and President Trump have not shown any inclination toward effecting that type of change. At some point though, sooner or later, the United States will legalize marijuana nationwide — not just move it to Schedule 2 or 3 of the Controlled Substances Act, but fully deschedule it. It’s not too early to think about what nationwide legalization would look like and how it would affect cannabis businesses that are open today.

There are three main routes that legalization could take. First, there is total unregulated legalization — treat marijuana like apples. That option is so unrealistic that it’s not worth discussing. Next, there is the alcohol model, with a mixture of federal and state regulations. Products can be distributed and sold across state lines, and states can regulate however they choose, but they can’t show preference to local actors. Finally, we could build on the current cannabis legalization model. Every state creates its own market with its own licensing system and regulatory scheme. Product cannot move across state lines, and many states limit or ban ownership stakes in marijuana businesses by out of state individuals.

If the U.S. ultimately takes the last route, continuing the current trend, market change would be gradual. Banking would certainly be easier, and marijuana businesses wouldn’t pay as much in taxes. States would likely ease some of their regulations that they have in place solely because of the Cole Memo. But on the whole, the state markets would continue on much the same trend as today. Note that very few commodities cannot be transported interstate. Health insurance is one, but state insurance markets are more about individual states being able to regulate the types of policies that can be sold in the state. There isn’t a physical product that is being barred from crossing state lines.

Continuing with individual state cannabis markets doesn’t seem likely, either. If cannabis is legalized, it doesn’t make sense that Congress would bar states from opening their doors to out of state product. They don’t do that with any other similar products. The Dormant Commerce Clause would also present a major legal challenge for a state that wanted to only allow in-state actors to sell products to its residents.

The most likely outcome, then, is the alcohol/tobacco model, with interstate commerce allowed, and a mixture of federal and state licenses and regulations. Though this transition will undoubtedly be an exciting moment for many, it will also be a scary time for the cultivators and processors across the country that are already doing business. Two different kinds of consolidation would start happening at the same time. First, there is corporate consolidation. In 2015, 90% of the beer sold in the United States was owned by 11 multinational corporations. Constellation, owner of Corona and other beer brands, has already made a large investment in a Canadian marijuana company. Big business will certainly look at marijuana. But the other type of consolidation that isn’t talked about as much is geographic consolidation. In a free interstate market, it doesn’t make a lot of sense to grow marijuana in Nevada, Massachusetts, Washington D.C., and a number of other states that have current licensed marijuana cultivators. In the same way that Virginia and North Carolina dominate in tobacco cultivation, California, Oregon, and a few other places will likely dominate marijuana cultivation. That could leave producers getting licensed in other locations in a tough spot, when federal legalization finally happens.

washington cannabis marijuana
Is Washington doing enough for the little guy?

Lester Black has a good article up at FiveThirtyEight about the Washington marijuana market. Washington’s mandatory data transparency presents a fantastic opportunity for the kind of market analysis that is challenging in other industries that don’t have access to that type of data. In this context, the data reflects what a lot of Washington marijuana producers already know: The market out there is incredibly tough. Even though Washington’s window for marijuana licensing was only open for a month in late 2013, there is still enough product cultivated and sold in Washington that wholesale prices continue to drop, over four years later. This makes it hard for small businesses to compete.

Washington’s legislative and regulatory systems try to prop up small, local businesses a few different ways. The mandate that all business owners reside in Washington is a big one, of course. But we also have consolidation limits. An individual cannot have in ownership interest in more than three licensed producers and/or three licensed processors. On the retail side, no one is allowed to own more than five retail stores.

Those anti-trust pot market provisions have worked to some extent in providing initial market entry to a lot of different people. Entering a market and surviving a market, however, are very different. When the Washington market was first coming online, wholesale prices of more than $5.00 per gram were common. The average wholesale price in September was half that, at $2.53. Some amount of price decline was always expected, but small businesses that based their cost structure on that higher price point are struggling to make things work.

In any market with unexpected decreases in profits based decreased demand, increased competition, cost spikes, etc., well-financed business actors will be better able to survive than businesses that don’t have access to capital. Of course, if a business has so little money that it can’t pay its bills, it won’t survive. But access to capital provides additional advantages. You can get better financial planning advice from the outset so you know how best to plan for 280e. You are less likely to be swindled by consultants or other vendors with backloaded payment contracts. You have better access to credit. The list goes on.

The most eye-opening aspect of Black’s article may be the section on nationwide cannabis demand. According to Jonathan Caulkins of the Drug Policy Research Center at RAND, you can grow all of the THC consumed in the United States on 10,000 acres of farmland. That isn’t really that much, and it helps clarify why Washington producers continue to struggle. Even with its fixed number of production licensees, Washington likely has too much licensed production capacity for its in-state demand.

Where does that leave small Washington producers? They have a few different routes to success. One is to become large Washington producers, winning a race that so many others are losing. Another is to hope that marijuana demand trends upward — something that state regulators wary of DEA intervention hope does not happen. There is also the chance that marijuana goes legal nationally, opening up a much larger market without established players. Otherwise, no matter how much the state fights it, the industry will continue to trend toward consolidation with larger, better financed businesses surviving longer than small companies can hang in there.

Jeff Sessions wants U.S. Attorneys to “Just Say No” to Marijuana Legal Reform.

Yesterday proved to be a wild day, featuring Jeff Sessions single-handedly demolishing the federal government’s former cannabis enforcement framework. Now that 24 hours have passed since the news came out, we have had a chance to refine our analysis of the Department of Justice’s move.

Reactions in the media have ranged from treating the Sessions announcement as nothing more than an attempt to frighten the cannabis industry to claiming that it was the first step in an organized crackdown of the marijuana industry that could affect cannabis businesses and users. For now, we must treat both of those possibilities as plausible futures. Trump and Sessions may be gearing up for a wave of arrests, prosecutions, and asset forfeitures related to marijuana businesses —or Sessions may just be trying to put a fright into marijuana business owners and investors. Only time will tell.

The “Sessions Memo” was short on specifics. It didn’t contain an outright directive ordering U.S. Attorneys to go after marijuana businesses. Instead, it simply withdrew the earlier marijuana-specific guidance memoranda and directed U.S. attorneys to treat marijuana sales like any other federal crime. The withdrawn memos include, among others, the August 2013 Cole Memo that has underpinned federal marijuana policy for the past four and a half years; the February 2014 Cole Memo that extended low enforcement priority status to apply to banking activities; and the 2014 Wilkinson Memo that was a sort of Cole Memo for tribal lands.

So now, U.S. attorneys have full discretion to determine to what extent they can/should enforce federal law in the context of marijuana crimes in states with legalization and medicalization. Sessions referred to the principles of enforcement in the U.S. Attorneys’ Manual, but that document reinforces the level of discretion and authority that each U.S. attorney has already. The Cole Memo was useful in providing a consistent nationwide federal policy. Under the new Sessions Memo, we are back to the days of having potentially 93 different enforcement policies — one for each U.S. Attorney. Here’s what we know already about a selection of the U.S. Attorneys that will be making these decisions:

Robert Troyer, District of Colorado: Bob Troyer issued a statement yesterday saying that his office “has already been guided by [the U.S. Attorneys’ Manual’s] principles in marijuana prosecutions.” This statement implies that Troyer doesn’t see any difference in Colorado between prior policy and today’s policy.

Annette Hayes, Western District of Washington: Annette Hayes, who has served as either the Acting U.S. Attorney or an interim U.S. Attorney since October 1, 2014, also put out at statement, but it was significantly denser than Troyer’s statement. It wasn’t overtly negative, but it also wasn’t as direct as Troyer’s regarding enforcement policies remaining the same.

Joseph Harrington, Eastern District of Washington: Joseph Harrington is another Acting U.S. Attorney that is a holdover from the Obama administration. Harrington did not issue any specific statement in response to the Sessions Memo. When media outlets asked Harrington about his position, he responded by referring media requests to the Department of Justice in Washington D.C. Harrington, for now, is something of a black box on this.

Billy Williams, District of Oregon: Billy Williams was also appointed during the Obama administration, but Trump did nominate him to stay on as U.S. Attorney in December. Williams prosecuted two Oregonians for federal cannabis crimes in 2016, but there were Cole Memo priorities implicated, including sales to minors. More recently, Williams invited Sessions to visit Oregon to discuss Oregon’s cannabis market in September 2017. In response to the Sessions Memo, Williams issued a press release saying: “We will continue working with our federal, state, local and tribal law enforcement partners to pursue shared public safety objectives, with an emphasis on stemming the overproduction of marijuana and the diversion of marijuana out of state, dismantling criminal organizations and thwarting violent crime in our communities.” Again, this statement doesn’t read too poorly, but it is sufficiently vague enough to still be worrisome.

California: California is a bit of a mess in all of this. Oregon and Colorado only have one U.S. Attorney each. Washington has two, but they are neatly separated into eastern Washington and western Washington, which often feel like two different states anyway. California, on the other hand, has four U.S. Districts.  And none of those four has or will have a U.S. Attorney with more than two months on the job.

  • Northern District: The U.S. Attorney for the Northern District of California, Brian Stretch, resigned yesterday to join a private firm. No replacement has been named.
  • Central District: The Central District is a populous jurisdiction that includes Los Angeles, Riverside, San Bernadino, Ventura, Santa Barbara, and San Luis Obispo. Two days ago, Sessions appointed a new U.S. Attorney for the Central District, Nicola Hanna. Hanna doesn’t seem to have much written history regarding his views on marijuana, but the fact that Sessions picked him and specifically called him out for “taking on drug traffickers” isn’t the most positive sign.
  • Eastern District: McGregor Scott, also a recently-named U.S. Attorney, has actually been a U.S. Attorney in the past, having prior experience in the Northern District of California. He did not earn positive marks from the cannabis community, as he did pursue aggressive marijuana prosecutions in the mid-2000s.
  • Southern District: Finally, Adam Braverman was named U.S. Attorney for the Southern District of California a couple of months ago in November. He is most well-known for international cartel work as well as other types of organized crime. Braverman made a statement in support of the Sessions Memo, saying: “The Attorney General’s memorandum today returns trust and local control to federal prosecutors in each district when it comes to enforcing the Controlled Substances Act.”

If we are reading the tea leaves to see what is going to happen next (and they are indeed tea leaves), Colorado appears to be in the safest position, but California could turn into a real mess with different enforcement standards in different counties depending on which judicial district a business is in. Banking will be a major unknown for some time as well. FinCEN’s 2014 Guidance heavily referenced the Cole Memo, which is now rescinded. If FinCEN withdraws that guidance, what kind of ripple effect will it have on other bank regulators?

It also remains unclear how all of this policy will work out. Cory Gardner, a republican senator from Colorado, appeared furious when he responded to the initial announcement of the Sessions Memo (video below). He went so far as to threaten to hold up DOJ nominations, which would include those newly appointed California U.S. Attorneys. Sessions’s actions, as well as those of the U.S. Attorneys, are not yet set in stone. Ultimately, political pressure from Congress may still have an effect on the final outcome.

Will Washington finally tear down the walls?

When Colorado and Washington kicked off recreational marijuana legalization and business licensing, both states limited ownership of licensed marijuana businesses to their own state residents. Oregon’s ballot measure, passed two years later, followed suit. But Oregon’s legislature almost immediately removed that restriction. Colorado’s legislature similarly lifted the restriction in 2016, allowing U.S. citizens to qualify for ownership of licensed cannabis businesses. California, Nevada, and the clear majority of legal cannabis states allow at least some level of out of state ownership of licensed businesses. Washington, however, continues to maintain its strict residency requirement for ownership of marijuana businesses.

Washington’s residency requirement does not have any de minimis baseline — a 0.01% business owner is subject to the same restrictions as a 100% business owner. And the residency requirement doesn’t only apply to owners: any person that can exert control over a business (such as a director, officer, or contract manager), anyone that has the right to receive business profits, and the spouses of all those people are all required to live in Washington. The restrictions even rope in things that may not be apparent on first read. For example, the state Liquor and Cannabis Board still considers royalties on branded products (e.g. a trademark license for 2% gross sales on products carrying the mark) to invoke the residency restriction.

As with all regulated industries, businesses push as much as they can at the bounds of these rules to accomplish their objectives. Out of state residents enter into business deals that include providing capital loans for a fixed interest return, which was itself restricted for the first few years of legalization. They lease or sublease real property, purchase and lease capital equipment, enter into consulting contracts, and enter into branding deals with fixed payments. The closest that they can come to a profit share or revenue share is an agreement to sell inputs at a markup to licensed cannabis businesses – be they branded packages or ingredients for edibles. The various restrictions and promises in these agreements test the boundaries of whether or not the out of state businesses exert “control” over cannabis businesses.

Some state lawmakers and many licensed businesses cite these out of state business deals as reason to partially lift the residency restrictions. If these types of deals are being entered into anyway, why not allow them to encourage transparency, the logic goes. It’s a similar argument to the one made about legalization in the first place.

But there are voices in Washington that support maintaining the residency restriction. Retailers, craft and cottage industry advocates, and established businesses think that the negative ramifications of more out of state money flowing into the state would outweigh any potential benefits. And for now, Washington agrees. While the August 2013 Cole Memorandum put out by the Department of Justice did not have any language touching on state residency of cannabis business owners, the follow-up financial guidance from FinCEN did include payments to non-state residents as a red flag event for marijuana businesses.

A quirk about marijuana businesses is that the states really don’t want them to fail. If this were any other new industry getting a lot of press buzz, you would expect to see lots of business failure in the early days. Businesses that are not adequately capitalized would have a tough time going up against competitors with large bankrolls that can afford to sell at a loss in the early days of the market. In a regular market, that trend would course correct in a reasonable amount of time, and the market would stabilize. But with cannabis, business failure can be a scary thing for the state. A dying marijuana business is a risky candidate for black market and out of state diversion of product. And that type of diversion is precisely the type of activity that could trigger direct involvement from the DEA and DOJ, agencies that would love nothing more than to have a good reason to bust up state-legal cannabis businesses. Many business owners and legislators in Washington think that maintaining the state residency requirement contributes to current industry stability, and they prefer the status quo to the unknown possibilities of a large influx of out of state capital.

The Washington legislature goes back into session in January, now under unified Democratic Party rule. After taking on cannabis issues every year since 2014, the legislature seems ready to move on to other things, but don’t be surprised to see the state residency restriction rear its head in proposed legislation.

Cannabis franchising
Who will be the McDonald’s of Marijuana?

We often work with cannabis businesses that want to license their brands to third parties. Licensing is a great way to expand the reach of a brand and make some revenue without the capital expense of funding and owning a new location outright. For states that restrict ownership of marijuana businesses to state residents, licensing can be one of the primary ways non-state residents get into the market.

But any time a business enters into a licensing deal where the licensee is in the same line of work as the licensor, challenges arise. Specifically, that licensing agreement can be interpreted by state and federal regulators to create a quasi-franchise. As we’ve written before, this can cause problems because franchises must comply with a bevy of state and federal rules with which non-franchises do not have to contend.

Just because franchises are regulated, however, does not mean they are to be avoided forever. The first cannabis company to execute on a well-planned franchise model is going to make an absolute fortune. To date, there hasn’t been a lot of movement of would-be marijuana franchisors. Part of the reason is that would-be franchisees want to see established brand and operations value before entering into a franchise agreement. To demonstrate that value, a franchisor company’s best bet is to show positive performance at multiple locations. A single cannabis retail store may do great business, but from the outside, it is hard to tell whether that store is benefitting more from its location or its local team or its marketing or its branding. But when multiple locations carrying the same branding and using the same business practices consistently put up big numbers, they become very enticing to potential franchisees.

Market consolidation is already happening — a first step in creating the types of chains that can be precursors to franchises. In Colorado, data shows that more and more retail stores are becoming part of corporate retail chains. Washington recently increased its cap on direct ownership of marijuana businesses, allowing an individual to own up to five retail licensed businesses, and has seen similar movement toward consolidation.

In looking for potential franchise locations, California’s new demand-rich market is a logical target. California also boasts some of the nation’s most restrictive franchise laws, providing significant protections for franchisees. Franchises must, of course, be registered with both the Federal Trade Commission and with the state of California. California also requires the Franchise Disclosure Document, a large comprehensive document defining the ins and outs of the franchise relationship, to be registered with the state. Franchisors are prohibited from terminating franchise agreements early without good cause, and a franchisor cannot stop a franchisee from selling or transferring the franchise to a different person that meets all of the franchisor’s current standards for new or renewal franchisees. If a franchisor wrongfully terminates a franchise, the franchisee is entitled to the fair market value of the franchised business and assets as damages.

And though California has the strongest protections for franchisees, most other states offer similar protections. A franchise isn’t a relationship a franchisor can enter into on a whim; it is a significant long-term commitment of time and money.

All that said, it’s only a matter of time until we see big movement in cannabis franchises. They represent part of the natural progression of a growing industry.

Cannabis sexual harassmentOver the past few weeks, story after story has come to light of sexual assault and sexual harassment in the entertainment industry. But though high profile actors, directors, and producers are getting most of the press attention right now, the vast majority of workplace sexual harassment is experienced by low-wage hourly employees, often in small businesses. Employers in every industry should take advantage of the current wake-up call to make sure their policies and procedures are effective in preventing sexual harassment in the workplace. For one thing, harassment does expose a business to potential liability because of lawsuits from current and former employees. But more importantly, a hostile workplace is less likely to hire and retain the best performers, both women and men. This isn’t the 1960s any longer; a company that doesn’t have a clear sexual harassment policy is on the road to failure.

The cannabis industry is particularly vulnerable to harassment situations for two main reasons. First, marijuana businesses are still predominately made up of men. Male-dominated businesses often develop a language and culture that can be overtly hostile to women, and cannabis businesses are no different. Second, the industry is still young, and a large number of people in cannabis management do not have similar executive-level experience in other businesses. Many cannabis businesses lack any sort of policies to address workplace harassment.

Sexual Harassment Policies 

A company’s written sexual harassment policy should have a few goals. Specifically, it should

  • inform employees and contractors of the company’s objective to maintain a workplace free of harassment in all forms, including sexual harassment,
  • define prohibited conduct,
  • give examples of prohibited conduct,
  • establish procedures for reporting sexual harassment, including clarifying a duty to report and establishing confidentiality of any reports,
  • prohibit retaliation, and
  • inform employees and contractors of potential disciplinary actions for violating policy.

No matter the precise nature of the policy, training and reinforcement have to be mandatory. Just about everyone can agree that certain activity crosses the line at the workplace. But many people, especially those who have not received formal sexual harassment training, can unwittingly create a hostile workplace with actions they did not perceive to be wrong. A company’s sexual harassment culture should become stronger over time if the company takes advantage of the feedback loop of training, reporting, retraining, and reinforcement training.

Dealing with Sexual Harassment Reports

Maintaining a policy is only half the battle. Employers must make sure their policy is consistently implemented company-wide. Businesses need to accomplish two goals that can be at odds with one another. They need to provide multiple avenues for employees to report harassment, but they also need to make sure the company deals consistently with reports no matter from where reports come in. Company owners and managers must be subject to the same policy as their employees, and companies need to have an avenue to discipline owners and managers to show employees that their sexual harassment policies are applied consistently across the board.

One avenue a company can encourage, when possible, is for the person levying the complaint to address the situation with the offending coworker directly. Oftentimes, a simple misunderstanding can be cleared up that way. But if that isn’t possible or if the employees is uncomfortable doing that for any reason, the next step is generally for the employee to report the harassment to their immediate supervisor or to the company’s HR department. Multiple layers of reporting are necessary, especially when the harassment may be coming from, for example, the employee’s direct supervisor. Companies that are not large enough to have dedicated HR departments should still have employees or owners that are taking on the role of HR. Some companies even have dedicated harassment committees or ombudsmen that are generally not associated with management or ownership and that can ensure that there is an outside voice to keep HR and management honest regarding the company’s sexual harassment policy.

Once a complaint has been made, a business needs to have a consistent policy toward discipline and corrective action. This can’t be a one-size-fits-all policy. Sometimes a simple training is enough to deal with an event. Other times, the offending employee should be fired on the spot. But the correct combination of corrective action and discipline needs to be consistent.

All of this can seem difficult when you are a new company just trying to get by, but successful businesses and their owners and managers need to be able to walk and chew gum at the same time. Ignore harassment policies at your peril.

International CannabisThis post is a follow-up to one I wrote a year ago about foreigners investing in U.S. marijuana businesses. What are the legal ramifications of the reverse? If marijuana business is fully legal in a foreign jurisdiction (think Uruguay or Canada in the near future), can a U.S. resident contribute cash in exchange for stock of a company that cultivates and sells marijuana in that jurisdiction? This is timely because Constellation Brands, the New York-headquartered owner of Corona beer and other holdings in the alcohol industry, agreed to buy a significant stake in Canopy Growth Corporation, a Canadian publicly traded cannabis cultivation company. Are they breaking the law? It’s not as simple a question as one might think.

Reuters ran a story on this topic a few years ago. In that piece, the DEA spokesperson and a financial institution money laundering risk specialist respectively implied and stated outright that such activity violated U.S. law. The DEA spokesperson said that the DEA would be “most interested in those types of activities.”

To our knowledge, the U.S. has never brought charges against a U.S. investor in these limited circumstances, so we don’t have any case law directly on point. But we can review the primary statutes that cannabis investors should be worried about —the Controlled Substances Act and the criminal money laundering statutes.

It is a general rule in the U.S., as stated in 2016 by the Supreme Court in RJR Nabisco Inc. v. European Cmty, that without “clearly expressed congressional intent to the contrary, federal laws will be construed to have only domestic application.” This means statutes that are silent on where they have effect will generally be interpreted as applying only to activities in the United States. And the U.S. does have laws on the books that are intended to be applied outside the United States. For example, the Controlled Substances Import and Export Act (21 U.S.C. § 959) outlaws possession of controlled substances overseas with the intent to import them into the United States. That’s one of the statutes that the U.S. used, for example, to go after Manual Noriega in the 1990s. To be clear, this statute wouldn’t apply to Canadian operations that have no intent to export marijuana to the United States and intend to only sell it within the Canadian regulated market.

Reading the text of the domestic Controlled Substances Act (21 U.S.C. § 821), there isn’t any clear indication that it is intended to apply to overseas conduct.  And in practice, we haven’t seen the United States try to claim that residents who travel to Amsterdam and use marijuana there have violated U.S. law. To the extent that the same statute exists for both possession of narcotics and manufacture of narcotics, it doesn’t look like extraterritorial application would apply.

Money laundering laws, however, are interpreted as having broad extraterritorial reach. So are U.S. investors in Canadian marijuana businesses in danger of violating those laws? 18 U.S.C. § 1957 makes it criminal for someone to knowingly engage or attempt to engage in a monetary transaction in criminally derived property of a value greater than $10,000 when such property is derived from “specified unlawful activity.” This law applies even if the offense takes place outside the United States if it involves a U.S. person or business entity formed in the U.S. “Specified unlawful activity” includes a laundry list of crimes, including violations of the Controlled Substances Act. So that doesn’t look great.

But here’s the thing — if the domestic Controlled Substances doesn’t apply because it only applies in the U.S., and if the Controlled Substances Import and Export Act doesn’t apply because there is no intention to send marijuana product to the United States, then a reasonable argument would be that the business of a Canadian licensed marijuana company would not constitute “specified unlawful activity.” And the money laundering law wouldn’t apply.

Therefore, Constellation Brands has a solid argument that it isn’t violating U.S. law by making an investment into the Canadian marijuana industry. There a bunch of caveats here, and there’s no way for a blog post to have a full legal analysis, and the DEA may well disagree with this interpretation even if it were an airtight legal analysis. Most U.S. banks will still shy away from offering any services connected with marijuana businesses even in countries that have legalized completely, including Uruguay. But at the end of the day, prosecutors would have an uphill climb if they truly wanted to go after a U.S. resident for investing in a foreign marijuana business that intends to serve that foreign market and is fully compliant with the laws of that nation.

Cannabis business disputesThe cannabis litigation lawyers at my firm have litigated many partnership lawsuits involving cannabis businesses where better planning could have avoided the dispute. Business owners will always disagree with one another, but good partnership agreements, LLC operating agreements, and shareholder agreements figure out ways to get past disputes without going to trial. Litigation is expensive and stressful and doesn’t leave either side feeling great. In a business ownership dispute we are working on now, in addition to legal fees, both sides are hiring their own forensic accountants to come up with a company valuation more favorable to their side, and this is before a complaint has even been filed. Costs add up fast. Partnership disputes have a lot in common with divorces disputes, where logic and reason often give way to emotion, and the parties seek to punish each other more than they try to come to a reasonable settlement. The best time to plan for disputes is before your company has any revenue, any investment, any debt, or any obligations. In this post and subsequent posts in this series, I’ll discuss negotiable provisions in partnership agreements that business owners should make sure to address as early in their business’s life cycle as they can.

Today’s post will talk about individuals getting ownership for services and what happens when a company needs to raise more capital.

Ownership Interest in Exchange for Service

This is a common arrangement, but companies often get themselves into hot water by not thinking through the implications. If an individual is going to receive a significant percentage of equity in a company without putting in a proportional value of cash or property, company owners need to think long and hard about the implications. The question that all too often goes unasked is what happens if the partner receiving the equity in exchange for services stops working for the company or fails to perform those services well? If the partnership group doesn’t put thought into how it structures the grant of ownership in exchange for services, it can find itself having signed away a large chunk of equity in their cannabis business without any recourse if the service-for-equity owner stops working.

There are a couple of solutions to this. One common fix is for the equity interest to vest over time. Every month or quarter or year in which a partner contributes services corresponds to a partial grant of the equity interest. With a vesting schedule of three to five years, the company knows it will either be getting good value for the services or it will be able to terminate the services and cut off any further vesting. But another problem shows up even if the services are terminated — you have a voting owner of the company who likely holds some ill will against the other partners. This is where another clause in the operating agreement can help – company buyout right triggered by termination of the partner’s services. The company will still have to pay out for the equity vested to date by the services provider, but it has a clean way of removing that person from the company, likely avoiding additional clashes.

Additional Financial Contributions

It’s hard to estimate how much capital a company is going to need. Many of our cannabis producer clients found out mid-stream that they were having a tough time selling their dried marijuana flower, so they pivoted and moved into the oil extraction business. But the capital equipment needed for that and the construction costs to set up the lab can be expensive, and when those expenses are not planned for additional capital is needed.

One of the main differences between LLCs and corporations is that default corporate law makes it easier to bring in new capital in exchange for equity than default LLC law does. In corporate law, the board of directors generally has the authority to issue new shares in exchange for capital. And if the current shareholders don’t have a negotiated right of first refusal, the directors are free to look to whomever they want, whether that person is a current shareholder or not. Compare to LLCs, where the default law tends to say that unless the operating agreement says otherwise, the members of the company must unanimously approve of any new members. LLC agreements, then, should have clear clauses on what happens when the company needs more money. If only one member is willing to put that money in, do they get additional interest that dilutes the other members? If the company doesn’t want a dilutive issuance but wants a member to loan money to the company, does that member get priority payback on the loan debt? And if no one in the company is willing to pay money, can they still vote against allowing a new member into the company in exchange for capital? Because if they can refuse to put in more money themselves and can keep the company from raising money from an outsider, they have the power to tank the company. Any negotiated partnership agreement needs to address this issue.

Canada cannabisIt has been a while since we looked at how our good neighbors to the north have been doing with their legalization effort. Uruguay is still the only country to implement a nation-wide legalization system including legalized sales, but it has run into some implementation problems because of lack of access to the American financial system. Canada has a stronger domestic financial industry than Uruguay and both the Bank of Montreal and Toronto –Dominion Bank, among others, appear to have more tolerance for the marijuana industry. But as has been reported over the last couple of weeks, things have not been simple in Canada, where the government has announced that it plans to legalize marijuana by July 2018.

In the United States, most state legalization measures have occurred through ballot measures as opposed to through legislative processes. That approach comes with both pros and cons. On one hand, a ballot measure process can occur relatively quickly. An initiative is drafted by a campaign using whatever stakeholders the campaign wants to assist in drafting, the campaign goes out to get sufficient signatures to put the initiative on a ballot, people campaign for and against the measure, and the people all vote on the measure on a pre-determined date. Once you get past the initial drafting stage, there isn’t much in the way of horse-trading. The measure is what it is. The legislative process, on the other hand, is a never-ending process of starts and stops. Legislation can be drafted, amended, put forth for debate, and withdrawn countless times before it ever gets voted on.

Many stakeholders in Canada have been voicing their concerns about Canada’s proposed legislation. As it stands, the law would give significant authority to individual provinces to develop and implement distribution networks. But many of the provinces have viewed that grant of authority primarily as an additional cost burden. So, Prime Minister Trudeau’s government moved to increase local revenues by adding a 10 percent excise tax. Though this isn’t enough to stop the Premiers from Manitoba, Quebec, and Nova Scotia from grousing that the revenues won’t be very high, it is a push in their direction.

One interesting wrinkle in Canada is the level of potential government involvement in cannabis sales. Ontario, Alberta, and Quebec are all looking at publicly participating directly in the retail system. Ontario plans to open 40 stores through its Liquor Control Board by next summer. This hasn’t been met with enthusiasm by local consumers, who fear government involvement will lead to inferior product on store shelves. Other commentators and industry watchers fear public cannabis monopolies in Alberta and Ontario will open the door to continued illegal market activity.

But as we have seen across the United States, opening a legal marketplace takes a long time and it seems unlikely that by July 2018 Canada will be bustling with open marijuana retail stores packed with product, whether government-owned or privately owned. It looks like the liberal government is moving forward with full steam, but there will continue to be fits and starts along the way before the Canadian market is close to being settled. But on the bright side, even if local retail marijuana isn’t available, Canada Post, the Canadian version of the U.S. Post Office, is going to start delivering recreational marijuana through the mail as soon as legalization moves forward. Maybe physical retail marijuana’s main fear shouldn’t be government regulation — it should be mail-based competition.