california bcc cannabis rules
Huge changes ahead. Get your comments in by Nov. 5!

Last Friday, we wrote about the amended proposed permanent cannabis regulations that are now in a 15-day notice-and-comment period for each California agency—the Bureau of Cannabis Control (“BCC”), Department of Public Health (“DPH”), and Department of Food and Agriculture (“DFA”). Each of the proposed rules can be found here, here, and here. The next round of written public comments is due to each agency by November 5, 2018. It’s important then for California cannabis businesses to get a handle on the proposed regulations as quickly as possible to determine whether to provide written comments since some impactful changes are coming.

Here are the key proposed changes from the BCC regulations:

Intellectual Property Licenses: Yesterday, we explained the threat that the BCC’s regulations pose to cannabis intellectual property licensing in California. Our California cannabis lawyers are regularly involved in intellectual property licensing deals and we think it’s critical for cannabis businesses to speak up in opposition to this proposed rule. California would be the only state in the cannabis union to bar third-party IP-licensing deals for cannabis licensees, which will certainly undercut the business growth of a good amount of operators if this rule passes.

“Owners”: The BCC modified the definition of “owner” (as well as “financial interest holder”; see below), which now includes “[a]n individual entitled to a share of at least 20 percent of the profits of the commercial cannabis business.” This is much broader than the existing 20 percent aggregate ownership threshold (which also still stands). To illustrate, the current ownership threshold definition expressly states that it does not apply where that interest holder holds “solely a security, lien, or encumbrance.” This new addition to the rules seems to capture a mere security holder—so long as that security holder is entitled to 20 percent of the profits.

The BCC also expanded upon the form of “ownership” that requires disclosure based on assumption of responsibility for the license, by specifying certain kinds of persons or entities who qualify (note that this list is not exhaustive or complete, so it likely will be read even more broadly), as:

  • Persons who manage or direct the licensed business in exchange for a portion of the profits. Note, there is no minimum threshold for profit entitlements here, so this could include persons who expect less than 20 percent of the profits.
  • Persons who assume responsibility for the licensed business’ debts. Here too, there is no threshold for debt assumption.
  • Persons who determine how “a portion” of the licensed business is run. This includes things such as “non-plant-touching portions of the commercial cannabis business such as branding or marketing”, but it too could include much more broad categories of business operations.
  • Persons who determine what cannabis goods will be cultivated, manufactured, distributed, purchased, or sold.

Notably too, these modifications now take the position that if an “owner” is an entity, all entities and individuals with a financial interest in that entity must be disclosed to the BCC and may be considered owners of the commercial cannabis business. The BCC emphasized that each entity and person in the corporate chain must be disclosed until the applicant can identify actual persons.

The takeaway from these changes is that the BCC now wants full identification of any person who has anything to do with an applicant entity—even if that person simply owns a company multiple steps away in a corporate chain. That is not dissimilar to what our cannabis business lawyers have seen in Oregon and Washington.

“Financial Interest Holder”: Like before, the BCC considers a financial interest to include an agreement to receive a portion of the profits of a licensed entity. Now, however, the BCC gives a number of examples of what qualifies as such an agreement:

  • An employee who enters into a profit-share plan with a licensee.
  • A landlord who enters into a lease agreement with a licensee for a share of the profits.
  • A consultant who provides services to a licensee for a share of the profits.
  • A person who acts as an agent, such as an accountant or attorney, for the licensee for a share of the profits.
  • A broker who engages in activities for the licensee for a share of the profits.
  • A salesperson who earns a commission.

The BCC will now also require the identification of all persons in the corporate hierarchy for interest holders, similar to the rules regarding owners. Meaning, if a financial interest holder is an entity, everyone in that entity is getting disclosed .

Annual License Fees: The BCC scrapped its previous test for determining the amount of appropriate fees for the annual licenses—estimating the maximum dollar value of planned operations—and now has created a new formula: “To determine the appropriate license fee due, the applicant or licensee shall first estimate the gross revenue for the 12-month license period of the license.”

Changes in Ownership: The BCC is also expanding its prohibition on changes of ownership over a licensed entity. If any new person is added as an “owner” by virtue of a change in ownership of a licensed entity, that person will need to provide the vast categories of information required by section 5002(c)(20) within 14 calendar days of the transfer. This will obviously have an impact on California cannabis M&A. The business can still operate pending the change so long as one previous owner remains on; otherwise, operations will need to cease pending the BCC’s review of the new owner. The BCC is also now requiring 14 calendar days’ notification of changes in any of the following:

  • Any changes to the contact information that was provided to the BCC in the original application;
  • Any change in legal name, business name, trade name, or fictitious business name of the licensee;
  • Any change to financial information, including funds, loans, investments, and gifts required in the original application;
  • Any change in the required bond; or
  • Any change or lapse in a distributor’s insurance coverage.

Annual License Applications and Requirements: As to annual licenses, the BCC made tweaks to the information that it will require for submission, which signals its desire to place more scrutiny on applicants and ensure compliance with California law. We won’t explain every change here, but here are the essential ones:

  • First, the BCC changed the requirement to provide it with “The business-formation documents” for the licenses business to “All business-formation documents”.
  • Second, the BCC is requiring that applicants provide it with state employeridentification numbers (“SEIN”), which the BCC explains in its notice of modification as being “necessary to ensure that all applicants that are required to obtain such a number have obtained it and are thus, in compliance with California law.”
  • Finally, licensees with more than one employee must attest that within one year of receiving their license, the licensee will have employees who have undergone certain Cal-OSHA safety training.

The BCC is also beefing up its requirements for renewal of licenses to require documentation of any change to any item listed in the original application. So, chances are that if a cannabis business obtains an annual license before these proposed changes become effective (and assuming they do), that business will need to provide these additional disclosures later.

Premises: There are a number of modifications to the proposed rules concerning licensed premises, but here are the highlights:

  • While it’s been routine for multiple licensees to operate on the same premises, the proposed modifications now expressly state that they do not “prohibit two or more licensed premises from occupying separate portions of the same parcel of land or sharing common use areas, such as a bathroom, breakroom, hallway, or building entrance.”
  • The premises must consist of permanent structures—shipping containers, modular buildings, or anything on wheels are a no-go—that are affixed to the ground and not capable of movement.
  • There is now a form (BCC-LIC-027) to submit to the BCC to request to make a physical change or alteration to the premises.

Marketing and Promotions: Licensees will be prohibited from selling or transporting goods that are identified as any kind of alcoholic product (and they cannot refer to anything as containing or being an alcoholic product). There are also now definitions for promotional goods and branded goods. If licensees want to sell branded goods that are not listed in the definition, they will need to seek BCC approval first. The proposed modifications also clarify that licensees can provide customers with promotional non-cannabis goods—and it looks like these goods could be provided at the premises or via delivery, too.

Packaging: The proposed modifications set up a time tier for cannabis packaging, whereby until January 1, 2020, cannabis packaging needs to be tamper-evident, in some cases re-sealable, and must not look like packaging that is marketed to children. Until January 1, 2020, retailers and microbusinesses can satisfy this rule by providing opaque exit packaging that meets the foregoing standards.

Testing and Quality Assurance: The proposed regulations include prohibitions on re-sampling previously tested batches, new requirements for remediation plans for failed batches, and new requirements for quality assurance testing for the level of THC, CBD, and terpenoids, among other things. If goods have undergone testing and haven’t been sold in 12 months, they now  have to be destroyed.

Retailer Packaging: Similar to the revised distribution rules, the proposed modifications set up a time table that require tamper-evident packaging until January 1, 2020, and re-sealable, tamper evident, and child-resistant packaging thereafter. There are opposite requirements for retailer exit packaging—it must be child-resistant, re-sealable and opaque until 2020, and then just opaque thereafter.

Deliveries: The rules now more heavily regulate a retailer’s use of tech platforms for delivery (i.e., the platform can’t share profits and can’t be the one doing the delivery, presumably unless it too is licensed). Delivery vehicles cannot contain any exterior markings that indicate that they are delivering cannabis goods. Delivery vehicles may now carry only $5,000 in cannabis goods at once. And the biggest change of all, per the modified section 5416(d), deliveries can be made into any jurisdiction in the state, so long as they comply with the BCC’s delivery rules. Currently, localities can and do prohibit deliveries from other jurisdictions. The BCC’s proposed regulations, however, now open the floodgates to previously “dark” delivery jurisdictions.

For the next few days, we’ll be writing on the proposed rules issued by DPH and DFA. We cannot emphasize enough how licensee stakeholders need to speak up and provide public comment for the rules they like and don’t like so that industry can better shape the regulatory playing field. So, get those comments in by November 5!

City cannabis licensing in action.

Recently, the City of Portland announced that it would lower cannabis business licensing fees. Most notably, retail license fees have been reduced from $4,975 to $3,500, in line with other license types. That is still too steep (especially considering the state licensing fees), and although the City has cleaned up its process over the past few years, it’s still redundant, unnecessary and something of a cluster. Like all cities, Portland should stop licensing cannabis businesses.

It’s been over three years since Portland adopted its poorly written Code Chapter 14B.130, which sets forth license procedures and requirements for marijuana businesses. The oppressive fee schedule adopted at that time placed an outsized burden on retailers to cover the cost of administering the Portland Marijuana Policy Program. In the early days, the program was staffed by functionaries at the Office of Neighborhood Involvement (ONI) who shall go unnamed and mostly seemed to follow each other in circles, sometimes passing applicants back and forth with the Bureau of Development Services (BDS). Most of those folks have moved on.

ONI has since been rebranded as the Office of Community & Civic Life (people still call it ONI) and slotted under a different Commissioner. All of this followed from campaign promises made by Portland’s new mayor, who acknowledged that the City’s relationship with marijuana was a mess. For further reading on how bad it got — from credible estimates that local red tape was costing the industry $22 million per month, to disapproving letters penned by Congressional reps — go here, here, here, here, here, here and here. The City’s actions also caused one of my all-time favorite Oregon cannabis rumors: A class action suit would be filed “any day now” by private industry against the City. It’s been a trip.

Three years later, the Marijuana Policy Program is better run, and the lawyers and paralegals in my office get along with everyone there and push licenses through on the regular. But the question remains: What exactly is the point of having a local regulatory program for cannabis businesses? Everything is redundant to what the state is doing, and when it’s not, it’s usually worse. So why do cities think this is a good idea?

Those are complex and provocative discussions, but the motivation by cities may be some combination of the following: 1) licensing cannabis generates revenues; 2) licensing cannabis generates jobs; 3) licensing cannabis is novel; 4) licensing cannabis may appease people who dislike pot businesses; 5) cities may already be licensing alcohol (although to a lesser extent, invariably); 6) other cities are licensing cannabis; and 7) it’s hard for regulators not to regulate things. All in all, it’s a dismal mix.

Unfortunately, there is not much that industry can do when a city decides it wants to license cannabis. In states where legal marijuana markets exist, cities (and counties) have significant leeway in dealing with cannabis businesses. Some cities opt out entirely; others choose to license. Still others take a middle path, charging a variety of fees and taxes to hapless pot businesses but stopping short of licensure. Although fees and taxes are burdensome, those cities tend to avoid the logjams that prevent many businesses from even getting off the ground.

In all, the Portland experience is not unique. Hilary Bricken has been writing on this blog for some time about City of Los Angeles’ convoluted three-phase licensing protocol, for example, and the unintended consequences that come with it. Others have taken a broader survey, chronicling “extortionate” application, permit and license fees from municipalities nationwide. In comparison to some locales, cities like Portland and Los Angeles don’t seem so bad.

It’s also important to remember that cities can do a lot of good for cannabis, if they skip the licensing step and focus on other things. In August, Portland directed $350,000 in funds toward record-clearing and workforce efforts for communities that prohibition has impacted disproportionately. It also dropped another $150,000 to support equitable cannabis initiatives. Both announcements were met with general approval.

Most recently, Portland rolled out a “Social Equity Program”, which modestly reduces licensing fees to qualifying businesses. Before you get too impressed, though, consider: The better move would be dropping the licensing structure altogether.

washington lcb marijuana candy ban

By April 3, 2019, Washington retail marijuana stores will no longer carry infused hard candies, tarts, fruit chews, jellies, and gummies due to a newly enacted ban on the production said products. The announcement came from the Washington State Liquor and Cannabis Board (“LCB”) during a recent meeting. A PowerPoint presentation from the meeting is available here.

The LCB reevaluated its stance on marijuana candies finding that infused candies are “especially appealing to children.” The LCB’s regulations (WAC 314-55-077(7)) prohibit processors from creating products that appeal to children. The LCB claims that its new policy is intended to comply with this provision.

Going forward, the following products are prohibited:

  • Candy – hard candy (of any style, shape or size) and tarts.
  • Fruit chews, jellies and all gummy type products.

The new LCB policy will also impact other products. The following infused products are allowed “with limitation on appearance”:

  • Chocolate
  • Cookies
  • Caramels
  • Mints

What does “limitation on appearance” mean? The LCB provides some examples:

  • Chocolate in its original color and not coated, dipped, sprayed or painted with any type of color.
  • Chocolate in the shape of a bar or ball. No shape or design that is especially appealing to children.
  • Caramel and fruit caramels. No color, shape or design that is especially appealing to children.
  • Cookies that do not contain sprinkles or frosting.
  • Mints that have no color (white or white with small color fleck to represent the flavor only).

Finally, the LCB lists the following “allowable infused products”:

  • Beverages
  • Baked Goods
  • Capsules
  • Chips and Crackers
  • Sauces and Spices
  • Tinctured

Though the LCB has categorized the above products, it still will consider whether any product is especially appealing to children. In making that determination, the LCB examines the appearance, the similarity to products that are marketed towards children, and color. Our Seattle office knows all too well how difficult it can be to determine exactly what the LCB will approve, given these highly subjective criteria.

If you are a Washington marijuana processor, you may have seen this coming. The LCB has been pushing back on many products based on the “especially appealing to children” limitation, signaling that more stringent policies were on the horizon. The LCB now recommends that processors cease all production of hard candy, tarts, fruit chews, colorful chocolates, jellies, and gummies, because they will not be approved. Licensees are allowed to sell their products until inventory is depleted or April 3, 2019, whichever comes first.

This change will have a significant impact on processors that have built brand loyalty by creating suddenly outlawed infused candies. Consumers will also have fewer options. We anticipate that the industry will push back on this ruling, especially because the LCB has claimed that this is to address the public health risk of children accessing infused marijuana candies, but has not provided evidence that kids are, in fact, getting their hands on these products.

The LCB will host a webinar to answer questions on marijuana infused edibles on October 16, 2018. The link will be available on the agency’s website.

OLCC marijuana license employment
Your license transition plan should consider employees.

You’re new to the Oregon cannabis scene and quickly realize you won’t be able to open a newly licensed cannabis retail store due to the Oregon Liquor Control Commissions (OLCC) pause on issuing new licenses that went into effect on June 15. But what about purchasing an existing retail store from a licensee?

It is possible to purchase a retail marijuana business and receive a license from OLCC. However, no money or control of the store can take place until the OLCC vets the new ownership to ensure compliance with the marijuana rules and statute. Typically, the seller and buyer enter into binding agreements to sell the store (technically, an asset or stock purchase) pending approval from the OLCC of the change in ownership. As we recently wrote, the OLCC recently increased scrutiny on these applications and can take up to 3-6 months to approve. During that time, your dreams of owning a retail cannabis store are paused. However, based on our recent discussions with the OLCC, there is a legal way to start the transition to the new owner without violating the rules: through employees.

Employees are a key part of any business. Employees keep the day to day operations of business running smoothly. In a retail store, they are the face of the company. It’s important to select people you trust and will work hard for your company. One way to begin control of the new company is to enter into an agreement with the seller to hire certain employees. There are a lot of things to consider when doing this—so it’s important to do it right.

First, it’s probably best to mention this when you first begin sale negotiations. Let the seller know you’d like to immediately “place” employees of your choice, who will be hired by the seller, prior to OLCC approval of the change in ownership. It’s best to be up front with these things rather than watch your deal fall apart later because you failed to mention your intentions.

If the seller agrees, the seller will need to hire the employees. Remember: You the purchaser cannot have a financial interest or control in the company until the OLCC approves. The employees will either need to be hired on a short term employment agreement to terminate when the sale is finalized, or enter into an employment agreement that will be assignable to the new entity once the sale is finalized. This would be a great time to talk with an Oregon cannabis employment attorney  to ensure everything is done correctly.

You’ll also want to be super clear with the employees about the arrangement. Again, you don’t want your employment relationship with the individuals to fall apart because you weren’t clear that the employee’s boss or employment status will change once the OLCC application is approved.

Assuming all of that goes smoothly, what kind of employees should you hire? For the transition period, its best to hire those that will exhibit decision making powers such as managers and supervisors. Qualified people in higher up positions tend to be more difficult to find. Get them in early and the transition will be even easier.

You might not be able to run the business the way you want during the period the OLCC is reviewing the change in ownership application, but you may be able to instill employees that can start the transition for you.

california cannabis enforcement
Unlicensed cannabis traders, beware.

California has experienced some growing pains as it has continued to roll out its regulated cannabis regime pursuant to the Medicinal and Adult Use Cannabis Regulation and Safety Act (“MAUCRSA”), but despite delays in implementing permanent regulations, the state and many local jurisdictions are not waiting to enforce against unlicensed operators. We first covered this dynamic back in April, and the enforcement trend has only accelerated since then.

As we’ve noted many times before, in order for state legalization to succeed in the long run, regulators will need to take a tough stance against black and “gray” cannabis markets in order to ensure an even playing field for licensed, compliant operators. Other states have already taken action to make sure that unlicensed, unregulated cannabis operators don’t undermine their licensed counterparts, and California is finally beginning what will undoubtedly be a long and extensive endeavor to do the same. Although the Compassionate Use Act will not be repealed until January 9, 2019, there is no protection for cannabis businesses engaged in commercial activity without a local and state license.

And the enforcement in California will come from both state and local authorities. The City of Los Angeles recently launched a massive crackdown on unlicensed, illegal cannabis businesses, filing misdemeanor charges against more than 500 people and shutting down 105 illegal cannabis businesses, including cultivation operations, extraction labs, and delivery companies across the city. In Los Angeles, a charge of unlicensed commercial cannabis activity within the city carries a potential sentence of six months in jail and $1,000 in fines. Los Angeles’ City Attorney Mike Feuer, who has a track record of going after illegal cannabis businesses within the city, summed up the city’s reasoning behind its recent enforcement actions succinctly:

If they’re going to go through this process, it just cannot be the case that others that flout the rules are allowed to function. It’s bad for those who buy from them, it’s bad for the communities in which they’re located and, again, it threatens to undermine the viability of a system that’s predicated on lawful licensing.”

Although there are currently around 165 approved cannabis storefronts and delivery businesses in Los Angeles, there are many more operating without the necessary approvals, a problem that has plagued the city for years and will likely be an ongoing issue.

The state is also commencing its own enforcement actions in conjunction with local authorities, and has sent out several emails in recent weeks to stakeholders with the details of those crackdowns. Enforcement actions are being carried out by the Bureau of Cannabis control (BCC) and the Department of Consumer Affairs’ Division of Investigation – Cannabis Enforcement Unit (DOI-CEU). It appears that many of these actions, including one last month against an unlicensed cannabis home delivery business in Sacramento called The Cannaisseur Club, and another against an unlicensed cannabis retail store in Costa Mesa called Church of Peace and Glory, both resulting in criminal charges, have been initiated based on complaints received by the BCC (complaints related to unlicensed commercial cannabis activity can be filed here, by the way). Based on our experienced in other jurisdictions, we anticipate that the number of complaints filed, especially by licensed and compliant operators, will continue to increase.

As a reminder, all commercial cannabis activity in California requires a license from either the BCC, the Department of Public Health, or the Department of Food and Agriculture. Obtaining these licenses requires local approval. This is only the beginning of extensive enforcement by both state and local authorities, which will be necessary to ensure that California’s regulated cannabis market succeeds, not just in sales, but in eradicating the black market.

california marijuana cannabis licensing
So many questions.

We’re still in the early days of the complete roll out of the Medicinal and Adult-Use Cannabis Regulation and Safety Act (“MAUCRSA”) in California. Currently, the only rules in play are the readopted emergency rules that are still full of ambiguities and unknowns, which will hopefully be addressed in the final permanent rules, which the state will likely release in coming months. We detailed the initial proposed permanent rules from back in July, the public comment period for which concluded at the end of last month. We assume the state is going to take into account a lot of that public comment before it pulls the trigger on adopting any permanent rules, which will likely happen by the end of the year.

While we’re in this interim emergency rules period, there are still a lot of unanswered questions for California cannabis businesses as they try to navigate an emerging, newly regulated industry. And some unknowns keep coming back again and again. I cover the top ones below.

1. Cannabis banking–when, when when. We’re all familiar with the cannabis banking epidemic. As a result of current federal laws, in certain states securing a bank account is nearly impossible (though in some states, banking is readily available because of the 2014 FinCEN guidelines). Unfortunately, California is still one of those “banking no-no” states because we don’t have a robust licensing scheme yet (that will certainly come though as regulators get down to business on permanent rules and enforcement). As a result of a lack of banking, there’s a lot of bad behavior out there, so beware of cannabis banking scams and fraudsters. And don’t count on any form of a public bank saving the day. However, if you’re lucky enough to find a financial institution in California that’s following the FinCEN guidelines, here are some useful tips on how to secure an account.

2.  Provisional licenses. There’s a sinister deadline looming for all temporary licensees. Namely, after December 31, 2018, no more temporary licenses will issue to any cannabis businesses. In addition, if you secure a temporary license on or around December 31 of this year, it will run its 120-day course and the governing state agencies will not renew it after that. To date, the agencies implementing MAUCRSA have renewed temporary licenses for 90-day stints (so long as a licensee is in pursuit of their annual license) to allow licensees to continue to operate once they secure local approval but before they get their full-blown annual license. Temporary licensure is without a doubt a big deal since it’s the only way to legal operate prior to receiving annual licensure, which is taking months at the state level to nail down. The silver lining is that the state legislature is contemplating creating provisional licenses under MAUCRSA to ensure that the industry doesn’t come to a screeching halt after December 31, but that bill is still pending.

3. Local control. Before you can receive a state temporary license, you must first show the state that you have the local approval of your city or county to operate within their borders. Once in pursuit of the state annual license, you can voluntarily provide evidence of your local approval, but the state will follow up with your local government regardless to make sure that you’re in compliance with local laws. The debate over local control and the fact that most California cities and counties ban commercial cannabis activity continues to rage in Sacramento. And the debate will ultimately play out in the permanent MAUCRSA regulations. For example, in the initial proposed permanent rules, state agencies, specifically the Bureau of Cannabis Control, proposed that retail delivery be borderless–meaning, licensees wouldn’t have to get local approval to delivery into/complete delivery in a given city or county. We are positive that such a decision made cities and counties cringe, but that likely won’t be the last time that the state and local governments butt heads over control over licensees.

4. CBD. CBD derived from industrial hemp in California is nothing short of a complete enigma. Why? Because, unless you’ve been living under a rock, you know that the California Department of Public Health Food and Drug Branch (CDPH-FDB) via an FAQ recently prohibited using hemp-derived CBD in food for pets and humans. Essentially, California is following the FDA lock-step on its treatment of hemp-CBD under federal laws. Other states have decided not to kowtow to the FDA in this area, but California surprised everyone by attacking hemp-CBD in this way. How enforcement will go and what it looks like remains a mystery. And since you’ll be hard-pressed to find a ton of juice bars, health food stores, breweries, coffee makers, and pet stores across the state not carrying hemp-CBD products meant for human or pet consumption, enforcement from CDPH-FDB could take a while.

5. Corporate versus cottage interests. The express intent of Prop. 64 was to hoist up and protect cottage interests in the cannabis industry. One of the biggest points of contention in Sacramento over MAUCRSA regulations has been the refusal of regulators to limit the number of cultivation licenses available to licensees. Namely, even though Type 3 medium sized cultivation licenses (I.e., 10,001-22,000 square feet of plant canopy) has been limited to one person/entity, anyone can still secure multiple and endless Type 1 and Type 2 cultivation licenses thereby getting around the limitation on medium sized grows. Combined with other regulatory barriers to entry and reporting and tax requirements, a lot of smaller cultivators and smaller business licensees are crying foul on MAUCRSA regulations being too corporatized. Whether regulators will really listen to this camp will be revealed in the permanent rules, and only time will tell.

6. DOJ and Jeff Sessions rescinded all DOJ marijuana guidance in January. As we all know, Jeff Sessions personally loathes cannabis. Sessions and whether you believe he’ll make good on his personal hatred or not, you cannot argue with the fact that the rescinding of the 2013 Cole Memo is unsettling if you’re a state-licensed cannabis business. Now that Sessions has take the position that U.S. Attorneys should prosecute cannabis crimes within their districts essentially according to the resources and priorities of the individual district, no one really knows what exactly enforcement will look like in each of the four federal California districts. So far though, to the best of our knowledge, the DOJ in California hasn’t been busting people for securing licenses under MAUCRSA.

7. Enforcement of rule violations. Temporary cannabis licenses began issuing in California on January 1, 2018. The program has been up and running for about a year and a half, and enforcement of rule violations against licensees has been varied at best. The state is mostly in the mode of getting people into the system and licensed in the first place. I’m confident that enforcement will finally begin to increase into next year as the dust settles on permanent licensing. And cities and counties are beginning to take the lead on enforcement anyway (see, for example, the latest from the City Attorney in Los Angeles). Still, exactly when the state will kick into higher enforcement mode is genuinely unknown.

We recently wrote about the new Oregon Liquor Control Commission (OLCC) rules for marijuana businesses, and observed that those rules were issued with the stated intent to stave off diversion of cannabis. In addition to its public-facing actions, we have seen an apparent shift in internal OLCC review policies and procedures. A few weeks ago, we covered the apparent adoption of new settlement policies. Today, we cover what appears to be increased scrutiny for each of the following: new license applications (those submitted prior to June 15th), license renewal applications, change in business structure applications, and change-in-ownership applications. OLCC investigators are looking at all of these submissions more carefully than ever.

It was never easy to get an OLCC license. It only felt that way, given the stricter and more tedious requirements faced by cannabis program applicants in other states. In Oregon, the application process was somewhat cumbersome initially (remember the narrative-based forms, released in 2015?), but the state quickly progressed to “check the box” paperwork in combination with its online data entry system. Today, there are a few interesting quirks in that protocol, but it’s navigable and sensible and clean overall.

So what changed? Generally, the administrative environment is different these days. Licensing has existed for a couple of years, OLCC has refined its processes, and investigators are better trained than before. Specifically, investigators have raised the bar for the content of application submissions, and they are looking under rocks that previously would have been left unturned. In many cases, they are finding things.

OLCC marijuana cannabis license
OLCC investigators are taking a harder look.

Gone are the days when an applicant could submit a business document in the belief that, regardless of that document’s contents, the inspector would summarily tuck it into her file essentially unread, and pass the application along to “final review.” OLCC investigators are now actively requesting and reviewing legal documents, and doing a really good job of it. Here is a sampling of investigator questions we have seen in the past month or so, that never would have surfaced even a year ago:

  • “Does this lease’s rent reconciliation provision mean that the landlord is entitled to a percentage of profits? Explain that.”
  • “Was this asset purchase agreement ‘deposit’ escrowed? Or have these funds used in the business operations already?”
  • “Why does this business structure form contain an LLC member who is not listed on the state business registry?”
  • “At what point did the seller transfer these utility bills into the buyer’s name?”

Etcetera. We have seen businesses tripped up (badly) in the both the change-in-ownership and renewal processes by questions like these. In the worst case, these inquiries can result in proposed license cancellation and/or non-renewal by OLCC. Those situations can be incredibly frustrating and stressful for a business, especially one with sunk costs and accumulating obligations. They should be avoided if legitimately possible.

In all, the new licensing paradigm leaves us with a couple of key takeaways going forward. The first is really simple: Run your business like a real business and ensure you have everything in place prior to OLCC submission. This means writing things down, to start, and using appropriate forms to do so. The second takeaway is to enlist help when needed. That doesn’t mean you need to pay an attorney or a consultant thousands of dollars to process your application. In our Portland office, for example, we have experienced marijuana licensing paralegals who process OLCC applications literally all day every day, and who talk with OLCC investigators on the regular. Our cannabis business lawyers only enter the picture to draft documents, or deal with nuanced or delicate matters.

Going forward, we expect OLCC to continue to ratchet up standards for both applicants and licensees on everything from rulemaking to license review to site inspections. That’s a good thing for compliant operators and for businesses that want to do things correctly. Really, it’s exactly how it should be.

california marijuana cannabis SB1459
Provisional licensing would benefit state AND industry.

The California legislature is currently finalizing a bill (SB-1459) which would establish a provisional licensing regime for California cannabis businesses. The bill moved into “enrolled” status late last week, which means that SB-1459 has been approved by both houses of the state legislature and is being proofread to ensure all amendments were properly inserted. Once SB-1459 is “correctly engrossed”, only a signature from Governor Brown is needed for the bill to take immediate effect. In all, provisional licensing seems imminent.

These pending, provisional licenses would provide holders with a year-long, non-renewable, provisional license to operate after filing completed license applications. These provisional licenses would alleviate pressures on licensing agencies caused by the backlog of pending applications. Provisional licenses would also allow holders to continue operating, rather than potentially ceasing operations later this year. On that point, the SB-1459 legislative findings are compelling:

The significant number of cultivation license applications pending with local authorities that do not have adequate resources to process these applications before the applicants’ temporary licenses expire on January 1, 2019, threatens to create a major disruption in the commercial cannabis marketplace.”

Cannabis licensing in California is a relatively recent phenomenon and is a requirement for any cannabis business operating in the state. Under current law, licensing authorities may issue temporary licenses pending the approval of final licenses. Temporary licenses can be issued for 120-day periods, with certain allowable extensions. According to the Senate Floor Analysis of SB-1459, the temporary license was intended as an intermediary step while local and state regulatory bodies themselves came into compliance with California’s new law. Notably, under the current law, temporary licenses cannot be issued after December 31, 2018.

Perhaps as expected, thousands of cannabis businesses submitted license applications this year. Many of these licenses were sought in Humboldt, Monterey, and Santa Barbara counties, where regulators were not prepared to (and have not been able to) address the flurry of applications. As noted in the Senate Analysis accompanying SB-1459, the barrage of environmental disasters in California—particularly in Santa Barbara—have contributed to the delay in the process. Thus, of the thousands of applications that have been submitted to date, many have yet to be completed.

Originally introduced in February 2018 as a method to bill concerning agricultural reporting issues, SB-1459 underwent substantial revisions during the legislative process. SB-1459 is now almost an entirely new piece of legislation and contains the provisional licensing scheme intended to alleviate the pressures identified above. If the current SB-1459 is codified into law, it would permit licensing authorities—in their sole discretion—to issue provisional licenses for a non-renewable period of 12 months. These licenses could be issued to applicants that hold or even held a temporary license for the same premises and same commercial cannabis activity sought to be licensed, have submitted completed license applications, and in connection with those completed license applications have submitted evidence that compliance with the California Environmental Quality Act (or “CEQA”) is underway. Notably, the Senate Analysis accompanying SB-1459 notes that a provisional license applicant could obtain a license without proof of full CEQA compliance.

SB-1459, if passed, would remain in effect only until January 1, 2020. This would both provide an additional year of breathing room for already swamped regulators and would prevent cannabis businesses from potentially having to cease operations. Not surprisingly, numerous public bodies, private entities, and industry groups (including our California cannabis business lawyers) have supported the bill. Barring unforeseen circumstances, it’s a safe bet that SB-1459 will become law.

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.

l.a. social equity cannabis tier
Written agreement strongly recommended.

Applicants who qualify for commercial cannabis licensure during Phase II of the City of L.A.’s cannabis licensing process only have until September 13 to get their applications into the Department of Cannabis Regulation (“DCR”). This phase of licensing is reserved for existing, non-retail, social equity applicants. To get a license during this phase, the DCR requires proof of operation in the City prior to January 1, 2016, proof of service to an “Existing Medical Marijuana Dispensary” prior to January 1, 2017, and proof of eligibility as a Tier 1, 2, or 3 social equity applicant. For more on Phase II eligibility, see here and here.

I wrote earlier this month about the unusual business relationships our L.A. cannabis business lawyers are seeing born out of social equity in L.A. It’s pretty clear that lots of applicants will go for Tier 3 social equity status (i.e., where a Tier 3 incubates a Tier 1 or 2 social equity applicant). In that situation, the Tier 3 social equity applicant has to sign a social equity agreement with the City, but little to no detail on the content of that agreement exists in the law. In addition, licensees would be extremely unwise not to maintain social equity business agreements between themselves in order to ensure mutual performance and compliance. In turn, this post is dedicated to covering the details that should be included in social equity agreements between licensees:

  1. Mandatory Assistance.
    1. Capital. Under L.A. cannabis laws and regulations, Tier 3 social equity applicants must provide “capital . . . to Persons who meet the criteria to be a Tier 1 Social Equity Applicant. . .” L.A. does not mandate a minimum capital allocation. In turn, it is extremely important to specifically define in the private social equity agreement the amount of money and how often it will be paid to the Tier 1 social equity applicant. The contract should also address what occurs between the parties in the event the City mandates a higher amount to be paid from the Tier 3 to the Tier 1. This mandatory financing will also render the Tier 3 a “financial interest holder” of the Tier 1 under state law, so the disclosure process to the state of that fact should be addressed in the parties’ agreement.
    2. Leased Space. Tier 3s also have to provide certain amounts of leased space, rent-free as well as prorated utilities to Tier 1s. The amount of space the Tier 3 must secure for the Tier 1 is dictated by license and type and size as set by LA law. Current state law prohibits licensees from subleasing to each other (and state law dictates that only one license per “premises” is allowed), so any solid private social equity agreement will address the fact that the Tier 1 has to have its own lease for its own premises where the Tier 3 will pick up the rent and ensure prorated utilities. This situation opens all kinds of contingencies relative to the Tier 1 lease regarding default in rent payments by the Tier 3, indemnities, ongoing compliance with state and local laws by the Tier 1, and the list goes on and on. Additionally, if any build out or code compliance is necessary for the space, the question of who bears that cost and for how long and/or who has creative control over the process should also be negotiated.
    3. Business, Licensing and Compliance Assistance. A Tier 3 must also provide to both Tier 1s and 2s “business, licensing, and compliance assistance.” These terms are not defined by LA, so their meaning is currently up to the licensees and should be clearly defined in the private social equity agreement. For example, will the Tier 3 undertake the entire application process or just a portion of it on behalf of the Tier 1 or 2? Will the Tier 3 cover all licensing expenses on the state and local level? Will the Tier 3 allocate a certain amount of hours per week or month to ensure that the Tier 1 or 2 is in full compliance with both state and local law?
  2. There is no State Social Equity Program; Loss of Licensure. Where there is no state social equity program, the Tier 1 or 2 will still be personally responsible for compliance with MAUCRSA at all times. In turn, the parties need to discuss and agree on what will happen if the Tier 1 or 3 violates MAUCRSA in a way that jeopardizes the standing of their licenses. The same goes for material defaults of L.A. law and regulations.
  3. Social Equity Restrictions. Under L.A.’s social equity laws, a social equity applicant can’t really behave like a normal business. There are a slew of situations in which, before acting, the social equity applicant has to check in with the DCR. As a result, the private social equity agreement should force the Tier 1 or 2 into constant compliance with specific social equity reporting and vetting as required by local laws.
  4. Relationship of the Parties. Like any contract ever, the parties should be clear that their social equity relationship doesn’t otherwise create any partnership, joint venture, or agency relationship where one party can bind or create liabilities on behalf of the other.
  5. Term; Termination. The City of LA mandates that a Tier 3 “incubate” a Tier 1 or 2 for no less than a term of three years. On grounds for termination, the parties should contemplate a mutually beneficial code of conduct that goes to compliance with LA and state laws and regulations as well as maintaining respective social equity status.
  6. Taxes. Despite their local social equity relationship, each license is still responsible for the remittance of cultivation and/or excise taxes to the California Department of Tax and Fee Administration. Any contractual code of conduct between social equity applicants should make clear that each licensee bears the burden of tracking and paying its own taxes.
  7. Disputes. There are likely going to be many legal disputes between Tier 3s and their Tier 1 and/or 2 incubees. For one reason or another, it’s likely that either licenses won’t issue, construction will be stalled, and/or their will be material breaches to the detriment of either or both parties. We’ve already seen this occur in the Oakland social equity program. Therefore, Tier 3 social equity situations call for a clear protocol of what to do in the event of disputes. For more on the cannabis corporate disputes we’re seeing, see here.

Even though social equity is fairly heavily regulated in L.A., government cannot cover all the business details between parties (nor should it). That’s where a well thought out, written agreement becomes incredibly important in order to curb risk and get the parties in line for success or for a more orderly break-up in the event that things don’t work out.