Cannabis business lawyers
Why so few cannabis warehouses?

Among several changes to marijuana laws that SB 5131 enacted in July, Washington’s license cap on retailers moved from three licenses to five licenses. The Washington State Liquor and Cannabis Board at first wanted to delay implementation of the new license allotment to 2018, but has now consented to begin processing license acquisition applications immediately. This isn’t for new license issuance — that window is still closed. But existing retailers that own three licenses can now acquire two more.

As market consolidation occurs in Washington’s retail cannabis space, our cannabis business lawyers have been working with retailers on the problem of inventory management in the marijuana space. Inventory issues represent a misunderstood but glaring headache for marijuana businesses across the state.

Any time a retail operation has more than one location, that operation wants to run its inventory processes as efficiently as possible. Many multi-location retail operations in other industries utilize centralized warehousing as a key cog in their inventory management systems. Having a single regional warehouse able to directly supply many retail stores has significant benefits. First, the per square foot price of storage at a warehouse location is significantly cheaper than at a high-traffic retail area. Additionally, if a retailer controls the warehouse, it effectively separates itself from the friction point of dealing directly with suppliers. All outside vendors can deliver to the warehouse and the warehouse can distribute the goods to the individual retail stores at a time and method convenient for the retail stores — delivery becomes less of a hassle and negotiation.

But, as always, this is significantly more challenging in the cannabis space. The state’s tied-house rules and tiered licensing severely limit the movement of marijuana product and who can control it at any stage in that process. A single retail license works for a single retail location   — a licensed retailer cannot maintain a separate warehouse and a retail store with a license. Every retail location must negotiate and organize shipments from licensed processors that, because of the tiered licensing rules, are third parties. If I own five retail locations and I want to stock them all with a specific product, I must organize five different shipments of that product.

There are two different fixes to this predicament. One is to take advantage of WAC 314-55-079(8), which states: “A marijuana retailer may transport product to other locations operated by the licensee or to return product to a marijuana processor . . . .” So if I own four retail locations, I have a little bit of flexibility. I could maintain a networked internal distribution model, where each location transports to each other location when necessary. Or, I could use one location as my de facto warehouse. If I have three retail stores in the city and one out in the county, I could expand the county’s inventory space, direct all deliveries there, and manage distribution from that central location.

There’s a catch, of course. This rule only applies if all the retail stores are owned by a single entity — a real liability concern. Most companies with multiple retail cannabis locations that each carry their own liability insurance hold the locations in separate business entities. This limitation of liability strategy is a core component of U.S. corporate law. If there is a massive tort or contract claim against a single retail location held in its own entity, the plaintiffs have access to every asset and insurance policy of that specific entity, but they don’t have any claim to the parent company or to other affiliated retail entities. Managing liability exposure through different business entities can represent the difference between a disastrous occurrence killing your profits for a year and killing your business forever. Retailers in that context must undertake a cost benefit analysis by figuring out whether the liability risk is worth the gain from increased inventory management efficiency?

The other solution is to negotiate a form of symbiotic relationship with a licensed processor. As stated, before, tied-house rules limit the ability of retailers and processors to engage in many business arrangements. Retailers cannot borrow money from, get discounts from, or receive gifts from licensed processors. They cannot enter any binding agreement where the purchase of one product is contingent upon the purchase of another product.

However, the rules don’t prohibit communication between cannabis retailers and processors and they don’t prohibit processors from making purchases based on the needs of retailers with which they do business. In theory, then, a processor could know the demand schedule of a retail group with whom it does business and act as an intermediary purchaser for that retail group. The retail group would probably end up paying a higher price for the product, as it would be adding an additional middle-man to the transaction, but this model pulls in some of the benefits of centralized warehousing. This system does present some risk to both parties, though, as their ability to enter contingent contracts is severely limited. A processor making a bulk purchase it assumes the retailer is going to buy may find itself in deep financial straits if the retailer chooses to buy elsewhere.

There are a few rule changes that could make things easier for retailers here in Washington State, but the WSLCB’s goal isn’t necessarily to make things easy for marijuana retailers. Outside of increased lobbying, cannabis business owners will need to continue doing the best they can within the system we have.