We write frequently about the importance of contracts to the state-legal cannabis industry. (For a crash course, check out Doing Business with Pot Businesses #2: Cannabis Business Contracts; Marijuana Contracts: Get them in Writing; and How to Draft an Effective Marijuana Contract.) We preach about the need to have solid contracts in place before you need them, covering everything from purchasing and employment to services such as security and laboratory testing. The hope is that your agreements are on solid legal footing and clearly describe the parties’ rights and obligations, thereby obviating the need for the parties to resort to arbitration or litigation to solve their dispute. But if a problem arises that the parties can’t work out among themselves, the litigants may find themselves confronted with a second challenge: is their contract worth the paper it’s written on? In other words, is it even enforceable?
We touched on this issue in “Doing Business with Pot Businesses #2: Cannabis Business Contracts.” There, we briefly explained that “illegal” contracts may not be enforceable, depending on the degree of relation between the subject of the contract and illegal activity. Since this is a complicated and important issue, it bears further discussion.
The “illegal activity” of course is the growing, buying, selling, and dispensing of marijuana. The most likely scenario is that a defendant in a contract action asserts “illegality” as an affirmative defense; so, for example, a security company that is sued for having breached the terms of its service agreement with a dispensary may defend itself by arguing that the subject matter of the contract (securing illegal product) is illegal and therefore the contract cannot be enforced. Illegality can also be used offensively, by a party seeking to void all or part of a contract.
Whether the court will accept an illegality argument will depend in large part on the facts of each case. The cases where an illegality argument stands the best chance at success are those where marijuana is the clear subject of the contract: a sales contract between grower and dispensary, or maybe a services agreement between processor and laboratory. Where the relationship between marijuana and the contract is more tangential, such as a lease, financing agreement, or purchase orders for packaging, the contract is more likely to stand up in court.
In one notable case, Harborside Health Center, the country’s largest dispensary, faced an eviction action based on its landlord’s argument that its pot business was an illegal activity and created a nuisance on the property. (The federal government forced the landlord’s hand when it instigated forfeiture proceedings against the property. For more on that case, read here and here.) Harborside was saved by a provision in its lease expressly authorizing it to run a dispensary on the property, but also by a skeptical judge who held that illegality under federal law was not a basis to void the lease of a state law-compliant dispensary. Note though the importance of having your lease written for your specific industry. See Marijuana Commercial Leases: This Industry Is Different, You Know.
Our firm was recently involved in a Washington case where one of a dispensary’s financial backers sought to recoup start-up funds invested in the business. Although it was undisputed that the funds were used in part to purchase marijuana, the court ruled that the relationship between the plaintiff’s investment and the federally illegal dispensary activities was too attenuated to invalidate the contract governing his capital contribution.
These are only two examples, and the results might well have been different in other courts or other states — even those that have legalized. One major reason for this is that the illegality argument is rooted in public policy — the idea that courts shouldn’t be acquiescing or even encouraging behavior that legislatures have deemed illegal — rather than bright-line prohibitions. The fact that these cases are highly fact-specific and the judge has discretion to determine the facts also contributes to varying results. We predict that as law and policy concerning marijuana continues to evolve and relax, so too will judicial attitudes towards enforcing cannabis-related contracts.
So, what is the best way to protect yourself and craft an agreement that can withstand an illegality challenge? Come back for the second part of this post to find out.