Recreational Marijuana

oregon cannabis industry

Here we are at the end of 2018, which means it’s time for the third annual “State of the State” post on Oregon cannabis (the 2017 post is here and the 2016 post is here). The year 2018 was truly remarkable in the Oregon industry, and we saw a lot of change, from regulatory evolution to industry consolidation to overall market dynamism. Below is a high-level summary of what we are seeing in the industry as we move into the new year.

Competition is intense.

The marijuana market is saturated with both licensees and product. October is always the peak month for harvest, and the Portland Business Journal, by way of OLCC, reports that producers brought in 2.54 million pounds that month (measured in wet weight). This was a slight increase from 2.48 million harvested pounds in 2017. For the full year, production was running 9% higher than 2017, and wholesale prices fell by more than 50% from mid-2017 to mid-2018. As any store owner will tell you, retail prices have fallen significantly too.

In addition to product saturation in the market, the number of licensees has continued to grow. OLCC issued an additional 300+ producer licenses in 2018, bringing the total number to 1,110. There are also 1,141 additional producers awaiting licensure. With respect to retail, there are now 606 active dispensaries in the state, including 173 of them in the City of Portland alone. Although OLCC officially “paused” its review of all new applications submitted after June 15th, we don’t see the market becoming less competitive anytime soon.

The M&A market is also intense.

There are no readily available statistics on the number of purchases and sales of marijuana businesses statewide. Anecdotally though, the amount of this activity coming through our office is remarkable. In the past 12 months, we have handled more cannabis business mergers and acquisitions than we ever could have predicted. These transactions range from people giving up failed businesses for a song, to leading local brands joining forces, to the seemingly never-ending stream of reverse mergers and acquisitions involving Canadian public companies. Although Oregon is no longer the only state to allow non-resident ownership, we don’t see a slowdown in this type of activity anytime soon. Expect Oregon to remain a buyer’s market in 2019.

The rules are pretty settled…

Oregon’s statutory changes and administrative rules didn’t change radically in 2018– at least compared to the past few years. OLCC continues to work around the edges, as with the recent push to end the alternating proprietor arrangement and to tighten up the definition on banned “added substances” in finished products. Overall, though, much of the legislative and agency efforts were centered on black market eradication and on building out the industrial hemp program. We applaud both of those efforts.

… But people keep stepping in it.

If the leading 2018 activity for our Portland marijuana business lawyers was buying and selling businesses, dealing with administrative violations was a close second. OLCC has stepped up its efforts program-wide in this manner: It begins with application scrutiny and extends through notices of violation against licensed operators. Certain violations are unfortunately common. Those include “financial interest” violations (yes, lenders must be disclosed), unapproved site changes, camera issues and manifest issues. We are seeing the same types of things, over and over, from companies large and small. Although many of these matters can be settled, they require extreme care and attention, and are best avoided through vigilant compliance.

People are suing each other.

We mentioned litigation last year, and this year is no different. Some of these disputes stem from business failure, undocumented transactions or deals gone south. We still come across the odd con job. There are also more exotic matters like RICO lawsuits and nuisance battles between marijuana and hemp farms. As long as the industry continues to evolve at its current rapid pace, we expect to see more litigation than in other commodities markets.

Hemp just keeps getting bigger.

This has been another big practice area for our office. Industrial hemp demand skyrocketed in 2018 with the CBD craze. Many Oregon farms and processors capitalized, with the number of Oregon Department of Agriculture (ODA) growers rapidly expanding from 233 to 568. As compared to OLCC licensing, acquiring a hemp grower’s or handler’s registration from the ODA is fast and easy, and restrictions on sale are far less cumbersome. Now that hemp is legal nationwide, we only expect this trend to continue into 2019.

california marijuana cannabis licensingIn California, under the Medicinal and Adult-Use Cannabis and Regulation Safety Act (MAUCRSA), temporary licenses began issuing to cannabis businesses on January 1, 2018. Since then, the state agencies in charge of MAUCRSA’s implementation (the Bureau of Cannabis Control (BCC), the California Department of Public Health (CDPH), and the California Department of Food and Agriculture (CDFA)) have worked pretty much round the clock on adopting permanent regulations. In case you forgot, the agencies dropped their initial proposed permanent rules this past summer, tweaked those, and then released another round of revised proposed permanent regulations last month (which are now in the hands of the Office of Administrative Law (OAL) for an overall review). That last round of proposed permanent rules (see herehere, and here) is very likely to become effective (pending OAL’s review) in early January. Right now, all licensees are still operating under the emergency rules that came out in fall of 2017. And pretty much everyone is racing to get their temporary licenses, which will NOT be available after December 31.

Despite the fact that the state has made great progress towards permanent rules, many questions and ambiguities around licensing and operational conduct remain. In fact, some of the grayer areas of the emergency regulations have been expanded by the proposed permanent rules for better or worse. In turn, with 2019 just around the corner, here’s my list of the top 10 unknowns that still remain for California cannabis:

    1.    IP licensing and white labeling restrictions.

In case you’ve been living under a rock, one of the most shocking proposed permanent rules to come from the BCC is section 5032(b) (which, yes, affects all licensees). Essentially, section 5032 (b), as originally written, basically prohibited all IP licensing and white labeling agreements between cannabis licensees and non-licensees. That rule stated that:

(a) Licensees shall not conduct commercial cannabis activities on behalf of, at the request of, or pursuant to a contract with any person that is not licensed under the Act. Such prohibited commercial cannabis activities include, but are not limited to, the following: (1) Procuring or purchasing cannabis goods from a licensed cultivator or licensed manufacturer; (2) Manufacturing cannabis goods according to the specifications of a non-licensee; (3) Packaging and labeling cannabis goods under a non-licensee’s brand or according to the specifications of a non-licensee; (4) Distributing cannabis goods for a non-licensee.

For more detail on that original rule, see our write-up here. During public comment on 5032, there was a good amount of dissent (including our own) in that it’s pretty obvious if such a rule went through a lot of branded product currently on the shelves would have to be tossed. In addition, California would be the only state in the cannabis union to adopt such a strict rule. When the BCC then released the revised proposed rules, 5032(b) was pared down to read as follows:

(b) Licensees shall not conduct commercial cannabis activities on behalf of, at the request of, or pursuant to a contract with any person that is not licensed under the Act.

As you can see, the IP licensing and white labeling examples were deleted, but the rule still makes clear that licensees can’t undertake commercial cannabis activity (i.e., manufacturing, labeling, processing, etc.) “on behalf of, at the request of, or pursuant to a contract” with a non-licensee. Just removing former examples (1)-(4) may have no impact whatsoever here, and it’s certainly confused the situation as a result. And while the BCC’s own comments to 5032 (in its Final Statement of Reasons) indicate that it takes no issue with non-licensee to licensee IP licensing and white labeling relationships, a plain reading of the rule indicates otherwise.

    2.    Ownership issues. 

The BCC struck again in the proposed rules revising “owner” disclosure standards to be much stricter at section 5003. Now, in addition to anyone with 20% or more in equity, the board of directors, the CEO, and anyone or any entity that exercises any direction, control, or management over the licensee, is also an owner. Any individual or entity merely entitled to profit share at or more than 20% is also an owner. This calls into question though how the BCC plans to treat things like cashless options and warrants that have no immediate entitlement to ownership in or profit sharing with the licensee. And what about husbands and wives (which are in community property marriages in California) since there’s no spousal disclosure requirement and they’re technically one person under existing law? The BCC has been silent on all of the foregoing and I have no doubt that these new revised rules may actually incentive people to be even more “creative” in order to avoid owner (and financial interest holder) status.

    3.   Financial Interest Holder woes.

Identifying financial interest holders (FIHs) is more complicated than owners because the FIH definition now encompasses a variety of folks and entities. I recently spoke to the OC Register about how now even lawyers who take a share of the profits of a cannabis business (in exchange for legal services) will now have to be disclosed as FIHs under the new rules. The BCC also made clear that it’s going to sort through more convoluted corporate structures around FIHs to get to the humans providing the capital to or profit sharing with cannabis businesses. At section 5004 of the proposed rules, the BCC now mandates that:

“When an entity has a financial interest in a commercial cannabis business, then all individuals who are owners of that entity shall be considered financial interest holders of the commercial cannabis business. For example, this includes all entities in a multi-layer business structure, as well as the chief executive officer, members of the board of directors, partners, trustees and all persons that have control of a trust, and managing members or non-member managers of the entity. Each entity disclosed as having a financial interest must disclose the identities of persons holding financial interests until only individuals remain.”

Of course, we have no way of really knowing how far the BCC will go here in vetting the individuals behind these structures, though I’m sure more than a few publicly traded companies are suffering severe heartburn at reading this new rule.

    4.    Packaging and labeling compliance in 2019. 

Under CDPH proposed permanent regulations, manufacturers will not have to implement child resistant packaging (CRP) for their cannabis products until 2020. In the interim, retailers will fill the gap by using CRP exit bags. And while CRP is going away for manufacturers, there are a slew of revised and new packaging and labeling standards being implemented upon the rules becoming effective in the new year. The outstanding issue then is that CDPH created no affirmative grace period for manufactured product that’s out there right now and compliant with the emergency regulations, but that doesn’t meet the new packaging and labeling regulations. (A great example is that manufacturers of certain products now have to put the universal symbol not only on outer packaging but also on the product container itself if that outer packaging is “separable” from the product container.) What’s for sure is that retailers cannot possess or sell finished product that doesn’t adhere to the new packaging and labeling rules. So, what exactly will happen to existing, non-compliant product in 2019? That remains a mystery.

    5.    Provisional licensing. 

Provisional licensing is the new temp licensing. (See here for more on the temp license race to secure provisionals for 2019.) Even though a provisional license is the new hot ticket in town, the BCC and CDPH have given no insight into how a licensee actually secures this license. I surmise that the issuance of provisionals will be automatic (similar to how the state was just renewing temp licenses automatically if a temporary licensee was in clear and earnest pursuit of its annual license). CDFA is the only agency that’s produced a fact sheet on the topic, but no agency has publicly announced the exact logistics around provisional licensing yet.

    6.    Social equity programs. 

For every city that’s done a social equity program, it’s been a challenge out of the gate to do it correctly and sustainably. Los Angeles is just getting started with its program while certain other California cities are trying but are producing meager results at best. While the state finally decided to financially back local social equity programs, it’s clear that the state and the cities need to study this particular social experiment for some time before a gold standard will actually emerge. In turn, the success of these programs is definitely a large unknown.

    7.    Banking.

Banking in California is the number question I get on a weekly basis at this point: namely, when the hell is it going to commence? I’m a firm believer that unless and until our permanent regulations are finalized and are proven to work relative to barriers to entry and vetting owners and FIHs, we will not see private sector banking in California. Our licensing and enforcement systems are still too loose/inchoate to satisfy the 2014 FinCEN guidelines, and no public bank is going to materialize here either for various complicated and practical legal reasons (be sure to watch out for banking fraudsters, too). And while California cannabis companies will likely continue to use management companies to help them alleviate some of the inability to access banking, it’s certainly not a long-term solution and it’s downright illegal when that relationship isn’t legitimate or at an arm’s length anyway.

    8.    Fee slotting agreements and anti-competitive tactics. 

On a regular basis now, I’m seeing retailers introduce to my cultivation and manufacturing clients a variety of fee slotting agreements so that my clients can secure known shelf-space in order to remain competitive. This month, I questioned whether such contracts were valid under MAUCRSA where anti-competitive behavior is strictly barred. Only time will tell whether regulators will address these agreements and their impact on the marketplace.

    9.    Tech platforms and delivery. 

The BCC seems to have developed an appetite for wading into increased regulation regarding retailers and delivery tech platforms. Pursuant to section 5415.1 of the proposed permanent BCC regulations, we now have a more robust code of conduct between retailers and tech platforms when it comes to delivery. Now that the BCC has finally opened the door to invading this relationship regarding contractual limitations and restrictions on advertising and marketing for licensees via tech platforms, it begs the question as to whether California is going to go further down the road of trying to essentially regulate tech platforms or not. Given the fact that California is one of the few states that’s embraced delivery, it’s a very important area for development, both legally and for public policy.

    10.    Corporate versus cottage debate rages on. 

Every single state that’s undertaken recreational cannabis has to battle between corporate and cottage interests. And every single state is different in how it’s handled the issue. In the proposed permanent regulations, it’s hard to tell which way California is leaning since those rules still contain some fairly big business friendly propositions (such as still being able to secure countless small cultivation license types, local law permitting, in order to aggregate big acreage) as well as some rules that cut against “Big Marijuana,” like having to disclose shareholders in a publicly traded company as FIHs unless they hold 5% or less of the equity. In 2019, I think we can fully expect the debate between small and large business interests to carry on, but where California lands remains unknown. That’s going to probably continue for quite some time as it works out the kinks spurred by the proposed regulations.

What’s a Washington beverage processor to do?

The Washington State Liquor and Cannabis Board (WSLCB) is creating a real niche in the beverage product design industry through some of its most recent policy pronouncements. As has always been the case, edible (and drinkable) marijuana products are regulated so that they are not appealing to children. There are a host of old and new policies and rules that focus on avoiding marketing marijuana to kids, some of which are explicit (new policy mandating dull colors), and some of which are subjective (packages and labels cannot be designed in a manner that is “especially appealing to children.”).

But in one of a new set of policies that the WSLCB has issued recently, it has also sought to avoid packaging and labeling reminiscent of products made for adults — alcohol. Under BIP-07-2018, marijuana-infused products must not “Mimic, imply, represent or contain any statement, depiction, illustration, design, brand, or name of a product containing alcohol.”

Further, the WSLCB claims that if a product looks like alcohol, a licensee can’t get its product approved even if it includes a disclaimer on the packaging that the product does not contain alcohol. Even though this is a recent development as a written policy, we know that the WSLCB has been treating this as actual policy for a while. We have seen products turned away because of their bottle shape, the typeface on the label, and the ingredient list.

We have so many questions about this policy. Why? Are there large numbers of people going to marijuana retail stores, buying a product because they think it has alcohol, and going home to be disappointed that it doesn’t? Is this something that the alcohol lobby wants the LCB to do? To what end?

In trying to come up with some reason that this policy makes sense, the most charitable interpretation is that the WSLCB is trying to protect someone who lives with other people and reaches into the fridge to get a beer, only to find later that the beer was in fact marijuana. But even that case doesn’t stand up to scrutiny, as it could apply to marijuana beverages in any sort of container. There are only so many types of bottles and labels in the world, and all of them could conceivably be used for drinks that are either marijuana-infused or not. There’s nothing special about a beer bottle that would make it especially more confusing than a plastic soda bottle.

More importantly, this policy seems to contradict the WSLCB’s policy that marijuana beverages should not be marketed to children. I remember being a kid and being nervous when someone handed me a dark glass bottle of root beer for the first time. I knew that I wasn’t supposed to drink alcohol, and I had to triple check, that there wasn’t any in there because the color and shape of the bottle communicated to me that the drink was for adults-only. The WSLCB seems to be taking that tool away from marijuana beverage processors.

Now the WSLCB seems to be telling people that they can’t communicate with their products that something is specifically for children or specifically for adults. This is where smart product designers come in. Marijuana drink makers in Washington must find some type of middle ground that communicates neither. We’re not sure exactly how they can do that, but we wish them the best.

los ángeles cannabis licensingThe ups, downs, and unknowns around L.A. cannabis licensing have abounded from the passage of Measure M back in March 2017. This is not uncommon, especially in large cities, as regulators determine how to handle things on the fly and as issues arise (see, for example, social equity in L.A. and the ability to re-locate for Existing Medical Marijuana Dispensaries (“EMMDs“). L.A., to its credit, has been transparent and pretty consistent in the way it’s treated licensees and stakeholders. To that end, this month, L.A.’s Department of Cannabis Regulation (“DCR”) released a Phase 2 licensing bulletin that’s significantly important for those Phase 2 would-be licensees that seek a temporary license.

Recall, to qualify for Phase II temporary approval/licensing (which triggered priority licensing for existing “non-retailers” like growers and manufacturers) — folks had to meet all of the following criteria:

  1. Engagement prior to January 1, 2016, in the same Non-Retailer Commercial Cannabis Activity for which it sought a license;
  2. Supplier to an Existing Medical Marijuana Dispensary prior to January 1, 2017;
  3. The Business Premises meet all the land use and sensitive use requirements under cannabis laws and the existing City code;
  4. The applicant’s premises have to pass a pre­-license inspection without any fire or life safety violations either;
  5. All outstanding City business tax obligations were paid to the City and the Applicant had to indemnify the City;
  6. Provision to the City of a written agreement with a testing laboratory for testing all Cannabis and Cannabis products and attests to testing all its Cannabis and Cannabis products in accordance with state standards;
  7. Attestation that the Applicant would cease all operations if denied a State license or City License, and the Applicant cannot do any retail activity at its premises;
  8. Qualification under the City’s Social Equity Program (see here for more info); and
  9. Attestation that the Applicant will comply with all operating requirements imposed by DCR and that DCR may immediately suspend or revoke the temporary approval if the Applicant fails to abide by any City operating requirement.
Number 4 above was causing a lot of heartburn amongst Phase II license applicants in that they didn’t really know what to expect. Pre-licensing inspections can be fairly labor intensive depending on the state of the property at issue versus the build out and business plans of a given applicant, and each City has a different standard for a passing grade. In L.A., pre-licensing inspection (which is a pre-requisite to temporary approval) “may include, but is not limited to [an inspection of the business premises by], employees or agents of the following City or county departments: DCR, Building and Safety, Police Department, Fire Department and Los Angeles County Department of Public Health.” And a pre-License inspection consists of, but is not limited to, the following: “approval of the premises diagram; on-site inspection of all applicable building code and fire code requirements; approval of the security plan; fingerprinting; and approval of the fire safety plan (if applicable).”

Plus, applicants must upgrade all applicable electrical and water systems to Building and Fire Code standards before their application will move forward. Again, this is no small task depending on how your building is holding up/what its previous uses and occupancies were.

Temporary approval in L.A. is essential for applicants to also apply for and receive their temporary licenses from the state, which will not be given out or renewed after December 31. This month, L.A. thankfully illuminated for Phase II applicants what to expect for pre-licensing inspections in the City. In its bulletin, the City states:

To be eligible for Phase 2 Priority Processing, among other requirements, an applicant must pass two inspections. One is a DCR inspection to confirm that the applicant’s business premises is built out to substantially match its business premises diagram (i.e., the location and layout of entry points, interior doorways, rooms and walkways match the diagram) and that the business premises is sufficiently secured. The other is a Los Angeles Fire Department Cannabis Unit inspection to confirm that the applicant’s business premises and operations comply with the Los Angeles Fire Code.

The onus here is on the applicant to confirm for the City that it’s ready for pre-licensing inspection. In addition, when DCR confirms a date for an applicant’s inspection, the applicant will be asked to provide its most up-to-date premises diagrams to the DCR (including showing. accurate placement of security cameras). The bottom line of the City’s bulletin is that the physical premises be substantially similar to the premises diagram submitted to the DCR and that the premises be sufficiently secured per City and state law. During the inspection, the DCR will:

  • Walk through each room or area in the premises and assess whether its layout and location is substantially similar to the premises diagram;
  • Determine whether surveillance cameras are recording all areas required to be under surveillance (practically, this is anywhere on the business premises where cannabis goods will be present at any point in time);
  • Determine whether the surveillance system is in a secured area, is functional and can play back recordings upon request; and
  • Determine whether the premises are equipped with a functioning alarm system.

Another big question in L.A. was what the DCR would do with premises that are not 100% built out. The bulletin tells us that:

DCR will inspect the built out area and if all other Phase 2 eligibility requirements are met, grant Temporary Approval for cannabis activities limited to that specific area. Once the remaining areas of the premises are built out, DCR will send out an inspection team again before authorizing cannabis activities in those areas. However, given the large number of Phase 2 eligibility inspections to complete, DCR cannot provide a timeline for when it will be able to schedule a second inspection for an applicant.”

All of this means that it is best to be fully built out (in accordance with your premises diagram and with the fire and safety code) and ready for inspection if you want to get your temporary approval in L.A. anytime soon for your entire facility.

On inspection, also don’t expect to sweet talk the DCR investigator or to learn about the status of your application. Neither will advance your cause with the DCR at this point. Instead, applicants should proceed with business as usual in a professional manner and be as helpful as possible to the DCR investigators and to LAFD.

oregon cannabis license marijuanaRunning a cannabis business is difficult and many people fail. There are a myriad of reasons why these ventures bottom out, although owners tend to blame federal law issues first of all. It’s true that federal law creates a tough environment for cannabis businesses (banking issues, tax issues, branding issues, etc.), but federal prohibition also kept big money sidelined at first, giving small business a real head start. My personal view, after seeing many spectacular business failures and slow motion crashes over the past several years, is that most are some combination of the following: 1) a challenging legal and regulatory environment, 2) saturated markets, and 3) operator error.

A start-up cannabis business cannot control the first two items listed above, but should be able to navigate them. The third item is a different animal. Margin of error tends to be slim for most new ventures, and self-inflicted wounds are difficult to overcome. This blog post covers the five biggest mistakes we continue to see in early stage Oregon cannabis business, and gives suggestions to avoid them.

  1. Failure to properly estimate license transition timelines

Because the Oregon Liquor Control Commission (OLCC) “paused” review of applications submitted after June 15, 2018, most new market entrants are buying their way in through asset or stock sales from existing licensees. The OLCC has a small and overtasked team of change-in-ownership investigators who work with both buyers and sellers on these transactions. Recently, agency higher-ups have advised us that these changes can still happen in as quickly as four to six weeks. However, that almost never occurs. Four to six months seems more common.

Even a non-cannabis business sale can be delayed by many things, from diligence issues to lease negotiations to ironing out terms in final agreements. In the Oregon cannabis industry, administrative vetting and disclosure requirements must be added to that list. Delays are almost always on the buyer side, stemming from initial business structuring, filling out OLCC business structure and individual history forms, submitting fingerprints, etc. Buyers should create realistic timelines to avoid hemorrhaging cash during this phase, and should strongly consider working with someone who has navigated the change-in-ownership process before. It’s a singular process and there is definitely some art to it.

  1. Paying lawyers to expedite your OLCC application

This is a bad idea, but many people do it. Whether for new applications (pretty straightforward) or change-in-ownership (harder) many new businesses spend significant money on lawyers to guide them through the application process. Our Portland office philosophy has always been not to blow through client retainers on ministerial work: We want people to succeed so we can work with them for years. For that reason, we have trained licensing paralegals who push these applications through efficiently and expertly. Attorneys only come in for unusual situations. The bottom line here is that new businesses should save their legal budgets for work that cannot be done by non-lawyers.

  1. Starry-eyed forecasting

You are not going to sell your marijuana for $2,000 a pound in Oregon. Forget it. You also do not have a strain of marijuana that you will patent and license one day to big pharma. You are not the only person trying to run down hemp for distillate, and, closer to home, you should not budget a six-figure salary for yourself or anyone else in the early stage. Although the market challenges have been well publicized, too many people believe that an OLCC marijuana license is tantamount to a license to print money. It’s not. All of this means that it is crucial to dial in your research and expectations before starting out – especially if you are taking on investment and the legal risk attached to that.

  1. Employment issues

For whatever reason, employment practices are often subpar with cannabis businesses. There are a couple of important things to note here. The first is that employee actions, even if unauthorized, can lead to license revocation in Oregon. This means you must ensure your employees are well versed in compliance, and you have to watch them. The second thing to note is employment law is complex and seems to change as often as cannabis licensing rules. We have a host of new employer requirements coming online January 1, 2019 in Oregon, for example. Whenever there is a dispute, courts and administrative bodies tend to favor employees, so it’s important to keep your team in order.

  1. Bad (or no) business agreements

You do not need a tall stack of complex documents to start a cannabis business. You do need the basics, though, and those agreements should be solid. If you are renting property, get a tailored industry lease. If you are organizing an LLC, get an operating agreement that covers matters important to your business, such as management, distributions, protocol for when someone jeopardizes the OLCC license, etc. Or, if you have a white label agreement, ensure that all processes and intellectual property ownership are delineated. The list goes on.

Starting a business can be expensive, and people tend to skim on legal. But nearly all of the cannabis litigation matters my firm is currently handling stem from defective contracts, and from people operating informally in that sense. Reasonably tailored contracts should be a part of any new business plan, and they should not break the bank. These contracts will set both guidelines and expectations for the business, and they operate like insurance when things go wrong.

california cannabis BCC

Today, the Bureau of Cannabis Control (BCC) published its Proposed Text of Regulations Submitted to Office of Administrative Law for review here. We are still in the process of reviewing everything, but there are enough ambiguities to cause us a good deal of concern, particularly with respect to IP licensing and contract manufacturing agreements.

We are also reviewing the BCC’s responses to comments submitted on the proposed regulations back in early November, of which there are about a thousand pages. We’ll be analyzing the regulations section by section and writing about all of the changes over the course of the next week.

Stay tuned.

marijuana bank fincen
Slowly but surely, it’s happening for canna businesses.

According to a recent report from the U.S. Treasury Department’s Financial Crime Enforcement Network (“FinCEN”), a growing number of financial institutions are willing to work with cannabis businesses. As of September 30, 375 banks and 111 credit unions were managing marijuana business accounts.

These numbers reveal a steady growth in the number of financial providers willing to engage with the cannabis industry, despite its federal illegality. The report confirms what our cannabis business lawyers have observed over the past few years in Washington and Oregon: namely, most of our licensed cannabis business clients in those states are banked, and it isn’t as hard as it used to be to acquire a basic merchant account. (California is a different story.)

Nationwide, though, most financial services providers have been reluctant to serve the marijuana industry for years, fearing the federal cannabis prohibition would trigger liability under money laundering laws. Earlier this year, many concluded that banks would refuse to associate with cannabis businesses following the decision by then-U.S. Attorney General Jeff Sessions to retract policy protections for licensed marijuana businesses from federal interference. However, the latest FinCEN report reveals that those fears were mostly speculative.

The American Bankers Association, which recently conducted a survey on the issues faced by banks that are serving cannabis businesses, is advocating for greater legal clarity to banks operating in states where recreational and medical cannabis has been legalized. Indeed, the guidelines currently used by the financial services industry are those published in 2014 by the FinCEN and could use an update given the continued ascendance of marijuana reform.

Several key officials of the Trump administration have also expressed the need to clarify cannabis banking issues. For instance, Treasury Secretary Steven Mnuchin stated in congressional testimony that he wants businesses operating in states where marijuana is legal to be able to store their profits in banks.

I assure you that we don’t want bags of cash … We do want to find a solution to make sure that businesses that have large access to cash have a way to get them into a depository institution for it to be safe.”

In June, Federal Deposit Insurance Corporation Chariwoman Jelena McWilliams explained that she instructed her staff to consider ways to address the banking issues, but that the agency’s hands were “somewhat tied” until federal law legalizes cannabis.

Support for clarification and for fixing marijuana banking problems also comes from the states. A few months ago, a coalition of the top financial regulators located in thirteen states asked Congress to take action to protect banks working with the cannabis industry.

In their letter, the regulators wrote:

It is incumbent on Congress to resolve the conflict between state cannabis programs and federal statutes that effectively create unnecessary risk for banks seeking to operate in this space without the looming threat of civil actions, forfeiture of assets, reputational risk, and criminal penalties.”

Finally, back in June, a bipartisan group of twelve governors urged lawmakers to pass the Strengthening the Tenth Amendment Entrusting States (“STATES”) Act, which proposed to amend the Controlled Substance Act to exempt state-legal marijuana activities.

This growing support for permanent protections of banks that serve cannabis businesses is a promising sign that legal reform is on its way. The newly formed Democratic House has expressed a strong desire to move cannabis legislation, including banking issues, in the new year. Only time will tell whether the Republican-controlled Senate will allow it.

shelf space california cannabis contract
Shelf space is a big deal right now in California cannabis.

With the roll out of the Medicinal and Adult-Use Cannabis Regulation and Safety Act (“MAUCRSA“), our California cannabis attorneys see all kinds of agreements between and among licensees. From IP licensing to white labeling to distribution contracts, we’re beginning to see people emerge from the shadows and enter into written agreements with each other, which is undoubtedly for the best given the amount of litigation that already exists in the industry and given the amount of fighting that’s sure to come regarding commercial disputes. Lately though, what we’ve seen a lot of are “pay-to-stay” and slotting fee agreements between cannabis cultivators, manufacturers, distributors, and retailers. In these agreements, cultivators, manufacturers and distributors are locking retailers into contracts for dedicated, prime-time shelf space. The question, though, is whether such agreements are kosher in California and what you need to know to have a reliable, enforceable, pay-to-stay contract.

California is still pretty dynamic when it comes to contracts between licensees. Unlike other states, California hasn’t really broached the subject of massive restrictions on contracts between licensees (the lone exception is the most recent of proposed permanent regulations that attacked IP licensing and white labeling between licensees and non-licensees). Other states are very particular about licensees exerting undue influence over each other via contract when it comes to things like control, term, and the legitimacy of services/goods being provided to the licensee. Here in California, though, the following are pretty much the only contractual restrictions that exist between licensees in the marketplace:

A licensee shall not perform any of the following acts, or permit any of the following acts to be performed by any employee, agent, or contractor of the licensee:
(1) Make any contract in restraint of trade . . .
(3) Make a sale or contract for the sale of cannabis or cannabis products, or to fix a price charged therefor, or discount from, or rebate upon, that price, on the condition, agreement, or understanding that the consumer or purchaser thereof shall not use or deal in the goods, merchandise, machinery, supplies, commodities, or services of a competitor or competitors of the seller, where the effect of that sale, contract, condition, agreement, or understanding may be to substantially lessen competition or tend to create a monopoly in any line of trade or commerce.
(4) Sell any cannabis or cannabis products at less than cost for the purpose of injuring competitors, destroying competition, or misleading or deceiving purchasers or prospective purchasers . . .
(6) Sell any cannabis or cannabis products at less than the cost thereof to such vendor, or to give away any article or product for the purpose of injuring competitors or destroying competition . . .
In turn, licensees pretty much have free reign to contract for whatever they want for however long they want without fear of interference from state regulators (so long as such agreements basically don’t amount to anti-competitive behavior). In addition, in case you’re thinking that licensee contracts don’t matter, California already passed legislation ensuring that commercial cannabis contracts are indeed enforceable in state court so that no one is left holding the bag over some illegality defense to performance.
On to slotting fee and pay-to-stay agreements. When you walk into the grocery store, the retailer likely isn’t just arranging products by name or color. In fact, what’s likely going on is that certain shelf space for new products has been negotiated and paid for by a manufacturer. And with good reason. In commodities, especially saturated ones, face time with consumers isn’t great and margins can be really poor and the competition is vast. In California, only cannabis retailers can sell to the public, so it’s hugely important for wholesale and distributor licensees to have good placement on shelf space in dispensaries and on the retailers’ online menus. The slotting fee agreement essentially amounts to the lump sum fee the supplier pays to the retailer to reserve their sacred, strategic shelf space. The pay-to-stay agreement (which can be similar to the slotting fee) typically takes things a step further where it’s instituted after the initial slot and addresses issues for existing products like marketing, promotion, inventory stocking, failure fees, and paying extra to ensure that your competitors don’t get any valuable shelf space near you or at all.

What should go into these contracts? Like any other agreement, if you’re the supplier, you want to fully articulate exactly where your placement will be in the store, how often that placement occurs, your inventory schedule, what happens in the event you cannot deliver on the inventory, what happens if no one wants your product despite its placement, what happens if the retailer (for its own benefit) wants to place another, better performing product in close proximity to yours, and the list goes on and on. Suppliers of cannabis in California should not be paying robust slotting fees to retailers willy-nilly. Even though retailers have a lot of leverage where there are still so few of them and because they’re the only licensees with a daily, face-to-face relationship with the public, if you are a supplier of a recognized brand (or even if you’re consistent with product potency and quality assurance testing), you still have some leverage where many cannabis consumers are still coming to the marketplace trying to decide what they like. The other reason cannabis suppliers shouldn’t be paying super high slotting fees is because the contract could be invalidated not because of the cannabis aspect, but because it’s anti-competitive in nature.

You’ve probably already concluded that the companies that can afford the highest slotting fees are the ones who will make it to the shelves of cannabis retailers in California. And you’re likely not wrong since retailers also have to financially survive in this newly regulated marketplace and slotting fee agreements certainly help to allocate the risk on what products to buy and re-sell (or not). In addition, the bigger cannabis brands may not even face the prospect of these contracts from retailers because the retailers desperately want to carry on them on their shelves anyway. That begs the question then of whether slotting fee agreements and pay-to-stay contracts are actually anti-competitive in violation of MAUCRSA. There’s no doubt that they certainly could be if retailers band together and start to create extremely high, universal slotting fees. Or if suppliers decide to lock up entire dispensaries. The upside, though, can be that retailers are actually more willing to take on new products since they shift liabilities for their failure back to the supplier, the slotting relationship makes product distribution more efficient, and consumers can benefit from lower prices where the retailer can better allocate its risk on investing in the presentation of new products. In any event, state regulators have stayed silent on this practice for now (although the FTC, the sleeping giant of the cannabis world, has debated the subject a good amount).

The bottom line? Unless and until regulators squarely address it or suppliers start to sue over the practice, if you’re presented with or need a fee slotting agreement or a pay-to-stay contract, make sure that you check the box on the details of the relationship. Make sure, too, that you’re avoiding anti-competitive terms and conditions if you want to make hay in California.

oregon marijuana cannabis clackamas deschutes We always talk about the cannabis industry being dynamic. That’s true from a markets perspective and it’s true from a regulatory point of view. When it comes to regulations in particular, industry observers tend to focus on the big picture developments: e.g., whether marijuana will finally be re- or de-scheduled at the federal level, whether we will get a farm bill legalizing industrial hemp nationwide, or which new states have legalized cannabis. Those broad issues deservedly get a lot of press. However, marijuana business owners are often more concerned about what is going on locally, at the city or county level. In fact, most cannabis business owners get more passionate about proposed changes to local regulations than proposed state- or even federal law developments.

My law firm has worked with regulated cannabis business in Oregon, Washington and California since 2010. I suspect that none of our cannabis business lawyers support extensive local regulation of marijuana (let alone local licensing programs). Because states tend to promulgate extensive regulatory structures, local rules tend to be duplicative and controversial once you get beyond basic land use concepts. That said, cities and counties are often pressed by their citizens to regulate cannabis businesses, and state governments give ample regulatory authority to local jurisdictions– often including the choice to “opt out” of industry participation altogether.

When localities do regulate cannabis, the process is often iterative, meaning rules are adopted and amended over time. Sometimes the changes accrue in response to changes in state law; sometimes they are in response to litigation; sometimes they are needed when current rules are failing; and sometimes the local population just changes its opinion about cannabis businesses altogether (usually, for the better).

We continue to see cities and counties modify their rules in Oregon. Below is a brief encapsulation of what is going on around the state today, based on client projects. This list is probably not exhaustive, so if you have updates on what is going on in your area, we’d love to hear from you.

Clackamas County

Clackamas County is home to 220 cannabis licenses by our count, making it home to over 10% of OLCC licensees and the fourth largest cannabis county statewide. We have been a part of most rulemaking processes on offer at the County, from the original implementation of Measure 91 to the reversal of the ban on cannabis processing. Recently, Clackamas County proposed to modify its rules yet again, by limiting the availability of production on certain lots. The relevant Planning Commission hearing was held last night, and the Board of Commissioners will hold a public hearing on the proposed license limits on January 16. The amendments, if approved, would limit continguous lots of record under the same ownership to one OLCC producer license, or one medical marijuana (OHA) grow site. The change would apply only to lots zoned as Ag/Forest, Exclusive Farm Use, and Timber. Current OLCC producer licenses existing on contiguous lots in these zones would be grandfathered. The proposed revised regulations are here, and an FAQ is here. There is still plenty of time to submit comments.

Josephine County

Anyone familiar with the Oregon marijuana industry knows that Josephine County has had a rough time in its efforts to regulate cannabis. The County has suffered several consecutive legal setbacks, but apparently is pushing forward with a new effort to limit OLCC marijuana activities on “rural residential” zoned properties. The Board of Commissioners most recently held a land use hearing on November 7, with a first reading of the proposed new ordinance. No word yet on next steps, but it appears that the County is going through the proper public notice requirements this time, and fortunately the current ordinance draft includes grandfathering rights for current licensees (“non-conforming use” application options).

Deschutes County

Deschutes County Ordinance 2018-012 took effect on Friday. The new regulations reduced the available County acreage for cannabis by 17%, mostly by prohibiting marijuana production and processing in the multiple use agricultural (MUA) zone. The ordinance contains many other provisions as well, from new setback requirements to noise and odor mitigation rules. Although Ordinance 2018-012 is now in effect, we are including Deschutes County here because an appeal of this ordinance was filed with the Oregon Land Use Board of Appeals a few weeks back. The appeal means that these regulations are in flux to some extent, and will not be affirmed or rejected for several months.

New Oregon cities 

Last month, we covered the industry-friendly reversals of Ontario, Klamath Falls, Clatskanie and Sumpter, a quartet of cities scattered about the state which initially prohibited cannabis but are now opening their borders to OLCC licensed businesses. It now appears that the cities of Gates and Joseph may have “legalized” as well. For information on Ontario rulemaking, go here. For information on the Klamath Falls process, go here. We do not yet have information on the remaining four cities, but interested parties should reach out to those City Councils to gauge plans for rulemaking in the newly green jurisdictions.

oregon marijuana OLCC report
Pretty good report for licensed Oregon producers.

On Monday, the Oregon Liquor Control Commission (“OLCC”) released results of enforcement inspections of recreational marijuana producers, which indicate that the majority of inspected licensees are in compliance with Oregon laws and the OLCC rules.

“Operation Good Harvest” was a saturation compliance effort that focused on Oregon’s fall 2018 legal outdoor cannabis harvest. OLCC inspectors were in the field for the past two months and conducted 354 inspections across the state, with an emphasis on southern Oregon, a hotbed of marijuana production, accounting for more than a third of the recreational marijuana licenses in the state.

The OLCC inspected a total of 354 outdoor producer licensees and found that 259, or 73 percent of them did not have any “deficiencies” nor were they likely to commit potential violations. Of the 95 licensees with deficiencies, 41 have potential violations that could lead to the cancellations of their license, which roughly represents 12 percent of the outdoor producer facilities inspected. A more comprehensive overview of the inspection results is as follows:

Region

Inspections Licensees with Deficiencies Compliance Rate

Possible License Cancellations

Statewide

354

95

73%

41

Bend

11

5

55%

2

Eugene

44

9 44%

5

Medford

167

43 74%

22

Portland Metro

102

33 68%

11

Salem

30

5

83%

1

The inspections reflect our agency’s effort to prevent diversion from Oregon’s legal cannabis market, and we’ll continue compliance activity across all license categories to maintain the well-regulated market that Oregonians expect”, declared Steve Marks, OLCC Executive Director.

The results of Operation Good Harvest demonstrate that the OLCC continues to take steps to corral Oregon’s overproduction of marijuana by taking a tougher stance on rule violations by licensees. (For some background on this administrative policy progression, we have recently written about OLCC’s recent “tightening up”, from application scrutiny through dealing with non-compliance.)

The result of Operation Good Harvest also seems to reinforce the fact that the surplus of marijuana in our state does not generally emanate from cannabis grown and produced by OLCC licensees, despite earlier reports to the contrary. Instead, illegal export tends to stem from unlicensed grows and from poorly regulated, quasi-commercial systems like the Oregon Medical Marijuana Program.

As far as the violations actually turned up by OLCC inspections in Operation Good Harvest, the most common deficiencies pertained to issues with cameras and surveillance coverage. Other common violations included:

  • Data in the Cannabis Tracking System (METRC) not matching plants or product found on the licensed premises;
  • Marijuana plants not tagged and entered into METRC;
  • Failure to provide the OLCC with harvest notification information;
  • Making unapproved alterations to the licensed premises; and
  • Using scales not approved by the Oregon Department of Agriculture.

The agency is currently investigating licensees for alleged violations and will decide how to charge these license holders once its investigations are complete. Any licensees whose license will be revoked will be entitled to challenge the OLCC charges through the State of Oregon’s Administrative Hearings process However, the final decision on any charges will be made by the OLCC Commission.

Operation Good Harvest produced promising results, showing that Oregon continues to be a leader in regulating cannabis, and that this nascent industry is slowly but surely finding its equilibrium.