california cannabis seminar san franciscoOn Thursday and Friday of next week, January 17 & 18, our own Daniel Dersham and Julie Hamill will present at a two-day continuing legal education (CLE) event in San Francisco called The Business of Marijuana in Northern California, to discuss cannabis real estate and land use issues in California. The roster of speakers lined up for this CLE includes an array of lawyers, consultants, and business professionals working with the cannabis industry, and everyone, including non-lawyers, would be well served to attend. For a full event description, including topics, speakers and registration links, click here.

Looking back over the past two years since the passage of Prop 64 legalizing adult-use cannabis in California, it is amazing to see how much things have changed in California cannabis. At this point, the state’s adult-use and medicinal cannabis regulatory regime is fully built out, with thousands of license applications now on file with the state. We are proud to call many of these California producers, processors, wholesalers and retailers our clients, alongside the many investors and ancillary service providers we represent.

Now that the California regulatory groundwork has stabilized, local jurisdictions have continued to open up their markets to the cannabis industry, and the legalization and decriminalization movement has continued to forge ahead, cannabis business activity in California is at an all-time high. Many of these new industry entrants bring skills, capital, and experience from other regulated markets, while others are new to the space. California attorneys and business owners alike need to be familiar with the unique regulatory concepts and industry dynamics that will be discussed on January 17 & 18 in order to best serve the California cannabis industry.

Specific topics at this CLE include: state laws and administrative rules, developments in the highly dynamic federal sphere, and practical approaches to working with and in the cannabis industry. Attendees will hear from consultants, lobbyists, business professionals, and, of course, lawyers aplenty, with specialized experience in fields such as insurance, tax, real estate, litigation, intellectual property, investment, and regulatory compliance.

If you are in or around San Francisco next week, we hope you will join us on January 17 & 18 for a two-day exploration of California cannabis law and business that is both broad and deep. And if you are a Harris Bricken client or a friend of the firm, please click here to request a promotional discount code, which can be applied to either the webcast, or to in-person attendance.

See you soon.

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

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

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

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

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

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

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

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

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

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

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

california marijuana leaseWe’ve previously written about some of the pitfalls for landlords to avoid when leasing to commercial cannabis tenants in California. We’ve also recently discussed some relevant issues for landlords created by the state’s near-final regulations. And we’ve also looked at some of the biggest uncertainties remaining after the state issued those regulations. Now that we have a clearer picture of what the regulatory regime will look like in 2019, here are some issues we’ve encountered in practice that both landlords and tenants should consider before finalizing a commercial cannabis lease in California.

Status of Cannabis Enforcement in California

As of today, the cannabis plant (which includes hemp), including any parts of the cannabis plant and all derivatives therefrom, remains a Schedule I controlled substance that is illegal under the Controlled Substances Act, except to the extent it contains a THC concentration of not more than 0.3% on a dry weight basis (i.e. not psychoactive), in which case it is now legal under federal law thanks to the 2018 Farm Bill. This confusing result follows a year in which the federal government, despite some early drum-beating about a resurgence of the drug war, made clear time and time again that its priorities when it comes to cannabis enforcement are illegal grows on federal land and organized crime. There has been no crackdown on state-licensed cannabis businesses in California (or elsewhere, as far as we know), and on the other side of the equation, the legalization and decriminalization movement has forged ahead to now include several more states, Canada and Mexico, and an incoming Democratic House leadership that has pointedly prioritized the issue in line with surging public support nationwide. Still, however unlikely federal enforcement efforts against state-legal cannabis businesses may seem, until full federal legalization occurs, landlords and tenants alike should consider building contingencies into the lease to anticipate enforcement actions and how they will affect the tenancy.

Structuring the Tenancy Relationship

Even before California came out with its new regulations, it was still a risky proposal for landlords to accept ownership in or profits of a cannabis tenant in lieu of rent. That concern has become even more salient under the state’s new regulations, since landlords can unintentionally become undisclosed “owner” or “financial interest holders” of the tenant cannabis business, thereby subjecting themselves to unanticipated and burdensome disclosure and vetting requirements. The parties to the lease should consider the unintended consequences of anything other than an arms-length tenancy and pay careful attention to the new regulations on point.

Licensing and Permitting Contingencies

The easily obtainable temporary state cannabis license is a thing of the past; now applicants must submit the full annual license application, which is far more robust and demanding (although applicants can now obtain provisional licenses if they previously held a temporary license, they can only do so after submitting a full annual application). Similarly, it can take months for an applicant to obtain a conditional use permit in localities that require one, which is common. Understandably, neither landlord nor tenant will know quite how they feel about the tenancy–and how much they want to invest in tenant improvements–until there is more certainty on licensing. A common solution has been to build into the lease an anticipated licensing timeline with benchmark contingencies that allow the parties to evaluate progress and decide whether to terminate if there is not enough.

Operating Expenses

Cannabis tenancies often involve unexpected costs that neither party fully anticipated, which can create a problem especially for multi-tenant properties. For example, you can expect that the landlord’s building insurance policy will not allow for a cannabis tenant and that the replacement policy will be more expensive. Cannabis businesses in California have to comply with strict security protocols that require security cameras, fencing, and security guards on site, and depending on what the existing uses are at the leased premises and the needs of other tenants, adding a cannabis tenant could create unique requirements that upset the existing proportional allocation of operating expense, and this should be addressed up front in the lease. If a cannabis tenant is a manufacturer or an indoor cultivator, it’s also likely that utility usage will not only increase beyond that of other tenants on a multi-tenant premises, but that additional water or electricity infrastructure will need to be installed to accommodate the increased usage, thereby creating additional capital improvement costs that need to be amortized and proportionally allocated. Another issue that comes up is cannabis waste management: for one, cannabis licensees—especially cultivators—must have strict waste management protocols in place that include securing waste on site or hauling it away under strict requirements. The regular building garbage service will likely not be a good match for a cannabis tenant.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

  1. Limited number of licensed businesses.

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

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

  1. Survival plan.

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

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

  1. Growth plan.

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

  1. Exit/liquidation plan.

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

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

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

hemp cbd vape californiaLast week, the 2018 Farm Bill became law. Included in that law is a milestone provision that removes hemp from the Controlled Substances Act (CSA), and another that prohibits states from preventing transportation or shipment of hemp or hemp products across state lines– even if a state has itself outlawed hemp or hemp products. However, following passage of the Farm Bill, the Food and Drug Administration (FDA) issued a statement virtually ensuring that regardless of changes to the CSA, the FDA will effectively maintain the prohibition on most uses of CBD until further notice, because it retains control over the safety of foods and dietary supplements that include cannabis or cannabis products.

A quick review of some relevant terminology for context: The cannabis plant (Cannabis sativa L.) is cultivated in many strains, with varying levels of the psychoactive ingredient tetrahydrocannabinol (THC) and the non-psychoactive ingredient cannabidiol (CBD), along with hundreds of other constituent ingredients. The Farm Bill amends the CSA to define “hemp” (formerly referred to as “industrial hemp”) as the cannabis plant, any parts of the cannabis plant, and all derivatives therefrom, to the extent they contain a THC concentration of not more than 0.3% on a dry weight basis (i.e. not psychoactive). Any cannabis plant or derivative with more than 0.3% THC remains a Schedule I controlled substance that is illegal under the CSA.

The FDA’s statement clarifies that with respect to foods and dietary supplements, absent further action by the FDA, CBD-infused food or dietary supplements still cannot be legally sold in interstate commerce, even if the Farm Bill mandates that interstate transport and shipment of hemp and hemp CBD must be allowed. The FDA has also taken the position that if CBD-infused products of any kind are marketed as having medical uses or disease-curing properties, they will be subject to FDA regulation as “drugs” under existing law.

But a question that has not yet been answered is how these recent developments affect the legality of hemp-derived CBD extract oil used as an additive in vape products, which is a common application for CBD, but which is not within the realm of foods or dietary supplements. Electronic nicotine delivery systems such as vape pens are regulated separately by the FDA as tobacco products, but it’s unclear how a hemp CBD-only (i.e. containing no tobacco-derived or cannabis-derived products) vape pen would fare under federal law post-Farm Bill. It’s also not clear how the FDA would view hemp CBD as a standalone additive to vape products, and whether it would fall within FDA regulatory purview.

Here in California, it’s also unclear how the Department of Public Health (CDPH), the agency charged with regulating manufactured cannabis products in the state, will view hemp CBD use in vape products. We’ve previously looked at the muddy state of California hemp CBD regulation. Although current CDPH regulations allow cannabis-derived CBD as an additive in licensed manufacturing of cannabis vape products, they also mandate that “[a] manufacturer licensee shall only use cannabinoid concentrates and extracts that are manufactured or processed from cannabis obtained from a licensed cannabis cultivator.” This would seem to foreclose hemp CBD altogether as an option for manufacturing licensees. However, California cannabis statutes make clear that regulated cannabis does not include hemp, and that hemp is an entirely separate regulated substance for which only cultivation is currently regulated by state law.

We already know that the CDPH has determined that hemp CBD will not be a permitted food additive until either the FDA says it is or the CDPH determines it is safe for human consumption, even though cannabis-derived CBD is already allowed as a food additive under state law. And although it may seem reasonable for CDPH to seek to prohibit licensees from using any CBD (including hemp CBD) derived from unlicensed sources, as well as to prohibit unlicensed persons from manufacturing at least cannabis-derived CBD from any source given that existing regulations restrict it, we will not know for sure how the state is going to deal with hemp CBD use in vape products until CDPH issues guidance as it did with respect to hemp CBD as an additive to foods.

So what does all of this mean? Despite passage of the 2018 Farm Bill legalizing hemp, it may not have helped much with the confused state of regulation in California and other states. Use of hemp CBD in vape products is still a grey area at best, and use of hemp CBD as a food additive is still prohibited in California. There appears to be interest in passing California legislation regulating the sale of hemp CBD, and perhaps this legislation will also address the use of CBD in manufacturing in a way that reconciles potential inconsistencies with existing state cannabis regulations as well as federal deregulation. For now, this might be the first time in modern history that a cannabis substance appears to be treated more permissively by the federal government than California—at least for now.

On January 1, 2019, the City of Pasadena in Northeastern Los Angeles County will open up its 30-day window to apply for one of six retail, four cultivation, or four testing facility permits. These 14 licenses will be highly coveted and sought after, and the winners will not be derived from a lottery system, but selected instead on scored applications. For anyone looking to get licensed in Pasadena, it’s going to be a busy month and an uphill battle.

Licensing in Pasadena is based on the June 2018 approval of local ballot measures CC and DD, which allow these limited permits and establish local taxing regimes. These ballot measures set hard caps on the license types as noted above. Unless Pasadena elects to allow more license types or licenses at later dates, this one-month window will be the only time to apply for commercial cannabis licenses in this city. And where the majority of California cities and counties still ban commercial cannabis activity, having Pasadena come online is a big win for overall legalization.

Notably, section 17.50.66 of the Pasadena Municipal Code precludes businesses from being licensed within the same building or even within 500–1,000 feet of one another, depending on the license type. In other words, Pasadena won’t be allowing combined license types in the same building or even anywhere near one another (which is much stricter than applicable state laws). Nor will it allow manufacturing or distribution, so there won’t be complete vertical integration for businesses in the near future in Pasadena.

Pasadena’s official screening information can be found here. To summarize, Pasadena will require information about owners of the business and about the proposed business generally. This includes detailed operations and security plans, statements of the owners’ previous experience, and statements of how the proposed business would be compatible with the surrounding community. The paper applications will have a hard cap of 100 pages. If you tried for a license in West Hollywood earlier this year, this should all sound very familiar.

Every aspect of these written plans will be reviewed based on scored criteria (found here). This scoring, in combination with the detailed plan requirements and page limitations mean that applications will need to be both comprehensive and polished. Pasadena will be evaluating these applications for owner experience, and if the applications are not well done or formatted properly, they may be dead on arrival.

Applicants may be tempted to approach this like a lottery as there are relatively few spots open. But this process will be very different from a lottery, where putting together a quick application or using a lot of the same boilerplate materials from other applications may be in the applicant’s best interest. Here, Pasadena has made pretty clear that it wants to see top-shape applications from folks with business acumen and industry experience. It’s even more important to ensure that applications are as perfectly formatted and complete as they can be, as the fee is a whopping $13,654 per permit.

Our L.A. cannabis business attorneys expect many Pasadena applicants, as there were with other popular L.A. cities with very limited license openings, and which awarded on a merit basis. For anyone who is applying in Pasadena, sharpen your pencils. January’s going to be a busy month.

As we’ve stated time and time again, the cannabis industry is rampant with risks and scams, and can be an ethical minefield for attorneys to navigate. Legalized cannabis is a multi-billion dollar industry, however, and legitimate businesses need good and ethical attorneys to provide legal advice.

This is complicated, because due to federal laws, an attorney providing legal advice to a cannabis business in compliance with state and local laws could technically be aiding and abetting violations of the federal Controlled Substances Act.

Earlier this month, I gave a presentation to California attorneys regarding ethical representation of cannabis businesses and how to navigate the complicated tension between state and federal laws. I was joined by municipal lawyer Ruben Duran, partner with Best Best & Krieger, who advises public agencies.

This post will focus on the ongoing tension between state and federal laws. My next post will discuss the application of California’s new Rules of Professional Conduct, and the third post in this series will touch on on attorney-client privilege concerns and real life ethical scenarios.

Tension Between State and Federal Laws

MAUCRSA, codified at Business and Professions Code section 26000 et. seq., provides a comprehensive system to control and regulate commercial cannabis activity in California. Civil Code section 1550.5(b), which took effect January 1, 2018, provides that commercial activity conducted in compliance with local and state laws is the lawful object of a contract, not contrary to good morals, and not against public policy. This is important for practicing and prospective attorneys because good moral character is a prerequisite for admission to the bar.

Under federal law, however, commercial cannabis activity is unlawful pursuant to the Controlled Substances Act. An attempt to violate or a conspiracy to commit a violation of the Controlled Substances Act is subject to the same penalties as the underlying offense. Accordingly, there is potential for attorneys to be roped in to a criminal action if they are considered a co-conspirator.

Any investment into a marijuana business puts an individual at risk of criminal prosecution, and those assets, investments, and profits are subject to forfeiture.
Financial transactions that involve proceeds generated by marijuana business can form the basis for federal prosecution under money laundering statutes, the unlicensed money transmitter statute, and the Bank Secrecy Act. (18 U.S.C. §§ 1956, 1957.)

For the last several years, a rider to the appropriations bill that funds the Department of Justice (commonly referred to as the Rohrabacher-Blumenauer Amendment or Rohrabacher-Farr Amendment) has provided some degree of protection to certain categories of marijuana businesses. In the case of US v McIntosh, a Ninth Circuit panel held that the rider prohibits the Department of Justice from spending funds to prosecute people engaged in conduct permitted by state medical marijuana laws who fully complied with such laws. The panel wrote that individuals who do not strictly comply with all state law conditions regarding the use, distribution, possession, and cultivation of medical marijuana have engaged in conduct that is unauthorized, and that prosecuting such individuals would not violate the rider. Note that the rider says nothing about adult use/recreational marijuana or manufactured marijuana.

In addition to the potential criminal risks, there are many other ways the federal government is working against the cannabis industry. There are potential immigration consequences (for example, see the recent lifetime entry ban of Canadian investors), bank accounts and credit card accounts may be shut down, TSA pre-check privileges may be revoked, among other perils. On the bright side, national legalization of cannabis in the United States has been a talking point for many congressional representatives lately, and it seems like legalization may be a priority for incoming legislators. We won’t hold our breaths, but federal policy will be something to watch in 2019.

Stay tuned for the next post in this series regarding the application of California’s new Rules of Professional Conduct to attorneys working in the cannabis industry.

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.

FDA CBD Industrial HempYesterday, President Trump signed the 2018 Farm Bill, paving the way for industrial hemp legalization. Within hours, the U.S. Food and Drug Administration (“FDA”) Commissioner, Scott Gottlieb, issued a statement clarifying the FDA’s position on industrial hemp.

The FDA’s position: Just because industrial hemp is legal doesn’t mean that you can put it in food or call it medicine.

Gottlieb was quick to point out that even though the Farm Bill modified the Controlled Substances Act, the FDA still retains the authority to “regulate products containing cannabis or cannabis-derived compounds under the Federal Food, Drug, and Cosmetic Act” (or “FDCA”). Gottlieb went on to state that the FDA fully intends to exercise that authority:

[I]t’s unlawful under the FD&C Act to introduce food containing added CBD or THC into interstate commerce, or to market CBD or THC products as, or in, dietary supplements, regardless of whether the substances are hemp-derived. This is because both CBD and THC are active ingredients in FDA-approved drugs and were the subject of substantial clinical investigations before they were marketed as foods or dietary supplements. Under the FD&C Act, it’s illegal to introduce drug ingredients like these into the food supply, or to market them as dietary supplements. This is a requirement that we apply across the board to food products that contain substances that are active ingredients in any drug.”

Moving on, Gottlieb was careful to point out that the FDA is open to taking steps to clearing pathways for those who wish to seek FDA approval—as it did for Epidiolex. And in fact, the statement incorporates yet another statement by the FDA issued yesterday which concluded that the FDA “has no questions about Fresh Hemp Food’s conclusion that the following ingredients are GRAS under their intended conditions of use: hulled hemp seed (GRN765), hemp seed protein powder (GRN771), and hemp seed oil (GRN778).”

But Gottlieb was careful to cite, in general terms, a number of different kinds of conduct by companies selling products containing CBD that, according to the statement, are unlawful. These include things like claiming CBD or cannabis products cure diseases prior to undergoing FDA approval. And Gottlieb noted that the FDA will not hesitate to warn consumers and even initiate enforcement actions. In that sense, status quo prevails.

What does this mean for California? We’ve written pretty extensively on the California Department of Public Health’s FAQs which take the position that industrial hemp derived food products are unlawful. In fact, we wrote just days ago that the Farm Bill was unlikely to change the core of the FAQs.  The FDA’s statement from yesterday in combination with the FAQs seem to hammer home that in California, CBD in food products will not be considered lawful unless the FDA and CDPH say otherwise.