We have spilled a lot of ink on this blog related to the 2018 Farm Bill, which legalized hemp at the federal level. It’s huge news. And there are so many ramifications, from food law to trademarks to the financial services environment. This blog post is going to cover financial institutions and hemp at about 10,000 feet. Since late December, we’ve had many clients come to us with frustrations about the ongoing lack of access post-Farm Bill, and questions about how things will play out in 2019.

To frame this issue, it’s important to summarize what the Farm Bill actually is and does. In a recent post, we explained that “the 2018 Farm Bill modified the Controlled Substances Act (the ‘CSA’) to exempt hemp from the definition of marijuana. Not only is hemp now clearly excluded from this definition and thus not a scheduled drug, but states and tribes also cannot prohibit the distribution of hemp.” Seems easy, right?

industrial hemp bank credit unionIf only. Going forward, hemp will be subject to stiff regulation at the state and federal levels. For example, although hemp is no longer a controlled substance under the CSA, the Farm Bill reserves certification rights to the Department of Agriculture over state and tribal industrial hemp production “plans.” Those plans will be nuanced, and what any given state’s plan will look like next year is unknown. That fact alone may be the biggest reason that most financial institutions are still on the sidelines.

Financial institutions are also conservative by nature. We represent a handful of banks (and a larger handful of credit unions), and we give those outfits advice on banking hemp and marijuana. A few of these clients are relatively nimble and bold, but at the end of the day they are still banks. They have directors who worry about individual liability, lawyers and officers who worry about byzantine state and federal laws and policy, and shareholders and members who may see outsized risk and steep learning curves. When banks move into these areas, they tend to offer limited services, which are seldom more than basic merchant accounts.

Financial institutions also understand that when a new piece of federal regulation is enacted, it takes some time for rules to be written in support of the new law (both federally and by states), for programs to be staffed and built, for guidance to issue, etc. Finally, there is often a wave or two of litigation to interpret the administrative environment. All of that happens over the course of years, not months, and all of that will happen with hemp and the Farm Bill. Like the rest of us, financial institutions cannot see around corners and will be watching closely.

So what does all of this mean? Ultimately there will be banking, but banks and credit unions will not come in all at once. When they do come in, early actors will likely provide services for hemp clients that look similar to what is out there today in states like Washington and Oregon for hemp and marijuana businesses. This means limited access to institutional lending, ongoing compliance reporting and audits, and short leashes overall. Everything that happens will be fluid and consistent with best practices for high-risk industries.

Ending prohibition is a lot of fun, but then you get to wake up and go to work. We are optimistic that the hemp industry will have ample banking options. It will take some time, though. In the meantime, we will continue to monitor this issue and other hemp-related matters closely. Stay tuned.

california hemp CBD
We’ve got you covered on California, hemp, FDA and CBD.

A few months ago, I wrote a blog post about the precarious state of industrial-hemp derived CBD in California. Since then, as everyone knows, President Trump signed the Agricultural Improvement Act of 2018 (or “Farm Bill”). A lot of people think that in the wake of the Farm Bill, hemp-derived CBD (“Hemp CBD”) is now completely legal. This is in many cases a wildly inaccurate misconception—especially in California. Now, the legal status of Hemp CBD is arguably even more confounding than it was then. And it was pretty bad.

What did the 2018 Farm Bill Actually Do?

Before getting into California Hemp CBD laws, it’s important to discuss what the new Farm Bill even changes. If you follow us here at the Canna Law Blog, you know we’ve written pretty comprehensively on this topic. For a brief overview, the 2018 Farm Bill modified the Controlled Substances Act (the “CSA”) to exempt hemp from the definition of marijuana. Not only is hemp now clearly excluded from this definition and thus not a scheduled drug, but states and tribes also cannot prohibit the distribution of hemp. However, as I explain below, that doesn’t necessarily mean hemp or Hemp CBD can be sold without state restrictions.

The current Farm Bill also gives the U.S. Department of Food and Agriculture (the “USDA”) authority to oversee state hemp regulatory programs. For example, states and tribes must submit plans to the USDA for implementing regulatory schemes, and these plans must be approved by the USDA. In the event that they aren’t, the USDA can implement its own plan.

One other interesting component of the Farm Bill is that crop insurance coverage could be extended to hemp, meaning hemp crops could actually gain federal insurance. In a state like California that is prone to natural disasters, this is critical.

These aren’t all the changes that the new Farm Bill brought along, but they are some of the key ones. Now, on to California.

Hemp CBD in Food/Beverages in California

Over the summer, the California Department of Public Health (“CDPH”) issued its now infamous FAQs (the text is here), which took the position that:

[A]lthough California currently allows the manufacturing and sales of cannabis products (including edibles), the use of industrial hemp as the source of CBD to be added to food products is prohibited. Until the FDA rules that industrial hemp-derived CBD oil and CBD products can be used as a food or California makes a determination that they are safe to use for human and animal consumption, CBD products are not an approved food, food ingredient, food additive, or dietary supplement.”

Under California law, “food” is defined as “[a]ny article used or intended for use for food, drink, confection, condiment, or chewing gum by man or other animal” and “[a]ny article used or intended for use as a component of any article designated” in the foregoing definition. What this means is that the CDPH views anything that counts as food or drink that’s intended for human or animal consumption as unlawful.

On an important side note, the Medicinal and Adult-Use Cannabis Regulation and Safety Act (or “MAUCRSA”) defines “cannabis” to exclude industrial hemp (and therefore doesn’t regulate industrial hemp), and instead incorporates provisions of the California Health and Safety Code which leave the regulation of hemp cultivation to the California Department of Food and Agriculture (“CDFA”). The CDPH expressly cited this issue in MAUCRSA back in response to the 45-day comment period for its proposed regulations to note that the CDPH doesn’t have jurisdiction over regulating industrial hemp. This doesn’t mean that the CDPH can ban hemp in other things (like manufactured cannabis, see below), but it just means that under MAUCRSA, the CDPH can’t start issuing hemp regulations.

Back to the main story, it was pretty clear after the FAQs were issued that the CDPH wouldn’t continue to tolerate sales of foods or beverages with Hemp CBD for long. But we weren’t aware of any sort of enforcement efforts or actual regulations by the CDPH regarding Hemp CBD in foods or beverages. However, after the Farm Bill wound its way through Congress but before Trump signed it, there was some question on whether the Farm Bill would negate the CDPH FAQs.

A few days before the Farm Bill was signed, I wrote a post predicting that the 2018 Farm Bill would not do away with the FAQs. This was because the FAQs are based on the CSA’s prohibitions on hemp as well as the federal Food and Drug Administration’s (“FDA”) stance that Hemp CBD foods are not permissible. The Farm Bill changed the CSA, but not the position of the FDA.

In fact, while the ink from Trump’s signature on the Farm Bill was still drying, the FDA issued a statement (see here) telling companies to pump the brakes and that it still regulates hemp and CBD in at least medicines and foods. In an accompanying Q&A document, the FDA takes the fairly unequivocal position (see response to Q.13) that it is illegal to introduce into interstate commerce food that has CBD in it.

So what is going to happen now? As noted above, we aren’t yet aware of any enforcement actions in California. We’re also unlikely to see any sort of new guidance from the feds during the shutdown or in the immediate future thereafter. But localities may be taking a very different approach.

For example, the L.A. County Department of Public Health’s Environmental Health Division (“LADPH”) published an undated PDF concerning industrial hemp in food and saying that the LADPH will begin actually enforcing them: “Effective July 1, 2019, prohibited use of industrial hemp derived products in food will be considered adulterated and cited by [LADPH] as a violation resulting in a deduction of two (2) points on the official inspection report.”

This is one of the first instances we’ve seen of a county taking an official enforcement position on CBD food products, and interestingly comes on the heels of the L.A. Department of Cannabis Regulation (“DCR”) creating an attestation (which I wrote about here) for businesses who sell hemp products to advise that those products don’t fit within the legal definition of cannabis.

Now it seems like we have our first glimpse of what is going to happen when companies sell CBD foods or beverages. While this is only in L.A., we can assume that other counties will follow suit and may be even more aggressive in their pursuit of these hemp CBD food companies.

What is much less clear though is what this means for simply manufacturing or distributing food products that contain hemp CBD. The CDFA’s website Q&As still say that “California law does not currently provide any requirements for the manufacturing, processing, or selling of non-food industrial hemp or hemp products.” It seems like we will need to wait and see what the final answer is.

Licensed Cannabis Products

Cannabis products will generally contain at least some level of CBD naturally. But what about adding CBD from an industrial hemp source to a manufactured product under the Medicinal and Adult-Use Cannabis Regulation and Safety Act? Well, the CDPH (which governs the manufacture of all cannabis products in California) says no.  In the proposed final regulations (no. 40175(c)), the CDPH states pretty clearly that, “A manufacturer licensee shall only use cannabinoid concentrates and extracts that are manufactured or processed from cannabis obtained from a licensed cannabis cultivator.” With this regulation, the CDPH has effectively cut Hemp CBD out of the manufacturing process altogether.

Alcohol Products

In 2018, the California legislature passed a piece of legislation that prohibits cannabis or alcohol licensees from introducing Hemp CBD (or THC) to alcoholic beverages. You can read more about that here.

Dietary Supplements and Medicinal Products

The FDA’s statement makes clear that it will retain jurisdiction over CBD products making medicinal claims, and the accompanying Q&A (see response to Q.12) says that the FDA views dietary supplements containing CBD as unlawful. That said, the FDA notes that there is at least a path towards FDA approval. For what it’s worth, the FDA’s not all talk—see the case of Epidiolex (and see subsequent statement by California’s Attorney General, Xavier Becerra, on Epidiolex). Also, the same day that it issued the statement discussed above, the FDA issued a companion statement listing as generally recognized as safe (“GRAS”) hulled hemp seed, hemp seed protein powder, and hemp seed oil. The FDA is making clear that it’s willing to work with the CBD industry, but it will probably not be cheap.

Vaporizers and Other Products

We recently wrote a comprehensive post about Hemp CBD in vape cartridges. What we said then still holds—it’s a grey and undefined area. This is probably another area that the FDA may eventually regulate given its similar work with nicotine-based vape products. But given the shutdown and just the general speed of regulators, we’re unlikely to know anytime soon.

For what it’s worth, the FAQs are only tailored to food, but it’s possible that regulators could view all products containing Hemp CBD intended for human consumption as unlawful. This seems a bit less likely to happen right away because the CDPH and other agencies have had ample chance to do this but haven’t. But it’s certainly possible, and we’ll make sure to keep you informed of any developments.

Cultivation

We know that at least for cultivation, California’s recent bill SB-1409 (which we’ve written about here and here) was intended to create an application and registration scheme for cultivators. Now that the Farm Bill will require states to submit plans to the USDA for hemp production, it’ll be interesting to see what happens with SB-1409.

Packaging and Labeling

Anyone in the California cannabis game knows that the packaging and labeling regulations are tough, ever-changing, and hard to comply with. The point of these laws seems straightforward—regulators want people to know what they are consuming, and to ensure that cannabis products are properly labeled so that people don’t unwittingly ingest cannabis. They also want to avoid false and misleading claims in labeling.

Because CBD products in California are either in grey or quasi-illegal areas, things aren’t so clear. There aren’t specific packaging and labeling laws for it here, so people who still are selling these products are operating in a labeling wild west. This is different from states like Oregon or Indiana, which have actually begun to figure out how some CBD products should be labeled. We published a post recently on the complexities of and in many cases lack of instruction for hemp labeling laws at the FDA level—and the fact that there may not be guidance for another year or two.

The FDA’s Q&As (see response to Q.15) note that in deciding whether to institute enforcement actions, the FDA will now consider factors, such as “agency resources and the threat to public health.” This may be the FDA’s way of saying that in light of its limited resources, it’s going to spend its enforcement power on those companies selling dangerous products or making false or misleading health claims. One thing we do already know is that the FDA has already sent warning letters to companies that have marketed CBD as new drugs, in the FDA’s view. So in post-shutdown mode, we may see the FDA step in more aggressively on enforcement, especially for products and claims that it views as unlawful.

With the passage of the Farm Bill comes the possibility of a completely new playing field for industrial hemp producers. It appears that the question of whether IRS Code 280E (which prohibits deductions for any amount paid or incurred in carrying on any trade or business that consists of trafficking in a Schedule I or II controlled substance under the CSA) will apply to hemp producers is now settled.

But what about issues like banking or federal intellectual property protections? While it seems like these may be a reality soon, the answer is not as clear cut. If the FDA starts using its enforcement powers against companies that make Hemp CBD foods, for example, it’s certainly possible that banks will still stay away from those companies or that the USPTO won’t register their trademarks. It’s all too soon to say how this will play out, so stay tuned to the Canna Law Blog.

It may seem difficult to understand why cannabis, which is still prohibited federally, is at the state level treated more liberally than Hemp CBD. But the reason is clear—there are strict regulatory testing and quality assurance requirements for cannabis, there will be a track-and-trace system in place to ensure that only white market sources are used, and there are tight packaging and labeling rules that create uniformity in how cannabis products are identified to consumers.

That level of regulatory security doesn’t really exist yet for Hemp CBD and so regulators and lawmakers are naturally more concerned about products that they cannot trace, that may not be labeled at all, and that have undergone zero testing. When Hemp CBD is regulated more like cannabis, regulators may very well relax some of their positions.

Stay tuned to the Canna Law Blog as we will be sure to follow and interpret each and every development in this complex and fast moving space.

marijuana cannabis M & AWe handle a lot of cannabis M & A in our Los Angeles, San Francisco, Seattle and Portland offices. Over the years, it’s become pretty clear that in robustly regulated cannabis states, the secondary market for buying and selling businesses really peaks (after initial legalization) as local and state governments finally begin to settle their local control entitlement processes, and once the state rules governing cannabis businesses are less volatile. In California specifically, our cannabis business attorneys have worked on a good amount of cannabis M & A deals since the implementation of the Medicinal and Adult-Use Cannabis Regulation and Safety Act (“MAUCRSA”)–  especially in Los Angeles, Long Beach, Santa Ana, Santa Barbara, San Diego, San Francisco, the Emerald Triangle, and Oakland.

Lately though, there’s been a massive uptick in our firm’s M & A practice for cannabis businesses in a multitude of states. Below is an outline as to why this is happening.

  1. Limited number of licensed businesses.

Securing a cannabis license in any state is no picnic. Setting aside the federal illegality of cannabis (which has its own business and legal risks), licensees not only have to deal with the shifting state regulatory landscape, but they must also constantly navigate local control from city to city and county to county. Licensees also have to meet numerous strict local and state requirements for their location, daily operations, finances, owners, financial interest holders, true parties of interest, and their employees. To further complicate things, certain states (mainly on the east coast) only allow a limited number of licenses for which applicants compete, and the expense of the application process in those states can force an applicant to expend six figures or more with no guarantee of licensure. Other states have become so saturated with applicants that they’ve suspended their licensing window indefinitely (see Oregon), or they only had a limited licensing window in the first place (see Washington). Even in California, where the barriers to licensing are very low on the state level, the majority of cities and counties still ban commercial cannabis activity.

All of these human, political and regulatory factors have had one practical effect on industry: The number of licensed cannabis entities existing today is very limited and will be slow to grow and expand in states with legalization. In turn, just by virtue of holding a license, your cannabis business holds inherent value to strategic and financial buyers.

  1. Survival plan.

Getting a cannabis license is a bit of a hollow victory because no matter how difficult the road to licensure has been, your entity now faces the far greater challenge of securing revenues and turning profits. Many licensees underestimate this side of the game, and they truly believe that cannabis will just sell itself with no tactical thinking or business effort. Oftentimes, due to poor planning or general lack of sophistication on the business side, cannabis partnerships break up and businesses run out of money. Sometimes, licensed businesses go belly up before operations really commence.

Some cannabis operators are happy (even eager) to abandon the business at this stage of great stress. Depending on the market, they may find buyers willing to pay hundreds of thousands or even millions for their newly-minted cannabis businesses that’s slowly becoming distressed (though it’s no secret that most cannabis business valuations are still squirrelly at best). On the other hand, other cannabis businesses in this situation will look around and find similarly-minded peers to potentially combine with them on a cash-free basis via a share swap, thus increasing their licensing portfolio and the likelihood of finding new finances and surviving the start-up stage– exponentially increasing their valuation.

  1. Growth plan.

After surviving the start-up phase, cannabis businesses should start evaluating themselves against their peers and competitors, thinking about ways to increase their market share. Here, businesses may begin thinking about acquiring a competitor or an entity that can add to a vertical integrated structure, improve the supply chain, add to the brand portfolio, ultimately expanding the geographical reach of the business and brand. Purchasing an operational entity will likely be cheaper than starting new operations and applying for a very hard-to-get license for those operations. Therefore, existing cannabis entities that actually sustain operations will likely be approached with an offer of an acquisition, a share swap, or some other offer of an acquisition or a combination transaction. In addition, in preparation for the larger corporate players entering the cannabis industry, some cannabis companies will choose to merge to make themselves a more attractive target for a liquidity or an exit event.

  1. Exit/liquidation plan.

The holy grail of most entrepreneurs is an “EXIT.”  The basic formula is: Create it, build it, grow it, capitalize on it, rinse and repeat.  It’s no different in the cannabis industry. Many cannabis businesses do not intend to compete in the marketplace or create a lasting legacy. Instead, the usual goal is to sell the business off to a larger corporate player. Some of these cannabis businesses are beginning to realize that vision after witnessing multi-million dollar acquisitions by Acreage and investments by Altria. As a result, many licensed cannabis businesses will likely go through some kind of M & A transaction in the next year or two. Because of the clear race to the bottom for cannabis on pricing, we have no doubt that bigger companies will quickly start to eat up distressed cannabis operators for better or worse (which is already happening in certain states).

In my upcoming blog posts, I’ll be detailing what buyers and sellers need to do and consider regarding deal mechanics for state and local licensing ownership changes, defaults, closing covenants, and indemnities and liabilities for successful M & A in cannabis.

For now, and for more on cannabis M & A, check out the following blog posts:

oregon cannabis license marijuanaRunning a cannabis business is difficult and many people fail. There are a myriad of reasons why these ventures bottom out, although owners tend to blame federal law issues first of all. It’s true that federal law creates a tough environment for cannabis businesses (banking issues, tax issues, branding issues, etc.), but federal prohibition also kept big money sidelined at first, giving small business a real head start. My personal view, after seeing many spectacular business failures and slow motion crashes over the past several years, is that most are some combination of the following: 1) a challenging legal and regulatory environment, 2) saturated markets, and 3) operator error.

A start-up cannabis business cannot control the first two items listed above, but should be able to navigate them. The third item is a different animal. Margin of error tends to be slim for most new ventures, and self-inflicted wounds are difficult to overcome. This blog post covers the five biggest mistakes we continue to see in early stage Oregon cannabis business, and gives suggestions to avoid them.

  1. Failure to properly estimate license transition timelines

Because the Oregon Liquor Control Commission (OLCC) “paused” review of applications submitted after June 15, 2018, most new market entrants are buying their way in through asset or stock sales from existing licensees. The OLCC has a small and overtasked team of change-in-ownership investigators who work with both buyers and sellers on these transactions. Recently, agency higher-ups have advised us that these changes can still happen in as quickly as four to six weeks. However, that almost never occurs. Four to six months seems more common.

Even a non-cannabis business sale can be delayed by many things, from diligence issues to lease negotiations to ironing out terms in final agreements. In the Oregon cannabis industry, administrative vetting and disclosure requirements must be added to that list. Delays are almost always on the buyer side, stemming from initial business structuring, filling out OLCC business structure and individual history forms, submitting fingerprints, etc. Buyers should create realistic timelines to avoid hemorrhaging cash during this phase, and should strongly consider working with someone who has navigated the change-in-ownership process before. It’s a singular process and there is definitely some art to it.

  1. Paying lawyers to expedite your OLCC application

This is a bad idea, but many people do it. Whether for new applications (pretty straightforward) or change-in-ownership (harder) many new businesses spend significant money on lawyers to guide them through the application process. Our Portland office philosophy has always been not to blow through client retainers on ministerial work: We want people to succeed so we can work with them for years. For that reason, we have trained licensing paralegals who push these applications through efficiently and expertly. Attorneys only come in for unusual situations. The bottom line here is that new businesses should save their legal budgets for work that cannot be done by non-lawyers.

  1. Starry-eyed forecasting

You are not going to sell your marijuana for $2,000 a pound in Oregon. Forget it. You also do not have a strain of marijuana that you will patent and license one day to big pharma. You are not the only person trying to run down hemp for distillate, and, closer to home, you should not budget a six-figure salary for yourself or anyone else in the early stage. Although the market challenges have been well publicized, too many people believe that an OLCC marijuana license is tantamount to a license to print money. It’s not. All of this means that it is crucial to dial in your research and expectations before starting out – especially if you are taking on investment and the legal risk attached to that.

  1. Employment issues

For whatever reason, employment practices are often subpar with cannabis businesses. There are a couple of important things to note here. The first is that employee actions, even if unauthorized, can lead to license revocation in Oregon. This means you must ensure your employees are well versed in compliance, and you have to watch them. The second thing to note is employment law is complex and seems to change as often as cannabis licensing rules. We have a host of new employer requirements coming online January 1, 2019 in Oregon, for example. Whenever there is a dispute, courts and administrative bodies tend to favor employees, so it’s important to keep your team in order.

  1. Bad (or no) business agreements

You do not need a tall stack of complex documents to start a cannabis business. You do need the basics, though, and those agreements should be solid. If you are renting property, get a tailored industry lease. If you are organizing an LLC, get an operating agreement that covers matters important to your business, such as management, distributions, protocol for when someone jeopardizes the OLCC license, etc. Or, if you have a white label agreement, ensure that all processes and intellectual property ownership are delineated. The list goes on.

Starting a business can be expensive, and people tend to skim on legal. But nearly all of the cannabis litigation matters my firm is currently handling stem from defective contracts, and from people operating informally in that sense. Reasonably tailored contracts should be a part of any new business plan, and they should not break the bank. These contracts will set both guidelines and expectations for the business, and they operate like insurance when things go wrong.

cannabis business contractsYou can spend a lot of money on lawyers, accountants and consultants when starting a cannabis business. There is so much ground to cover from concept to execution– especially in a complex and highly regulated industry. Related to this issue, we have written on this blog about finding a team, and we have talked about the importance of things like operating formally, staying away from generic agreements and avoiding the seemingly bottomless pit of industry scams and schemes.

Today’s blog post will cover which documents are really necessary when structuring a cannabis business, and what you may be able to do without— at least in the beginning. Note that these are general guidelines. They are not intended to serve as legal advice and every business should use its best judgment and consult with counsel on these items.

  1. Stuff you cannot do without

Articles of Incorporation or Organization

This is very basic, but you cannot have a company unless the entity has been duly registered with the relevant Secretary of State. These days, most filings in most states can be done online, although there are situations where online filings are a bad idea, like when you want to do anything nonstandard with your Articles of Incorporation (for a corporation) or Articles of Organization (for an LLC). Those situations arise somewhat frequently. For example, you may want specific indemnity provisions for your board of directors beyond what the statutes contemplate. Or you may need to outline the attributes of preferred stock your corporation plans to issue. Many state registration portals do not allow “check the box” options for this type of tailored structuring. Get a solid cannabis business lawyer to help.

Internal Governance Agreements

If you have registered a multi-member LLC, it is a bad idea to proceed without an operating agreement and without an initial set of consent resolutions. The operating agreement in particular is going to define the spectrum of voting and economic rights each member has in the company, as well as crucial operational concepts. These concepts include non-industry specific matters (what happens when the company requires more capital?) to cannabis-specific matters (what happens when a member endangers the company’s state-issued license?).

In a corporation, you are going to have a few more agreements to start. Of these, bylaws and initial consent resolutions cannot be skipped. You will also need a shareholder agreement in most instances, and you will need to issue shares to owners (certificated or uncertificated). Other items, like a voting agreement, proxy agreements, etc., may be less important for some companies and you can often skip these to start.

Lease Agreement

Even if one of the cannabis business owners also owns the real estate at issue, you are going to need an industry-specific lease. A well drafted lease will insulate the property and its owners from liability if the cannabis business fails, or finds itself in litigation. When your business is leasing from a perfect stranger, the lease becomes even more important to outline the basic terms of the landlord-tenant relationship, on everything from your rights to occupy the property, to your rights to make modifications required to obtain a license.

Employee Handbook

If you have even one employee in your new business, get a handbook together. These internal business documents serve as a key communication tool between a business and its employees. A good handbook will set forth guidelines and expectations for workers, and perhaps most importantly, it can give a broad array of legal protections to business owners, as we previously explained here.

Third-Party Agreements

If your brand new cannabis business is doing a business transaction with a third party (some frequent, early examples include loans and services agreements) make sure you have adequately papered those items. Not memorializing a business or financial relationship in writing is asking for trouble.

  1. Stuff you can probably skip (for now)

Employment Agreements

Today, all states recognize at-will employment, with various limitations. This means that a written employment agreement is not needed (or even desirable) for many types of employees. An exception may be where the employee is occupying a highly specialized or highly compensated position, or has rights to vest in ownership. But if all you are worried about is an employee having access to proprietary information, you can generally cover this in an employee handbook, or through a simple non-disclosure agreement.

Stock Purchase Agreement

Lots of cannabis businesses try to raise capital shortly after formation, or as they approach licensure. They do this by selling stock or another form of ownership in the company. In our experience, though, it’s often best to wait until the business understands exactly how much money it needs to raise, and from whom, before drafting a stock purchase agreement. In many cases funds are raised from just one or two targets, and it does not make sense to draft purchase agreements until terms have been negotiated, or even memorialized in a letter of intent or other term sheet with prospective purchasers.

Business Plan

It’s a great idea to have a business plan, but not to pay a lawyer or consultant thousands of dollars to draft this for you. There is enough publicly available information out there for anyone to put together his or her own marijuana business plan these days; and you will know more than anyone you could hire about your goals. Even if you are unsure about some of the concepts at first, doing the research needed to put this document together will go a long way in educating and setting yourself up for success.


It’s easy to get lost when starting a business, and to rack up costs on unnecessary items, or items that are less important in the near term. Focus on the basics to start, and enlist a knowledgeable cannabis business attorney to get you off the ground. The lawyer should be able to provide you estimates for basic services, and allow you to focus mostly on what matters most– running a successful cannabis industry business.

cannabis marijuana scams
DON’T BE THE MOOCH.

This morning when I went to the gym before work, I put on an NPR podcast that delved into the story of the FTC’s bust of David Diamond. Diamond is an infamous Angeleno who defrauded hundreds of people via telemarketing scams. In the podcast, the interviewee does a great job of explaining the common scammer term, “mooch.” A mooch is, according to the podcast, “… someone who will essentially buy anything from anybody who calls [them] on the telephone.”

This got me thinking about the ideal marijuana mooch since so much fraud and bad behavior is rampant in the national marijuana marketplace. We’ve covered multiple marijuana scams here, here, and here (and have written about fraud and important red flags (and red herrings) in the industry multiple times in this past).

This time however, I want to dedicate this post to the top 5 red flags of which a marijuana mooch should be aware:

1.  Anyone who tells you to invest in cannabis at all costs because you might “miss the boat.”

News flash–big alcohol, big tobacco, and big pharma are not active in the U.S. cannabis space. Even though they may be thinking about it and may have future plans for it (and even if states may already creating “Big Marijuana” interests), there’s not one single U.S. cannabis company (that actually traffics in cannabis under state licensing laws) that’s tied officially or legitimately back to these big business interests. Normally, the mooch hustle is “You’re going to miss this once in a lifetime opportunity with cannabis since the bigger companies are flooding the space already, so you better invest all you have now, now, now.” Utilize your judgment to understand that this statement is not only overblown, but it’s untrue, and the source of the information is seriously suspect, even today. In any event, before you invest cannabis, which is an extremely volatile prospect, do your homework and determine whether there’s real value at the end of the elevator pitch.

2.  Marijuana penny stocks. 

Stay away from most marijuana penny stocks. As both we and the SEC keep pointing out, many (but not all) publicly traded cannabis companies are vehicles for investor fraud. As we have written before:

It almost seems that publicly traded stock companies are more focused on selling their stocks than on competing in the market. The herd mentality of investors seems to encourage this. Here’s how that basic logic works: Marijuana is booming. Therefore, marijuana businesses must be booming. In turn, all marijuana businesses must be booming. Therefore, I need to invest in a marijuana business. The only way I can easily invest in a marijuana business is to buy the stock in a publicly traded marijuana business. And so the stocks just keep booming.

All of which leads to pump and dump scams where “the group behind the scam increases the demand and trading volume in the stock and this new inflow of investors leads to a sharp rise in its price. Once the price rise has formulated, the group will sell its position to make a large short-term gain.” Pump and dump scams with publicly traded marijuana companies are still quite popular, especially as more and more states have legalized and “medicalized.”

3.  Marijuana franchises. 

Most marijuana franchise “offers” are just plain garbage because they fail to account for all of the reporting, registration, and disclosure requirements required by federal and state franchise laws and regulations. Franchising is governed by FTC and various state agency rules. Because of the state and federal law conflict with cannabis, franchising a cannabis business is a very risky proposition, and we are finding that most cannabis “franchisors” are not providing their potential “franchisees” with nearly enough risk disclosures to really inform franchisees and their investors what they’re getting themselves into at the end of the day.

4.  Marijuana reverse mergers (ESPECIALLY CANADIAN ONES).

Seems like everyone and their mother is trying to accomplish a Canadian reverse merger in the U.S. cannabis industry. Reverse mergers are a relatively fast, cheap and easy way for a private company to “go public” without having to go through all of the SEC reporting, disclosure, and registration requirements required by a standard initial public offering. Just like penny stock fraud though, reverse merger stock fraud is nothing new. In the typical reverse merger transaction, a privately operating company seeks to acquire controlling shares in an already publicly traded company with the goal of acquiring the public company’s listing. In the reverse merger scam, the underlying publicly traded company is usually just a shell company with little or no assets or positive business history. Because the underlying publicly traded shell has no assets, no real management base, and oftentimes no business at all, the whole point of these scams is to acquire investors and raise capital based on pumped-up stock statistics, prices, and claims before everything eventually goes bust. These scams tend to involve the same subset of marginal accounting and law firms that assist by securing IRS and SEC reporting delays. Like anything else, if you’re looking at acquiring stock in a reverse merger company, do your due diligence and know the red flags.

5.  Marijuana crowdfunding.

Back in May of 2015, the SEC released new crowdfunding rules designed to let the small fry swim with the sharks. As of May 16, 2016, companies were able to solicit $2,000 from anyone (and more in many cases) in exchange for an equity stake in their business. Companies can now raise up to $1 million annually through these offerings, which fall under Title III of the 2012 JOBS Act. As we have written before, the SEC does not care whether your business is a pot business, so long as you follow its offerings rules. Though the SEC’s rules for crowdfunding advertising are incredibly strict, we know there are a wind of crowdfunding cannabis companies seeking to skirt these new rules to the detriment of investors and mooches.

Don’t be the marijuana mooch! For more on cannabis scams, check out the following:

california cannabis indemnity
Don’t skim over that indemnification clause!

Coming from Seattle to Los Angeles, I’ve already seen one state flip from being a “gray medical cannabis state” to a fully regulated licensing system and I understand how painful a process this can be. So much of what I saw in Washington State is now happening in California.

In California today, folks are jockeying for operational licenses on the state and local levels under MAUCRSA and “the cream” is rising to the top, just as it did in Washington. One-to-two-person shops and mom and pop operators are feeling the financial pinch of licensing costs and compliance woes. The secondary market for buying cannabis businesses is also beginning to open up as cities and counties solidify and stick with their local cannabis entitlement programs. Transactions between cannabis licensees are becoming increasingly sophisticated, from IP licensing agreements, to distribution agreements, to white labeling agreements, to purchase and sale agreements for inventory.

And just as happened in Washington State at the onset of legalization there, we are seeing many cultivators and manufacturers overpromising on what they can deliver, more often due to overconfidence as to dishonesty. In legal terms, this means we are also seeing cultivation and manufacturing licensees, and distributors agreeing to indemnify retailers and other licensees for everything under the sun, quite often to their own detriment. Even though the cannabis industry is maturing rapidly in California, many are still using boilerplate or Google-discovered or Legal Zoom and Rocket Lawyer contracts for these very serious transactions. This use of bad template documents (most of which are modified little if at all for the realities of the cannabis industry) has got to stop, or cannabis licensees will soon find themselves embroiled in costly and counter-productive disputes/litigation.

And that brings me to the crux of this post, which is one of the most important “boilerplate” contract provisions that absolutely must be tailored for a California cannabis contract: indemnification. What, exactly, is indemnification? It’s when one party (the “indemnitor”) agrees to hold harmless and compensate the other party (the “indemnitee”) for losses suffered by the indemnitee.

Many cannabis sellers in California are far too willing to indemnify third parties for things completely out of their control, like lab results, changes in regulations that may affect the other party’s operations, and unforeseen conduct by users of the cannabis product. These blanket indemnification provisions are creating liability and exposure.

In the past month or so, many cannabis companies have come to us (both in Los Angeles and in San Francisco) with poorly drafted, irrelevant or nonsensical indemnification provisions and agreements from cannabis sellers. So, what makes for a good indemnification provision in a cannabis contract?

A preliminary question should be the breadth of the indemnification. If you are the seller and you want to protect yourself, you should tailor your indemnification to what makes sense and to what you can afford. You do not want something like the following (which is being used fairly often in California these days by inexperienced lawyers and lawyerless companies):

“The Indemnitor agrees to indemnify, defend, and hold harmless the Indemnitee, its officers, directors, employees, owners, agents, assigns, and affiliates (collectively, the “Indemnified Parties”) from and against any and all claims, liability, loss, expenses, suits, damages, judgments, demands, and costs(including reasonable attorneys’ fees and expenses) (each a “Claim”) arising out of any accident, injury, or death to persons, or loss of or damage to property, or fines and penalties which may result, in whole or in part, by reason of the use or sale of any Product, or its packaging, except to the extent that such damage is due solely and directly to the gross negligence or willful misconduct of the Indemnified Parties and that the Indemnified Parties, or any of them, were acting in bad faith.”

This sort of provision is a bad idea for any cannabis seller. It means that seller will be liable to the buyer for just about anything that could go wrong–anywhere, for anyone–from the product. No one wants to be on the hook for things they cannot control.

Here are a few important things to consider when crafting a cannabis indemnification term:

  • Both the cannabis seller and buyer need to focus on what kinds of losses will or will not be covered by indemnification. If I’m the seller, I’m going to want to exclude incidental, punitive, and indirect damages even if foreseeable. If I’m the cannabis buyer, I’m going to want to include at least incidental damages and foreseeable indirect damages.
  • It is both unusual and risky for a seller to agree to indemnify a party indefinitely, and yet this too has become common in California. If you are the seller, make sure your indemnity agreement or provision has an end date.
  • Your indemnification agreement or provision should include a protocol for making indemnification claims to the indemnifying party. The boilerplate indemnification provisions and agreements we are seeing typically never even mention any claim deadline or claim notice requirements. As the cannabis seller you should, at minimum, address these two issues in your indemnification provision or agreement.
  • If the indemnification is mutual, and captures reciprocal indemnification obligations in the same paragraph or contract section, ask yourself “why?” Putting the same parameters around indemnification for both parties often makes no sense, because each party has a different role in the business relationship. Consider separating the indemnity obligations and applying tailored language for each party, as appropriate for that party’s role in the transaction.
  • Finally, can you just cross it out? If you have deal leverage, and someone presents you with an indemnification provision (particularly an onerous one), you may be able to get rid of it altogether. Sometimes, you can convince the other party to give you everything they need to feel comfortable through appropriate representations and warranties.

There are certainly very good and reliable stock indemnification provisions in most contracts, and there’s a reason for that boilerplate in that it’s time-tested and mostly appropriate for more standard business agreements. However, be sure that whatever you’re putting into your cannabis contracts on indemnification is tailored to your specific situation. If not, you could find yourself holding the bag on way more than what is fair — let alone what you expected or can afford.

california cannabis marijuana privacy policy
No longer optional for your canna business website.

Unless you’ve been living under a rock for the past few months, you’ve probably read about the host of sweeping new laws in California, like its new Internet of Things law, cannabis privacy law, or net neutrality law, to name just a few. California has long been regarded a trailblazer when it comes to making people who are outside of California do things to comply with California law. So it probably comes as no surprise that website operators outside of California may need to comply with a privacy policy law in California: the California Online Privacy Protection Act.

Pursuant to this law, any business that owns or operates a website that advertises to, services, or in many cases is simply accessible by California residents will almost certainly need to conspicuously post (and—importantly—actually follow) a privacy policy containing statutorily defined disclosures. This requirement applies when a website collects “personally identifiable information” about California consumers, including first and last name, home or other address, email address, telephone number, Social Security number, or any other information that would permit a person to contact a website user (either physically or online). Moreover, a policy may be required even for businesses located in distant areas of the United States just by virtue of the fact that its website can collect this information.

If a company fails to create or adhere to a privacy policy and does so either intentionally or in a material and negligent way, that company may be in violation of the law. The law does state that website operators will not be in violation until 30 days after being notified that their website does not contain a privacy policy, but it does not specify where notification can come from (i.e., the state or any source), which means that reliance on this window may be risky. The law is enforced by the California Attorney General, with penalties of up $2,500 per violation. These penalties could be a severe for businesses that offer mobile apps, as the California Attorney General has taken the position that a new (potentially $2,500) violation occurs each time a non-compliant app is downloaded.

You may be wondering how this applies to your cannabis business. The fact is that there are numerous ways in which even seemingly passive websites collect protected information from and about users. Even if your website does not sell any products, it may include “Contact Us” or mailing list subscription portals which collect protected information. If your website sells or ships any sort of product, it may collect at least some protected information. Even if your business has not collected information about any California residents in the past but simply could do so, the mere possibility may mean it needs to comply.

Furthermore, there are other good business and legal reasons to post and adhere to a privacy policy. Customers appreciate when businesses are transparent about their privacy practices. For obvious reasons, ensuring that cannabis customers’ privacy is maintained is important. Additionally, in the event of a data breach which requires notification to state or federal authorities, the fact that a company took steps to maintain customer privacy may be important considerations in determining if any enforcement actions should be taken.

The good news is that, unlike some laws or regulations that cannabis companies face, California’s privacy policy law is relatively straightforward in that it specifies what a company needs to disclose in a privacy policy and how that policy needs to be displayed on a website. That said, ensuring that a privacy policy accurately describes a company’s current and future privacy practices can be a challenge, and inaccurate or gratuitous statements in a privacy policy could expose a company to additional liability. In other words, a policy needs to be tailored to a company’s specific practices, and so copying language from other privacy policies could cause even more trouble for a company.

Cannabis companies have enough to worry about. They shouldn’t add to the problem by failing to address privacy or data security laws. A good place to start is engaging counsel to draft a comprehensive privacy policy. After all, at least according to California, one is required.

oregon marijuana cannabis data securityLast week we discussed the data breach notification laws with which cannabis companies doing business in Oregon must comply following a cyber intrusion. Today, we discuss the safeguards these companies must adopt to protect the security, confidentiality and integrity of customers and employee (collectively, “Consumer”)’s personal information, who reside in Oregon.

Pursuant to Oregon Revised Statutes (“ORS”) § 646A.622 any business that “owns, maintains or otherwise possesses, and has control over or access to,” written and electronic data that includes personal information used for business purposes, must develop, implement, and maintain reasonable safeguards to protect the personal information.

Generally, “personal information” means a Consumer’s first name or first initial and last name in combination with, for example, a Consumer’s social security number, driver license number or financial account information, if (1) encryption, redaction or other methods have not rendered the data element or combination of data elements unusable; and (2) the data element or combination of data elements would enable a person to commit identity theft against a consumer.

The company must act in accordance with this law by:

(1) Complying with:

  • State or federal laws with greater protections for personal information than ORS § 646A.622;
  • Gramm-Leach-Billey Act as of January 1, 2016 as of June 2018, if the company is subject to this act; or
  • Requirements of the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) as of June 2018, if HIPAA applies to the company;

and

(2) Implementing a security program that includes:

Administrative Safeguards, such as:

  • Frequently identifying reasonably foreseeable internal and external risks;
  • Frequently training and managing employees in security program practices and procedures; and
  • Selecting service providers that are capable of maintaining appropriate safeguards and adhering to procedures and protocols to which you and the service provider agree, but also requiring the service providers by contract to maintain the safeguards, procedures and protocols.

 Technical Safeguards, like:

  • Assessing risks and vulnerabilities in network and software design;
  • Taking reasonably timely action to address the risks and vulnerabilities; and
  • Applying security updates and a reasonable security patch management program to software that might reasonably be at risk of or vulnerable to a breach of security;

and

 Physical Safeguards, including but not limited to:

  • Monitoring, detecting, preventing, isolation and responding to intrusions timely and frequently; and
  • Disposing of personal information after you no longer use it for business purposes, pursuant to local, state and federal law.

So what does all of this mean? Simply put, business owners with 100 or fewer employees (which includes almost all Oregon cannabis businesses), will comply with these statutory requirements if their information security and disposal program contains administrative, technical and physical safeguards and disposal measures that are appropriate to: (1) the size and complexity of their business; (2) the nature and scope of their activities; and (3) the sensitivity of the personal information collected from or about a Consumer.

Cannabis business should take these safeguard standards seriously. Each violation if subject to a penalty of up to $1,000. Note that each day of a continuing violation is a separate violation, but the maximum penalty for any occurrence is $500,000. Civil penalties under ORS § 183.745 may also apply.

Complying with ORS § 646A.222 is not only required by law, it is also a very good idea for all cannabis business. Indeed, developing a vetted, comprehensive plan of action is the best way to effectively respond to an attack and to reduce the amount of damage to your company. Be safe out there!

noncompete marijuana cannabis
Noncompetes aren’t always enforceable.

Marijuana has been legal in Oregon for about three years now. Employees with specialized skills are starting to jump ship and head to competitors. What do you do, as an employer, if a candidate for employment shows you a non-competition agreement they signed with their former employer? Typically, the former employer will go after the employee to enforce the non-competition agreement, but the former employer may seek an injunction against your business to prohibit you from hiring the candidate.  Is there a way around this? Perhaps.

First, you should consider whether the non-competition agreement is enforceable. As we’ve previously discussed, non-competition agreements in Oregon are highly disfavored. Non-competition agreements in Oregon are only enforceable if the employee was making at least the median income of a family of four at the time of termination and the employee was given the non-competition agreement at least two weeks prior to the commencement of employment, or if the non-competition agreement was entered into as a part of a bona-fide advancement with the employer. If these factors are not met, the agreements are not enforceable.

However, this does not automatically invalidate the agreement. The Oregon Court of Appeals ruled in Bernard v. S.B., Inc. that the employee must take affirmative steps to invalidate or void the obligation of the non-competition agreement. Meaning, they need to send a written notice to the former employer that they intend to void the agreement. Have an attorney review the agreement to determine if its enforceable in the first place, if it’s not, it may be easy for the potential employee to void the agreement and make it safe for you to hire the individual.

Second, some employees may have entered into non-competition agreements in other states. Those agreements may be entirely enforceable under choice of law provisions in the agreements. What then? It’s time for negotiation skills. Some companies may not want to deal with the hassle of attempting to enforce a non-competition agreement and may agree to sign a waiver releasing the former employee from their obligations under the agreement. Others may truly want to enforce the non-competition agreement and refuse to release the employee from the agreement. At that point, you may want an attorney on your side to review the non-competition agreement and see if there is a way to avoid violating it. Perhaps the agreement only prohibits the employee from working with edibles, but you plan on utilizing the employee’s skills to clone plants, for example. Further, an attorney may be able to work with the former employer to convince them to waive the non-competition agreement.

Non-competition agreements can be a good tool to protect your investment in your employees and to protect trade secrets. Alternatively, they can be a pain when you are attempting to hire. Whatever side you’re on, it’s always best to have an attorney on your side to review the agreement and ensure your company is protected to the fullest extent.