BCC california cannabis marijuana
We’ve got a lot of questions for the BCC right now.

Last month, California’s regulatory agencies charged with writing commercial cannabis rules released new modifications to the final rules proposed in July. The Bureau of Cannabis Control’s (BCC) proposed modifications contained some of the most dramatic changes, including what would effectively be an outright ban on intellectual property licensing for cannabis products—something we are still trying to wrap our heads around due to the seismic effect it would have throughout the industry. The comment period is now closed on the proposed modifications, so now we must wait and see what the BCC decides to do with its final rules in the next few weeks. (To see at our law firm’s comments to BCC on this, go here.)

The proposed rule banning IP licensing agreements is the result of the BCC’s attempt to redefine what constitutes “commercial cannabis activity.” Existing California statutes—which allow the BCC to create and modify cannabis rules—already require that “all commercial cannabis activity shall be conducted between licensees.” So, if you are conducting “commercial cannabis activity” you must have a license to do so. But what truly is “commercial cannabis activity,” and where should the state draw the line?

Current state law defines “commercial cannabis activity” as “includ[ing] the cultivation, possession, manufacture, distribution, processing, storing, laboratory testing, packaging, labeling, transportation, delivery or sale of cannabis and cannabis products.” That much makes sense—activities that touch the plant or its products fall squarely within a common sense understanding of what activities should require a license from the state. But under the BCC’s new proposed rules, the following would now also constitute commercial cannabis activity:

  • Procuring or purchasing cannabis goods from a licensed cultivator or licensed manufacturer on behalf of, at the request of, or pursuant to a contract with a non-licensed person;
  • Manufacturing cannabis goods according to the specifications of a non-licensee;
  • Packaging and labeling cannabis goods under a non-licensee’s brand or according to the specifications of a non-licensee; and
  • Distributing cannabis goods for a non-licensee.

Distributing cannabis goods for an unlicensed operator seems straightforward. But for the other additions, such a broad reading of the statute would undoubtedly sweep many activities within this prohibition that in fact have little or nothing to do with actual cannabis activity. For example:

  • Some types of cannabis licensees are not prohibited from conducting certain types of non-cannabis activity (e.g. manufacturing, distributing, and selling cannabis accessories). To prohibit any of those non-cannabis contracts from having any interaction with cannabis contracts would add an unnecessary restraint on trade. Perhaps a non-licensee makes vape batteries and as part of its distribution agreement wants to require its licensed retailer partner to only purchase cannabis oil from a certain licensed manufacturer to preserve its brand integrity. Under the new rules, that would be prohibited.
  • Imagine that same battery manufacturer wanted to require that same manufacturer by contract to produce vape oil to certain specifications, to ensure the device functions as designed. Under the new rules, that would be prohibited.
  • The third point is perhaps the most concerning, as we have already discussed previously and written directly to the BCC. It means that anyone with a brand, whether they already associate it with cannabis products or not, would now be prohibited from selling licensees the right to use that brand on packaging or labels for cannabis goods. This would mean that if you want to have a brand you also have to have a license, which means you also have to be a cannabis operator of some kind. And the entity that holds the license to operate must also own the rights to the brand – holding the intellectual property in a separate entity for liability purposes would not be allowed. Such an arbitrary barrier to the use of intellectual property is an unnecessary restraint on trade.

It’s not clear exactly why the BCC believes these rule modifications are necessary or justified; it only states in its notice of modifications that it had been made aware “that licensees may be engaging in such conduct” as would now be prohibited by the new rules. It’s also unclear whether the BCC will stick with these changes or discard them based on feedback received during the comment period—only time will tell.

federal court cannabis marijuana
Federal courts are finding ways to enforce cannabis contracts nationwide.

We’ve written previously about how courts, especially U.S. District Courts charged with applying and interpreting federal law, are wrestling with inconsistencies between state and federal law when it comes to state-legal cannabis. A little over a year ago, the emerging solution when it comes to enforceability of contracts involving cannabis was to apply the legal principle that “even where contracts concern illegal objects, where it is possible for a court to enforce a contract in a way that does not require illegal conduct, the court is not barred from according such relief.” Mann v. Gullickson (N.D. Cal. 2016). Fast forward to today, almost a year after California’s new cannabis regulations have been percolating into the world’s fifth largest economy, and that permissive, mostly hands-off approach to state cannabis contracts seems to have not only solidified, but appears to have been applied in other states that have recently legalized cannabis.

In an Oregon case, the plaintiff sought to recover economic damages in a personal injury case stemming the future earnings of a cannabis company. The defendant argued that because cannabis is federally illegal, the court cannot award future earnings from what amounts to an illegal business. In denying the defendant’s motion for summary judgment, the court found that “Marijuana’s legal status is unique. It is neither fully legal nor illegal. Because [plaintiff’s] family cannabis business is allegedly legal under Washington law, I conclude that . . . Plaintiff may recover economic damages based on projected profits from that business.” Tarr v. USF Reddaway, Inc. (D. Or. 2018). In so doing, the court also favorably cited a 2017 Oregon federal case holding that an employee of a marijuana testing laboratory could bring a claim under the federal Fair Labor Standards Act despite the federal illegality of marijuana. Id., citing Greenwood v. Green Leaf Lab LLC (D. Or. 2017). Key to both decisions was that in order to grant the requested remedies (allowance of future economic damages for personal injury; allowing a claim to proceed for violation of labor standards), the court did not need to order either party to directly violate the federal controlled substances laws that otherwise prohibit cannabis. Rather, the remedies were ancillary to the fact that the parties happened to be engaged in cannabis business activity.

In Nevada, a state that legalized cannabis in 2016, a plaintiff wanted to enforce certain promissory notes against a cannabis cultivation business. Some terms of the notes required defendants to use the loan money to pay off debtors and purchase certain real estate in Nevada—both things the court found to be lawful objects of a contract. Other terms of the notes, however, required the defendants to use some of the funds as operating capital in their cannabis business, and to grant the plaintiff a right of first refusal to purchase part of defendants’ business, both things the court found to be unenforceable because they would require defendants to violate federal law. The court, citing favorably to the Mann principle, found in favor of the plaintiff and denied the motion to dismiss, and noted that Nevada law allows courts to interpret contracts so as to sever unlawful or unenforceable provisions while retaining and enforcing the lawful parts. Bart Street III, Inc. v. ACC Enterprises, LLC, et al. (D. Nev. 2018). The significance of Bart Street is that the court expanded the use of the Mann decision, which merely dealt with nonpayment of promissory notes, and narrowly interpreted cannabis contracts so as to allow plaintiff to proceed in its suit to enforce the lawful terms, even where other terms clearly violated federal law and the contracts as a whole involved a federally illegal business purpose.

Finally, in a Texas case applying the law of Illinois, a state that recently legalized medicinal cannabis, a plaintiff sought payment for certain promissory notes involving cannabis businesses, similar to the situations in Mann and Bart Street. The defendant raised the defense of illegality of the contracts as justification for not performing. The court, collecting cases from all over the country in support, found that the defense of illegality under federal contract law was more equitable than remedial, and more presumptive than absolute, instead requiring a balancing of factors such as “the avoidance of windfalls or forfeitures, deterrence of illegal conduct, and relative moral culpability.” Ginsburg v. ICC Holdings, LLC (N.D. Tex. 2017). The court also noted the importance of “creating stability in contract relations and preserving reasonable expectations” as counterbalances to the “costs in forgoing the additional deterrence of behavior forbidden by the statute” that renders the contract illegal. The court concluded that the defendant had not met the standard for a motion to dismiss if its sole argument was for illegality of purpose in the contracts. Ginsberg is remarkable in that the court continued the whittling down of federal law as an invalidating presence upon state contracts involving state-legal cannabis activity, and did so in a way that frames the decision as a culmination of established principles of contract law.

It remains to be seen what will become of the absolute federal illegality in cannabis, but in the meantime, federal courts continue to find ways around invalidating contracts simply because they happen to involve cannabis, and sometimes even when they include terms that require parties to violate federal law, so long as those provisions are severable.

Hemp and Hemp-CBD in California is wild right now.

As readers of this blog know, California is on its way to developing robust laws governing the sale (and all other aspects) of cannabis and cannabis products. So, it’s somewhat surprising that California’s laws concerning the sale of industrial hemp and hemp-derived cannabidiol (“hemp-CBD”), to the extent they even exist, are all over the map. And in some cases, selling industrial hemp or hemp-CBD is apparently unlawful, in spite of the fact that it may contain just trace amounts of THC found in California-legal cannabis products and despite the fact that that hemp-CBD is coming from Farm Bill-sanctioned sources.

Our California cannabis lawyers often get asked what the requirements are for selling industrial hemp or hemp-CBD in California. This post tries to explain California’s convoluted regulation of industrial hemp and hemp-CBD.

As a baseline, “Industrial Hemp” is legally defined as parts of the Cannabis sativa L. plant, or derivatives of that plant, containing less than .3% THC. The Medicinal and Adult-Use Cannabis Regulation and Safety Act (“MAUCRSA”) specifically defines “Cannabis” to exclude Industrial Hemp. The Health and Safety Code echoes this sentiment, and also states that the California Department of Food and Agriculture (“DFA”) exclusively regulates industrial hemp.

The Food and Agriculture Code, which the DFA enforces and interprets, includes some provisions regarding industrial hemp—but notably that Code contains nothing concerning its sale. We have been monitoring (here and here) California’s SB-1409, which modifies these parts of the Food and Agriculture Code, but again there are no requirements concerning actual sales (for what it’s worth, you can also read more about the expiration of the federal 2014 Farm Bill here). Even the DFA has recognized that “California law does not currently provide any requirements for the manufacturing, processing, or selling of non-food industrial hemp or hemp products.”

The message here then is that there are no regulations governing the sale of industrial hemp or hemp-derived CBD. There are, however, some other pretty important requirements at the legislative, policy, and even local levels that could affect hemp and hemp-CBD businesses across the state:

  • Legislation: California recently passed legislation banning licensed cannabis or alcoholic beverage companies from selling alcoholic beverages that contain cannabis, or cannabinoids derived from industrial hemp. Stay tuned for in-depth coverage of that in another post.
  • Policy: Over the summer, the California Department of Public Health’s Food and Drug Branch (“FDB”) drafted a FAQ taking the position that “the use of industrial hemp as the source of CBD to be added to food products is prohibited.” We don’t yet know what FDB’s enforcement measures will look like, if anything, but it’s pretty clear what its position is on hemp-CBD in food and drinks.
  • Local Level: This is where things get dicey. As anyone familiar with cannabis law knows, every one of the hundreds of cities and counties in California has different laws on cannabis licensing. One common requirement for any business in most municipalities is to have a form of business license—and this may be an area in which local jurisdictions create specific industrial hemp and hemp-CBD requirements. For example, the Department of Cannabis Regulation (“DCR”) within the City of Los Angeles recently published an “attestation” form that hemp business owners must sign under penalty of perjury, certifying that their hemp-CBD or industrial hemp products meet the definitions of the Health and Safety Code, and that those products are not “cannabis”. This is now apparently a requirement for Los Angeles hemp businesses that wish to obtain local business licenses, and it looks like that’s the only hemp/hemp-CBD “regulation” that the City of Los Angeles currently has on the books.

Overall, the bottom line is that we still lack the critical legal infrastructure for industrial hemp and hemp-CBD in California. We don’t know how the state or localities will enforce the FDB FAQ. We don’t know how the state will regulate hemp-CBD sales. We don’t know how the locals will regulate hemp-CBD businesses, if at all.

So, stay tuned, as we’ll be sure to write about new California hemp and hemp-CBD laws as they come.

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

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

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

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

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

DEA and FDA are in a bit of a tiff over CBD.

Last week, following the highly-anticipated U.S. Food and Drug Administration (“FDA”) approval of Epidiolex, G.W. Pharma’s oral cannabidiol (“CBD”) solution for the treatment of seizure associated with Lennox-Gastraut and Dravet syndrome, the Drug Enforcement Administration (“DEA”) issued a Final Order rescheduling FDA-approved drugs containing cannabis-derived CBD with no more than 0.1 percent THC under Schedule V of the Controlled Substances Act (“CSA”).

The DEA’s decision to reschedule this very specific formulation of FDA-approved CBD was largely influenced by a joint recommendation made by the U.S. Department of Health and Human Services (“HHS”) and the FDA earlier this year (“Memo”). However, according to a letter released last week by HHS Assistant Secretary Brett Giroir (“Letter”), the FDA concluded that CBD and its salts “could be removed from control” because:

  • “There is little indication that CBD has abuse potential or presents a significant risk to the public health”;
  • “No evidence for a classic drug withdrawal syndrome for CBD, and no evidence that CBD causes physical or psychic dependence”;
  • “CBD does not appear to have abuse potential under the CSA”;
  • “There is no signal for the development of substance use disorder in individuals consuming CBD-containing products”; and
  • “It is unlikely that CBD would act as an immediate precursor to THC for abuse purposes.”

Upon sharing its conclusion with the DEA, the FDA was advised that removing CBD from the CSA would violate international drug treaties to which the United States is a signatory. Specifically, the DEA explained that the United States would “not be able to keep obligations under the 1961 Single Convention on Narcotic Drugs if CBD were decontrolled under the CSA”. Consequently, the FDA revised its recommendation and advised the DEA to place CBD in Schedule V—which applies to drugs with demonstrated medical value and deemed unlikely to cause harm, abuse, or addiction—instead. Nonetheless, the FDA declared that “[i]f treaty obligations do not require control of CBD, or the international controls on CBD…are removed at some future time, the above recommendation for Schedule V under the CSA would need to be revisited promptly.”

As we previously discussed, the World Health Organization (“WHO”) Expert Committee on Drug Dependence submitted a recommendation in July to the United Nations Commission on Narcotic Drugs (“CND”) that “preparations considered to be pure CBD” should not be scheduled under any international drug treaty. The CND is scheduled to consider this recommendation at its annual meeting in March 2019. Yet, even if the CND were to deschedule CBD, the DEA would be free to ignore the FDA’s recommendation (i.e., scientific advice) and continue resisting a broader rescheduling of CBD. After all, the United States is currently disregarding the scientific data supporting the therapeutic value of CBD and refusing to join the global medical community, which favors its use and descheduling. That being said, if CBD were to be descheduled at the global level, the United States, specifically the DEA (i.e., Jeff Session’s Department of Justice), would no longer be able to hide its personal biases behind international treaties.

We will continue to monitor these actions and provide any domestic or international updates. In the mean time, feel free to contact us with any questions you might have on CBD-related issues.

foreign investment california cannabis
Coming soon to California cannabis?

In addition to our California cannabis business attorneys’ work on corporate, finance, and transactional issues with marijuana-related businesses, we also work with our firm’s foreign direct investment group. As California has implemented MAUCRSA since January 1 of this year, we have been getting tons of interest and questions in and about foreign investment into California’s booming cannabis industry. As would be expected, much of this interest is from Israel, Canada, Spain, Turkey, South America, the Netherlands, the UK and Germany. These investors are interested in California because of the size of the market, but also because California has no residency or citizenship requirement to invest in cannabis businesses.

In general, foreign direct investment (FDI) refers to any type of cross-border transaction where a company or investor from Country A invests money in a company located in Country B. It generally doesn’t refer to dumping money broadly into stocks and bonds — it is specifically about a concentrated, single-enterprise investment.

FDI exists in several forms. Foreign investors can start a new company and can finance and build it from the ground up. They can participate in a joint venture with U.S. partners. They can wholly or partially acquire a U.S. business. They can also take a lighter touch, where they provide primarily branding and process support while having U.S. parties take on the bulk of the financial risk — the basic franchise model.

In the marijuana industry, we have already seen large FDI projects in cannabis ancillary services (i.e., the companies that provide the goods and services that support the actual marijuana traffickers). Foreign investors have opened up domestic companies for the manufacture and import of cultivation equipment like grow lights and hydroponic equipment, processing equipment like automated trimmers and extraction machines, and associated inputs including soil, fertilizer, vapor pen batteries and cartridges, and more. We have also seen large amounts of foreign money come in for cannabis real estate projects, especially in the Coachella Valley and certain desert cities. In addition to buying the real estate, the foreign investors put money into greenhouses, grow lights, storage facilities, and more to offer turnkey cultivation and processing facilities for lease to local businesses. These companies are largely unregulated at the state level, and their foreign investment issues are similar to non-cannabis businesses, dealing with things like registering as U.S. taxpayers for partnership taxed businesses, complying with FIRPTA, and dealing with immigration issues.

For firms directly involved in the buying and selling of cannabis, state-specific restrictions become more of a concern. States like Washington do not allow anyone who is not a state resident (much less not a U.S. resident) from having any profit interest in a marijuana business. California, similar to Oregon, is extremely liberal with its cannabis regulations regarding owners and “financial interest holders.” As mentioned above, there is no residency or even citizenship requirement to participate. Still, on the whole, state regulations and state laws are typically written with U.S. residents in mind. In turn, things like criminal and financial background checks on foreigners remain a bit of a gray area (though California’s Department of Public Health, which oversees manufacturers, has accommodated the situation somewhat with an “out of state owner” background check). Ultimately though, neither state officials nor the FBI are likely to have any real information on foreign nationals who haven’t had prior contact with the United States. How the Feds will react to foreign ownership in terms of the Department of Justice (rather than via immigration through the Department of Homeland Security) still remains to be seen, though nothing’s been publicly reported that’s a red flag against foreign marijuana business ownership in California.  

As far as federal laws go, the Controlled Substances Act doesn’t differentiate between activities that are international, interstate, or fully intrastate in nature. Possessing, manufacturing, and distributing marijuana are illegal federally regardless of where the company’s owners live. Still, there are a couple of criminal statutes that add fuel to the fire when interstate and international commerce are involved. 18 U.S.C. § 1952, for example, criminalizes traveling or using the mail in interstate or foreign commerce with intent to distribute the proceeds of marijuana sales.

More questions arise when considering foreign ownership in the context of the Department of Justice marijuana enforcement memoranda that cannabis-legal states are working under. The main takeaway from the August 2013 Cole Memorandum (which has been rescinded by U.S. Attorney General Jeff Sessions) was that if the states want to keep federal law enforcement away, they need to make sure their regulations prevent state licensees from violating the various federal enforcement priorities. One of those priorities was that state regulations need to prevent “revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels.” If the state and federal criminal background check databases don’t have extensive coverage on foreign crimes, how can a state, including California, have faith that the foreign investors don’t fall into one of those categories?

For now, with no broad pronouncements apparent, it appears that the federal government is taking a wait-and-see approach to foreign ownership of state cannabis businesses. That means it is up to state cannabis business participants and the states themselves to ensure that foreign owners do not violate federal enforcement priorities — starting with California.

california cannabis data privacy
California is taking steps to safeguard canna consumers.

Yesterday, California Governor Jerry Brown signed a new piece of privacy legislation—AB-2402—which places restrictions on how licensed cannabis companies in California share information about their customers.

AB-2402 is significant in that it prevents licensed cannabis businesses from sharing expansive categories of customers’ personal information with third parties—except in limited circumstances in connection with payments, or where a customer has consented to sharing his or her data with a third party. Notably, AB-2402 prohibits licensed cannabis businesses from discriminating against or refusing service to consumers who do not consent to disclosure of their personal information to third parties.

So what kinds of personal information is AB-2402 designed to protect? The bill incorporates the definition of “personal information” from existing California law, which definition includes a person’s first name or initial and last name in combination with a (1) Social Security number, (2) driver’s license number, (3) financial account number in combination with a security or access code, (4) medical information, or (5) health information. “Personal information” can also include a username or email address in combination with a password, or with a security question and answer that would permit access to an online account.

AB-2402 is also significant in that it expands the legal definition of “medical information” in the cannabis context to include medical marijuana identification cards, which also cannot be disclosed except as noted above (and also to certain government officials if necessary to perform certain official duties). In fact, AB-2402 goes so far as to deem licensed cannabis businesses that receive medical marijuana identification cards to be providers of health care—but only for purposes of the Confidentiality of Medical Information Act—which could subject businesses to penalties for improper use or disclosure of information.

The law is welcomed by many privacy advocates, including the Electronic Frontier Foundation, which cited surveys by Politifact which had found that a number of cannabis dispensaries kept broad categories of customer information. It is understandable why privacy advocates support stronger consumer rights in the cannabis industry. Cannabis is, after all, still illegal at the federal level, and so it is not difficult to imagine why customers would want their information to be kept under lock and key.

At the same time, compliance with this new privacy law may appear difficult to cannabis companies. That said, the law is not a totally new concept—California already requires companies (and not just cannabis companies) to provide notification to affected individuals in the event that similar information is acquired by a third party without authorization. AB-2404 simply modifies and expands existing obligations to encompass almost any kind of third-party information sharing.

Complying with AB-2402 will likely require companies to take stock of and retool their data security and sharing practices, and to retrain employees. This is not an impossible task, but it’s one that companies should place at the top of their agenda. After all, California is the state with (arguably) the most intense focus on protecting citizens’ personal information.

AB-2402 was only just signed, and its text does not identify when it takes effect.  We’ll keep you posted on any updates.

RICO cannabis landlord
RICO suits are not just busting up gangs these days.

The Racketeer Influenced and Corrupt Organizations Act (RICO) is a federal Nixon-era law originally intended to combat drug cartels and organized crime. Among other features, it allows average citizens claiming a loss in property value to bring suit for triple damages plus attorney’s fees against any “person” or “enterprise” that has a part in any neighboring “racketeering activity” which includes—you guessed it—“dealing in a controlled substance.” Currently, federal law continues to classify cannabis as a Schedule I controlled substance—meaning it has no medicinal value, and is supposedly more dangerous than methamphetamine, methadone, hydromorphone, and oxycodone, among other things.

RICO has been read broadly enough by its patrons to include operators, as well as landlords, lenders, and even government licensing agencies and customers, as co-conspirators in licensed cannabis operations, meaning angry neighbors have found their deliverance when it comes to trying to shut down state-legal cannabis businesses. The painful irony of all this is that anyone with an aversion to cannabis in a state where voters democratically decided to legalize it has unique power to be an American Gangbuster because of an almost-half-century-old relic of the federal War on Drugs; yet, meanwhile, companies that would be investing in local communities are looking north to do five-billion-dollar Canadian Blockbusters. The bottom line is that as long as federal law remains unchanged, it does not matter how state voters decide to govern themselves, or even how sensibly the federal government decides to enforce federal laws prohibiting cannabis. RICO provides a private right of action for any would-be provocateurs that can plausibly claim they have been damaged by a neighboring cannabis business.

So how can landlords and tenants approach this issue when designing a cannabis tenancy? The short answer is that RICO will continue to be a real issue for as long as federal law allows it to be, but the parties can take some proactive measures in drafting the lease to mitigate that threat:

Build in an early termination option for third-party lawsuits. Just as the lease can include early termination options for a variety of cannabis-specific occurrences, it can provide an opportunity for one or both parties to address an undismissed third-party lawsuit by terminating the tenancy. This can include RICO actions as well as standard nuisance actions, which often have longer legs than RICO lawsuits. It can also include indemnification obligations if, e.g., the tenant causes the problem by failing to comply with the lease terms, or if the landlord misrepresents neighborhood sentiment (more on that below).

Vet the neighbors. Just as a tenant would analyze the zoning laws applicable to a proposed use, a cannabis tenant should take some time to see what the neighborhood is all about. Does the community support the use? How are the neighboring areas zoned? Is there any kind of history of bad actors in this space that’s left a bad taste? The tenant will have to make sure the site isn’t within any prohibited buffer zones of schools or youth centers as part of its state license application anyway, and what better opportunity to get to know your potential neighbors? Even some casual exploring is better than nothing, and can save loads of trouble down the road. Depending on how the parties negotiate the lease, it can include, e.g., landlord warranties of no known neighbor objections after diligent inquiries, or a term that puts the responsibility on the tenant to figure out how the use would go over in the community.

Tighten up those compliance obligations. Compliance with state and local law is the key to avoiding enforcement actions, and is equally important when it comes to neighbor relations. State regulations contain strict requirements about security protocols, waste management, hours of operation, and product transportation. Local rules will typically dictate things like parking requirements, odor management, and noise. The stronger and more specific the lease is with regard to complying with these various rules, the better chance you will have that the tenant (i) knows them, and (ii) follows them. Simply indemnifying yourself in the lease makes little difference if you end up losing an otherwise good tenant because they were uninformed.

Research the local politics and get to know local law enforcement. California’s cannabis regulatory regime is unique in that local jurisdictions are still king when it comes to who gets to operate and where. And we’ve already seen a repeat of what’s happened in other states that have legalized: jurisdictions sometimes change their minds and declare previously allowed cannabis operations to be non-conforming uses. Having your finger on the community pulse and knowing the level of support for your local cannabis ordinance when it passed is going to put you in a better position to know whether your cannabis tenant or your cannabis operation is more likely to be a welcome neighborhood feature or a walking lawsuit.

For more on California cannabis leasing, check out the following:

washington residency marijuana constitutional
Could definitely be unconstitutional.

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

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

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

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

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

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

california cannabis marijuana development agreement
California municipalities are missing the mark on development agreements.

Development agreements have become a popular tool for California municipalities regulating commercial cannabis activities. We’ve talked a bit about development agreements in the cannabis context here. In a nutshell, a development agreement is a contract between a municipality and developer that freezes applicable rules, regulations, and policies pertaining to a property at the time of execution. Our California cannabis real estate and land use lawyers have come across quite a few of them lately. Unfortunately, many times local jurisdictions are misusing them at the industry’s expense.

Development agreement laws were enacted to provide assurances to developers faced with uncertainty in government approval processes for complex and long-term development projects. A development agreement should provide developers with assurances that the developer will see a return on investment by providing vested rights to engage in a particular use on a property. The rights are locked in so that if local laws change in the future (e.g., the voters or legislative body prohibit a particular use), the uses permitted in the agreement can continue for the remaining term of the agreement.

The scant authority dealing with development agreements focuses on the broad purpose of the statute to provide assurances to developers as soon as project commitments must be made. Santa Margarita Area Residents Together v. San Luis Obispo County (2000) 84 Cal.App.4th 221, 230.

Development agreements allow municipalities to impose fees without having to deal with the uncertainty and expense of putting the matter before voters (as required with the imposition of a tax), and to negotiate community benefits and public improvements to be provided by developers. They also put municipalities in privity of contract with developers, providing an additional degree of control and remedies for each party that would not otherwise exist.

In the context of cannabis, we are seeing a perversion of the intent of California’s development agreement statutes. Many municipalities require development agreements for commercial cannabis activity regardless of whether there is actual land development involved. The terms are incredibly short (often only 1 to 5 years), the fees are substantial, and developers are not expressly provided with vested rights to operate. In other words, most of the cannabis-related development agreements fail to provide developers with assurances that they will see a return on their investment.

Further, the vast majority of municipalities do not allow any negotiation of commercial cannabis development agreements, which calls into question the validity of any associated fees. After all, the justification for exempting development agreements from the constitutional and statutory requirements applicable to municipal fees and taxes is that the terms are bargained for between the parties.

Stay tuned for the next two parts of this series on demystifying development agreements. In part two, I’ll break down the basics of development agreement laws, and what they mean for the marijuana industry. In part three, I’ll cover some key terms to fight for in development agreement negotiations related to California cannabis use.