Something has gotta give in Phase 3.

The City of Los Angeles has long endured questions surrounding its elusive Phase 3 licensing process for cannabis businesses. The City completed Phase 1 and 2 licensing without too much crazy change, but Phase 3 is very likely going to be a different story, and will affect a lot of stakeholders for better or worse.

On February 8, 2019, the Department of Cannabis Regulation (“DCR“) wrote to the Rules, Elections, and Intergovernmental Relations Committee (“Committee”), proposing total reform for Phase 3 licensing in the face of multiple regulatory issues caused by undue concentration, the promotion of social equity businesses, and the overall economic interests of various stakeholders who are waiting for Phase 3 to open. DCR wrote to the Committee that it wants to make certain strategic amendments to the licensing process in Phase 3 that “would make our licensing process more efficient, transparent, and, most important, equitable.”

DCR’s obvious concern in its letter to Committee is that Phase 3 successfully hoist up social equity applicants and be as efficient as possible at the same time. In particular, the letter states that:

DCR recognizes that the existing licensing process provided in the Cannabis Procedures ordinance and regulations will take significant time to implement and that many Phase 3 storefront retail applicants will have to make significant investments in the application process before knowing for certain whether they might be denied because another applicant within 700 feet of them gets licensed first or the Community Plan in which they are located reaches undue concentration before they obtain a license.

Based on its letter, DCR looks to be seeking to award those stakeholders that are patiently sitting on eligible commercial cannabis properties (bleeding rent and other costs while waiting for Phase 3 to commence) through swift and efficient licensing. The bottom line is that the current proposed licensing process potentially harms everyone, including social equity applicants who have either already made the investment in the unsettled program or that don’t have the resources to invest ahead of time to their detriment (since the City hasn’t yet established the assistance programs necessary to aid social equity applicants, but is finalizing a draft RFP “to identify vendors who can provide a suite of business and licensing support to Tier 1 and Tier 2 social equity applicants”).

Combine the foregoing with the fact the City “expects approximately 200 storefront retail licenses will be available through Phase 3 before undue concentration is reached in most or all of the City’s Community Plans,” and DCR has taken the position that Phase 3 licensing procedures must change, and fast. DCR therefore proposes in its letter that Phase 3 licensing for the remaining estimated 200 retail licenses (probably all of which will go only to social equity applicants per existing laws) take place as follows:

First come, first serve for verified Tier 1 and Tier 2 applicants (that also have locations ready to go) for the first 100 licenses OR a lottery system to issue the first 100 licenses (with various barriers to entry, including having a location on lock). And for the second 100 licenses, the DCR wants a merit-based system with various qualification criteria.

There were other pretty important recommendations made in the letter to Committee regarding other amendments to current LA cannabis licensing laws, but the change-up on the Phase 3 licensing process is, by far, the most impactful.

Even though the DCR has studied the foregoing issues for months, the City Council was not yet ready to act on the DCR’s recommendations. On Friday, February 15, after a hearing with Committee and then a hearing with Council regarding the DCR’s recommendations, Council instructed DCR “to report back at the next Rules, Elections, and Intergovernmental Relations Committee meeting with a further analysis of the recommendations for Phase 3 Storefront Retail processing and Non-storefront Retail processing, including consideration of a social equity applicant registry platform similar to the City of San Francisco” and to “suspend any Phase 3 processing until the enhanced Social Equity analysis for the San Fernando Valley, Boyle Heights, and Downtown Los Angeles is completed.”

What does all of this mean? Basically, we’re back to square 1 in L.A., and original Phase 3 processing remains in place despite the DCR’s attempt at an overhaul. Without question though, Phase 3 licensing should change. The current timing alone on issuance of Phase 3 licenses will bankrupt or scare off the vast majority of people. First come, first serve likely appeals to most people, but it’s just as imperfect and arbitrary as a lottery system. So long as the right barriers to entry and restrictions are implemented, either system can work to effectuate quick and efficient licensing (just ask Washington State whose biggest problem with a lotto system was actually movement of winners after-the-fact).

Lotto likely edges out first come, first serve if we’re talking maximum efficiency, because it eliminates the timing pressure and order of applicants at the outset when they file with DCR. With either proposal though, ambiguities would hinge around what a “complete” application really means and/or the ability of people to game the system by paying off family members (or whomever) to act as straw applicants to increase their chances of success. Merit-based also poses its own challenges regarding what qualities should net you the most points, especially when dealing with social equity applicants who remain the most popular form of licensing capital in L.A. and therefore the most vulnerable when it comes to scams and hawkish investor behavior.

Interestingly enough at Friday’s hearing, Council did instruct the City Attorney to draft an ordinance (with input from DCR) to, among other things:

  • grant temporary approval to phase 3 retailers (which would allow them to instantly open their doors upon securing state licensure),
  • exempt non-storefront retailers from hearing before the Cannabis Regulation Commission prior to full licensure,
  • force Tier 1s or 2s to give a right of first refusal on ownership transfers to their existing partners to purchase their ownership interests at market rate (after expiration of the applicable Social Equity Agreement term),
  • bar from Phase 3 retail or delivery licensure applicants or landowners with “evidence” against them for illegal cannabis activity at any time since January 1, 2018.

So, we know change is coming to Phase 3 licensing albeit at a glacial pace. For now though, it appears that the DCR will really have to persuade Council on adopting its Phase 3 recommendations for the licensing process, or all Phase 3 stakeholders will invariably suffer licensing by a thousand cuts.

oregon marijuana cannabis
Time to kick back and consider Oregon cannabis.

On January 31, the Oregon Secretary of State released an audit of Oregon marijuana regulation. The audit is a hefty 37 pages, but its core findings are listed right there on the cover sheet: “Oregon’s framework for regulating marijuana should be strengthened to better mitigate diversion risk and improve laboratory testing.” Now: we would all like to see less diversion and better testing, but those findings are not exactly surprising. And no one should expect big fixes anytime soon.

Below is some straight talk about the audit’s two primary conclusions, and a few thoughts about where things are headed.

  1. Much of the medical market is a black market and diversion is unstoppable at this time.

The Oregon Medical Marijuana Act (OMMA) was passed over 20 years ago, in 1998. As we explained a few years back, OMMA was (and is) little more than an affirmative defense for designated marijuana possessors and distributers from state criminal prosecution, and from federal hassles to the extent possible. Those are commendable goals, but the program never made sense from a commercial perspective. Thus, the Oregon Health Authority (OHA) has always found itself in the unenviable position of struggling to write rules around legislation that creates a marketplace while ignoring the market itself.

When the legislature did decide to shepherd the primitive market, it did so in fits and starts. It took seven years to put a grow site registry together, and fifteen years for dispensary licensing. Heck, even the first grow site inspections (and there haven’t been many) didn’t occur until 2016. All of this was toothpicks and BAND-AIDS. And all the while, many people made money trading in the “medical” market. Did a lot of that weed and cash make its way across the country? You bet.

Even if Oregon were to follow the audit recommendations, however, and ramp up funding for inspections and enforcement in both the OHA and OLCC (adult use) programs, there are inherent and well documented limits to supply-side efforts when it comes to federally controlled substances. Oregon can invest heavily in keeping its cannabis under seal, but its energy would be better focused on federal lobbying to de- or reschedule marijuana under the federal Controlled Substances Act, or even on longshot solutions like promotion of interstate marijuana exchanges.

The state should also continue to push medical marijuana regulation, including enforcement, into the OLCC purview. The audit briefly suggests as much, and we’ve been talking about that forever on this blog. It’s not such a political quagmire anymore, especially as more overlap comes with each legislative session. The fundamental question is this: why have a revenue raising agency and a health authority both focus on intensive regulation of the same plant, especially when both are under-supported? It doesn’t make a lot of sense.

Finally, here’s the part that administrators, legislators and even executive branch actors aren’t saying out loud: leakage into interstate commerce really doesn’t matter at this point, especially if the state is running its studies and making token efforts to stop it. There may be some federal enforcement against black market actors (which is great), but no one is shutting these state programs down. In 2019, cannabis leakage exerts more pressure on the feds to find legislative solutions than enforcement ones.

  1. Testing is a tough issue, but more fixable.

Back in the day, when OHA first started licensing dispensaries, there were no real rules around testing. People would take weed to labs with inadequate equipment and inconsistent practices. They would leave with unreliable results. In 2016, when OHA began accrediting the first laboratories for the medical and adult use (OLCC) markets, not many of them signed up. In the OLCC market, this meant bottlenecks for an extended period.

Nowadays, all cannabis making its way to retail sale is tested more strictly than other agricultural crops, but medical marijuana outside that channel typically goes untested (unless the flower is processed by a medical marijuana processor, which is pretty niche). That’s a shame because medical marijuana patients are the ones who would benefit from testing the most: many of these individuals have conditions like cancer and HIV that directly compromise their immune systems. And roughly 10% of Oregon’s medical marijuana patient community includes children under 18 years of age and seniors over 70.

As far as testing issues that affect our industry clients (OLCC businesses and financiers) the audit recommends expanding testing requirements to screen for microbiological and heavy metal testing, and it promotes “shelf audits” at dispensaries. In theory, those steps could drive up costs along the supply chain, but we wouldn’t expect much variance. Altogether, the testing push is more about protecting vulnerable individuals in Oregon, including people in limited, patient-caregiver relationships. We can get behind that.

william barr federal law
Hopefully, anyway…

Back on January 4, 2018, the industry was in a slight tailspin due to then acting Attorney General Jeff Session’s (renowned marijuana hater) rescinding of all marijuana enforcement guidance from the Department of Justice (“DOJ”). Reactions in the media ranged from treating the Sessions announcement as nothing more than an attempt to frighten the cannabis industry to claiming that it was the first step in an organized crackdown of the marijuana industry that could affect cannabis businesses and users. Both possibilities are arguably realistic. And the drama that followed Sessions’ moves was pretty satisfying, including when Cory Gardner vowed to (and did) block DOJ appointments until the issue was resolved in favor of the states, culminating in a deal with President Trump to back off of state-legal marijuana. However, now that Sessions is out at the helm of the DOJ, industry folks can breathe a little easier where new Attorney General nominee William Barr has gone on record stating that state-law abiding cannabis businesses will not be prosecuted by the DOJ and essentially that the 2013 Cole Memo will be back from the dead.

In rescinding all DOJ guidance on marijuana enforcement, Sessions torpedoed the famous 2013 Cole Memo, which outlined eight specific enforcement priorities of the DOJ in states with legal marijuana and which, between the lines, indicated that “robust” state regulations would keep the DOJ at bay regarding enforcement of the federal Controlled Substances Act. After that memo, entire states built their comprehensive cannabis licensing and taxation systems on those eight enforcement priorities, ensuring that compliance restrictions and barriers to entry were strong enough to support the same. Instead, Sessions put in place the “Sessions Memo,” which was short on specifics. It doesn’t contain an outright directive ordering U.S. Attorneys to go after marijuana businesses. It simply withdraws all of the earlier marijuana-specific guidance memoranda and directed U.S. attorneys to treat marijuana sales like any other federal crime. The withdrawn memos include, the 2013 Cole Memo, the February 2014 Cole Memo that extended low enforcement priority status to apply to banking activities (although the FinCEN guidelines are, importantly, still alive); and the 2014 Wilkinson Memo that was a sort of Cole Memo for tribal lands.

Right now, U.S. attorneys have full discretion to determine to what extent they can/should enforce federal law in the context of marijuana crimes in states with legalization and medicalization–which they always had anyway–but the 2013 Cole Memo helped them prioritize certain marijuana issues across the DOJ. In his memo, Sessions referred to the principles of enforcement in the U.S. Attorneys’ Manual, but that document reinforces the level of discretion and authority that each U.S. attorney has already. The Cole Memo was ultimately useful in providing a consistent nationwide federal policy. Under Sessions Memo, we are back to the days of having potentially 93 different enforcement policies — one for each U.S. Attorney. To date, there haven’t been any reported incidents of the Feds going after state-law compliant cannabis operators in states that have legalized and regulated.

A new sheriff is coming to town though, and that could be a very good thing for the momentum of state-by-state legalization in that states will better know what to expect from Big Brother as will marijuana businesses and their investors. William Barr may end up becoming a very unlikely helper when it comes to state-legal cannabis. He was Bush I’s attorney general from 1991-1993, and he’s a dyed in the wool conservative who, as Attorney General, was “tough on crime” and put many, many people in prison. As reported by Marijuana Moment, Barr in a mid-January hearing with Congress testified that:

My approach to this would be not to upset settled expectations and the reliant interests that have arisen as a result of the Cole memorandum . . . However, I think the current situation is untenable and really has to be addressed. It’s almost like a backdoor nullification of federal law . . .

While Barr also testified that he wouldn’t go “after companies that have relied on [2013] Cole memorandum . . . ,”  he also didn’t completely kowtow to state legal cannabis. He further testified that “we either should have a federal law that prohibits marijuana everywhere, which I would support myself because I think it’s a mistake to back off marijuana. However, if we want a federal approach—if we want states to have their own laws—then let’s get there and get there in the right way.”

In reading the tea leaves, it sounds like, personally, Barr would have no issue with continuing the War on Drugs as it relates to cannabis. As a department under his watch and command, however, the DOJ probably wouldn’t spend time and valuable resources on state-legal operators — even if Barr is concerned that the current dynamic is breeding “disrespect for the federal law.” Reasonable minds can differ, but I’d say that most cannabis operators and states are very mindful of federal law enforcement and it’s really Congress, the DOJ, and the President to blame for creating legal confusion because of varied enforcement over the years.

In the end, Barr’s testimony ultimately serves to show the country that Congress has been woefully impotent and ignorant when it comes to cannabis as a whole and especially as the topic relates to states’ rights. What’s good to know though is that if Barr is confirmed, we’re very likely returning to the 2013 Cole Memo principles, which will at least create a political atmosphere of certainty in that the DOJ has bigger fish to fry than state-legal marijuana. Right now, Barr is pretty much a lock for U.S. Attorney General, so hopefully he’ll make good on his cannabis compromises.

international trade cannabis marijuana

Recently, we’ve been getting tons of questions from clients regarding the international import and export of cannabis around the globe. 2018 was a historic year for the cannabis industry not just in the United States, but also internationally. Canada legalized recreational marijuana for the entire country. Many countries (e.g., Thailand, New Zealand, Mexico, Lithuania, U.K.) took significant steps to decriminalize or legalize medical or recreational marijuana. In December, Israel became the fifth country to pass legislation legalizing the export of medical marijuana (after the Netherlands, Canada, Uruguay, and Australia).

Despite these advances, international trade in legal marijuana currently is limited. Under a 1961 international treaty (Single Convention on Narcotic Drugs), cannabis is classified as a controlled substance with no medicinal use or value (we explored this recently here). Most countries are signatories to this and other international treaties that set forth the ground rules for the international drug control regime for controlled substances. Individual countries, however, can and have begun to make their own determinations on whether cannabis should be treated as a narcotic substance. Countries that have legalized marijuana can agree to allow trade in marijuana between those countries. Dutch and Canadian companies have gotten a head start in the global marijuana trade with medical marijuana being exported to Germany, Italy, Croatia, Australia, New Zealand, Brazil, and Chile. Currently, Israel, Australia, Uruguay, and others are also pushing to get into the medical marijuana export game.

While other countries have begun to legalize cannabis, the United States federal government still classifies “marijuana” as a Schedule I controlled substance with no medical use and a high potential for abuse. Thus, federal law effectively prohibits importation of marijuana into the United States. In September 2018, however, the U.S. Drug Enforcement Administration (DEA) granted permission for a Canadian marijuana company (Tilray) to export medicinal cannabis to University of California San Diego for clinical trial. Although DEA’s approval of this importation may be just a one-off, this one approval could signal an eventual broader opening of the U.S. market to imported marijuana.

If (or when) the U.S. finally allows the importation of cannabis products from other countries, it seems likely that some type of trade dispute will likely occur. Legalization of marijuana has often resulted in supply and demand imbalances that result in prices rising or falling sharply. In Oregon, prices for licensed marijuana plummeted with overproduction, and nearly 70 percent of the legal recreational marijuana grown has gone unsold. In Canada, medical marijuana dispensaries faced shortages as licensed producers shifted to selling to the much larger legalized recreational marijuana market. Italy faced consistent shortages of medicinal marijuana and ultimately permitted imports from Canadian companies to ease the supply shortages.

Trade disputes often result when producers in one country complain that imports from another country are being sold at unfairly low or subsidized prices and harming the domestic industry. Domestic producers can petition their government to investigate imported products and often antidumping or countervailing duties are imposed. If imported cannabis products are allowed into the U.S., it would not be surprising if U.S. marijuana producers resort to U.S. trade laws in order to fend off import competition. Which countries might be likely targets of a cannabis trade dispute?

  • Canada –Given the head start that Canadian cannabis companies already have in developing international distribution networks in a number of countries, bigger and better funded Canadian companies could swoop in and aggressively price their product to overwhelm U.S. competitors and take over a dominant market share in the United States. U.S. cannabis companies could try to seek trade protection from Canadian imports by filing antidumping or countervailing duty petitions like those filed against Canadian softwood lumber in multiple rounds going back to the 1980s.
  • Mexico – Mexico’s new President Lopez Obrador has proposed legislation to legalize marijuana. If Mexico ever legalizes exports of licensed marijuana, Mexico’s relatively lower farm labor rates could provide significant cost advantages over U.S. or Canadian licensed suppliers.
  • China – Although marijuana is illegal in China, China is nevertheless the world’s leading producer of industrial hemp cultivation. China likely will have a significant advantage in producing more cost-effective hemp fabric and medicinal products than any other country. As of 2017, Chinese companies hold more than half of the 606 patents filed around the world that relate to cannabis. These patents could trigger plenty of litigation as companies try to attack or defend the intellectual property rights of their hemp products.

It’s hard to think of international trade disputes involving cannabis when it is still illegal for marijuana to cross U.S. state borders, let alone international borders.  But as the trend of marijuana legalization continues globally, it is likely a matter of time before licensed marijuana products become treated like any other commodity subject to competitive market forces and resulting litigation over fair and unfair competition. Once imported marijuana products are allowed, it is not difficult to foresee the day when import competition in the legal marijuana markets may trigger some type of international trade dispute either in the form of an antidumping or countervailing duty petition or a patent infringement action.

california cannabis licensing rulesThe State of California finally adopted permanent cannabis regulations earlier this month. In a series of posts, we’re going to cover the highlights of each agency’s permanent rules so that you know what big changes to expect during 2019. This post will cover the main changes (in our opinion) regarding the California Department of Public Health Manufactured Cannabis Safety Branch’s (“CDPH-MCSB”) permanent regs. Without further ado:

No more Farm Bill hemp-CBD ingredients or additives. It’s no secret that the California Department of Health Food and Drug Branch (“FDB”) has an issue with hemp-CBD. Specifically, an FAQ that issued from FDB last year made clear that FDB prohibits hemp-CBD in “Food” for humans and pets. Now, CDPH-MCSB is following suit (indirectly). Pursuant to new regulation 40175(c), “a manufacturer licensee shall only use cannabinoid concentrates and extracts that are manufactured or processed from cannabis obtained from a licensed cannabis cultivator.” What this means is that using Farm Bill hemp-CBD as an ingredient or addictive to cannabis manufactured products is not allowed unless it comes from a licensed cannabis cultivator. The protections of the Farm Bill won’t apply.

Owners and financial interest holders. I recently wrote about how it’s unclear as to how far the state will now go in finding and vetting entity owners and entity financial interest holders, especially since the Bureau of Cannabis Control (“BCC”) articulates in its rules that it intends to locate and vet every human possible in pretty much any ownership structure. But what about MCSB? MCSB entity owner regulations now state that “if the owner . . . is an entity, then the chief executive officer and members of the board of directors of the entity shall be considered owners,” and for financial interest holders, MCSB rules mandate only that “financial interest holders shall be disclosed on the application for licensure.” On balance, the BCC’s owner and financial interest holder rules are much more aggressive than MCSB, and the BCC’s comments to its owner and financial interest holder rules was that all agencies would apply the same standards for vetting. However, this clearly isn’t going to be the case if stakeholders go off of a plain reading of the law. Though it will be strange, the MCSB will very likely stick to its minimal vetting requirements while the BCC goes full bore on retailer, distributor, and lab owners and financial interest holders.

Changes in ownership. Again in contrast with the BCC, the MSCB is going to be much easier on changes in ownership of licensees. Under BCC regulations, if there’s a full buy-out of all existing owners, the entity can no longer operate while the change of ownership is being reviewed and processed by the BCC. The MCSB however has no such standard, at least not one that’s codified under the new regs. Specifically, for any changes of ownership or changes to financial interest holders, the MCSB expects the following protocol:

“The licensee shall notify the [MCSB] of the addition or removal of an owner through [the agency’s online system] within 10 calendar days of the change; Any new owner shall submit the information required [by law]; The [MCSB] shall review the qualifications of the new owner in accordance with [state law] and these regulations to determine whether the change would constitute grounds for denial of the license. The [MCSB] may approve the addition of the owner, deny the addition of the owner, or condition the license as appropriate, to be determined on a case-by-case basis; An owner shall notify the [MCSB] through [the state agency’s online system] of any change in their owner information . . . within 10 calendar days of the change; and a licensee shall notify the [MCSB] through [the state’s online system] of any change in the list of financial interest holders . . . within 10 calendar days of the change.”

Labeling. Labeling is still just as intense and comprehensive as it was under the emergency regulations. Now though, manufacturers need to ensure that, if a product container is separable from the outer-most packaging (e.g., a container placed inside of a box), the product container includes the following: (1) For edible cannabis products, topical cannabis products, suppositories, or orally-consumed concentrates, all information required for the primary panel except for cannabinoid content, and (2) for inhaled products (e.g., dab, shatter, and wax), the universal symbol (which is the black triangle with a cannabis leaf and an “!” with “CA” underneath). We also now (finally) have specific labeling requirements for pre-roll and packaged flower that didn’t exist before outside of the statute, itself. Overall, there are additional technical change requirements for labeling, including the weight of the product now needing to be in metric and U.S. customary units, specific labeling for flavoring in line with federal law, and more specific labeling restrictions for cannabinoid content.

Packaging. Until 2020, manufacturers are off the hook for providing child resistant packaging (“CRP”). Until then, retailers will bear the burden of CRP through the continued use of CRP exit packaging. Once CRP for manufacturers kicks in though, they’ll need to adhere to a litany of requirements, including compliance with the Poison Prevention Packaging Act of 1970 Regulations.

New product definitions. Via the permanent regulations, MCSB has introduced a number of newly defined terms, which is ultimately better for licensees so that confusion doesn’t abound as product development continues. For example, we now have as recognized definitions like:

  • “Infused pre-roll,” which means “a pre-roll into which cannabis concentrate (other than kief) or other ingredients have been incorporated”;
  • “Kief,” which means “the resinous trichomes of cannabis that have been separated from the cannabis plant”; and
  • “Orally-consumed concentrate,” which means “a cannabis concentrate that is intended to be consumed by mouth and is not otherwise an edible cannabis product. ‘Orally-consumed concentrate’ includes tinctures, capsules, and tablets . . .”

OSHA training. Given that cannabis remains federally illegal, people often think that violating one federal law somehow gives you a license to violate every federal law, which is entirely untrue. Under the permanent MCSB regulations:

“for an applicant entity with more than one employee, the applicant employs, or will employ within one year of receiving a license, one supervisor and one employee who have successfully completed a Cal/OSHA 30-hour general industry outreach course offered by a training provider that is authorized by an OSHA Training Institute Education Center to provide the course.”

Clearly, safety and federal compliance in the workplace still applies, even to cannabis operators, which is now demoralized under the permanent MCSB rules.

Changes to operations that now require state approval. As the state moves along with licensing and enforcement, it was inevitable that certain licensee actions would first require state approval. What this usually means is that major changes to your business or SOPs can’t go down without the state’s blessing, which can take weeks or months to secure. Specifically, for the MCSB, licensees will now have to report to and clear with the state the following action items before the licensee pulls the trigger on them (all to the tune of a $700 change application fee, which is non-refundable):

  • the addition of any closed-loop extraction method;
  • the addition of any other extraction method that necessitates a substantial or material alteration of the premises;
  • the addition of infusion operations if no infusion activity is listed in the current license application on file with the [MCSB] (you’ll also have to tell the state about “any changes to the product list on file with the [MCSB] and provide a new product list within 10 business days of making any change” to the products you’re making”); or
  • a substantial or material alteration of the licensed premises from the current premises diagram on file with the [MCSB].

Importantly, a “substantial or material alteration” includes: “the removal, creation, or relocation of an entryway, doorway, wall, or interior partition; a change in the type of activity conducted in, or the use of, an area identified in the premises diagram; or remodeling of the premises or portion of the premises in which manufacturing activities are conducted.” Be advised!

marijuana civil rights

Happy MLK Day!

For our international readers, Martin Luther King, Jr. Day is a federal U.S. holiday marking the birthday of its eponymous civil rights hero. Dr. King was the chief spokesperson for nonviolent activism in the Civil Rights Movement, which successfully protested racial discrimination in federal and state law. Dr. King was assassinated in 1968, four years after the passage of one of the great U.S. laws of the 20th century, the Civil Rights Act of 1964. His death also came two years prior to one of the 20th century’s most controversial and insidious laws, the Controlled Substances Act of 1970 (CSA).

As cannabis business lawyers, we write about cannabis law topics every day of the year on this blog, but we seldom address pure social issues. When it comes to cannabis, however, it is sometimes difficult to separate law and policy. This is because the federal prohibition of marijuana in the U.S. has had a racially disparate impact on non-white individuals, especially black and Latino Americans. That should come as no surprise to anyone: It is well documented that former president Richard Nixon wanted to link marijuana use and its negative effects to black people and hippies, who he perceived to be his enemies, when he signed the CSA.

That was almost 50 years ago, but in a way, not much has changed. Although the Trump administration has instated policies that make it more difficult to track drug arrests, publicly available FBI data reveals that 659,700 marijuana-related arrests occurred in 2017, comprising 40.4% of all reported U.S. drug arrests. This is nearly 12,000 more marijuana arrests than were made in 2016 (which, in turn, saw an increase from 2015). Thus, marijuana arrests are increasing, even as more states legalize possession and sale of the plant. It is profoundly regrettable that non-white individuals are arrested for marijuana crimes on a grossly disproportionate basis to whites, today and historically, despite lower levels of consumption overall. Most arrests are made for simple possession of small amounts of weed, and are made at the state and local level.

Last year at this time, Jeff Sessions was our attorney general. Although he is gone, his retrograde policies live on as Department of Justice directives with respect to marijuana and marijuana-adjacent issues. These policies include:

  • Support of draconian federal sentences for drug-related convictions (which affect blacks and Latinos disproportionately);
  • Support of federal private prisons (which impound blacks and Latinos disproportionately);
  • Support of the police tool of asset forfeiture, a legally problematic procedure which allows law enforcement to seize property of individuals who have been suspected of, but not charged with, crimes (in violation of everyone’s civil rights, but to affect blacks and Latinos disproportionately); and
  • Rescission of the Cole Memo, which gave some cover to marijuana businesses.

Today, it seems fairly certain that William Barr will be our next confirmed attorney general. He won’t be as bad as Sessions, but he is no friend of marijuana either. Barr commented last week that although he would not use federal dollars to chase state-compliant actors, “it’s a mistake to back off marijuana.” That’s not the type of leadership we need from the nation’s chief law enforcement officer.

As to Congress, it recently passed the First Step Act, a mild reformation of the federal criminal justice system. That law is mostly a dud when it comes to marijuana, however. And none of the “straight” marijuana bills, from the STATES Act on down, have made it to a floor vote. All the while, marijuana arrests continue to increase, despite the facts that: a) two in three Americans now support legalizing marijuana, and b) new adult use and medical marijuana states are coming online in waves.

The War on Drugs started out as a war on minority groups, and not much has changed in 50 years. If Dr. Martin Luther King Jr. were alive today, it is almost certain that he would be advocating for an end to the War on Drugs, starting with removal of marijuana from Schedule I of the CSA. Until that happens, and in honor of Dr. King, here are some ways you can pitch in to reverse the racist, immoral and counterproductive state of federal law with respect to marijuana:

Dr. King died 50 years ago, but his legacy continues to resonate and expand. On this day honoring one of our greatest leaders, it is important to remember all of the reasons we strive to put an end to prohibition, including the most important ones.

Let’s hope to finally see some meaningful progress on marijuana and civil rights in 2019, particularly at the federal level.

california cannabis final regulations

Yesterday afternoon, on January 16, 2019, the California Office of Administrative Law (“OAL) finally approved the sets of final regulations under it had been reviewing after submissions from the California Department of Public Health (“CDPH”) which regulates cannabis manufacturers, the California Department of Food and Agriculture (“CDFA”) which regulates cultivators, and the Bureau of Cannabis Control (“BCC”) which regulates distributors, retailers, event organizers, and testing laboratories. You can find the final regulations here.

The three sets of regulations follow on the heels of final proposed regulations that the CDPH, CDFA, and BCC submitted to the OAL for its review in December. We will be providing some overview of the key components of the final regulations shortly, but it looks upon initial review like these regulations adopted most or all of what was submitted for review in December.

These regulations are “final”, meaning cannabis operators and applicants no longer need to worry about discrepancies between emergency regulations (which as of now are no longer effective per the OAL’s statement) and whatever version of proposed regulations were then out in the ether. But though these regulations are “final”, we’re pretty positive that there will be changes and modifications—probably on a more incremental level—in the future.

Stay tuned to the Canna Law Blog for further insight and analysis into these final regulations and any final regulations that will come.

california cannabis license merger saleOur California cannabis lawyers are seeing a major spike in mergers and acquisitions (M & A), and it’s time to discuss what’s on the horizon for changes of ownership for some California cannabis businesses. In every cannabis state, M & A is no breeze because the regulators almost always require pre-approval of the transaction or of the new buyer(s). In California, it’s going to be more of the same in the red tape department in the future, as per the proposed permanent rules that will (likely) take effect at the middle of this month.

As you all know, multiple agencies in California run point on licensing. The Bureau of Cannabis Control (“BCC”) is the lead agency though when it comes to the implementation of the Medicinal and Adult-Use Cannabis Regulation and Safety Act (“MAUCRSA”). Under the BCC’s proposed permanent rules (which are still under review by the Office of Administrative Law), we now have a revised change of ownership process for distributors, labs, and retailers. (The California Department of Public Health the California Department of Food and Agriculture both have new change of ownership rules that significantly differ from the BCC in certain ways.)

First, and most importantly for all licensees, state licenses are not transferable. What this means then is that buyers have to purchase the companies that hold those licenses. Second, to accomplish a change of ownership under the new rules, would-be sellers of BCC-licensed businesses will need to submit a “Notification and Request Form” (see here) and check the box entitled “Change in Ownership” or “Change in Financial Interest Holder.” Specifically, for changes of “owners,” under the proposed permanent rules at section 5023(c),

If one or more of the owners of a license change, the new owners shall submit the information required for . . . each new owner be submitted to the [BCC] within 14 calendar days of the effective date of the ownership change.”

This timeline is almost the same as what was set forth under the emergency rules–it’s no surprise that the state has a deadline on disclosure for changes in ownership, as it affects licensure. However, this is the new curve ball for the M & A crowd pursuant to section 5023:

The business may continue to operate under the active license while the [BCC] reviews the qualifications of the new owner(s) in accordance with [MAUCRSA] and these regulations to determine whether the change would constitute grounds for denial of the license, if at least one existing owner is not transferring his or her ownership interest and will remain as an owner under the new ownership structure. If all owners will be transferring their ownership interest, the business shall not operate under the new ownership structure until a new license application has been submitted to and approved by the [BCC], and all application and license fees for the new application have been paid . . . In cases where one or more owners leave the business by transferring their ownership interest to the other existing owner(s), the owner or owners that are transferring their interest shall provide a signed statement to the [BCC] confirming that they have transferred their interest.”

In my experience, most business buyers in cannabis are looking for a full buy-out. And your typical cannabis M & A deal will (hopefully) have as a condition to closing that the state and/or local government(s) approve of the transaction/new buyer(s) prior to closing. However, in California, retailers, labs, and distributors will not be able to operate during a complete buy-out while the state is processing not only all of the new owners (including their background checks) but also an entirely new license application, which could take weeks or months to complete. Without a doubt, buyers will want the business to keep operating during the transaction so this is going to be problematic for a complete buy-out, and it’s pretty much unprecedented that the business shuts down during the transition.

What we’re now very likely to see then is that at least one of the original selling owners will always stay on the licensed entity as part of the transaction and only after the state clears the new license application will that person finally be able to transfer all of their equity (once they provide that written statement to the BCC). What this means is that buy-outs of cannabis businesses in California just got that much tougher and risk-laden for buyers as these transactions will now certainly drag out and become even more complicated.

And if you’re not looking at a full buy-out, life is somewhat easier in that “[a] change in ownership does not occur when one or more owners leave the business by transferring their ownership interest to the other existing owner(s),” and changes to financial interest holders (i.e., anyone who holds less than 20% of the business’s equity) don’t constitute a change of ownership that warrants a new application, etc.

You may be thinking that there’s a silver lining here in that these new rules may only apply specifically to annual licenses. However, regulators ensured that the change of ownership standards apply to those who hold a “License,” which is defined statutorily as “a state license issued under this division, and includes both an A-license and an M-license, as well as a testing laboratory license.” In turn, these standards should apply to those companies that hold temporary, provisional, and annual licenses.

California has certainly set itself apart as a very mixed place when it comes to cannabis business friendliness. And these recent BCC-imposed changes of ownership, at least in my opinion, help bring the state closer to more arbitrary barriers to entry than necessary.

california cannabis packaging labeling
You simply must reconsider your packaging and labeling.

In early December, California’s cannabis regulators released their proposed final regulations. If the regulations aren’t changed, it’s expected that they will take effect at some point this month, or shortly after. These regulations have some pretty important changes from the current readopted emergency regulations. One of the notable areas of change is the packaging and labeling requirements. In spite of some of the changes, there is almost no grace period for compliance. If the regulations go into effect as is, requirements could change overnight.

For some background, the regulations between the agencies permit manufacturers to package and label manufactured cannabis products such as vape cartridges or edibles, and distributors to package and label cannabis flower. Retailers are not permitted to do any labeling. In large part, this will remain unchanged. But the requirements for different license types will change significantly.

First is child-resistant packaging, which is the only major packaging change that has any kind of transitional period. The proposed final regulations of the California Department of Public Health (“CDPH”), which regulates manufacturers, postpone the child-resistant packaging requirements until January 1, 2020. The Bureau of Cannabis Control (“BCC”), which regulates a number of license types including distributors and retailers, likewise will not require distributors to package cannabis goods in child-resistant packages. However, retailers are forced to ensure that any products sold on their premises are in child-resistant exit packaging until 2020, at which point the manufacturers will need to start providing child-resistant packaging.

Second, the specific labeling requirements will change, and most dramatically for manufacturers. There will be a number of specific changes, including:

  • For manufacturers, if product containers are separable from the outermost packaging (i.e., a product container is inside of a box), then the product container must also contain certain information that would be required on the outermost layer. For edibles, topicals, suppositories, and orally consumed concentrates, all primary panel information—with the exception of the cannabinoid content—must be on the product package. For inhaled products (i.e., dab, shatter, or wax), the Universal Symbol must be stamped on the product package.
  • The manufacture regulations include specific primary and informational panel label requirements for pre-rolls and packaged cannabis flower that are similar to the requirements for manufactured cannabis goods, which must provide certain information, have the universal symbol and government warnings, and identify the cultivator of the flower.
  • For packaged manufactured goods, the DPH will no longer require primary paneling to include THC and CBD content. Instead, the proposed rules state that cannabinoid content “may” be placed on the primary panel packaging. The DPH will allow distributors to label packaging with the correct cannabinoid content after required laboratory testing. Cannabinoid content labeling will include very specific requirements that will vary from product to product.
  • The DPH is prohibiting labels for edibles to contain pictures of the food product inside the packaging, and from making false or misleading claims that products are organic.

Crucially, other than the child-resistant packaging requirements, there will be no transition period in these proposed final regulations. The packaging and labeling rules in earlier emergency regulations included explicit transitional periods for prior modifications, but the proposed final regulations of both the CDPH and BCC specifically delete these transitional period requirements.

What the lack of transitional periods means is that these proposed regulations will change labeling requirements overnight if they are implemented. This will create major issues for distributors and retailers who have products in their possession that suddenly don’t conform to the new final regulations.

For example, retailers cannot accept or sell products except as they will appear in their final form and cannot do any packaging or labeling themselves. This means that products must be labeled in accordance with BCC and CDPH standards. If a package or label is suddenly insufficient, then retailers may be prohibited from selling those products.

Distributors may be in a similar bind. While distributors can package and label cannabis flower, their ability under these proposed final regulations to package or label manufactured cannabis products is very limited: They essentially can only correct labels’ THC content if testing confirms it was inaccurate. The regulations don’t seem to allow distributors, for example, to add required warnings that are not present on packaging.

In sum, if these regulations become final, there may suddenly be a host of products that overnight are not compatible with the regulations. And because these regulations may become final very soon, getting products into compliance now is critical.

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

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

  1. Limited number of licensed businesses.

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

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

  1. Survival plan.

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

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

  1. Growth plan.

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

  1. Exit/liquidation plan.

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

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

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