cannabis copyright marijuanaCopyright is an aspect of intellectual property (IP) law less frequently considered by cannabis businesses than trademark, trade secrets or even patents it seems. Yet, like these other forms of intellectual property, copyrights can afford their holders with market dominance and profitability when utilized correctly. Almost all marijuana businesses own numerous unregistered copyrights, whether or not they realize it.

This post briefly covers the concept of copyright and how it applies to the cannabis industry.

What does copyright protect?

Copyright is a form of IP law that protects creative expression of ideas. Specifically, copyright protects original works of authorship, including literary, dramatic, musical, and artistic works, such as poetry, novels, movies, songs, computer software, and architecture.

The cannabis industry protects copyrights in a variety of ways. For example, the writing and photographs on a cannabis business’s website are copyright protected. This might include descriptions of a particular product or just the layout of the website itself. Physical media like labels, product tags, packaging, logos, instructional materials, and product design can all be protected by cannabis industry copyrights. Books that discuss cannabis production methods, such as Ed Rosenthal’s “Marijuana Grower’s Handbook,” also have copyright protection.

Is registration necessary for copyright protection? 

No. A work of authorship is protected the moment it is created and “fixed in a tangible form.” A work is fixed in a tangible form if its expression is sufficiently permanent to allow it to be communicated for more than a transitory duration. Accordingly, registration is not necessary for copyright protection.

However, registration affords significant benefits, particularly in the context of copyright infringement. These benefits include:

  • The right to sue for infringement;
  • Automatic proof that the registrant is the rightful owner of the copyright, which shifts the burden of proof on the defendant to show that the registrant is not the rightful owner or that her work is not protected; and
  • Additional remedies, like statutory damages and attorney’s fees, if the registrant prevails on her infringement claim.

Given the fact that copyrights are inexpensive and quick to register online, we recommend registration in most cases.

Are cannabis copyrights registrable and enforceable?

The Copyright Act contains virtually no prohibitions on what types of work are eligible for copyright protection, including cannabis-related work. Instead, the Copyright Act simply contemplates the level of originality in a given item. And on that point, the Act provides a decidedly low bar to registration, requiring only “a minimal degree of creativity.” For cannabis brands, federal copyright protection is available to protect most business creations, as long as those creations are sufficiently original to be copyrightable.

Nevertheless, it is important to remember that under the Copyright Act federal courts have exclusive jurisdiction over infringement actions. Therefore, like in patent infringement lawsuits, there is a potential risk that the federal illegality of cannabis would be raised in various litigation aspects and would impeded the enforceability of a cannabis copyright. To this date, no cannabis copyright infringement claim has been raised, making it impossible to determine whether cannabis copyrights are in fact enforceable.

What rights does copyright afford?

Copyright affords the holder the exclusive right to control his work through reproduction, distribution, public display and performance.  Copyright also gives the holder the right to be compensated for the use of his work.

How long does copyright protection last?

Generally, works created by individuals are copyright protected for the life of the author, plus 70 years. Works created anonymously, pseudonymously, and for hire are protected for 95 years from the date of publication or for 120 years from the date of creation, whichever is shorter. Compared to the maximum shelf life of a patent, or terms of trademark registration, copyright protections last incredibly long.

How does copyright infringement occur?

Copyright infringement occurs when an individual uses another’s work without permission. Typically, permission is granted through a licensing agreement, which transfers some of the owner’s exclusive rights to another. In addition, the terms of the license agreement may limit the transfer of those rights to a specific period of time, to a physical location or to the means through which the rights may be exercised.

Note, however, that the legal doctrine of fair use, which promotes freedom of expression, permits certain unlicensed uses of copyrighted works, such as criticism, comment, news reporting, teaching and research.

As this post highlights, copyright affords valuable protection of certain intangible business assets.  As such, every cannabis business should take the time to determine which of its assets are copyrightable and whether registration would give them a competitive edge. Given the ease of registration and the rights associated therewith, it’s a no-brainer.

Oregon safety marijauana
The OSHA model. And a good look for cannabis business.

So, what is Oregon OSHA (“OR OSHA”)?

OR OSHA is the Oregon Occupational Safety and Health Act. This law requires employers to “furnish employment and a place of employment which are safe and healthful for employees.” In other words, employers are required to maintain safe workplaces. This means that employers are required to identify potential workplace hazards, prevent such hazards, and provide safety measures to employees to protect their health and safety, in all situations where hazards are inherent in the job or otherwise unavoidable. Does this law apply to cannabis employers? You bet.

OR OSHA also identifies certain conditions as inherently hazardous or unsafe, and regulates the condition or practice by imposing employer requirements to mitigate the condition or practice (think fall protection when on a ladder). The kind of marijuana business you run will dictate what OR OSHA regulations are triggered.

For example: marijuana producers are subject to the OSHA agricultural rules. These rules require employers to protect employees from things such as machine hazards, mold, electrical hazards, and heat exposure, among other things agricultural employees are subject to.  Marijuana processors must comply with special requirements for employees handling extraction chemicals. Retail operators must ensure employees are safe from slips, trips, and falls. Etc.

In addition to protecting employees from hazards at work, OSHA imposes reporting requirements on employers. Employers must report to OR OSHA within eight hours epodes like the death of an employee or a catastrophe. A catastrophe is defined as two or more employees fatally injured or three or more employees admitted to a hospital or an equivalent medical facility. Employers must report to OR OSHA within 24 hour of any employee being hospitalized, losing an eye or an amputation, or avulsion that results in bone loss. In addition to these reporting requirements, employers with 10 or more employees must record their injuries and illnesses that are a result of the work environment on a form called the OSHA 300 Log. Employers must also summarize the 300 log on a form called an OSHA 300-A.

Somewhat similar to the Oregon Liquor Control Commission (“OLCC”) — which is the state agency that administers marijuana licenses — OR OSHA has the power to investigate employers to determine whether or not they are compliant with OSHA requirements. OR OSHA does not have to provide advance notice of inspections, and the agency may randomly show up at an employer’s place of business to conduct an inspection.

So where might the agency show up? OR OSHA prioritizes inspections at locations that are determined to be the most unsafe. An OR OSHA investigator will investigate the employer’s property to determine if there are any violations. If there are violations, the investigator can issue a citation based on the type of violation. As with OLCC citation powers, the type of penalty associated with the citation depends on how serious the violation is.

OR OSHA safety requirements are comprehensive. The agency encourages employer compliance and has a series of free tools available to employers to assist with that compliance. OR OSHA’s most significant tool is its consultation services. Free of charge, an OSHA consultant will inspect a work site and provide safety, health, and ergonomic hazard assessments, recommendations to control and eliminate hazards, a written program evaluation, industrial hygiene services, training on health and safety topics, and assistance with safety and health programs. In short, a consultant will come out and point out potential OSHA violations and provide a plan to help with compliance.

Pro tip: A consultant is a great and free way to assess your compliance with OSHA prior to an inspector coming to your place of business.

Like with most employer regulations, compliance in the first place is the best way to avoid a hefty civil penalty or litigation. However, citations happen even when the best intentions are in place. This post has only scratched the surface of OSHA requirements. If you have additional questions, give us a call.

We’ve written (and talked) extensively about the dos and don’ts of filing cannabis-related state and federal trademarks, and we all know by now that you cannot obtain a federal trademark registration for goods or services that are not lawful pursuant to federal law. But I’ve heard a lot of creative arguments in this space, and have had many clients indicate an interest in challenging the status quo at the United States Patent and Trademark Office (USPTO).

Unfortunately (or fortunately, depending on how you look at it), the Trademark Trial and Appeals Board (TTAB) has handed down numerous opinions of precedent that lay forth the USPTO’s position on the “lawful use in commerce” requirement in detail. In this post, I thought it would be useful to breakdown the TTAB’s analysis on this issue via their In re PharmaCann LLC opinion, which was issued in June of 2017.

marijuana cannabis trademark
No lawful use in commerce = no trademark.

In the PharmaCann case, the Applicant sought registration of two trademarks: PHARMACANN and PHARMACANNIS, both for “retail store services featuring medical marijuana,” in International Class 35, and “dispensing of pharmaceuticals featuring medical marijuana,” in International Class 44. The Examining Attorney refused registration of both marks pursuant to Sections 1 and 45 of the Trademark Act, 15 U.S.C. §§ 1051 and 1127, on the ground that Applicant could not allege a bona fide intent to make lawful use of the marks in commerce because the services identified involved the distribution and dispensing of cannabis, which is a controlled substance whose distribution and dispensing are illegal under the federal Controlled Substances Act (CSA), 21 U.S.C. §§ 801 et seq..

In its opinion, the TTAB pointed out that it has “consistently held that, to qualify for a federal … registration, the use of a mark in commerce must be ‘lawful’.” In re JJ206, LLC, 120 USPQ2d 1568, 1569 (TTAB 2016) (affirming refusal to register POWERED BY JUJU and JUJU JOINTS for cannabis vaporizing and delivery services for lack of lawful use in commerce). The TTAB further elaborated that for a mark to be eligible for federal registration, “any goods or services for which the mark is used must not be illegal under federal law.” In re Brown, 119 USPQ2d 1350, 1351 (TTAB 2016). And even if an Applicant files on an intent-to-use basis (meaning they intend to use the mark in commerce in the near future but have not done so yet), if the identified goods or services with which the mark is intended to be used are illegal under federal law, “the applicant cannot use its mark in lawful commerce, as it is a legal impossibility for the applicant to have the requisite bona fide intent to use the mark.” JJ206, 120 USPQ2d at 1569.

In general, registration will not be refused for lack of lawful use in commerce unless either “(1) a violation of federal law is indicated by the application or other evidence …, or (2) when the applicant’s application-related activities involve a per se violation of a federal law.” Brown, 119 USPQ2d at 1351. In the case at hand, the TTAB deemed the Applicant’s marijuana distribution and dispensing activities to be a per se violation of the CSA. The analysis here was pretty straightforward, where the CSA prohibits, among other things, manufacturing, distributing, or dispensing controlled substances (21 U.S.C. § 841(a)(1)), and where marijuana is a Schedule I controlled substance under the CSA. 21 U.S.C. § 812(c) Schedule I (c)(10).

The Applicant here made two arguments in opposition to the TTAB’s position. The first argument was that “[s]ince 2009 the Department of Justice has consistently refused to treat medical marijuana as an illegal drug by consistently refusing to enforce the Controlled Substances Act against it.” In making its argument regarding the federal government’s lack of enforcement against medical marijuana businesses operating in compliance with state law, the Applicant relied on the (now rescinded) Cole Memorandum. But the TTAB clarified that it had previously decided in JJ206 that the Cole Memorandum “provides no support for the registration of a trademark used on goods whose sale is illegal under federal law,” and that this determination applied with equal force to the Applicant in this case’s intended use of its marks for distributing and dispensing medical marijuana.

The Applicant’s second, and more novel, argument was that “Congress has taken the same position as the Department of Justice,” because in the Consolidated and Further Continuing Appropriations Act of 2015 (as renewed in the Consolidated Appropriations Act of 2016, subsequent continuing resolutions, and in the Consolidated Appropriations Act of 2017), Congress has prohibited the Department of Justice from utilizing funds to prevent states that have legalized medical marijuana from implementing their own state laws authorizing the use, distribution, possession, or cultivation of medical marijuana. The Applicant’s argument was that Congress’ decision not to fund the DOJ to enforce the CSA against medical marijuana, “it would make no sense and serve no purpose for the Board to take a different position…”.

The TTAB, however, found this second argument equally lacking, and relied on United States v. McIntosh (833 F.3d 1163, 1169-70 (9th Cir. 2016)) for its analysis. In that case, the court concluded that the Appropriations Acts and the Rohrabacher-Farr Amendment did not make medical marijuana legal under the CSA. The TTAB applied that conclusion to the case at hand and rejected the Applicant’s argument.

These TTAB opinions are instructive in that they give us a clear view into how the USPTO is lawful use in commerce requirement; although the legal status of cannabis and particularly the federal government’s enforcement efforts remain murky, so long as marijuana remains a Schedule I controlled substance, federal trademark protection will not be available.

For other posts on cannabis trademarks, check out the following:

bank marijuana cannabis
Banking is within reach for many cannabis businesses.

In my previous post, I wrote about avoiding the scammers that abound when it comes to cannabis banking. Because cannabis is federally illegal, getting a bank account has been very difficult for cannabis businesses even though the 2014 FinCEN guidelines (see here) allow financial institutions to provide banking services to cannabis businesses under certain circumstances — which guidelines are still alive despite Attorney General Jeff Sessions rescinding the Cole Memo. Ultimately, FinCEN makes clear in its guidelines that they “should enhance the availability of financial services for, and the financial transparency of, marijuana-related businesses.”

But what exactly should a cannabis business do to get a legitimate bank account with a real financial institution? Plain and simple, you make it as easy as possible for the bank or credit union to abide by the FinCEN guidelines. This means you do not lie about or omit anything regarding your cannabis business.

To even get to this point though, your cannabis business must be in a state with “robust regulations” that give its regulators the authority to tightly control and govern its cannabis industry. And not all states are created equal when it comes to this.

In states like Washington, Oregon, and Colorado, banking is made a little easier because those states have hardcore regulations ranging from financial and criminal background checking on all cannabis business owners to knowing every single dollar that comes into a given cannabis operation and its source. In medical cannabis states like New Mexico and Arizona, which are basically unregulated medical cannabis states, banking is non-existent.  And in California (where I am based), which still has relatively weak cannabis licensing rules (for example, there are no spousal vetting requirements for owners of cannabis businesses), it is still nearly impossible for a cannabis business to get a bank account and this is not likely to change until California tightens up on its licensing regime.

But if you’re in a state with robust cannabis regulation, here’s what you need to do and expect when pursuing a bank account under the FinCEN guidelines:

  1. Banks that follow the FinCEN guidelines do so in open violation of the Bank Secrecy Act (BSA). This is the case because they are directly engaging in money laundering because cannabis remains federally illegal and this is why virtually none of the really big banks (like Bank of America and Wells Fargo) will knowingly take on cannabis accounts. But for those banks that are willing to take on cannabis bank accounts, you need to be prepared to basically do whatever the bank tells you to do to secure that account because the bank will be the one to be held accountable to the federal government for violating the BSA.
  2. You should expect your bank or credit union to conduct comprehensive due diligence on your cannabis business – nearly always at your expense. This due diligence usually will include the following:

(i) verifying with the appropriate state authorities whether your cannabis business is duly licensed and registered;

(ii) reviewing your cannabis license application and other documents your cannabis business submitted to obtain its state license to operate;

(iii) requesting information about your business and its related parties from state licensing and enforcement authorities;

(iv) developing an understanding of the normal and expected activity of your business, including the products to be sold and the type of customers to be served (e.g., medical versus recreational customers);

(v) ongoing monitoring of publicly available sources for adverse information about your business and its related parties;

(vi) ongoing monitoring for suspicious activity, including for any of the red flags described in the FinCen guidance; and

(vii) constantly updating the above information.

  1. Don’t get frustrated with the bank or credit union over this mandatory due diligence. Your job is to fork over as much documentation as you can to demonstrate that you are licensed and in full compliance with state and local laws.
  2. The Cole Memo, though rescinded, still matters to FinCEN. Specifically, the FinCen guidelines state that “[a]s part of its customer due diligence, a financial institution should consider whether a marijuana-related business implicates one of the Cole Memo priorities or violates state law. This is a particularly important factor for a financial institution to consider when assessing the risk of providing financial services to a marijuana-related business. Considering this factor also enables the financial institution to provide information in BSA reports pertinent to law enforcement’s priorities. A financial institution that decides to provide financial services to a marijuana-related business would be required to file suspicious activity reports (“SARs”).” This means you should review the eight Cole Memo priorities and implement them in your business practices.
  3. Your bank will regularly file SARs on your business. A financial institution is required to file a SAR if it knows, suspects, or has reason to suspect that a transaction conducted or attempted by, at, or through the financial institution: (i) involves funds derived from illegal activity or is an attempt to disguise funds derived from illegal activity; (ii) is designed to evade regulations promulgated under the BSA; or (iii) lacks a business or apparent lawful purpose. Because commercial cannabis activity is federally illegal, SARs are a must in the cannabis banking world.
  4. The following SARs will likely apply to your cannabis business: (i) Marijuana limited SARs, which mean you are not violating state law or violating a Cole Memo priority; (ii) Marijuana priority SARs, which mean the bank believes you are violating state law or a Cole Memo priority; and (iii) Marijuana termination SARs, which mean the bank thinks you are a threat to its anti-money laundering systems under the BSA so it must end its relationship with you. All these SARs get sent to the federal government for possible investigation.
  5. Your bank will constantly monitor the financial activity of your cannabis business because it must do so under the FinCEN guidelines. Your bank will monitor everything from your deposits to your social media accounts to your ability to keep your license in good standing to ensure that you are complying with state laws and rules. Again, if you want to keep your bank account, you need to assist your bank with this continued due diligence.
  6. The FinCEN guidelines list various red flags banks must watch for. One of those red flags is using management companies or middlemen to secure your bank accounts. The FinCEN guidelines are clear that Cole Memo priorities may be violated if a “customer seeks to conceal or disguise involvement in marijuana-related business activity. For example, the customer may be using a business with a non-descript name (e.g., a “consulting,” “holding,” or “management” company) that purports to engage in commercial activity unrelated to marijuana, but is depositing cash that smells like marijuana.” Cash structuring, commingling of funds with an unrelated business, and “deposits by third parties with no apparent connection to the accountholder” are additional red flags. Pay attention to the FinCEN guidelines’ red flags list and strive to avoid them.

Securing a bank account will not be easy but it is possible if you are in the right state and you prepare and act accordingly. Though state public banking and cryptocurrency have been floated as ways to provide wider access to banking, the FinCEN guidelines are still the key for both cannabis operators and financial institutions. And that’s not likely going to change anytime soon.

Editor’s Note: This post originally appeared in an Above the Law column, also by Hilary Bricken.

It is no secret that cannabidiol (CBD) is having a moment right now. Unlike its cousin tetrahydrocannabinol (THC), which is another cannabinoid found in the cannabis plant, CBD is not psychoactive. It has been growing in popularity for years for medical and other applications, but has really taken off lately.

Though CBD has become increasingly popular, it is still important to proceed with caution for any businesses operating in this space. Below are five important questions to keep in mind when dealing with CBD.

1.  What is the source of the CBD?

It’s not an accident that this question is first on this list. The source is key. If you are selling CBD at a licensed dispensary in a state that permits the sale of marijuana, then you need to verify that the product comes from a licensed source. Some states like Washington and Oregon may allow CBD additives from other sources, while other states are silent on the topic. You should act cautiously either way.

If you are selling across state lines or in stores that are not licensed to sell marijuana, then you must ensure that  your product is either derived from industrial hemp or from portions of the cannabis plant exempt from the Controlled Substances Act’s (CSA) definition of “marijuana.” If using industrial hemp, you need to make sure that the cultivator has a license from a state that  has implemented an agricultural pilot program in compliance with Section 7606 of the 2014 Farm Bill. If you are using exempt plant  material, you need to verify that the product was derived from mature stalks or seeds incapable of germination  as those sections are specifically exempted from the CSA.

If you a buying from a cultivator or processor, you should carefully draft your purchase and sales agreements to include representations and warranties from the supplier. It’s also important to learn about  who you are doing business as the question of source can determine whether or not something is legal.

2.  What do the lab tests say?

If your first thought in reading this is, “should I be testing CBD products?” the answer is “yes!” It’s important to test for items that could pose a risk to public health including pesticides, heavy metals, and microbials. States may require such testing, but the risk will ultimately fall on any company in the line of production. If a consumer is harmed, the cultivator, processor, and distributor may all be sued for product liability.

CBD is not independently listed as a controlled substance in the CSA. However, THC is. This means you need to test to make sure you CBD product does not contain THC, unless you are selling it in states that have legal marijuana programs. This is important whether your are dealing with Farm Bill hemp as it is defined as containing less than .3% THC on a dry weight basis, or if you are dealing with exempt plant material as THC alone is a Schedule I controlled substance.

3.  Where is the CBD going to be sold?

I recently wrote about how state law impacts the distribution of hemp-derived CBD products. If you are distributing products in a state that restricts the sale of CBD, like Michigan, you products could be seized and your company and its stakeholders could face criminal sanctions. It’s important to track where your products are being distributed and to inform your potential customers that they too must monitor state law.

4. What claims are you making about CBD?

We’ve written before that the FDA will treat products as drugs if their own labeling or marketing suggests they are “intended for use in the diagnosis, cure, mitigation, treatment, or prevention of disease.” Phrases like “combats tumor cells” and “[has] anti-proliferative properties that inhibit cell division and growth in certain types of cancer” clearly suggest that the CDB product can cure, mitigate, treat or prevent cancer, and is thus a drug.

Any suggestion that a product might have a role in treating or diagnosing disease, or that it is intended to affect the structure or any function of the human body of humans or other animals, is a health claim that subjects the product to drug regulations (unless it falls within the narrow confines of the Dietary Supplement Health & Education Act, which the FDA has ruled that  CBD does not.)

It’s important to remember that only the FDA can determine whether a drug can be labelled as safe and effective for a particular disease. Preventing health claims based on anecdotal evidence is one of the FDA’s core functions and  the agency will not hesitate to issue warning letters based on CBD health claims.

Long story short, don’t make health claims about your CBD products or allow others to post testimonials on your website.

5.  Has the law changed?

Finally, it’s important to keep up with the ever changing legal landscape. Tom Angell of Marijuana Moment recently reported that Mitch McConnell announced that his proposed  hemp bill will be included in the broad ranging agricultural act of 2018. This comes shortly after Congress approved a non-binding resolution acknowledging the vast potential of hemp.

In addition to federal law, stakeholders need to stay informed as to how the DEA feels about CBD that week. The DEA is often changing its policy on this subject, whether  that comes through a post on its website or an internal directive. It’s important to stay up-to-date on the  DEA’s latest position on CBD.

Finally, monitor state law. This is probably the hardest to accomplish  since there are 50 states who each  may  treat CBD  differently. Still, if you  are doing  business in  a state, it’s on you to  know the rules.

CBD law is incredibly complex and this list only scratches the surface as to what you need to look out for. If you have additional questions, give our firm a call to see how we can help your CBD business thrive.

Investors are savvy. Make sure you know your terms!

Equity financing has only recently become a viable option for companies in the cannabis industry. As a result, many industry entrepreneurs are unfamiliar with equity financing terms. Also, many entrepreneurs (in many industries) don’t dig deeply into terms they don’t understand, which is a dangerous game. For example, trying to read the National Venture Capital Association Model Term Sheet–all 16 pages of it–is not helpful for someone starting from scratch, because the document assumes knowledge of its terms, and no matter how many times you read “liquidation preference” on a term sheet, the meaning will not become clear.

Asking your attorney to walk you through the terms you don’t fully understand can be helpful, particularly so she doesn’t assume that you understand things that you don’t, and which are about to affect your pocketbook. It’s also a great way to vet your attorneys’ understanding of the terms. However, reviewing with your attorney is unlikely to be a comprehensive education; or, if it is, will be an unnecessarily expensive education.

In the end, the undeniable truth is: If you’re an entrepreneur who is serious about raising funds through an equity financing, then you owe it to yourself, your company, your investors and shareholders, to educate yourself. In business, “depending on the kindness of strangers” is not a viable strategy. If Tennessee Williams wrote “A Startup Named Desire”, it would certainly be a tragedy. There are many resources for your self-education, but top of my list for recommended reading is “Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist” by Brad Feld and Jason Mendelson.)

Until you complete your education, below is a primer on five equity financing terms that you must understand before you ever sit down with an investor to write a term sheet. I’ve gone with top five because these are the terms that are most critical, most likely to be negotiated, and the ones you need to understand to get the core of the financing right for your business. Of course, this list is by no means exhaustive.

1 – Valuation

Valuation is always the most critical term of an equity financing: it’s how much of the company you are selling, in exchange for how many dollars. Valuations are straightforward with the exception of two aspects that perplex entrepreneurs:

  1. There is no one-size-fits-all science to the process of arriving at a valuation. It is a negotiation between the company and the investor. There are models, there are metrics, there are comps, there are hopes, dreams, and business plans, but ten investors could look at a company and arrive at ten different numbers. Cannabis business valuations are especially unique, as we have covered here and here.
  2. Valuations are expressed as the value of the company before the investment round (the “pre-money valuation”) and the amount it will be worth after the investment round is completed, accounting for the “new money” the company has received (the “post-money valuation”). The confusing aspect of this is that this can be expressed in any order, and not necessarily using “pre-money” and “post-money” (which are almost always shortened to “pre-” and “post-” because syllables = time = money, right?). Often the expression will be stated as a total dollar figure based on pre-money valuation (“I’ll put in two million, based on eight pre-“), or as a a percentage using the post-money valuation (“I’ll put in two million to own 20% post.”)
  3. And one more, which I get often: Remember that you are not selling a set-in-stone percentage of your company. You are selling shares, a.k.a. stock. An expression of a percentage will determine the number of shares of stock to be sold (which will be newly-issued “Preferred Stock”) and the purchase price of the shares, based on the number of shares currently outstanding. But you don’t get to 100% and run out of equity–more shares will be issued in the next financing, the number of shares will increase over time, and percentages will change. Expanding the size of the pie is the focus, rather than the size of each slice.

2 – Liquidation Preference

A liquidation preference is an investor right that is triggered when the company is sold, merged, or otherwise liquidated, and it allows the investors, who are holding preferred stock, to be paid (and sometimes paid multiple times over) for their stock before the common holders receive anything. In theory, this can result in preferred stock getting a large portion of a sale, or even theoretically all of the sale (although the company is unlikely to pursue such an acquisition, if the price was only sufficient to cover the preferred shareholders’ liquidation preference). A liquidation preference may seem unfair if you equate the sweat equity of the founders and employees who built the company with the investors’ dollars that funded it. But, the liquidation preference is central to why VCs invest: Any acquisition, even a modest one, will be favorable for the investor, and offset all of the other, inevitable company failures in the investor’s portfolio. Company founders are unlikely to remove a liquidation preference entirely, but should be able to keep it at 1x or 2x at most. Liquidation preferences of 2.5x or greater are only appropriate in the riskiest, moonshot-style deals.

3 – Participating Preferred  

Participating Preferred is another “pot” sweetener for the investor that is triggered upon a sale (must ensure that rate of return doesn’t disappoint the fund’s limited partners!). Again, it involves the preferred stock being paid on more favorable terms than common stockholders receive. Here the participating preferred gets to first receive a liquidation preference, and then receive a share of the sale proceeds as if its preferred shares had been converted to common stock. Even an investor would admit this is a “double dip”, and companies are wise to push investors to choose the liquidation preference over participating preferred rights (but not both), or at the very least introduce a “cap” whereby an investor can either use their participation rights to receive a set multiple of their original investment (say, 3x). Or, if it’s a better outcome, they can choose to convert to common and share in the proceeds of the sale. If it’s a home run they’ll choose the latter, but even a home run gets you one trip around the bases, not two.

4 – Anti-Dilution Protections

There are a number of types of anti-dilution protections, which fall broadly into categories of structural anti-dilution protection, right of first refusal or preemptive rights, price-based protection, and full ratchet anti-dilution protection. They all boil down to protecting investors in the event later financings result in the sale of cheaper equity, a.k.a. a “downround.” Luckily term sheets usually deal with anti-dilution protections summarily, and at the term sheet level the big takeaway would be that “Customary NVCA broad-based weighted average anti-dilution protection” is generally considered fair (whereas “full-ratchet anti-dilution protection” is not). In theory, full ratchet would seem fair to the investors who invested in a higher-priced earlier round, giving them the equivalent deal as later investors. In practice, however, the presence of full ratchet is likely to scare away subsequent investors, or force a workaround, meaning hybrid equity and debt financing to prevent triggering full-ratchet.

5 – Voting Rights (and Board Seats!)

That a Series A lead investor will receive a board seat is a given, but custom voting rights giving the Series A Board Member the right to veto day-to-day transactions, employee hires, etc., shows mistrust in the company’s leadership and existing board. I always push back on voting rights that misalign interests or shift power dynamics between the company and investor, or on the Board.

Also to look out for: Protective Provisions and “Matters Requiring Preferred Shareholder Approval.” I’m increasingly seeing investors–in cannabis businesses and elsewhere–seek the right to veto any transaction of total value exceeding X dollars, which I’m seeing as low as $50,000. This threshold for investor involvement is low enough to capture employee hires, purchase of equipment, and standard business partnerships. Wrangling shareholder signatures is not how company leadership should be spending their time, or holding up deals. At most, companies should agree to a higher dollar threshold or types of transactions, and board approval.

Why the First Terms Matter the Most

If you’re raising your first round (likely a Series A) it’s important to note that the rights you grant to investors now will form the basis for all subsequent rounds. This means that the Series B investors will seek equivalent rights as the Series A investors, and so on. If offered only inferior rights, they may seek a discount on valuation to compensate for this imbalance. All in all, if you’re considering equity financing to fuel the growth of your business, then the time to learn the terms is now–before you meet with investors and before you put together your first Series A term sheet. You certainly should not be “learning on the fly” over the course of your Series A round. Your investors will know the terms they want, and you should understand how the terms work and what will work for you.

marijuana cannabis employment
Treat employees the same, regardless of age.

We have recently been exploring employment laws that only kick in once your cannabis company employs a certain number of employees. In the first part of this series, we discussed California’s sexual harassment policy requirements and last week we discussed federal and state leave requirements. This week we will look at age discrimination laws.

Federal ADEA

Federal and state age discrimination laws vary greatly, so it is important to know both the federal requirements and the state requirements. Both will apply to your cannabis business. The Federal Age Discrimination in Employment Act (ADEA) only applies to employers who employ at least 20 employees. The ADEA only protects employees over the age of 40. Under the ADEA, employers are prohibited from discriminating against employees in any aspect of employment, including hiring, firing, pay, job assignments, promotions, layoff, training, benefits, and any other term or condition of employment.

Employment claims under the ADEA typically arise when younger employees are frequently promoted over older employees or when an employee is terminated and replaced by a younger person for the same position. So if your cannabis business has at least 20 employees and some of those employees are over the age of 40, be careful!

State Age Discrimination Laws

Oregon

Oregon’s anti-discrimination statute is one of the broadest in the countries. Unlike the federal ADEA, the Oregon statute applies to any employer who employs at least one person. Further, the Oregon statute protects all employees 18 and over. Like the federal ADEA, the Oregon act prohibits employers from taking adverse employment actions against employees based on their age. Employers are allowed to set bona fide occupational qualifications necessary for the normal operation of the employer’s business. An example of a lawful bona fide occupational qualification would be cannabis companies refusing to hire anyone under 21.

As previously discussed, Oregon recently passed equal pay legislation. The equal pay legislation extends to pay discrepancies based on age. Employees performing substantially similar work must be paid the same, regardless of their age, unless one of the exceptions described in the act is met. Age is likely to play a big role in the equal pay legislation since older employees likely have more experience and earn more than new hires in the same position.

Washington

Washington’s anti-discrimination statute has similar parameters to the federal ADEA. The Washington statute applies only to employers with at least eight employees and prohibits discrimination against employees aged 40 and over. Like the ADEA, all employers, including cannabis employers, are prohibiting from taking an adverse employment action against an employee because of that employees age.

California

California prohibits employers with at least five employees from discriminating against employees aged 40 and over. Like the other states, employers are prohibited from discriminating against employees in any aspect of employment, including, hiring, firing, pay, job assignments, promotions, layoff, training, benefits, and any other term or condition of employment.

Age discrimination lawsuits can come with hefty awards. It is important to know the local and federal statutes and even more important to include an anti-age discrimination statement if your employee handbook. Best bets are to review pay practices, hiring, promoting, and termination practices to ensure you are complying with both federal and state requirements. Often times an outside expert can provide a neutral analysis of your practices and how to improve in weak areas.

marijuana banking fraud california
“Offshore cannabis bank.”

Of the many issues that prevent cannabis businesses from acting like regular businesses, lack of access to banking is probably the most hindering. Since commercial cannabis activity remains a federal crime, the federal Bank Secrecy Act prohibits financial institutions from accepting cannabis-generated dollars. Most cannabis businesses therefore must operate on an all-cash basis. This makes them targets for actual criminals and helps further the need for access to a bank account.

This lack of bank access in turn creates desperation, which hucksters and fraudsters then prey upon. This post is dedicated to helping cannabis stakeholders avoid those who blow smoke about “marijuana banking.”

Because marijuana is still a Schedule I controlled substance, proceeds from cannabis sales trigger anti-money laundering laws for banks. The Bank Secrecy Act requires banks combat fraud and money laundering and protect against criminal and terrorist activity. Certain banking laws require that national banks and credit unions file Suspicious Activity Reports (“SARs”) with the Financial Crimes Enforcement Network (“FinCEN”), when the financial institution knows or suspects an account holder is engaged in or trying to cover up illegal activity. Consequently, banks routinely deny or shut down cannabis business bank accounts (and cannabis-based financing) even in cannabis-friendly states.

In 2014, new FinCEN guidelines for cannabis banking provided that financial institutions could provide services to state-legal marijuana businesses without running afoul of federal regulations so long as they do the following:

  • Verify with state authorities that the business is duly licensed and registered.
  • Review the state license application and related documentation the cannabis business used to obtain its state license to operate its marijuana-related business.
  • Request from the state licensing and enforcement authorities available information about the cannabis business and related parties.
  • Develop an understanding of the normal and expected activity for the cannabis business, including the types of products to be sold and the types of customers to be served.
  • Monitor publicly available sources for adverse information about the cannabis business and related parties.
  • Periodically refresh information obtained as part of customer due diligence using methods and timetables commensurate with the risk.

These guidelines are still in place, despite Attorney General Jeff Sessions’s rescinding of the 2013 Cole Memo, and the Department of Justice’s Guidance Regarding Marijuana Related Financial Crimes. Banks acting under the FinCEN guidelines must file SARs for all their marijuana businesses customers. There are no direct consequences arising from these SAR filings, but this means that the federal government knows exactly who is involved in the marijuana indusry and with whom they’re banking.

The FinCEN guidelines demand transparency and strict due diligence of cannabis customers. Because of this, in states like California that are just coming online with a regulated cannabis regime, there are a host of fraudsters who claim to have access to “marijuana banking,” when all they are really doing is opening bank accounts with shell companies and/or obscure offshore entities and then running cannabis operators’ money through those accounts. This clearly violates the FinCEN guidelines and it puts both the financial institution and the cannabis company at great risk. My firm’s California cannabis lawyers are seeing a lot of this in California, to the point that many cannabis companies are convinced that what they are doing is legal.

What are the specific red flags to look for if you’re being pitched on a “solution to the marijuana banking problem”?

  1. A refusal or inability to disclose the actual financial institution is the biggest red flag. There’s no reason why the financial institution that will hold your cannabis funds cannot be disclosed to you by the person pitching you. And any third party that’s telling you otherwise is probably illegitimate and not planning to operate in line with the FinCEN guidelines.
  2. If the third party does not discuss the FinCEN guidelines or the level of reporting you will need to do with your financial institution or the level of due diligence with which the financial institution will put you through, you are almost certainly dealing with a hack.
  3. Huge fees to third parties that are unrelated to opening a legitimate bank account. The third party will tell you that you need to pay them a large premium for them to get you a coveted bank account, but there is rarely any reason why this should be the case.
  4. Running money through various accounts and third parties that are supposed to be acting as wardens of your cannabis money without direct verification of a vendor relationship with the ultimate financial institution. The FinCEN guidelines don’t bar a bank or credit union from using third parties to provide account marketing or due diligence support, but full transparency between banks and cannabis customers is mandatory.
  5. Out-of-state bank accounts require significant caution. For banks and credit unions to comply with Fin-CEN, they need to have a due diligence system that is tailored to each specific state. Cannabis businesses need to verify not only that a bank is willing to take cannabis customers but also that the bank has the due diligence and cash handling resources to take customers in the specific state.

At least twice a week, one of my firm’s cannabis business lawyers will get contacted by an ancillary company trying to pitch us on referring our clients to them for “marijuana banking services,” claiming they’ve cracked the code on marijuana banking. We routinely ignore these solicitations and all cannabis stakeholders should do the same.

What then should you do to properly secure a legitimate cannabis bank account? I’ll cover that in my next post.

Editor’s Note:  A version of this post originally appeared in an Above the Law column, also by Hilary Bricken.

Your cannabis business should have a team of professionals and advisors on which you can rely. Our cannabis business lawyers are often asked to recommend accountants who work with cannabis businesses. Like choosing a good attorney, choosing a good accountant is essential to the success of your cannabis business. The right accountant can be a huge asset to your business.

Many cannabis investors own other businesses and may already have an accountant they trust. But because the laws governing the accounting profession do not offer much protection to Certified Public Accountants’ (“CPA”) working in the cannabis industry,  some skilled CPAs choose not to work with cannabis businesses, while others simply do not want to spend the time required to develop the expertise related to cannabis business accounting.

Therefore, when evaluating whether an accountant is a good fit you should ensure the accountant has a strong grasp of IRC 280E and cannabis accounting, all while keeping in mind the following three things.

cannabis marijuana accountant CPA

Understand the Types of Accounting Professionals

It is helpful to understand the core skills of the CPA, the bookkeeper and the Enrolled Agent.

A CPA is a Certified Public Accountant. To qualify as a CPA one must take a certain number of accounting related courses, pass a rigorous examination and be licensed in at least one state. Only a CPA may audit, review and give an opinion on a business’s financial statements. The CPA gives assurances (i.e., “certifies”) that financial statements may be relied upon by third parties such as a bank or a potential investor.

The role of the bookkeeper is to review all of a business’s transactions and assemble this information into useful financial information. Bookkeepers also sometimes prepare state tax returns and other government filings.

Another category of accounting professional is the Enrolled Agent (“EA”). The EA may prepare tax returns and otherwise represent clients before the Internal Revenue Service. To qualify as an EA, a person must pass a comprehensive IRS exam or have experience working for the IRS.

Look for Honesty and Diligence and More

This is the baseline for evaluating all professionals. Though it seems obvious, some accountants in the cannabis industry fall short and the below are some red flags:

  • Your accountant does not respond to you. Skilled accountants are busy and need to balance their work so all their clients are treated fairly. It may take a skilled accountant longer to complete a project than you wish. However, an accountant that does not call you back or keep you informed simply cannot help your business.
  • Your accountant takes shortcuts. This is often marketed as “creativity.” The cannabis industry is fast-paced, takes guts and is highly regulated. It is understandable that you would want to move your cannabis business forward as quickly as possible. Though you may find yourself tempted to “fudge” representations to get things done faster, making misleading statements on tax returns or bank applications or even on your own books and records or otherwise omitting key information will only hurt your business and its owners. A skilled accountant protects its clients from these temptations.
  • Your accountant does not understand legal entities. The fundamentals of accounting require reporting financial operations by legal entity, not merely by business group. For example, the same group of investors may own several cannabis dispensaries. If each dispensary operates as a separate legal entity, separate books and records must be kept for each of the legal entities. This is required both for tax reporting purposes and for recording the information necessary to comply with a state’s licensing requirements.

Transactions between commonly owned legal entities should reflect actual business practices and legal agreements and they should be documented with legitimate contracts. It is the legal agreements and business practices that dictate how a transaction is recorded on the books, not the other way around. Recording a transaction as a loan between two legal entities is proper only if supported by a valid loan agreement. Payments between two legal entities for management services must be supported with a management services agreement.

Restructuring legal entities is a function of state law not accounting entries. For example, the merger of two corporations must be reflected in corporate governance documents such as board of director resolutions and filings with the Secretary of State and if such corporate formalities are not followed the merger will not be recognized by state law. Only after the merger is recognized under state law should an accountant record this transaction. Beware of an accountant who records transactions unsupported by legal documentation.

Choose an Accountant with a Strong Professional Network

Skilled professionals know other skilled professionals. A good accountant will look out for your interests and refer you to another professional when appropriate. Accountants can help you with budgeting, minimizing costs, evaluating financial opportunities and complying with tax and financial reporting. However, your accountant should not prepare legal documents or create legal entities. Your accountant also should generally avoid taking a financial interest in your company, underwriting insurance policies, and/or acting as your broker.

A good accountant can help you meet your financial goals. There are many skilled accountants working in the cannabis industry and it is important you find one right for your cannabis business.

Some employment laws are applicable to all businesses, such as minimum wage and hour laws. Other employment laws and regulations only kick in once a business employs a certain number of employees. Last week, we discussed when California’s sexual harassment laws kick in for cannabis employers. Today we will explore the Federal Family Medical Leave Act and its state equivalents.

marijuana employment
50 is the magic number for the FMLA.

Federal Family Medical Leave Act

Although marijuana is a federally controlled substance, cannabis businesses are subject to federal employment laws like any other business. The Family Medical Leave Act (“FMLA”) is one of those laws. The FMLA is a complicated piece of legislation and frequently trips up employers, especially ones without a human resources department.

To determine if FMLA applies, employers need to ask themselves two important questions: 1) Do we have enough employees for FMLA to apply?; and 2) Does FMLA apply to this particular employee?

FMLA only applies to employers who have at least 50 employees in 20 or more work weeks in the current or previous year. If the employer meets this, then FMLA applies as to the employer.

Only eligible employees are entitled to FMLA leave. An eligible employee is an employee who:

  1. Works for a covered employer;
  2. Has worked for the employer for at least 12 months;
  3. Has at least 1,250 hours of service for the employer during the 12-month period immediately preceding the leave; and
  4. Works at a location where the employer has at least 50 employees within 75 miles.

Employees who meet all of those criteria may take up to 12 work weeks of leave in a 12-month period for any of the following reasons:

  • The birth of a child or placement of a child with the employee for adoption or foster care;
  • To care for a spouse, son, daughter, or parent who has a serious health condition;
  • For a serious health condition that makes the employee unable to perform the essential functions of his or her job; or
  • For any qualifying exigency arising out of the fact that a spouse, son, daughter, or parent is a military member on covered active duty or call to covered active duty status.

If an employee is eligible and uses FMLA leave, the employee must be restored to their original job or an equivalent job with equivalent pay, benefits, and other terms and conditions of employment. Like all employers, cannabis employers cannot punish employees for using FMLA leave.

State Family Leave Acts

Many states, including Oregon, Washington, and California, where recreational marijuana has been legalized, have state family leave acts that are substantially similar to the FMLA.

The Oregon Family Leave Act (OFLA) applies to employers with at least 25 or more employees working in the state of Oregon. Oregon employees become eligible for OFLA leave after 180 days of employment if they averaged 25 hours per week during the 180-day period. OFLA allows eligible employees to use OFLA leave for the employees own serious health condition; a family member’s serious health condition; the birth or adoption of a child; the non-serious health condition of a child requiring home care; and bereavement leave for a family member. If an employee qualifies for both FMLA and OFLA leave, the leave runs concurrently, meaning the employee still only gets 12 weeks of protected leave. Employers are not required to pay employees for the leave under either act.

The Washington Family Leave Act (WFLA) mirrors the FMLA. Employers are covered if they employ more than 50 employees in Washington and employees are eligible under the same requirements as FMLA.

The California Family Rights Act (CFRA) allows eligible employees 12 weeks of leave in a 12-month period. CFRA kicks in for employers with at least 20 employees within a 75-mile radius. Similar to FMLA, to be eligible, employees must have worked at least one year and worked at least 1,250 hours for the employer.

Cannabis companies continue to grow and need to be aware of laws like the FMLA and their state equivalent. Cannabis companies should have a leave policy that meets the requirements of the FMLA and the state equivalent in their employee handbook. It’s best to have an expert familiar with the laws draft a leave policy.