california cannabis insurance
In California, it just got easier for landlords.

One of the most important elements of a commercial tenancy is insurance. Generally, the landlord maintains property insurance for damage to the building, existing improvements, and surrounding property, as well as liability insurance for bodily injury and property damage occurring on the premises. The landlord will typically pass the cost of that coverage on to the tenant as an operating expense, proportionally according to the tenant’s share of space in the building. The tenant will typically be required under the lease to carry, at its own expense, property insurance on all tenant improvements and tenant personal property, as well as its own liability policy covering injury and property damage occurring on the premises.

Because marijuana remains a Schedule I controlled substance that is federally illegal to produce or sell, most traditional insurance companies have declined to write insurance policies for the commercial cannabis industry. This relates to the federal illegality of marijuana itself, and also the increased risk associated with commercial cannabis as a result of such illegality, e.g. increased rate of loss from theft or burglary. As a result, landlords and tenants alike have often had to look to non-admitted carriers or surplus lines insurers to write a rider on a policy to cover cannabis activity. Such coverage is often extremely limited in scope, rife with exclusions, and very expensive. That said, rolling with a general liability policy that is not specific to cannabis is often even worse.

In industries other than cannabis, buyers tend to disfavor non-admitted carriers. This is due to the risk of losing out on various benefits offered through admitted carriers. Such benefits include: the certainty of financial stability and good business practices that comes with the state’s stamp of approval, the right to appeal claims that are denied, and the guarantee that the state will pay certain claims if the insurance company goes bankrupt. Cannabis businesses have had none of these benefits, until now.

Last week, the California Department of Insurance announced that it has approved a Lessor’s Risk policy issued by California Mutual, a traditional carrier with an “A- excellent” rating, for landlords renting to commercial cannabis tenants. Lessor’s Risk coverage is typically a comprehensive landlord insurance package that includes both the property and liability coverages often carried by commercial landlords. Specific commercial cannabis activities and businesses services by this announced coverage would include cannabis labs, product manufacturing, cultivation, and dispensary operations.

In the bigger picture, this is an important development for at least two reasons. First, it signals to other large insurers that the water is warm to start writing policies for cannabis businesses, and increased competition will mean lower prices, which will encourage more landlords to lease to cannabis tenants. Second, it is a huge step towards further legitimizing the cannabis industry by treating it like any other industry that requires business and government services. And it also highlights the need for perhaps the most important business service, banking, which is currently headed in the right direction as well.

All in all, when you have the Insurance Commissioner for the fifth largest economy on earth organizing cannabis facility tours for insurance executives, you can’t help but notice how seriously the state is taking this industry. That’s a good thing for landlords and tenants alike.

california marijuana lease
…of about a million frequently asked questions.

We’ve previously written a lot about commercial leasing issues in the California cannabis space, including some basic concepts, some key things to consider in getting leases right, and some ways to improve your leases. But there are certain common questions that tend to come up in a leasing transaction, and whether you are the landlord or the tenant, getting yourself up to speed on these issues now will save you loads of trouble down the road. Here are five examples of questions that frequently come up in cannabis leasing.

I’m a commercial landlord, what are my risks if I decide to rent to a cannabis tenant?

In a federal law enforcement scenario, the consequences could be serious. Marijuana is still (as of this writing) a Schedule I controlled substance, meaning that on the books, the federal government views cannabis as being on par with fentanyl-laced heroin. That may sound absurd—and it is—but in terms of federal drug enforcement it means that civil asset forfeiture actions are a real risk for landlords that knowingly rent to cannabis tenants. Making matters worse, the Department of Justice rescinded Obama-era enforcement guidance that deprioritized prosecution of state-legal cannabis businesses that comply with state law and don’t involve themselves with things that the federal government really cares about, like organized crime, growing on federal land, advertising to minors, or exporting to non-legal states.

So that was the scary part. The good news is that with each passing day, the federal government is getting closer to adjusting federal law to align with public opinion on legalization, whether it’s the administration apparently abandoning the federal crackdown on cannabis, or the Senate minority leader introducing a bill to decriminalize, or the former Republican Speaker of the House joining the board of a cannabis investment fund and saying his views on cannabis have “evolved.” While the Department of Justice is still prosecuting cannabis operations and filing asset forfeiture actions, in the last few years it has continued to follow the Cole Memo priorities, even post-rescission, a fact that may actually prove to help California establish and enforce its regulatory regime.

The key to this equation for commercial landlords is requiring a tenant’s strict compliance with state law as an affirmative obligation of the lease agreement, and building in termination contingencies for changes in law or federal enforcement actions.

My prospective tenant says she needs a signed lease before she can get a permit to operate, but I don’t want her in without a permit. How do I protect myself?

In most jurisdictions, both the local permit and the state license are tied to the property, and are non-transferable, so both parties almost always run into this chicken-and-egg problem. A common solution is to build in a licensing timeline and contingencies for failure of permits to issue. A bit like a tenant improvements build-out plan but with fingerprint scans and background checks, cannabis permits and licenses are no sure thing. But the uncertainty of getting government approvals can be built into the lease, sometimes with abated rent in the meantime.

My property insurance seems like it might increase, should I pass that cost onto the tenant?

Trick question: You need to start shopping for new insurance. You will likely lose your existing building insurance coverage when your carrier finds out you’re bringing on a cannabis tenant, and if you wait until you have to submit a claim to let them know, you could have a rude awakening when the carrier declines to pay on the policy due to breach of the insurance contract. While landlords can charge a premium for rent to cannabis tenants, so too can insurance companies charge a premium for premiums on commercial cannabis tenancies.

I have a mortgage on my building, will that be affected if I take on a cannabis tenant?

It depends on the contract, but probably. And that also applies if you want to refinance down the road. Most loan agreements and deeds of trust securing a loan with real property contain some sort of language requiring compliance with “all laws” regarding use of the property for the duration of the loan. Absent a smart carve-out for federal law inconsistent with state cannabis laws, such phrasing presents a problem for potential cannabis uses. Any decision to take on a cannabis tenant must consider existing security interests on the property and compliance with the terms of the contracts. That may mean shopping for hard-loans, but it’s certainly a problem better dealt with prior to the new tenancy rather than midway through when you find out your lender is calling your loan due for violation of contract terms.

My potential cannabis tenant wants to sublease to other operators. Is that a problem?

It depends what kind of subleasing we’re talking about. The general rule is that the state prohibits a tenant from subleasing all or part of a licensed premises. But as of last month, the state is now allowing manufacturers, under certain circumstances, to operate in shared spaces under a sort of timeshare arrangement. Depending on the nature of the space and the terms of the proposed subtenancies, a landlord may want to prohibit subleasing in the lease terms and work backwards from there.

At the current rate, we could soon see a sea change in federal policy such that cannabis tenancies become less risky and less expensive very quickly. But even if some of the more modest proposals take hold, it will still be imperative to mandate strict compliance with state cannabis laws as part of a tenant’s lease obligations as a means to protect the landlord, as well as the viability of the tenancy. Only time will tell.

For more on cannabis leasing generally, see:

California marijuana manufacturer
Finally, a boost for small manufacturers.

This past Friday, the California Department of Public Health—the agency charged with regulating commercial cannabis manufacturing—issued new emergency rules to allow certain types of manufacturers to operate in shared use facilities and on shared equipment, under essentially a sort of timeshare sublease arrangement. The move is a win for small, medium, and artisan manufacturers that don’t have the budget to buy commercial property or take on an expensive lease, and who have the ability to run a lean operation without large space requirements.

The new rules require an existing “primary licensee” with a Type 6 (nonvolatile extraction), Type 7 (volatile extraction), or Type N (infusion) license that either owns or leases suitable manufacturing space. If the locality approves of the arrangement and issues the appropriate permits, the primary licensee can then enter into a use agreement with multiple “Type S” licensees— manufacturers that can engage in packaging and labeling, food infusion, and some butter and oil extraction operations required for the infusion process, all in the same space, as long as they have less than $500,000 in annual revenue.

Each Type S licensee must have their own designated space to store their cannabis and cannabis products, and the shared-use facility must have a security plan as with any other licensee. Under this new arrangement, however, Type S licensees can have exclusive access to the shared-use facility and equipment at their own designated times, like a time share. The California Bureau of Cannabis Control’s existing rules prohibit licensees from subletting all or part of a licensed premises. But under the new Type S rules, the use agreement creating the shared-use arrangement satisfies the requirement of lessees to demonstrate the legal right to occupy a space and obtain landlord approval for the proposed cannabis activity, implying that the relationship is akin to a sublease and thus seemingly creating a limited exception to the prohibition.

What this means for manufacturers looking to break into the market is that even in high-priced areas, there is an opportunity to cut costs by sharing rent and equipment—two of the largest recurring expenses for manufacturing operations. Companies with shared space can also potentially take advantage of group savings on expenses like insurance, maintenance and service contracts, utilities, security services, and distribution. On the other side of the equation, the new rules also present an upside for landlords and master tenant “primary licensees,” whose owned or leased space will now be able to command more overall rent, much like a dated 3-bedroom apartment in San Francisco can command $6,000: more tenants to spread the cost.

The next question will be what other actions the state might take to benefit small and medium commercial cannabis operations, as it faces challenges claiming that it has benefitted large scale operators at the expense of the still-growing artisan industry. Time will tell, but at the moment, small-scale manufacturers have cause to celebrate.

marijuana bankruptcy lease
Bankruptcy cases have been hard, when cannabis is involved.

A recent unpublished decision out of the Ninth Circuit Bankruptcy Appellate Panel presents an interesting set of facts and a decision that may leave one questioning which direction the bankruptcy courts might be headed in the era of legalized cannabis. An elderly Nevada resident owned some commercial property at a shopping mall in South Lake Tahoe, and had been leasing it for several years to a medicinal cannabis dispensary (the lease specifically authorized the tenant to operate a “dispensary”). After several years of state-legal operations, an argument arose over an alleged option agreement to purchase the property, and the tenant sued to force a sale of the property. The bank holding the mortgage recorded a default shortly thereafter and began foreclosure proceedings.

The owner then filed for Chapter 13 bankruptcy, which is a form of debt reorganization that allows a debtor to pay creditors on a court-approved payment plan. Her proposed plan called for her to sell off the commercial property occupied by the dispensary but continue renting it in the meantime, so she filed a motion to reject the lease and the option agreement, and proposed a payment plan that included giving the bank rental income from the dispensary. The city also joined in, asking the court to reject the lease on the grounds that the tenant’s permit to operate the dispensary had expired due to the owner’s failure to provide written consent (a good plug for including a landlord cooperation clause in commercial cannabis leases).

The tenant fired back with an interesting approach: he moved to dismiss the bankruptcy petition altogether on the grounds that the owner’s acceptance of his cannabis dispensary’s rent payments violated the federal Controlled Substances Act (CSA). None of the motions were heard, though, because the lower bankruptcy court decided to dismiss the petition on its own, declaring that the owner had “committed a crime” by accepting rent from the dispensary while the bankruptcy case was pending.

On appeal, the bankruptcy appellate panel vacated the lower court’s decision and remanded, because the court had failed to articulate any findings or legal basis justifying the conclusion that the owner was violating the CSA and that violation was grounds for dismissal. The appellate panel in its opinion discussed the importance of establishing knowledge and intent to lease the property for marijuana cultivation in order to prove a CSA violation by an owner, and in turn to use that violation as a basis for rejecting a bankruptcy petition. In sum, the appellate panel highlighted the high bar that a court must clear to be able to use accepting cannabis rents as a reason to deny a property owner’s bankruptcy petition, even were the rents are accepted after the petition was filed.

While the owner’s bankruptcy case may have lived to fight another day, nothing about the case invalidates the CSA or even precludes using it as grounds for dismissing a bankruptcy petition. But the case highlights the ongoing conflict that federal courts are confronting due to the status of state-legal cannabis as being federally illegal. The lesson of the case is nicely framed in the concurring opinion: “With over twenty-five states allowing the medical or recreational use of marijuana, courts increasingly need to address the needs of litigants who are in compliance with state law while not excusing activity that violates federal law.”

oakland cannabis marijuana

Oakland’s City Council recently passed what is, to our knowledge, a first-of-its-kind ordinance intended to protect residential tenants in the city’s “Green Zone” from being evicted by cannabis businesses (as a resident of Oakland’s “Green Zone,” this is an issue of both personal and professional importance to me). The ordinance passed on its first reading last week, and the second reading will happen today.

The issue of cannabis-fueled residential displacement in Oakland seems to have come to everyone’s attention a few months ago, when a Denver-based cannabis company called Green Sage bought The Oakland Cannery, a community of live-work lofts that house more than 30 artists and makers. The tenants learned from representatives of the company that their intention was to convert the building to commercial use space, and to use it as a cannabis cultivation facility. Residents were told they would not be allowed to stay.

While many within the industry are quick to tout the economic benefits brought about by cannabis legalization (which are undeniable), Oakland is one of the first cities to grapple with the potential negative downstream effects on communities that are suddenly flooded with cannabis business dollars. The City recognizes the Bay Area’s affordability crisis in terms of housing, as well as the importance of “affordable housing and space for artistic and creative enterprises and small economic enterprises and businesses.” The City of Oakland Planning Code allows for a variety of live/work uses in its industrial and commercial zones, which provides important affordable housing and space for these creative and small economic enterprises.

The live/work spaces that the City is seeking to protect are located within the City’s “Green Zone,” which was established in May 2016. Since Spring of 2017, when the City began receiving applications for cannabis businesses, they have received more than eight hundred such applications. In its report, the City identified at least twenty-five permitted live/work properties in the “Green Zone” where cannabis businesses are allowed to situate. The City recognized that these properties, which are located in traditionally industrial areas, tend to be “both more affordable for residents and more conducive to businesses that support artists, makers, and other workers in creative sectors than in other areas of the City that allow more traditional housing and commercial uses.”

As anyone with any experience in vying for a properly-zoned space for their cannabis business in California knows, these spaces are hard to come by, and competition is fierce. The fact that an out-of-state cannabis company purchased The Oakland Cannery does not surprise us, and without intervention by the City, it’s likely that other owners of these live/work buildings would be tempted by the soaring purchase prices commanded by buildings that are zoned for commercial cannabis uses. Buildings in areas of Oakland that were for many years completely undesirable are now quite valuable, if those buildings can be put to use for cannabis cultivation or manufacturing.

In passing this ordinance, the stated purpose of the City Council is to “restrict and prohibit the issuance of cannabis approvals and permits in properties utilized for Work/Live or residential purposes [that existed as of March 6, 2018] to preserve the public peace, health, safety, and general welfare of the citizens and residents of the City of Oakland.” As we stated above, this is the first ordinance we’ve seen that intentionally carves out a cannabis zoning exception for live/work spaces, and given the character of the communities in Oakland that are encompassed by the “Green Zone,” I think this ordinance makes sense. It certainly shows that the City of Oakland continues to regulate cannabis in a way that is both progressive and beneficial to its communities and residents.

Oregon marijuana josephine
Josephine County’s anti-cannabis ordinance is frozen, for now.

The last few months have been a bit of a whirlwind for cannabis producers in Josephine County, Oregon. Back in September, a coalition of producers stopped a county ordinance targeting farms in rural residential zones that would have drastically increased setback requirements, required the OLCC licensee itself to own the real property, and prohibited any farm from using private roads, easements, or owner-maintained public right-of-ways.

Celebration proved premature, as the county adopted a new ordinance on December 6, 2017 that is arguably worse. The ordinance targets all properties zoned rural residential with more than 12 mature plants and drastically curtails commercial cannabis production. For example, on rural residential lots:

  1. Cannabis production is banned on all lots or parcels of five acres or less.
  2. Cannabis production on lots larger than five acres is limited to an eighth of the size that would otherwise be allowed under OLCC rules.
  3. 100 foot setback are on all sides are required for all structures and grow canopies.
  4. The OLCC licensee must itself own the real property.

Farms hoping to avoid these requirements must have been fully licensed by the OLCC before March 6, 2018 in order to apply for a variance from these regulations.

As expected, earlier this year a group of growers filed suit against the county before Oregon’s Land Use Board of Appeals (“LUBA”). Although LUBA petitions are not easily available, LUBA issued an order on February 5, 2018 that stayed (froze) implementation of the ordinance pending further proceedings, and gives us an insight into the claims raised by the petitioners.

The petitioners were tasked with establishing 1) “a colorable claim of error in the land use decision or limited land use decision under review;” and 2) “that the petitioner[s] will suffer irreparable injury if the stay is not granted.” The petitioner met both thresholds, so let’s see how they did it.

A Colorable Claim of Error

In Thurston Hills Neigh. Assoc. v. City of Springfield, 19 Or LUBA 591 (1990), LUBA stated that the standard to establish a colorable claim of error is “not a demanding standard”. The petitioners do not need to establish they will win on the merits. Rather, they need only show “that the errors alleged are sufficient to result in reversal or remand of the decision if found to be correct.” In fact, in Thurston Hills, LUBA simply looked to whether the petitioner’s claims were “devoid of any legal merit.” In the present case, LUBA found that the petitioners claims have legal merit. Specifically, the petitioners argue:

  1. The ordinance violates ORS 215.130(5) because it does not allow farms operating at the time the ordinance was adopted to continue operating. ORS 215.130(5) essentially prohibits a county from adopting an ordinance that retroactively bans existing lawful uses.
  2. The county failed to give mandatory notices to the owners of any properties that would be limited or prohibited from any previously allowed uses.
  3. Local jurisdictions are only allowed to place “reasonable regulations” on commercial cannabis production, and this ordinance does not qualify. Note that this same argument was advanced against a similar ordinance in Jackson County but that LUBA and the Oregon Court of Appeals determined that Jackson County’s ordinance qualified as a reasonable regulation.

Irreparable Injury

Because the “irreparable injury” requires an injury that cannot be compensated adequately in money damages, the petitioners focused primarily on the existing strains and customer goodwill that would disappear if the county succeeds in banning their farms. LUBA easily sided with petitioners on this point, but the question got a bit trickier because the petitioners needed to also show that the county’s conduct was “probable rather than merely threatened or feared” and that “the resulting injury must be probable rather than merely threatened or feared.”

The county argued that these negative effects on petitioners were overblown because the ordinance provided an opportunity for non-compliant properties to obtain a non-conforming use application. The petitioners cleverly noted that the OLCC will likely refuse any license renewals while a licensee is undertaking the non-conforming use process, so even participating in the process itself puts the farms at risk. The court was convinced and issued a stay.

Next Steps and Predictions

The petitioners and the county will advance their arguments at a hearing today, so we will soon find out whether this ordinance qualifies as a “reasonable regulation.” Similar arguments against Jackson County were shot down, but perhaps these petitioners have identified some nuances that will win the day. In this case, with the retroactivity and notice problems identified by the petitioner we feel comfortable putting our money on the growers.

Courts often invalidate unfair spot zoning ordinances.

We recently discussed the California Environmental Quality Act as a limitation on local zoning authority through environmental regulation. Another important limitation on local authority when it comes to cannabis ordinances is spot zoning, which is the act of singling out specific parcels of land to benefit specific owners at the expense of others in the surrounding areas. Spot zoning can exist in the form of restricting activities from occurring on specific parcels, or by providing exclusive use benefits to specific parcels—such as allowing licensed marijuana operations in select places. It is essentially the practice of creating zoning “islands” that are decidedly dissimilar to their surrounding areas, and is often the subject of legal challenges.

Recently, a San Bernardino County Superior Court judge invalidated Measure O, a voter-approved ballot initiative that eliminated a city-wide ban on medicinal cannabis and required the City of San Bernardino to allow commercial cannabis operations in certain parts of the city. The court found that although Measure O provided a variety of areas in which cannabis cultivation, manufacturing, testing, transportation, and distribution could occur, it limited the possible dispensary sites to just two addresses, one of which was the Flesh Showgirls strip club.

The court noted that not all spot zoning is invalid per se, but spot zoning is impermissible if there is no rational basis for it—i.e. if it is arbitrary or capricious. An example of potentially permissible spot zoning would be restricting a portion of land within a commercial development to residential use, because doing so might benefit the public interest by maintaining dedicated housing. Similarly, a city might allow an island of land within a residential neighborhood to obtain commercial licenses for retail and light manufacturing, in order to preserve a neighborhood commercial district for the benefit of the local community.

In the San Bernardino case, however, the court found no such rational basis. The court opined that no justification was provided for why two particular parcels were singled out as the only locations in the city that could have dispensary use. According to the court’s ruling, “these two addresses are separated from each other by several miles and are surrounded on all sides by similarly situated yet non-qualifying properties,” and that there was no rational basis for doing so, nor was there any discernible public interest served. The court determined that Measure O effectively created a zoning duopoly in the two dispensary addresses “with the owners of these two locations the sole beneficiaries.” Accordingly, the court concluded that unlawful spot zoning had occurred, and held that because it was not feasible to sever the dispensary zoning from the overall initiative, Measure O was invalid in its entirety.

We have heard rumblings of special interest groups organizing to pass initiatives in California jurisdictions that currently prohibit commercial cannabis activity. Any groups pursuing such a path should be mindful of the Measure O case and the invalidity of spot zoning without rational basis. While the idea of eliminating competition by drafting a ballot measure favoring select parcels of land may seem like an attractive business proposition, even if an initiative passes with support of the voters, it can still be overturned by a court of law if it is legally defective.

While San Bernardino County may have to go back to the drawing board on its cannabis zoning, the lesson is clear: if you’re going to limit the places where cannabis businesses can operate, there has to be a rational basis for doing so that serves a legitimate public interest, and it cannot create an unfair monopoly over the market for select participants. Otherwise, you risk a court invalidating the ordinance altogether.

cannabis subordination loan
Best if landlord, tenant and lender talk out that cannabis loan ahead of time.

Commercial cannabis leases are different than other commercial leases in many important ways. In other respects, however, they can be quite similar. One item that tends to fall into the latter category is the creation of a landlord’s lien on the tenant’s personal property in the event of an uncured tenant default. For example, if a marijuana producer fails to pay rent, the landlord acquires an ownership interest in that producer’s lights, fans, security equipment, and even the cannabis itself. If the lease is drawn up correctly, the landlord would then be able to seize these assets and liquidate them, in accordance with state law.

When representing landlords, this type of provision makes it into every type of cannabis lease we draft. When representing tenants, we often try to narrow this right, especially in situations where the tenant may be taking on debt. Why? Because lenders often insist on priority rights in the event that a pot business cannot repay a loan. In many cases, the lender will come prepared with a “Waiver and Consent Agreement” or a “Subordination and Consent Agreement.” The tenant is tasked with acquiring its landlord’s signature on this contract, so that if there is a default under the lease, the landlord does not preempt the lender’s rights in the tenant’s property (which serves as collateral for the loan).

From the landlord’s perspective, subordinating its lien on the tenant’s personal property is preferred to a total waiver of the lien. The lender won’t care either way, so long as it receives a primary security interest in the cannabis and everything else. For that reason, most of the time the parties will end up with the landlord agreeing that its lien is subordinate to the lender’s right, but not totally extinguished (“waived”). That way, the landlord is assured that its tenant will receive the cash needed to operate, and will retain the right to hop in line behind the lender and lien on any assets, as needed.

Landlords should be aware that the waiver or subordination agreement will typically allow the lender to enter the leased premises and remove the trade fixtures and even the marijuana itself, subject to state rules. On this point, the landlord will want to require that the lender minimize disturbance with respect to any other tenants on site, and require that removal occur prior to the end of the lease term. Once the lender is in the space, the landlord will want to ensure that the lender is required to comply with state marijuana rules, provide evidence of insurance, and keep the premises open for inspection, among other items.

There are a host of other concerns that a boilerplate consent or subordination document will create in the context of a cannabis loan to a tenant operator. These range from specific items, like the landlord’s obligation to notify the lender of a tenant’s default, to general items, like restrictions on the ability of a landlord and tenant to amend the lease agreement. Depending on which chair you are in—landlord, tenant or lender—these items will have different repercussions and should be negotiated with that in mind.

Each party’s goal, as always, will be to minimize risk and to maximize the ability to make and receive payments, in accordance with state and local rules. If you understand the basics of cannabis leases, lender subordination agreements, and your state’s disclosure requirements for cannabis lenders, you should be able to propose a contract solution that works for everyone. That way, in the event of a default under a loan or lease, the parties won’t have to fight over what happens next.

california cannabis
Pro environment? Or just anti-cannabis?

As we’ve discussed time and time again, California’s voter-passed cannabis legalization initiative, as well as all subsequent statutory and regulatory additions to that law, maintains local governments as the ultimate arbiters of whether and how commercial cannabis operations can take place within any given county or municipality in the state. The most prominent exercise of that authority exists through local permits and licenses (which are now a prerequisite for any state license), and land use laws, such as zoning ordinances. The starting point for any property owner considering a cannabis use on the property is the applicable zoning law and the local ordinance on cannabis, if any. Recently, property values in appropriately zoned places have appreciated accordingly.

But as the new laws are implemented, we are seeing the limits of local authority when it comes to zoning for cannabis operations. In one recent example, a group advocating for a moratorium on marijuana in San Mateo sued the County of San Mateo for opting to issue a “negative declaration” stating that its new cannabis ordinance would not have any significant impact on the environment, rather than engaging in the more rigorous option of preparing a full environmental impact report to study the effects of the proposed activity. The ordinance generally prohibits all cannabis activity except cultivation in greenhouses and transportation.

The petitioners in San Mateo brought the writ petition pursuant to the California Environmental Quality Act (“CEQA”), alleging that “the county prejudicially thwarted CEQA’s statutory goals, including environmental protection, informed decision-making and informed public participation.” According to NORML, the petitioners are an anti-cannabis group.

CEQA requires environmental review of discretionary projects to inform the public and government decision makers of the environmental consequences of their decisions and must be interpreted in such manner to afford the fullest possible protection to the environment within the reasonable scope of the statutory language. Unless exempted, all discretionary projects must receive environmental review pursuant to CEQA.

Under CEQA, the “lead agency”—the public agency principally responsible for approving a proposed project, in this case the County of San Mateo—is responsible for preparing the environmental documents for a project, including any negative declaration or environmental impact report (EIR). If a project is not exempt from CEQA, the lead agency must prepare an initial study to determine whether the project will have a significant impact on the environment, or skip the initial study and conduct an EIR if it is obvious that an EIR is required.

A negative declaration, as opposed to an EIR, is appropriate in two situations: (1) when there is no substantial evidence that shows that the project may have a significant impact on the environment, or (2) the initial study identifies potentially significant impacts, but revisions made to the project before public review of the negative declaration reduce impacts to a level of insignificance. Before approval of a negative declaration, the lead agency must find that there is no substantial evidence that the project may have a significant effect on the environment.

An EIR must be prepared if a project is not exempt from CEQA and does not qualify for a negative declaration. Generally, an EIR is required whenever it can be fairly argued that substantial evidence indicates that the project may have a significant impact on the environment. CEQA allows plaintiffs to sue public agencies for failure to comply. Plaintiffs can challenge a public agency’s decision to prepare a negative declaration instead of an EIR (like the San Mateo case), or a public agency’s determination that a project is exempt from CEQA, among other things.

CEQA litigation is rampant, and public agencies and developers alike are critical of its abuse by NIMBY groups and others who may bring an action for an improper purpose. For example, a competitor may file a CEQA lawsuit to delay or derail a competing project, or a labor union might file a CEQA lawsuit to secure an agreement that gives that union control over which project jobs will be allocated among which unions.

While public agencies, rather than private businesses, are ultimately responsible for determining how to proceed under CEQA, operators and developers should be mindful of the potential delays to their projects that could result from challenges brought by CEQA plaintiffs, and to pay close attention to any objections raised against the draft environmental document during the government approval process, which is a requirement for standing to bring a lawsuit under CEQA and could signal future legal challenges to the project. By the same token, cities and counties should be mindful of the high bar they will have to meet for any decisions involving potential environmental impact, and to plan accordingly by doing a thorough environmental review as part of the approval process for any cannabis-related proposals.

In some ways, CEQA challenges can be seen as part of the California cannabis regulatory regime’s rite of passage into public life, just as any other California industry has to contend with. But this is also an opportunity for California’s state regulators and local agencies to get it right and set an example for other states, and to show how the environmental damage caused by prohibition-era operations can be successfully mitigated with robust regulation and implementation of environmental standards. Until then, we expect to see more lawsuits brought by anti-cannabis and NIMBY groups using CEQA as a tool to challenge cannabis projects throughout California.

marijuana lease california
Leave yourself some room to maneuver with that cannabis lease.

The year 2018 began with a mixed bag. California, the nation’s most populous state and its most powerful economic engine, finally began issuing licenses to medicinal and adult use commercial cannabis businesses under the state’s new regulatory regime. Days later, the Attorney General issued a memorandum rescinding the 2013 Cole Memo enforcement guidelines, despite indicating to the contrary several months prior. There has since been bipartisan backlash against Mr. Sessions’ decision, and there are now numerous legislative proposals in congress as to how the federal government will move forward with respect to cannabis.

In the meantime, property owners still have to plan for the future, whether that means deciding how to use their property, or whom to rent commercial space to and under what terms. Operators and landlords alike are uncertain what to expect: on the one hand, state governments are issuing cannabis licenses freely; on the other, the federal government is telling its prosecutors to pursue any and all of them as they see fit–  regardless of any state’s laws. One strategy for approaching all this uncertainty is by building early termination contingencies into the lease. Below are a few of many contingencies that commercial cannabis landlords and tenants alike should consider including as part of a potential tenancy.

  1. Federal enforcement actions. This is what keeps state-legal operators up at night and what many legislators are currently trying to protect against. As long as cannabis remains federally illegal in all forms, however, this will remain a risk. One way to potentially mitigate that risk is by allowing for mutual early termination options in the event of any actual or specifically threatened enforcement actions, such as civil asset forfeiture. If the federal government’s goal is for cannabis operations on the premises to cease, then allowing each party an opportunity to force termination of the lease should be helpful.
  2. Changes in federal law and/or enforcement priorities. Similar to federal enforcement actions, the parties may want to include options to terminate the lease early if something changes at the federal level to an extent that both parties no longer feel comfortable with state law compliance alone. How significant that change would need to be is up to the parties’ negotiations and levels of risk tolerance. For example, while the Cole Memo has been rescinded, the Rohrabacher-Blumenauer amendment protecting state-compliant medicinal operations is still in effect (if only barely), so the recent federal action may not necessarily be cause for parties to end a tenancy.
  3. Cole Memo priorities as affirmative lease obligations. Just because the Cole Memo has been withdrawn does not make it irrelevant. The Cole Memo is essentially a well-thought-out list of the federal government’s highest priorities for enforcement against cannabis operators, such as preventing sale to minors, diversion to non-cannabis-legal states, and revenue to criminal organizations. Keeping these priorities in the lease as affirmative obligations that the tenant must comply with, and giving the landlord an early termination option if any one is violated, adds an extra layer of protection for both parties and helps further the state’s goal of elevating good actors and sorting out the bad. Also, we’ve already seen some federal prosecutors issue statements to the effect that existing enforcement priorities (i.e. the Cole Memo) will guide future enforcement decisions.
  4. Change in local laws/nonconforming use designation. Federal enforcement and changes in federal law are not the only things to pay attention to. California law gives cities and counties final say in whether and to what extent cannabis operations will be allowed in their jurisdictions. If something changes in local law, such as a zoning ordinance, and the proposed use becomes nonconforming and unlawful, then whether or not operations have commenced, the parties may want an option to exit the tenancy rather than fight the local government.
  5. Secured interests. Just as with residential mortgages, contracts supporting secured interests on commercial property often contain “compliance with all laws” provisions. In light of the recent federal action, lenders may be less comfortable with cannabis uses on the property securing their investment, and may be more prone to call the loan due in full, creating a problem for both landlord and tenant. In such event, the landlord may want an option to terminate the lease early without penalty.

We don’t know where the state-vs-federal conflict will go from here, and for now the cannabis industry will have to continue dealing with uncertainty. So far it seems the market is betting on the states to come out ahead. In the meantime, there are some meaningful items to include in a commercial cannabis lease that may mitigate some uncertainty and risk.