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.

cannabis management company 280EOn December 20th, U.S. Tax Court issued its opinion in Alternative Health Care Advocates et al. v. Commissioner of Internal Revenue. The long opinion details various issues related to the specific case, but we will concentrate on one relatively small piece of it. How would the Tax Court treat income paid from a marijuana retailer to a management services company for that retailer?

In this case, Alternative Health Care Advocates provided medical marijuana to individuals in California under California law. Another company, Wellness Management Group, Inc., provided management services to Alternative Health Advocates. These services included hiring employees and managing HR for those employees, paying wages for those employees, paying advertising expenses, paying rent, etc. Wellness did not provide services of that nature or any nature to any other business entity. Wellness made money by collecting fees for its services from Alternative Health Care Advocates.

Under Section 280E of the Internal Revenue Code, businesses that are engaged in trafficking controlled substances cannot take regular business deductions, so they end up paying taxes on their gross receipts less their allowed cost of goods sold (COGS). If an expense doesn’t fit into the category of COGS, a company that is considered to be “trafficking” would have to pay taxes as if the expense hadn’t been incurred in the first place. This is how the effective tax rate for marijuana businesses can be outrageously high.

Marijuana businesses set up management companies for a few reasons. Tax avoidance under 280E can be one of them, but trying to set up a management company structure to avoid 280E-related tax problems can be complex and can backfire. Instead, most of the value of the management company model comes from the ability of the management company to get banking and enter into regular electronic transactions with third parties, including running payroll services.

But the model backfires if the management company is considered to be trafficking, because a management company introduces new transactions to the system involving the same pot of money. Imagine that a marijuana retail company generates $1 million and has $500,000 in 280E non-deductible expenses. That company standing alone would pay tax on the full $1 million. Now imagine that a management company is set up to handle the $500,000 in expenses and charges the marijuana company $500,000 to do so. The marijuana company now has $1 million in revenue and a non-deductible $500,000 bill to the management company and pays taxes on $1 million. The management company receives $500,000 from the marijuana company and pays salary and other expenses that also equal $500,000. If the management company is treated like any other business, the transaction is a wash and ends the same way as if there were no management company. If the management company is deemed to be “trafficking” however, then the marijuana business will find itself paying tax on both entities for the same revenue. The $500,000 paid to the management company ends up being taxed twice.

Unfortunately, the Tax Court decided that Wellness’s management activities were “trafficking” as much as Alternative Health Care Advocates’ activities were. In response to the taxpayers’ arguments that disallowing the 280E deductions for both businesses was inequitable, the Tax Court simply stated that the tax consequences were a direct result of the organizational structure the taxpayers put together.

Here are the takeaways for existing businesses, especially management companies. First, it’s worth noting that this case will likely be appealed, so keep an eye on that. Second, businesses have to plan their transactions involving management companies as if management company revenue is subject to 280E. Some management companies that offer broader services to a variety of different businesses may have some additional arguments that they are not engaged in “trafficking.” But if your management company is just a stand-in for your operating marijuana company, the Tax Court has indicated that it will approve of the IRS considering you to be trafficking as well. This case is one more reminder that Section 280E presents an ever-present obstacle to the ongoing health of marijuana businesses. Advocates must continue to concentrate their efforts to finally get Congress to repeal Section 280E.

wslcb finance marijuana cannabisAfter years of us banging the drum for the WSLCB to change its financier approval process, there is a glimmer of hope out there that the agency is willing to listen to reason. The WSLCB has issued a new interim policy, BIP-06-2018, that allows existing true parties of interest and financiers to get clearance for providing additional funds to licensed marijuana businesses concurrently with contributing the funds.

The problem was that the WSLCB has required pre-approval of any new funding contributed to or spent on behalf of a marijuana licensee. That includes additional funding coming from financiers and true parties of interest that had already been approved by the state. This cumbersome process could take months, and it was creating a significant compliance problem in the state.

In the crowded marijuana business market, companies have needed to run extremely tight margins to stay competitive. Tight margins mean that any bit of bad luck can cause a company to go temporarily into the red. If a company doesn’t have the cash reserves to handle operating expenses in that time, the owners must often dip into their own pockets and fund the difference. But if payroll is due next week, it doesn’t help much that the WSLCB will allow an owner to contribute additional funds three months later. Faced with an impossible decision, most owners flouted WSLCB rules and contributed the money anyway. The penalty if the WSLCB found out about that was license cancellation, but there wasn’t much of an alternative. Failure to make payroll is a death sentence for most businesses regardless.

Under BIP-06-2018, however, existing true parties of interest and financiers may now contribute additional funds to a licensed marijuana business before those funds are approved. To benefit from this policy, the true party of interest or financier must have already been approved by the WSLCB with respect to the marijuana license they are contributing to. They must also submit the application for approval of funds prior to making the contribution.

There is a different type of risk at play in this new regime, namely what happens if the WSLCB does not approve the funding that has already happened. In its policy notice, the WSLCB clarifies that it can cancel the marijuana license if it cannot verify the source of funds. Hopefully the WSLCB would also allow the business to return the funds if it had cash on hand, but that isn’t guaranteed. So any true party of interest or financier taking advantage of this policy would need to feel confident that the source of funds is verifiable through tax reporting or other documentation.

We complain a lot about WSLCB policies, so it is nice to see them move in the direction to make life easier for regulated businesses every now and then. Here’s hoping this interim policy sticks, and for more smart rules changes in 2019.

What’s a Washington beverage processor to do?

The Washington State Liquor and Cannabis Board (WSLCB) is creating a real niche in the beverage product design industry through some of its most recent policy pronouncements. As has always been the case, edible (and drinkable) marijuana products are regulated so that they are not appealing to children. There are a host of old and new policies and rules that focus on avoiding marketing marijuana to kids, some of which are explicit (new policy mandating dull colors), and some of which are subjective (packages and labels cannot be designed in a manner that is “especially appealing to children.”).

But in one of a new set of policies that the WSLCB has issued recently, it has also sought to avoid packaging and labeling reminiscent of products made for adults — alcohol. Under BIP-07-2018, marijuana-infused products must not “Mimic, imply, represent or contain any statement, depiction, illustration, design, brand, or name of a product containing alcohol.”

Further, the WSLCB claims that if a product looks like alcohol, a licensee can’t get its product approved even if it includes a disclaimer on the packaging that the product does not contain alcohol. Even though this is a recent development as a written policy, we know that the WSLCB has been treating this as actual policy for a while. We have seen products turned away because of their bottle shape, the typeface on the label, and the ingredient list.

We have so many questions about this policy. Why? Are there large numbers of people going to marijuana retail stores, buying a product because they think it has alcohol, and going home to be disappointed that it doesn’t? Is this something that the alcohol lobby wants the LCB to do? To what end?

In trying to come up with some reason that this policy makes sense, the most charitable interpretation is that the WSLCB is trying to protect someone who lives with other people and reaches into the fridge to get a beer, only to find later that the beer was in fact marijuana. But even that case doesn’t stand up to scrutiny, as it could apply to marijuana beverages in any sort of container. There are only so many types of bottles and labels in the world, and all of them could conceivably be used for drinks that are either marijuana-infused or not. There’s nothing special about a beer bottle that would make it especially more confusing than a plastic soda bottle.

More importantly, this policy seems to contradict the WSLCB’s policy that marijuana beverages should not be marketed to children. I remember being a kid and being nervous when someone handed me a dark glass bottle of root beer for the first time. I knew that I wasn’t supposed to drink alcohol, and I had to triple check, that there wasn’t any in there because the color and shape of the bottle communicated to me that the drink was for adults-only. The WSLCB seems to be taking that tool away from marijuana beverage processors.

Now the WSLCB seems to be telling people that they can’t communicate with their products that something is specifically for children or specifically for adults. This is where smart product designers come in. Marijuana drink makers in Washington must find some type of middle ground that communicates neither. We’re not sure exactly how they can do that, but we wish them the best.

Jeff Sessions Hates Cannabis
Finally, Sessions is a goner.

Jeff Sessions, the drug warrior that may or may not have liked the KKK until he found out they smoked pot, is out as U.S. Attorney General. After two years of being relentlessly bullied by President Trump, Sessions has apparently had enough. The Sessions resignation is of special interest to the marijuana industry because of just how much he hates marijuana. So it’s great news that Sessions is out, right?

While it’s certainly not bad news, the real story is that it doesn’t really matter. Looking back at the Sessions era, the only truly significant act that he took regarding marijuana was the withdrawal of prior federal guidance to U.S. Attorneys regarding marijuana enforcement in January 2018. At the time, we couldn’t tell whether this was the first step in an organized crackdown on marijuana or simply a shot across the bow. As a result of the withdrawal of the prior guidance memos, discretion on whether to prosecute marijuana crimes shifted from the Department of Justice to each of the 93 U.S. Attorneys assigned to the various federal judicial districts.

But lo and behold, nothing actually changed in federal enforcement. There were rumblings out of Oregon (whose U.S. Attorney was just picked to chair the Attorney General’s Marijuana Working Group), but those rumblings led to stakeholder meetings and the issuance of detailed enforcement guidance. This is a far cry from the raids, arrests, and seizures that doom and gloom types predicted when Sessions was named Attorney General. To date, since Washington and Colorado legalized in 2012, there has not been a single instance in the United States where law enforcement has acted against a marijuana business unless it has been able to demonstrate significant violations of state law and violation of prior-stated federal enforcement priorities.

The takeaway, then, is that the cake has already been baked. With another round of state liberalization of marijuana rules, the country has continued its unstoppable march toward federal legalization/decriminalization. If the politics and logistics of enforcing federal marijuana laws against state legal businesses proved unworkable for Jeff Sessions, they are unworkable for anyone.

So celebrate – the Sessions era is over and hopefully we don’t have to sit through any more scoldings from the Attorney General trying to tie marijuana to the opioid epidemic. But even though we may be wrong, we think the real story of the Sessions era is that the fear of widespread federal enforcement of drug laws against state-legal actors will never come to fruition.

marijuana business litigation damages

When people have been wronged, they naturally want to get justice and want the party that wronged them to pay enough money to make them whole. The law generally holds that when someone commits a tort or breaches a contract against you, they owe you an amount of money equal to the value of your damages suffered because of the tort or contract breach. Unfortunately, getting justice isn’t so simple. The general order of events is as follows. The defendant breaches its contract with you, and you make a personal demand to the defendant to either cure the breach or pay you for the breach. The defendant ignores you, so you hire an attorney to send a demand letter. The defendant either ignores the letter or has its attorney send a response back disclaiming liability. You then must decide whether to continue making demands or whether to pursue more aggressive action, including filing a lawsuit.

This is a challenging time, as emotions run high. In the cannabis industry, so many entrepreneurs are working on a shoe-string budget and have significant portions of their savings tied up in an already risky industry. Of course you don’t want to ignore the contract breach or tort and let the defendant get away with its actions. But you also don’t want to throw good money after bad money in a quest for vengeance. Just because you have been wronged doesn’t mean that you have a legally actionable claim, or that the defendant’s bad acts proximately caused your damages, or that the defendant doesn’t have counterclaims against you.

Instead, you have to remove yourself sufficiently from the emotions of the situation to determine what to do in an unbiased way. Here is a simplified formula that can help guide that decision-making process:

(W% * D * AP%) — ((DCW% * CD) + AF + IC)

Here’s how we break that down:

W%: Chance of winning litigation

D: Realistic damages estimate, based on provable verifiable damages

AP%: Percentage of award defendant could pay based on defendant’s cash holdings and other assets

DCW%: Chance of defendant winning a counterclaim

CD: Damages estimate of defendant’s counterclaim

AF: Your expected attorney fees, expert witness fees, and other costs related to litigation.

IC: Your indirect litigation costs (stress, time missed from your business, negative effect on business relationships, etc.)

If the equation equals a positive number, it probably makes sense to file a claim. If the equation equals a negative number, it is probably better to let the matter go, or seek alternative claim resolution.

The hard part, of course, is filling in the details. This is where it pays off to have good attorneys that have the experience necessary to come up with smart and reasonable answers for these variables, and the integrity to answer them honestly instead of in a way that leads to them generating fees with your losing case. If your lawyer tells you that you have a 100% chance of winning any case, fire that lawyer immediately. There are no guarantees in litigation. If your lawyer tells you that you have a 0% chance of winning the case, your attorney is either overly cautious, or your case is really that bad (suing a pedestrian that you ran over in a crosswalk for your tire damage bad). On the damages side, you really are looking for measurable, provable damages that have some basis in objectivity.

We often go through this process with our clients, and it doesn’t always feel good for the clients. You’re paying your attorney a lot of money for personal service, and it can feel like your attorney is doubting everything you say. If you’re going to make smart decisions about litigation, though, you have to go through the exercise. You want to see all the holes in your case before you file that first complaint. All cases are different, but even small cases that look relatively simple can generate well over six figure in legal fees and costs, and turn on a point of law that seemed insignificant at first. If your attorney is pushing you into litigation without communicating the inherent chance involved, be cautious.

Finally, for marijuana businesses specifically, the indirect litigation costs variable has to include any potential losses you can face from your dispute going public. This comes up all the time when we have ownership disputes. These disputes often stem from one or more owners causing the business to commit regulatory violations. Sometimes these regulatory violations have not been uncovered and could lead to large fines or license cancellation. In cases like that, you absolutely need to quantify your risk exposure before pulling the trigger.

For more on cannabis business litigation, see our archive here.

LCB washington marijuana cannabis
Some LCB policies make hurdles tough to clear.

Regulatory challenges can be substantive or procedural. Substantive challenges include things like Washington’s ban on out of state ownership and its view that licensee royalty payment constitute profit-sharing. These types of rules and interpretations are challenging because, as a policy matter, businesses aren’t allowed to pursue certain strategies that they otherwise would. Procedural challenges, on the other hand, are challenges that arise in dealing with a regulatory agency. The Washington Liquor and Cannabis Board (LCB) requires that it approve of retail packaging for infused products before that packaging can be used, and the LCB also requires that a person submit a signed criminal history statement before that person can be a true party of interest in a licensed marijuana business. These types of procedural hurdles exist for a reason – the LCB requires them to pursue its legitimate goals of enforcing its substantive regulations.

But there is another type of procedural hurdle that arises in dealing with regulatory agencies (specifically the Washington LCB). These procedural hurldes present challenges to regulated businesses, but they have no relationship with the LCB’s enforcement of its regulatory goals. Here’s one example that has been frustrating us to no end recently: the Washington LCB will not process a change of ownership and a change of location for a marijuana license at the same time. Let’s say that an entrepreneur in Tacoma finds a perfect location for a marijuana retail store and leases that space. The entrepreneur can’t apply for a new license because the state isn’t accepting applications, so the entrepreneur has to find a marijuana retail license allotted to Tacoma on the market. Once the entrepreneur finds that business and negotiates a purchase, the entrepreneur has to make some tough choices.

Because the LCB will not process a change in location and a change of ownership request at the same time, buyers have to determine the order of applications. Both orders have drawbacks. If you apply for a location change first, you will have a marijuana retail store at your location within, hopefully, a few months. However, you run the risk that, in the intervening period, the business’s sellers that still own and control the business do something to put the business at risk. They could commit regulatory violations that risk license cancellation. They could take on business debt, putting the businesses assets at risk. The buyer would be powerless to stop these actions, because the LCB does not want to see any party exert control over a licensed business until that party has been approved by the LCB to do so.

If you instead apply for the ownership change first, you are less at risk of the bad acts of the selling party. Instead, you have to deal with getting a lease that would be in place for the time between when the ownership change is approved and the time when the new location is approved. The LCB wants to see landlord consent, and landlords often try to gouge buyers in this situation because they understand how much leverage they have. You also have to go through a sham process with the LCB when you do the ownership change application. The LCB asks for operating plan information, but you aren’t allowed to say that you don’t really plan on operating in the existing space, even if that is your plan. Instead, you are in a situation where you are just saying what you need to in order to get approved so that you can move on to the next step. LCB investigators understand this, but they still require the minimums so that they can check all the boxes off their checklists.

This type of procedural challenge is so frustrating because it isn’t tied to any policy. The LCB allows location changes, and it allows ownership changes. There is no reason that it shouldn’t be able to run both changes at the same time. But somewhere within the LCB archives, someone wrote down a policy that says investigators can’t do two things at once, and so far no one there is willing to do what it takes to change that policy. That policy has wasted enormous amounts of time and money and created enormous amounts of stress for parties on all sides, and it is part of why Washington has a reputation for being a hard state to do business. It invites actual regulatory violations, where people exert control over businesses that they haven’t been approved for, because the alternative can feel ridiculous.

For those of you with regulatory lobbyists out there, we encourage you to push the LCB on issues like this, in addition to substantive lobbying. There can and should be legitimate debate on whether businesses are allowed to sell marijuana-infused gummy bears. But for procedural challenges that have no basis in enforcing substantive rules, it’s important to keep pushing back. We want to see regulatory compliance, and the more logistically challenging the state makes it for businesses to comply with regulations, the more likely that businesses will ignore those regulations.

lcb washington cannabis marijuana
Unfortunately, a lot of this stuff is not written anywhere.

To successfully work in Washington’s regulatory cannabis industry, you need to understand the overlapping levels of laws and rules that are in the state’s regulatory arsenal. State statutes in RCW 69.50 set forth the boundaries of the regulatory system. State regulations in WAC 314-55 fill in the details of that regulatory system. Then there are official Liquor and Cannabis Board guidance documents, administrative cases, and court cases that formally interpret those statutes and rules. But there is yet another tier of rulemaking that is harder to see. This tier houses all the unwritten, often changing policies and interpretations of the LCB. If you aren’t aware of these unwritten rules, you can get yourself into a lot of trouble, including potentially losing your license — even if you think you’ve done everything by the book.

For example, did you know that the LCB has two different enforcement policies with regard to its “minor frequenting” violation? If a marijuana retailer does not check ID at its door, here’s the order of events. The minor enters the retail store and attempts to make a purchase. The store employee checks ID and sees that the minor is underage and asks the minor to leave without completing a sale. There is no violation. However, take this same set of circumstances and add an additional security ID check at the front door, in addition to the ID check at point of sale. In that circumstance, if the ID check at the front door misses spotting the date on the ID card but the minor is still turned away at the secondary ID check at point of sale, the retailer has committed a violation. If a retail business is going to have an outside security check, it has a different, stricter standard for what constitutes a rules violation than if it doesn’t have that security check. Regardless of whether that policy is bad (it is), you can’t find it anywhere in the LCB’s rules or in case law interpreting those rules.

In another example, the LCB has generally held that a financial contribution to a licensed business creates a financier relationship the entails a full criminal background check on the financier and a disclosure by the financier to the LCB of all that financier’s assets, debts, etc., all under penalty of perjury. On the other hand, if that same financier wanted instead to invest just in real estate and equipment and lease that equipment to a licensed marijuana business, no LCB disclosure or background check is required. All of that is reasonably reflected in the rules as written. However, the LCB also has a twist on that policy. If a marijuana business owner also wants to co-own the real property that is leased to the marijuana business, any other financiers or owners of that real property are considered as financiers or owners of the underlying marijuana business. Even if a property were purchased a year before the marijuana license was issued, a lender that holds a deed of trust on property that is owned by an individual that leases it to that individual’s marijuana business is considered a financier. Again, this policy is not reflected at all in any statute or regulation.

We deal all the time with people who are unwittingly violating written regulations. As a layperson in a regulated industry, it is your responsibility to know those rules, but that doesn’t mean it’s easy. When companies get into trouble because of violations of the unwritten rules, however, they don’t have real notice that what they are doing is contrary to LCB policy. And it allows the LCB to implement policies without being subject to the state’s mandatory notice and comment period for new rules. I don’t think that the LCB does this on purpose — the notice and comment period creates delays and can be taxing to work through. But there are enough tools in the LCB’s belt (emergency rules, interim policies, formal guidance documents, etc.), that any time we see the unwritten rules in practice, we need to push back. Lately, we’ve been doing that a lot around here.

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.