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.

washington residency marijuana constitutional
Could definitely be unconstitutional.

We think it is worth taking another look at whether Washington’s strict residency requirement is constitutional. Since Washington first licensed marijuana businesses in 2014, we have wondered if anyone would be willing to bear the expenses of that particular challenge. And to date, there are no Washington appellate or federal legal decisions determining the constitutionality of the residency requirement. If there were a challenge, Washington would have a tough time defending the constitutionality of the law.

There are two important constitutional concept here: the Dormant Commerce Clause (the DCC) and the Privileges and Immunities Clause (the PIC). We first wrote about one of these, the DCC, three years ago. The DCC is a body of law (all made by judges) that seeks to enforce free-trade rules among the states. The idea is that Congress has the sole authority to regulate interstate commerce, and state laws that blatantly interfere with interstate commerce are potentially unconstitutional. Our analysis of this issue is largely the same as it was in that blog post three years ago. To determine if a law violates the DCC, one first determines whether the law interferes with interstate commerce. Washington’s residency restriction likely does so because it stops out-of-state participants from engaging in commerce in Washington. If a state law discriminates against out of state residents, it is very likely unconstitutional. It can only survive if the state can show that the law is the least restrictive means by which it can achieve a non-protectionist purpose. In the case of Washington’s marijuana residency requirement, there are lots of other states without such a requirement, and they are doing fine.

It looks like the book could be open and shut with the DCC, but people are still hesitant to bring that case. The DCC is tough to understand in practice: It’s a constitutional restriction by inference and counterfactual. So if law by logical proof isn’t your thing, the PIC provides an alternative compelling constitutional argument that Washington’s residency restriction would lose a court battle. The PIC —  Article IV, Section 2, Clause 1 of the U.S. Constitution — says: “The Citizens of each State shall be entitled to all Privileges and Immunities of Citizens in the several States.” The PIC seeks to prevent discrimination by one state against another state’s residents. In addition to protecting civil liberties, the PIC also protects fundamental economic interests.

The weakness in the PIC arguments is that the right to own a marijuana business may not be considered a fundamental economic right that the PIC protects. In past cases, the PIC has successfully knocked out state residency requirements for attorney bar licensure and for employment, but the PIC has failed to stop a state from only giving hunting licenses to its residents. Cases seem to say that commercial activity, as opposed to recreational, is fundamental, but it would be reasonable for the discriminating state to argue that the right to own a federally illegal marijuana business cannot, by definition, be fundamental enough to get this constitutional protection.

The federal illegality of marijuana, of course, is the elephant in the room. There seems to be a misconception that federal courts would never protect a would-be marijuana business owner in a legal battle with the state. That fear, however, is a misreading of constitutional law. Marijuana’s illegality does get in the way of a lot of general legal enforcement. Contracts with an illegal subject matter can be found void as a matter of law. Federal bankruptcy courts will not process marijuana company filings because they cannot appoint a trustee to manage marijuana assets. And in cases where parties seek injunctive relief, courts can use the “clean hands” doctrine to say that they will not issue injunctions to help marijuana businesses because those businesses have not come to the court with sufficiently “clean hands” to receive the benefit of equitable rulings.

However, the Constitution is not a contract or an equitable ruling. The Constitution protects us from state and federal overreach in all circumstances, regardless of what we have done and regardless of what we are doing. To put it another way, let’s say that Washington had a law that said women not allowed to own a marijuana business. Does anyone think that a federal court would not overturn that law? Of course it would. It doesn’t matter that marijuana is federally illegal; the state cannot violate the Constitution with illegal preferences. Similarly, both the DCC and the PIC are constitutional protections. A litigant against the state of Washington seeking to overturn the residency requirement would win or lose on the merits. Even a federal court would not throw out a case simply because marijuana businesses were involved.

WSLCB washington cannabis
WSLCB seems to want it both ways on “residency.”

Despite lobbying efforts to the contrary, Washington has maintained its strict state residency requirement for Washington cannabis business owners. If a person wants to own 0.001% of a cannabis business, the Washington State Liquor and Cannabis Board (WSLCB) requires that person to be a Washington resident and to go through about 1,000 hoops before it authorizes the licensed cannabis business to issue that ownership interest. In general, cash-starved producer-processors looking for investment and out-of-state investors have pushed for the law to change, while more established retailers and certain producer-processors prefer the lack of out-of-state competition. The residency issue is resonating in Olympia, with many legislators openly discussing lifting or altering the state restriction on out-of-state ownership.

While the overall topic of the residency requirement is often discussed, one issue that doesn’t get as much attention is how the WSLCB is currently defining residency. And that’s because they don’t— at least not directly. The WSLCB’s marijuana regulations define the term “residence” as a place where a person physically resides, but that is only in the context of the rule that marijuana licenses cannot be issued to businesses whose location is at a personal residence. The section talking about the residency requirement, WAC 314-55-120(10) uses the terms “resided” and “residency requirement,” but the rules do not define those terms.

Neither does RCW 69.50, the section of Washington’s legislative code that contains its statutes related to regulated marijuana businesses. RCW 69.50.331(1)(b)(ii) contains the legislative requirement that someone must have “lawfully resided in the state for at least six months prior to applying” for a marijuana business license. Whether the drafters of that section meant “resided in Washington without breaking any laws” or “would be considered resident of Washington as a matter of law”, we cannot really say. The statute does not contain any significant guidance on what does and does not constitute residency.

When Washington first opened for licensing, the interpretation of these sections was key. Back then, in 2013 and 2014, the residency requirement was only three months, and entrepreneurs looking to take advantage of the market had been trying to figure out the least that they could do to establish residency in order to qualify for the new licenses. When people asked the WSLCB what constituted residency, they were deferred to other state agencies that had defined residency. I personally have been on multiple phone calls with WSLCB investigators where they deferred to the Department of Revenue’s (DOR) definition of residency.

The problem with deference to the Department of Revenue is that the WSLCB generally acts like it wants a narrow definition of residency, whereas DOR wants a broad definition of residency. DOR wants people to be considered residents because that means that they owe sales tax and/or use tax on their purchases. Even the WSLCB’s old rules FAQ still has a link (albeit a broken one) to this Access Washington webpage saying that there are many ways that one can show that he or she is a Washington resident, including registering to vote and obtaining a Washington driver’s license.

Although it provides resources that make it seem like it is easy to prove residency, the WSLCB’s enforcement officers and investigators continue to treat residency as a strict requirement that one physically inhabit Washington virtually every day of the year. We have an administrative case happening right now where the WSLCB claims that our client is not a Washington resident, even though that person owns residential property in Washington and gets all of his or her mail there, is registered to vote in Washington, and maintains a Washington drivers license (and no other state licenses or IDs). They can’t point to a single written definition of residency that this client violates, but they continue to fight on this point.

This isn’t all about one case, one client, or even one issue. The WSLCB is showing time and time again that it likes to live in the zone of vaguely written or non-existent regulations and stringent enforcement of the WSLCB’s interpretations of those vaguely written or non-existent rules. Unless you assume that the WSLCB has malicious intentions in drafting and enforcing its rules in this way (which we do not assume), it does not make sense that they would not adopt a stringent definition of residency if they want to enforce it that way. But until the WSLCB amends its rules by adopting an actual definition of residency, it will continue looking like it is speaking out of both sides of its mouth.

washington amnesty WSLCB
Coming soon to WSLCB.

We recently wrote about the Washington State Liquor and Cannabis Board’s consideration of a marijuana licensee amnesty program for licensees with undisclosed true parties of interest a couple of weeks ago. In that post, though we criticized the WSLCB for not doing more to put marijuana licensees in a position to succeed, we didn’t have much to say about the amnesty program itself. Other than the fact that the board was discussing offering leniency to companies with undisclosed true parties of interest, not many other details had emerged.

Since then, a few more details have emerged, including a draft notice to Washington marijuana stakeholders announcing the program. It is important to note that as of the writing of this post, the leniency/amnesty program has not yet been finalized, and details are subject to change. That said, here is what is proposed so far:

The program is targeted at licensees that have owners or financiers that have not been disclosed to or approved by the WSLCB. Applications for amnesty/leniency will be denied when:

  1. Owners do not reside in Washington;
  2. Financiers are not U.S. residents;
  3. Owners or financiers have disqualifying criminal history;
  4. Licensees are currently under investigation for hidden ownership;
  5. Entity and/or principal within entity exceeds marijuana licenses allowed; or
  6. Entity and/or principal has interest in cross-tiered marijuana licensee (can’t own both a retailer and a producer/processor).

Licensees will have one month, starting as early as August 1, to apply to the WSLCB on a form provided by the WSLCB for the leniency program. Once the WSLCB receives the form and contacts the licensee there will be a seven day period to complete the initial interview and another fourteen day period to provide all required documentation for all prior undisclosed true parties of interest or financiers.

The WSLCB defines ownership broadly. A legal owner of any shares or membership interest in a licensed business counts, but so do many other business relationships. The WSLCB currently mandates that spouses, even for marriages after initial licensing, be disclosed and vetted by the WSLCB. They also consider anyone who has the right to receive any percentage of the gross or net profits from a licensed business. The WSLCB still tells licensees that any payment of sales commissions to sales agents violates true party of interest rules, despite an administrative law judge ruling otherwise and the WSLCB signing off on that ruling a couple of years ago. Trademark licenses and consulting agreements can create ownership. The WSLCB has still not engaged in substantive rulemaking to implement RCW 69.50.395 that specifically allows for trademark licenses. Instead, they have developed an ad hoc approval process for trademark agreements, where non-attorneys at the WSLCB make judgment calls about whether standard trademark license provisions do or do not create the type of “control” that would render someone a true party of interest under WAC 314-55-035.

Our experience makes us think that there are a lot of marijuana businesses that have hidden ownership problems. The majority of them are not bad actors – they are simply people who either don’t understand that an agreement they signed technically creates an ownership interest as the WSLCB sees it or they have done things in the wrong order, transferring ownership before receiving WSLCB approval. So it is welcome that the WSLCB is moving along on potentially offering amnesty/leniency to the these businesses instead of shutting them down. While that doesn’t fix many of the underlying issues that we have been pointing out, it is still a band-aid that will prevent catastrophe for companies smart enough to take advantage of it.

We’ll post again as soon as we get word that this program is due to go live. In the meantime, check out the following for some recent thoughts on WSLCB program administration and enforcement.

Washington State Cannabis Lawyer
Talking with Washington State cannabis enforcement officers is like playing with fire

Many of my firm’s recent Washington State cannabis enforcement cases contain a commonality. During the investigation stage, Washington State Liquor and Cannabis Board (WSLCB) enforcement officers tell licensees that their main goal is to achieve compliance. They say they aren’t looking to get anyone’s licenses cancelled — they are just trying to get a full picture so they can help licensees come into compliance with the rules. As we have stated in prior posts, many seemingly benign actions can give rise to license cancellation. But despite these assurances, licensees often find themselves blindsided by cancellation notices after they thought they were participating in a project with their officers to achieve compliance. When the licensees press their enforcement officers, the officers blame “politics” at the WSCLB offices in Olympia. It’s as though the WSLCB enforcement officers are playing the role of the car salesman going upstairs to fight for a price reduction only to be rebuffed by faceless management.

What is really going on here? As with everything else in the cannabis industry, it’s complicated. One thing to remember is that there is a real split in the WSLCB between its licensing division and its enforcement division. “Licensing” people are your standard bureaucrats, throwing up a varying array of obstacles to opening a cannabis business while assessing whether a businessperson and his or her plans merit a license to produce, process, or sell marijuana. “Enforcement” people are, for lack of a better word, cannabis cops.

Being cops, they see their role as rooting out activity contrary to law, and they will portray themselves however they deem necessary to get as much information as possible. Their behavior can range from be-your-buddy good cops to intimidating and threatening bad cops. The same officer often finds himself or herself playing both roles in some circumstances all geared to getting licensees to reveal behavior that may violate the rules. Institutionally, police forces often pressure their officers to continuously find bad behavior and officers that aren’t reporting enough violations face consequences at work for falling behind. We would be naïve to think WSLCB officers don’t face these same internal pressures.

The status of WSLCB officers as regulatory enforcement police puts licensees in a tough position. Most of the public knows that if they are accused of a crime by a regular police force, they shouldn’t say anything and should ask to speak with an attorney. But there is a fundamental difference between criminal enforcement and regulatory enforcement. The right to remain silent and the right to speak with police only with an attorney present are criminal rights. Marijuana business licenses, however, are privilege licenses. If you don’t toe the line, regulators can take that license away. For example, WAC 314-55-050(7) says that the WSLCB can cancel a marijuana license if a licensee denies a WSLCB enforcement officer access to any place where licensed activity takes place or fails to produce any required record licensees are supposed to keep.

Licensees need to keep both of these fundamental facts in their minds when dealing with WSLCB enforcement officers. The licensee has to understand that regardless of what they say, the goal of the WSLCB officer is to find bad acts and either fine the licensee or shut them down. But the licensee cannot ignore or shut out information requests from enforcement officers. Strategically, walking this tight rope requires licensees answer every question from an enforcement officer honestly and never lie, while also avoiding answering more than is asked. It’s not always possible to have an attorney present when dealing with an enforcement officer, but lawyers — especially those experienced in dealing with the WSLCB do help in these situations. Primarily, they know how to consistently frame a business’s activities as compliant within the framework of the rules (assuming the activity really is arguably compliant). Licensees often get themselves into trouble when talking to enforcement officers without an attorney present because they forget the fundamental truth — WSLCB enforcement officers are looking for a reason to submit a violation notice.

If the WSLCB wanted, it could institute a more collaborative relationship between officers and cannabis licensees. At WSLCB meetings, the WSLCB’s enforcement and licensing directors often make it sound as though the goal of enforcement personnel is to achieve compliance more than to shut down cannabis businesses. Actions to date, however, don’t back that up. So long as it appears that issuing violation notices is the primary goal of WSLCB enforcement officers, cannabis licensees need to approach each interaction with an enforcement officer as potentially adversarial because to do otherwise is to put your cannabis license at risk.

WSLCB cannabis marijuana
The WSLCB approach is not working so well.

The Washington State Liquor and Cannabis Board (WSLCB) may finally be noticing that its current treatment of “true party of interest” violations is neither just nor sustainable. During an extended conversation at its monthly executive management team meeting in June, the WSLCB discussed potentially adopting a hidden ownership amnesty program. Basically, any existing businesses that had mistakenly created a true party of interest relationship would have a limited time to come forward and declare any owners or other true parties of interest in licensed marijuana businesses that had not been disclosed and vetted in the past. The licensee would then be able to get the person vetted, though some penalty other than license cancellation would potentially still be on the table.

The details are not set, and the WSLCB executive team is going to continue meeting and discussing the issue over the coming months. For those licensees in the middle of investigations or regulatory hearings with the WSLCB, there’s not much hope to pull from this. Even if the WSLCB moved with lightning speed to adopt something, the agency was clear that it would not avail anyone currently undergoing a formal investigation or violation hearing.

That the WSLCB is discussing the topic of leniency at all indicates that they are cognizant of problems with current regulations and enforcement, though their idea of an amnesty or leniency program won’t do anything to solve the underlying issues. The foremost issue right now is that the timing of getting financing approved doesn’t work. The WSLCB currently demands that all money contributed to a licensed business be approved prior to it being spent on behalf of the business. The approval process for capital can take months, even if the capital contributors have already been approved as owners or financiers of the business in the past. But the types of emergencies that require short-term capital infusions tend not to wait months for regulators to approve. Businesses are forced to violate a rule by either having current owners contribute new capital or having outsiders provide financing prior to getting WSLCB approval.

There are plenty of solutions to the financier predicament that the WSLCB could adopt. They could allow for after-the-fact vetting of certain types of loans. They could modernize and streamline their financial approval process. They could keep the exact same system and just hire more people so that new funds could get investigated and cleared immediately. Any move to temporarily allow for relaxed penalties for regulatory violators to come forward isn’t necessarily a bad thing, but the same problem will continue again and again. Academically speaking, the WSLCB is applying an over-inclusive rule to business actions that range from willfully criminal to entirely benign. This over-inclusive application of the law “makes regulatory unreasonableness not an occasional weakness but a pervasive problem.”[1]

[1] Quote is from the first full paragraph on page 40 of this linked article — the WSLCB should read it and redesign their enforcement structure.

The WSLCB’s current investigative and enforcement strategy feels targeted at unlucky businesses that have made mistakes. This is part of why their trigger-happy nature regarding license cancellation is so frustrating. Two of the cancellation cases that my law firm is currently working on have come because of voluntary disclosure of information by a licensee. There certainly are bad actors in the marijuana industry that are intentionally defrauding the WSCLB and may well have ties to organized crime, but the WSLCB seems to leave those businesses alone. It is tough, challenging work to investigate illegal activity when the actors are working hard to cover up the illegal activity. It is much easier to go after the low-hanging fruit of licensees that are fully transparent about their activities.

Fundamentally, the WSLCB underestimates the deterrent effect of large monetary fines and underestimates the huge collateral damage that business shutdowns can create. If the WSLCB wants to create real compliance, it is going to need to make some more drastic changes than temporary amnesty/leniency programs.

washington cannabis LCB
More crucial than ever for Washington operators.

We have represented clients in regulatory violation cases inside and outside the cannabis industry for years. Of all the jurisdictions in which we work, the Washington State Liquor and Cannabis Board in 2018 is unique in its eagerness shut down businesses. In case after case against licensed producers and processors, the WSLCB seems determined to seek violations that could lead to license cancellation and is generally refusing to offer alternative penalties. Because so many of these cases are still pending, it is hard to go into too much detail, but the WSLCB’s actions in these cases indicate a desire to cull the number of licensed producer/processors.

For those producer/processors in Washington that aren’t currently being investigated for regulatory violations, the WSLCB’s current policy generates mixed reactions. When licenses were available for application in November and December 2013, thousands of businesses applied for the right to cultivate and process marijuana. As the market as matured, wholesale prices of marijuana have continued to fall, and the ability of licensees to maximize production has continued to increase. There is so much marijuana available on the market right now that it is hard for producer/processors to compete. Just having a license isn’t enough to run a profitable business, and many of the top performing producer/processors in the state are not generating the profits that most outsiders would assume.

At the same time, the types of violations that can cause the WSLCB to cancel a license and shut down a business are surprisingly easy to commit, even for dedicated compliant businesses. For example, let’s say that a licensed producer/processor has an unexpected bad month and doesn’t have enough money in the bank to make payroll. There isn’t any way for a licensee to get expedited approval of a cash infusion from the business’s owners If those owners contribute more of their own money before getting that approval, though, the WSLCB will still cancel the licenses. Or let’s say that a licensee enters into a licensing deal to manufacture branded products developed by another company. If the contract for that deal includes any terms that the WSLCB determines allow the licensor to exert too much control, they will cancel the license.

License cancellation is not innocuous. Marijuana business regulations bar a company from using a licensed location for business other than marijuana operations. Therefore, any type of license cancellation is really a death penalty for the business itself. These businesses employ anywhere between a few individuals and more than fifty people. Many of the employees are not the most employable in other industries either; legal cannabis jobs are the only thing standing between them and poverty.

And this is where it is clear that the WSLCB’s primary goal in cancelling licenses has to be to reduce the number of active licenses overall. Even in cases where the owner that is the “cause” of the regulatory violation has offered to transfer ownership interest in the business to a third party, the WSLCB still seems determined to cancel the licenses. They don’t seem to consider the effect that license cancellation has on innocent employees, landlords, investors, and contracting parties.

If you’re a licensed producer/processor in Washington (retailers seem to get more leeway), there’s not much you can do about this in the short term other than to stay compliant. There are certainly strategic alternatives that could engender better compliance among licensees, but it isn’t clear that compliance is the WSLCB’s current primary goal. Until the WSLCB starts accepting alternative penalties for certain seemingly innocuous violations for which they are authorized to cancel licenses, though, licensees will not receive the benefit of the doubt from the WSLCB. The correct attitude to take is that the regulators do not want you to have a license to engage in marijuana business activities, and they will do everything in their power to take it away.

cannabis business marijuana
If only it were so easy.

There is a direct correlation between the complexity of a state marijuana business licensing system and the complexity of financial deals that industry participants undertake. Washington, Oregon and most of all, California, provide fertile grounds for increasingly complex deals. Outside of cannabis, my firm sees similarly complex transactions proposed in our international business practice, especially in our China law practice which is another body of law requiring specialized knowledge. Regardless of circumstance, though, it is vitally important that parties to a deal firmly understand how the deal shifts and manages risk.

Complex transactions can feel like a game of hot potato. Here is a relatively simple example that demonstrates some of the complexity I’m talking about: Sally signs a supply contract with a large processor to provide bulk raw material. Sally realizes that she can’t service this herself, so she asks Henry, who has a background in servicing large orders like this, to use his experience in coordinating and managing production to service the contract. Henry realizes that he needs significant capital to expand capacity and turns to outside investors. Those outside investors want security before they invest, so they ask for, among other things, a pledge from Sally of her contract rights to receive payment from the processor as collateral.

In a perfect world, Henry gets the investment and uses it to provide the raw material. Sally and Henry provide them to the processor and split the contract fees they receive, some of which go to pay back the investors. Everybody wins.

Sometimes deals like this do work for everyone. But there are so many different ways that they can go wrong. None of the parties should enter into the deal without understanding what the consequences would be of various potential failure risks. In the example deal, there are plenty of potential failure points:

  • Can Sally coordinate production to service the contract?
  • Can Henry actually produce?
  • If Sally and Henry can produce, can the processor actually pay?
  • What if state regulations change and disallow contracts like this midway through the production cycle after money has been spent?

All of the parties in the deal need to understand their exposure at each stage of the deal from beginning to end, in order to negotiate the arrangement but also to perform under the contracts. We have seen deals like this look like they are on a good path until, at the last possible moment, the processor decides that they can’t pay for the product.

But that’s the crux of almost any business arrangement. There is a moment where a party spends money with the anticipation of receiving that back with a return. Whether or not the return comes is a function of risk. Businesses that do best are those that can understand and quantify risks and that understand how best to shift risk and hedge against downside. Whether the hedging/shifting mechanism is through security agreements, outside insurance, or reliance on lawsuits, parties need to understand the costs and benefits of each in order to properly manage their risk position.

Risk isn’t necessarily bad. But if a party is taking on a significant portion of the risk in a deal and that risk isn’t properly hedged, that party should receive the lion’s share of the potential upside.

cannabis administrative lawAnyone that does business in a highly regulated environment like cannabis or alcohol needs to have a basic understanding of administrative law. The majority of government interaction as a cannabis business–and the primary sources of headaches–involve state agencies. In Washington, for example, our Liquor and Cannabis Board is the primary regulatory agency, but the Department of Labor and Industries, the Employment Security Department, the Department of Revenue, the Department of Agriculture, and others all play a role in the lives of marijuana businesses. Sometimes agencies feel all-powerful, as if they can govern by fiat. Other times, they seem extremely limited in their abilities to act in certain ways. Cannabis businesses interact with administrative agencies when they are applying for licenses, advocating for regulatory change, and when they are held liable for violations of regulations. Smart cannabis businesses know the ins and outs of authority that their governing agencies wield.

Some background on how these agencies are structured and why they exist is probably in order. We’ll use the federal government as our example because every state is a little bit different, but most are structured similarly to the federal structure. The power to write law is vested in the legislative branch – the U.S. Congress. The power to enforce those laws is vested in the executive branch — the President and federal agencies. And the power to interpret those laws is held in the judicial branch — the court system. Administrative law blends all of those authorities together somewhat and places them, in a limited way, in the hands of a regulatory agency.

Congress is not good at dealing with rapidly changing legal landscapes. Its statutes are written broadly, and meant to stand the test of time. As such, Congress almost always drafts statutes that delegate some portion of its authority to write further laws to the executive branch, via administrative agencies. This Congressional enacting statute provides the general boundaries in which the executive branch, through a named agency or department, can create rules and regulations. That same executive branch agency is also tasked with enforcing those rules, and adjudicating initial disputes of whether those rules are broken (often, with the involvement of administrative law judges).

In the cannabis context, the enacting statute hasn’t tended to come from legislatures — it tends to come from the people in the form of a citizen’s initiative. In that context, the citizens are playing the same role as the legislative branch — writing law for the executive to enforce. Sometimes, the state’s Constitution will allow the legislature to amend an initiative statute, even before it takes effect. Unless the legislature makes a broad alteration, though, the only authority granted to the regulatory body is whatever is included in that initiative. If a regulatory agency like the Liquor and Cannabis Board does something that either oversteps the authority granted in the initiative or acts directly contrary to the initiative, it is acting unlawfully.

But agencies have significant leverage here. First, there is a federal interpretation rule that many states also follow called “Chevron Deference.” Under this rule, if there is vague or ambiguous wording in a statute that grants administrative authority to an agency, courts will defer to that agency’s reasonable interpretation of that language. Agencies get to decide any question about the extent of their power in a way that maximizes that power, so long as it is at least a reasonable reading of that enacting statute. If you are suing an agency, this can be a difficult standard to overcome.

Additionally, you generally can’t challenge an agency action until you have “exhausted administrative remedies.” This means that if you want to take an agency to court because you think it is doing something wrong, you first have to go through the agency’s internal dispute process. This can take time and money, and it often feels like the deck is stacked against you when the writer of the regulation, the enforcer of the regulation, and the judge for that regulatory enforcement are all the same people.

We’ll write more in the coming weeks about agency authority generally, and interacting with regulators specifically. Sometimes, it is good to defer to regulatory decisions and go with the flow, but other times it’s vital that regulated parties push back hard to make sure that their regulators are following the law themselves.

marijuana cannabis business
Want to show you own that canna business? Write it down.

Of all the core legal concepts that first-year law students study, property law is the most esoteric. The concept of property boils down to relative rights. Do I have more or less of a right than you do to possess, manipulate, lease, or sell this thing that I am claiming ownership of? Things get harder when we deal with intangible property. While simple possession of real property or equipment doesn’t prove ownership, it at least provides some indication of ownership. But regarding intellectual property like trademarks and copyrights, or other intangible property like interest in a partnership or a limited liability company, there often isn’t anything to possess. This has led to major problems for inexperienced cannabis business owners.

Regarding ownership interests in corporations and LLCs, it is important to make some distinctions. I’ll use Washington as an example, but most states adhere basically to the same principles. The Secretary of State’s office is in charge of forming business entities, and it maintains a database of governing persons. If I look up a company on that website, it is going to list the names of one or more people that are reported to the state as governing persons of that company. However, that listing is not proof of or even evidence of ownership. The people listed are supposed to be managers of LLCs or directors and officers of corporations. They are not shareholders (owners) of corporations, and they are not necessarily members (owners) of LLCs. Frankly, it isn’t even proof that they are governing persons. I could go in and file a new annual report for any company I wanted to and change the listing of governing persons. It is just a courtesy database made public by the state.

That notice distinction is also true of the state’s licensing agency, the Liquor and Cannabis Board. When a company goes through cannabis licensing, renewal, change of location, etc., it self-reports its governing persons and owners to the state. The state, in turn, subjects those people to criminal and financial background checks, and maintains them in a database as “true parties of interest” of the licensed business. But just being reported to the Liquor and Cannabis Board is not itself proof of ownership. The law requires a company to accurately report its owners, but that is still just a notice and reporting requirement. If a business reports its true parties of interest incorrectly, it doesn’t change who those owners are and what they actually own. If a company went through receivership or other administered liquidation, the ownership listing maintained by the Liquor and Cannabis Board wouldn’t be the ultimate authority on ownership.

How, then, is ownership of business entities actually determined? It isn’t through any type of public reporting. The United States, unlike many other jurisdictions, doesn’t tend to have any type of broad public registration of company owners. Instead, companies and individuals maintain those records privately. In our experience, most small businesses do a poor job of that.

With LLCs, the record keeping requirement is easier. Upon initial formation, the members/owners execute a limited liability company operating agreement that defines for each of them the scope of their ownership. A third party should be able to read that operating agreement and understand what right each individual has to profit distributions, liquidation distributions, profit allocations, loss allocations, etc. The agreement should also define transferability of membership and what steps need to be taken to accomplish that transfer. Someone who is buying part of an LLC would need to read that agreement to make sure that they were actually able to acquire it, lest the transfer be found inoperable. The LLC operating agreement should also contain an updated schedule or exhibit that lists the relative percentage ownership interest of each member. That schedule should be updated regularly — at least every time there is any change in membership interest.

Corporations have more paperwork, but they are also more standardized than LLCs. A corporation is initially formed by an “incorporator,” a generally meaningless title that doesn’t grant any inherent ownership rights. That incorporator appoints an initial board of directors, who take over governance of the corporation. The board of directors than adopt bylaws. Finally, they are ready to issue shares of stock. Until they do that, nobody owns the corporation. The stock is issued to individuals for some buy-in price, which could be real money or could be entirely nominal. But only upon signing a resolution approving of the issuance of stock does ownership exist. That stock is generally evidenced by a printed stock certificate that is possessed by its owner, and a ledger is kept at corporate headquarters noting the certificates that are issued. The bylaws may allow for uncertificated stock. In that case, the same information kept in the normal stock ledger is maintained at the corporate headquarters, and shareholders are given notice of what they own.

If you own an LLC or corporation and have failed to do any of this, it’s not like you have zero claim to ownership. It just means that it’s harder for you to prove it. And with intangible property, the ability to prove ownership to third parties is what it’s all about. That’s how you make money on it by accomplishing a sale, or using it to secure a loan. That’s how you convince a judge in a business dispute or dissolution claim or a receivership case that you have an actual right to business assets. So, make sure you write it down.

marijuana cannabis bank
For now, banks are still taking that cash.

On January 22, the National Association of Cannabis Businesses (NACB) hosted a symposium on cannabis banking and finance in Washington, D.C. The NACB is an interesting group. It isn’t quite a lobbying organization like the NCIA. Instead, it views itself more as a standard-setting organization that wants to make sure that its members follow certain standards. The thinking is that by setting up industry self-regulation, members are seen in a generally positive light, and states and federal regulators are less inclined to promulgate the most draconian regulations possible. The symposium brought together lawyers from large and small firms, accountants, Canadian attorneys, and a few practitioners. In the wake of Jeff Sessions’s withdrawal of the Department of Justice’s prior guidance statements on marijuana enforcement, confusion continues to reign regarding whether financial institutions and institutional investors are going to view the cannabis industry different now than they did last year.

Attorneys from large law firms like Jones Day, Cadwalader, and Davis Polk all gave financial presentations. While they all don’t take cannabis business clients, the fact that those firms would even participate at an event hosted by a cannabis-focused group confirms that they, along with other large conservative organizations, are prepared to jump into cannabis as soon as federal legalization happens. More and more banks, after all, are already going there.

One of the most interesting tidbits coming out of the event, which confirmed what we had been hearing, was that FinCEN had not been given advance notice that Sessions was going to withdraw the prior guidance. For financial institutions that bank cannabis businesses, the FInCEN guidance is the primary factor determining whether or not certain banks or credit unions are willing to serve the cannabis industry. Certain institutions can get their heads around the criminal end. Yes, the federal government would have an argument that a bank accepting deposits from marijuana customers is violating the money laundering statutes and is potentially aiding and abetting in cannabis activity. But all the Sessions memorandum did was to move that discretion from the Department of Justice as a whole to the individual U.S. Attorneys. It doesn’t make any more sense that a U.S. Attorney would bring charges like that against a financial institution, pulling resources away from opioid enforcement and from other crimes that actually involve some type of societal harm.

FinCEN’s guidance to institutions that bank marijuana businesses, however, is absolutely necessary. If FinCEN were to withdraw it, you would see a massive pullout from the cannabis marketplace by those banks that currently offer services. It just isn’t possible to be a working institution and be purposefully out of compliance with FinCEN regulations. Additionally, the FDIC and the NCUA are explicit that deposit insurance for financial institutions that bank marijuana businesses is contingent upon the FinCEN guidance remaining in place. Without it, they would potentially pull insurance away from those institutions that continued to serve marijuana businesses anyway.

And if the federal government had actually coordinated (like they did when the DOJ and FinCEN first jointly announced the Cole Memo financial guidance in February 2014), we may have had a massive problem. But the DOJ didn’t give FinCEN any advance notice that it was withdrawing the prior marijuana prosecution memos. And in wake of the Sessions decision, FinCEN, the FDIC, and the NCUA have told banks and credit unions that the FinCEN marijuana guidance will continue in place. Though it makes several references to the now withdrawn Cole Memo in its introduction, the operative provisions of the FinCEN guidance don’t actually depend on the Cole Memo staying in effect.

So while new institutions are going to be less likely to enter the cannabis industry because of Jeff Sessions, most existing financial institutions seem likely to stay in the market for now, unless and until something concrete changes with enforcement or with regulatory guidance from FinCEN.