When it comes to marijuana licenses, some states are completely indifferent to residency, others give a slight competitive advantage to in-state license applicants, while others adopt a bright-line requirement that residents hold a controlling interest in the licensed entity. Are these restrictions on out-of-staters constitutional?
State governments can require licensees to be a certain age, have no felony convictions or recent bankruptcies, possess minimum amounts of investment capital, and so on. All of these are forms of discrimination governments engage in all the time with various types of licenses.
Generally speaking, federal courts have interpreted the Commerce Clause to prohibit states from adopting laws that regulate commerce to favor in-state interests at the expense of out-of-state interests. The Dormant Commerce Clause doctrine’s basic rationale is to prevent states from engaging in protectionism to gain economic advantages over other states.
Hawaii’s new cannabis program is a good example of how a state discriminates against non-residents seeking to enter its cannabis industry. Hawaii plans to require its cultivation centers and dispensaries be at least 51 percent owned by individuals who have been Hawaiian residents for at least 5 years. Hawaii’s medical cannabis law therefore enables the state to discriminate against non-Hawaiian residents in deciding whether to issue a business license.
What would happen if a Californian who wants to own 60% of a Hawaii dispensary asks a court to toss out Hawaii’s residency requirement?
Federal courts have developed a multi-part test to determine whether an economically discriminatory state law violates the Dormant Commerce Clause. First: does the law facially discriminate against interstate commerce? Making residency an explicit condition of licensure is almost certainly enough to satisfy the facial discrimination component. A more interesting question is whether the states’ cannabis laws discriminate against interstate commerce when they all provide that cannabis must be produced and consumed domestically. The Supreme Court may have already resolved this question when it decided Gonzales v. Raich, which held that even a purely intrastate market for medical cannabis, despite federal prohibition, still sufficiently affected the national marijuana market to qualify as “interstate commerce” under the Constitution.
Second, assuming Hawaii’s law is facially discriminatory, a court would apply strict scrutiny and examine whether the law or regulation is the only means to advance a “legitimate local purpose.” The most legitimate, non-protectionist reason to restrict residency is to reduce the threat of diversion across state lines. Conceivably, investors (or even purchasers) from out of state may have an incentive to traffic the product elsewhere, especially in bordering states without any legal cannabis market. However, for Hawaii, this policy objective is undermined by the 1,500 miles of ocean between it and the U.S. mainland. Even if there are other equally legitimate policy objectives, it isn’t clear that having a bright line residency requirement is the only way to achieve these objectives. It could give preference to in-state residents, or require that investors maintain a legal presence within the state (like owning property, or having a bank account).
There is almost no chance a federal court would tolerate similar residency restrictions if applied to any other legal business. But since cannabis remains an illegal, Schedule I controlled substance, courts might be reluctant to even entertain a Dormant Commerce Clause challenge to state cannabis laws. Even so, it’s only a matter of time before the federal government recognizes cannabis as lawful commercial activity and once that happens, these residency restrictions could be immediately susceptible to constitutional challenges that would probably succeed.
In the meantime, federal cannabis prohibition provides states legal cover to experiment with regulatory policies that won’t ultimately pass constitutional muster. To avoid these ticking time bombs, states should and probably will relax or remove residency requirements ahead of national legalization. If not, states should expect out-of-state investors to eventually force that change through the courts.