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One of the most persistent and common failures in the cannabis industry is using handshakes instead of written cannabis contracts. This is an issue I’ve written about for years (most recently here), and it doesn’t seem like there has been much of a willingness to change. A lot of companies would like to move into good contract practices, but written cannabis contracts can be too expensive or take too long to negotiate. It might be tempting to resort to AI to solve this problem, but there are a host of reasons why that’s not the case.
First off, precision is key in contract drafting. If a written cannabis contract is not precise, it could create an entirely new set of problems for the parties beyond what you’d expect in a handshake deal. While AI can be great for certain things, it would be very difficult for AI to generate a cannabis contract that precisely tackles all of the issues the parties want to negotiate. Sure, a competent individual might be able to work with the AI tool to hone in contract provisions, but that involves time and effort – the same thing an old school written cannabis contract requires.
Second, and on a related note, AI programs have been known to get things wrong or make things up. Take the case of some lawyers who were sanctioned (penalized) in part for submitting briefs with case citations that AI completely made up. Granted that was a litigation-related issue, but any transactional lawyer knows that there are circumstances where something like this could occur in a contract (say, a false representation and warranty).
Third, there have been many concerns about AI and its effect on data security laws, as well as confidentiality. To the extent that contracts contain confidential information or information that is protected by US or international data security laws, disclosing information to the AI program may lead to legal or regulatory violations or risk the confidentiality of information in the agreement.
Fourth, there are all kinds of other obscure and as-yet unresolved issues with using new technologies to draft cannabis contracts. For example, if a person inputting information into an AI program to generate a cannabis contract does so on behalf of an entity, does that constitute the practice of law? If so, that person may violate their state’s prohibition on the unlawful practice of law (commonly referred to as UPL). Or, if there is a massive error in an AI-generated cannabis contract, who can the injured party blame for the error – the person inputting the data? These issues are sure to be resolved in the coming years, but for now, it’s too early to tell how things will shake out.
Above are just a sampling of the key issues I expect to see with respect to AI-generated cannabis contracts. I’ve reviewed AI-generated contracts in the past and, while I’m sure that AI contracts will be huge in the future, I still think that what I’ve seen to date has a ways to go.
The post Don’t Use AI to Write Cannabis Contracts appeared first on Harris Sliwoski LLP.
Wishing all of our readers, along with friends and families, the very best this holiday season.
Whether you celebrate Hanukkah, Christmas, Kwanzaa, Winter Solstice, Festivus, or something else, we hope you can kick back and enjoy this wonderful time of the year.
Happy holidays!
The post Happy Holidays from the Canna Law Blog 2023 appeared first on Harris Sliwoski LLP.
2024 in weed strains, politics and more.
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The artisans at STIIIZY are bringing their legendary quality to a smoke shop near you with all-natural leaf blunt wraps.
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Heading into 2024, the cannabis industry is as dynamic as ever. New states continue to come online, legacy states continue to refine their programs, and the federal government is looking harder at cannabis than ever before — starting with a purported recommendation by Health and Human Services to move the plant to Schedule III, and renewal of the (extended) 2018 Farm Bill.
Our cannabis business attorneys have thoughts on all of this and more! On January 10th, please join Harris Sliwoski partners Vince Sliwoski (Oregon, transactions), Jesse Mondry (Oregon, litigation) and Griffen Thorne (California and Washington, transactions) for a wide-ranging and informative discussion on the state of the cannabis industry headed into 2024.
This webinar will be conducted in an “Ask Us Anything” format, giving you an opportunity to ask questions and gain insights into this complex industry from seasoned legal practitioners. Questions can be submitted in advance of the webinar at the registration links above and below. We will also take questions from attendees in real time on January 10th.
For now, we anticipate covering the following hot topics:
Whether you are a cannabis operator, investor, service provider, or just curious about the future of cannabis, this free webinar is not to be missed.
See you January 10th!
The post Attorney Insights on the Cannabis Industry 2024: Ask Us Anything (for FREE!) appeared first on Harris Sliwoski LLP.
That's a wrap on 2023—here are all the weed cup winners coast to coast to ring in 2024.
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Don't miss out on these five unique strains by Royal Queen Seeds. You won't find these cannabis seed strains anywhere else.
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Welcome to the eighth annual “State of the State” post on Oregon cannabis. Last year was memorable for Oregon the industry, pockmarked by OLCC scandal, heavy regulatory swings, and even marquee litigation. We also saw the state’s first very-large-business failure, more trade association consolidation, and other altibajos as my mother-in-law might say. Let’s go!
According to OLCC data, retail sales between January 1, 2023 and November 30, 2023 clocked in at $874 million. By my math, the state is on pace for roughly $953 million this year. That tally would be a 4.1% decrease from $994 million in 2022, which itself was the first calendar year cannabis sales contracted in Oregon. Someone with better credentials than me could ascertain whether this year’s drop is due to pricing decreases, volume decreases, or both, alongside whatever other factors (like population shrinkage). Overall, a 4.1% decline isn’t great news for industry, but it’s not terrible.
Nearly half, or 48.7%, of retail sales are “useable marijuana” (dried leaves and flower). The concentrates/extracts category sits at 24.7%; edibles/tinctures are 13.7%; inhalable products with “non-cannabis additives” are 7%; “other” is 5.2%; and industrial hemp products bring up the rear at 0.7%. This follows a years-long trend of usable marijuana sales decreasing per capita in favor of other categories. Like last year, my impression is that near-term growth may be limited to select SKUs and product categories.
In addition to decreased volume, prices remain low; but not as bad as last year. At this time in 2022, wholesale useable marijuana had been sitting at $600/lb for months, bottoming out at $550/lb for December. For the most recent three months of 2023, we’ve hovered at a respectable $745/lb. That said, the full effects of the Croptober harvest haven’t rippled through the system. This year’s harvest came in at an unwelcome 15% higher than 2022.
To the plus, we have slightly fewer licensees vying for market share than a year ago today. It’s not a big drop, but this was the first year I saw license numbers fall since the 2016 roll-out of the adult use program. Despite the number of “pending” license applications below, you can expect the number to flatline or fall a bit again next year. Yes, the HB 4016 licensing moratorium sunsets on March 31, 2024, but I’m guessing our legislators will pass an extension bill early in the 2024 session. Let’s see.
| 2022 | 2023 | 2023 (active + pending) | |
| Producers | 1,408 | 1,389 | 1,520 |
| Processors | 331 | 312 | 363 |
| Wholesalers | 276 | 269 | 299 |
| Retailers | 827 | 818 | 881 |
| Labs | 19 | 15 | 15 |
| Research | 1 | 1 | 4 |
Last year at this time, I wrote that “quite a few businesses are struggling and others have failed.” Same deal today. All throughout the year, we helped people sell (and try to sell) businesses we had helped them buy just a couple of years ago. It feels like the largest number of “business sales” are little asset purchase agreements for naked licenses. We’ve also helped quite a few clients throw in the towel, and our litigation team continues to assist in a series of disputes related to business dysfunction—for those who can actually afford to litigate.
Nothing better exemplified the weak state of the Oregon market than the Chalice receivership sale (see: Chalice Receivership Update: Weak Market, Insiders Pounce). Interest was scant, offers were few, and ultimately 20+ businesses sold for a mere $3 million. Last year at this time, I observed that Chalice was one of the largest operators in Oregon, trailing only Nectar Markets. Today, in one of the biggest Oregon cannabis stories of 2023, the Canadian heavy has gone belly up, to the detriment of stiffed creditors and hapless employees.
If one state agency should be happy to leave 2023 behind, it’s got to be OLCC. I explained in an earlier post that OLCC and the cannabis industry were “at a nadir with two-bit scandals” this spring. Stellar investigative reporting around OLCC’s handling of the La Mota chain caused the Oregon Secretary of State to resign, but also lead to some unfortunate, reactionary rules for the cannabis industry (more on that below). Separately, the OLCC’s Executive Director resigned as well, in the context of separate misconduct.
Most recently, the Commission got some good news in that the former Secretary of State’s cannabis program audit will stand, albeit with a disclaimer, turning the page on a difficult chapter for pretty much everyone and giving the Commission room to maneuver. As an aside, one former OLCC official commented that the audit “reads like a Leafly blog”, due to its general and specific recommendations to loosen regulatory strictures. Industry favored those findings obviously, and it’s a shame the process was tarred.
In my view, however, a key issue with OLCC remains unaddressed, and that is the Commission’s disparate treatment of large and small cannabis companies (see: The Real OLCC Scandal is that There are Two Sets of Rules). OLCC has allowed the largest Oregon cannabis retailers to coast after citing them for significant and repeated violations– including allegations of cannabis diversion. Small businesses get their tickets punched for less. In all, I see scant rhyme or reason to OLCC’s erratic enforcement efforts.
The Oregon regulatory landscape is ever changing. We had new rules to kick off the year, followed by new laws passed in Salem. Rulemaking commenced throughout the fall per usual. The biggest change, however, was the advent of “emergency” (and now permanent) tax compliance rules that arose from the La Mota scandal referenced above. All retailers and their “applicant” owners (but not producers or processors or wholesalers) are now required to certify tax compliance with OLCC via the Oregon Department of Revenue, to renew or transfer a marijuana license. Here in the office, we’ve seen the rules impact quite a few renewals and sales already.
Another huge story in Oregon cannabis for 2023 involves a rule that came and went, regarding aspergillus testing. In March, the Oregon Health Authority (OHA) promulgated a rule that required marijuana testing for certain microbiological contaminants, including aspergillus. The Cannabis Industry Alliance (CIAO) and others filed a motion for emergency relief. These parties won a temporary “stay of enforcement” of the rule, pending completion of judicial review. Rather than defend the rule at a subsequent hearing, OHA withdrew it. And doesn’t appear to want a second bite at the apple.
This is a great result for our cannabis producer clients, at least in the short term. I admittedly did not think they could win. Whether it’s a good long-term play remains to be seen. Oregon producers have long pushed for cannabis export rights— which conceivably could happen sooner rather than later if federal law changes. (See: Audit: Marijuana-rich Oregon must prep for US legalization.) This is salient due to the fact that most states require aspergillus testing for cannabis. It’s hard to imagine a scenario where those states agree to accept Oregon cannabis “contaminated” with aspergillus.
Finally, we have just one major trade organization in Oregon cannabis. Prior to October, the Oregon Cannabis Association (OCA) and the Cannabis Industry Alliance of Oregon existed side by side (quite a few others have come and gone over the years). Now, it’s all CIAO. Judging by all the emails I’m getting, the big-tent outfit is energized.
The first big task for CIAO should arise in the 2024 legislative session. I submit that the Oregon legislature seems less keen on dealing with cannabis issues over the past couple of sessions, than it has been historically. Given collateral damage to OCA from the La Mota scandal and all of the oxygen being taken up by Measure 110 scrutiny, CIAO will have its work cut out come February.
Oregon has only issued 187 hemp grower licenses as of December 7. This is a noteworthy drop from 294 licenses in 2022, to say nothing of the 1,961 licenses issued in the heyday of 2019. In spite of it all, Oregon is still a hemp leader on the national stage, somehow, per the 2023 National Hemp Report.
Last year I wrote:
the continued downward trend can’t last forever. Congress is scheduled to renew the Farm Bill in 2023. Changes on the table include everything from raising the “hemp threshold” from 0.3% THC to 1.0% THC, to addressing regulation of intoxicating cannabinoids derived from hemp. Another big driver will be the continued adoption of hemp-based textiles and building materials. Even though Oregon hemp has slowed dramatically, expect the state to remain at the fore if and when the trend reverses.
All of that is probably still true, except that Congress missed its deadline and we may not see a renewal of the Farm Bill until late in 2024. In the meantime, I and many others have been asking, “What Happed to Hemp”?
We’ve seen some noteworthy activity around the edges, locally, which I’d be remiss to leave off:
Let me know in the comments if you think I missed anything worth mentioning, or shoot me an email. There is always something. In the meantime, here’s hoping for better times for Oregon cannabis in 2024.
For previous posts in this series, check out the following:
The post Oregon Cannabis: State of the State (2023) appeared first on Harris Sliwoski LLP.
It's up to you, New York, New York.
The post New York City weed visitor’s guide 2023 and 2024 appeared first on Leafly.
Here’s why 2023 became the year we saw beyond both THC and terpenes.
The post The nose knows: Time to free your mind from THC and terp scores appeared first on Leafly.
95-point OZ Kush from Wonderbrett and more.
The post Leafly Ratings 2023: 45 top-shelf and value buy flowers rated from 8 US states appeared first on Leafly.
Fast Buds backyard autoflowers are a great addition for home gardeners or cannabis growers just starting out on their growing journies.
The post Why autoflowering seeds are an excellent choice for backyard cannabis cultivation appeared first on Leafly.
Verilife is here to make your holiday season even better than the last. Offering huge discounts on brands like matter., P3, and Magnitude.
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With Blue Dream, Wedding Cake, and more undeniable bangers.
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Rare cannabinoid gummies from Rare Cannabinoid Company now include options both with and without delta-9 THC.
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An independent, expert review of premium New York cannabis flower.
The post Piff Haze—Ithaca Organics + Piff Coast Farms, NY, fall 2023 appeared first on Leafly.
Here's what we bought.
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Refined work on lemony strains, Gelato lines, and Zkittlez lines took trophies.
The post 2024 trends emerge from the haze of The Ego Clash Invitational 2023 appeared first on Leafly.
Nondisclosure agreements (sometimes abbreviated, “NDAs”) are some of the most important agreements a company can sign. At the same time, they can be some of the simplest agreements to get in place. Today I want to do a deeper dive into nondisclosure agreements, what they contain, and why they are important.
A nondisclosure agreement is an agreement where one or both sides agrees to keep something confidential. There are generally two types of NDAs: unilateral NDAs where only one side must keep something secret, or mutual NDAs, in which both sides must keep the thing secret.
The choice between a unilateral and mutual nondisclosure agreement usually depends on the kind of deal and disclosed information. In a business sale, for example, a seller typically makes most or all disclosures. So the seller will ask the buyer to sign a unilateral NDA. In a proposed manufacturing agreement, the manufacturer may provide information about its services while the contracting party may provide formulations. There, the parties will probably use a mutual nondisclosure agreement.
The average NDA is usually pretty short – maybe even just a few pages. If you’ve read a lot of them, you’ll see a number of things pop up over and over again. These are:
Nondisclosure agreements may contain additional or different terms from those mentioned above, but this is the bulk of what you’ll see in the average NDA.
Yes and no. NDAs can be very formulaic and simple, but a rookie mistake would be to use a unilateral NDA form when a deal calls for a mutual NDA form. This mistake could be devastating.
Moreover, there may be very specific things within an NDA that need to be changed or modified depending on the deal. For example, one of the NDA provisions I see changed most frequently is third-party disclosure limitations. Some NDAs may only allow disclosures to an employee of the receiving party, but the receiving party may need to disclose Confidential Information to its outside financial advisors or attorneys – or to cannabis regulators.
Additionally, some NDAs may also obligate the receiving party to simply make third-party recipients of such Confidential Information aware of the NDA, whereas the disclosing party may want the third party to sign an NDA of its own before reviewing the Confidential Information. These kinds of bespoke provisions may not make it into a form NDA someone pulled off a search engine.
People and businesses generally do not have any obligation of secrecy unless they sign an NDA or similar confidentiality agreement. Without an NDA or other confidentiality agreement, anything one party provides to another party in a transaction or potential transaction can lose confidentiality. A very common issue we’ve seen over and over is businesses that ask for an NDA after holding preliminary discussions and exchanging information. While this is certainly helpful, it’s far too late. Companies that get it right ask for NDAs before even starting talks.
Let’s say John is the sole owner of ABC Manufacturing and wants to sell it to Steve. Steve will do “diligence” and ask for ABC’s financial information and customer list. If John provides this without an NDA in place, Steve may simply take the customer list for himself and walk away from the deal. Nobody in John’s place wants to be in that position.
It’s important to note here that NDAs are not the only sources of confidentiality protections. Sometimes you’ll see confidentiality provisions in letters of intent or in the ultimate definitive agreement (like a purchase agreement). The problem with this is that by the time the parties sign a letter of intent, they likely will have exchanged confidential information. And this definitively will have happened before signing the definitive agreement. Moreover, the average LOI’s confidentiality section may be a short paragraph and will not be anywhere near as robust as an NDA. It’s key to lock the other side into confidentiality as early as possible – and in a comprehensive manner.
NDAs are not the only way that companies can protect their confidential information or trade secrets, and it’s possible to sign an NDA with provisions that actually put trade secrets at risk. But in general, without an NDA in place, parties have no reasonable expectation that what they say or hand over will actually remain theirs.
NDAs also do not need to cost an arm and a leg. Good corporate counsel can generate NDAs quickly and cost-effectively, while avoiding issues with AI-generated forms or forms circulating on search engines.
The post Why Nondisclosure Agreements are So Important appeared first on Harris Sliwoski LLP (Formerly Harris Bricken).
Permanent Marker is poised for a huge influx in demand—ready your wallets. But if you can't find our Strain of the Year 2023 winner, we have a ready list of alternative strains that deserve their own laurels.
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Cannabis real estate transactions can be notoriously complicated – much more so than your average real estate deal. On January 9, 2024, I’ll be speaking on a panel called “Navigating Real Estate Issues Impacting the Cannabis Industry” for the Los Angeles County Bar Association, where my co-panelists and I plan on touching on many of the most precarious issues in these sorts of transactions. Today, I want to preview some of the key issues we see in these kinds of deals.
The most important factor in any cannabis real estate transaction is location. Licensing authorities impose all sorts of requirements or restrictions on real estate locations, including:
Each of the issues above can be automatic disqualifiers for a parcel of real estate. Things like buffer zone locations can be difficult to figure out and change over time. For example, a school might open up in an area before a cannabis business submits a license application, and it may lose out on its chance to do so. All of this is to say that performing diligence on a property and its location is absolutely critical prior to entering into a lease or committing to purchase a piece of real estate.
When a cannabis company finds a good piece of property in a good location, the next most important decision it needs to make is whether to buy it or lease it. There are some key exceptions here, like large farms or processing facilities in industrial or agricultural areas. But in general, most cannabis companies tend to lease. There are a lot of reasons why cannabis companies opt to lease real estate instead of buying. I discussed that in detail here. But generally speaking:
Securing financing has long been a challenge for cannabis companies. In fact, my last post analyzed key issues that cannabis companies can expect when trying to secure financing. Few startup cannabis companies are sufficiently capitalized to purchase real estate without financing, and because traditional financing is almost never available, buyers usually end up with much higher interest rates and more lender-friendly terms.
But buyers are not the only ones that have to deal with financing-related issues. If a cannabis company wants to lease a piece of property that is subject to a mortgage, it will probably not happen. Big banks do not usually bank cannabis money, and usually will have the ability to default their borrower (the landlord) for leasing to a cannabis company. I’ve seen a lot of potential real estate leases fail for this reason alone.
Another difficulty here is getting escrow companies or title insurance companies to work on cannabis real estate transactions. Like bigger banks, many of them simply won’t do touch cannabis transaction. This is especially so in jurisdictions when they commence licensing.
There is no way a cannabis company can guarantee that it will secure a license. Even in non-competitive jurisdictions, there are a host of potential property- or location-specific issues that could bar a license application. The chance of losing out is much, much higher in a city with 3 licenses up for grabs and 30 different applicants. I recently wrote about some key issues for competitive licensing jurisdictions and real estate leases here.
Of course, there are ways to hedge against these kinds of uncertainty. Here are a few I’ve seen:
It’s key to point out that licensing authorities may have strict requirements on what a tenant needs to show in order to apply. Some cities will not allow a document unless it is binding (i.e., an option or a full-fledged lease). This is yet another reason why early diligence is so key.
Some other key issues that I’ve seen come up more than once include the following:
I could keep going here for a long time. The point is that real estate deals in the cannabis space are difficult and are riddled with potential pitfalls. Using a form lease from a normal commercial transaction is almost always a bad idea, and failing to properly diligence real estate can lead to repercussions.
The post What to Expect in Cannabis Real Estate Deals appeared first on Harris Sliwoski LLP (Formerly Harris Bricken).
I stumbled upon this recent post by Jason Paltrowitz titled “Lawful but Awful: The Small Cap IPO Cycle.” It contains some interesting findings and I like everything about it for cannabis companies, except the conclusion. The conclusion is that OTCQX and OTCQB markets are a good bet for small companies, because these markets “offer a simplified path with financial, corporate governance, and disclosure requirements tailored to smaller companies.”
Plant-touching U.S. cannabis companies cannot list on the senior U.S. exchanges, meaning the NYSE or Nasdaq. Still, many U.S. cannabis companies that want to raise significant capital choose to “go public.” The well-worn path is either to: 1) list in Canada or overseas, via reverse merger, or 2) head to the abovementioned OTC markets, again via reverse merger, and pursue a Regulation A offering. However, in my experience, the OTCQX and OTCQB are not good places for cannabis companies.
Don’t take my word for it: here’s an SEC bulletin updated earlier this year and another in the specific context of cannabis stocks– going back to 2014. Here too is a FINRA warning, a sample DOJ microcap cannabis prosecution, and an FBI case study. As you might infer, sad stories related to OTC scams abound. This is because the OTC sandbox is a huckster’s paradise, due to the susceptibility of OTC stocks to dramatic price swings and the low level of required disclosures.
Now, one could argue that none of this is necessarily bad for OTC cannabis companies: instead, it’s bad for the people who invest in them. That’s not exactly right. An OTC cannabis company, along with its management, has fiduciary and governance-related obligations to investors. Public companies are no different than private firms in that respect. In all, the level of exposure for a cannabis company grows commensurate to the amount of capital it raises, as well as how it goes about the raise.
I have been in and around a sizable number of OTC cannabis company listings at this point. They’re weird. In many cases, a cannabis company will be approached by an M&A advisor and/or investment banker affiliated with an OTC company. These individuals may propose a reverse merger, whereby the cannabis company delivers all of its shares (sometimes through a newly created entity) to the OTC shell, in exchange for shares in that shell. At closing, the cannabis company owners receive some combination of common and preferred shares, and maybe even warrants, in the OTC company.
In many cases, cursory diligence on the OTC company throws off obvious red flags. I’ve seen proposals where the shares offered to the uplisting owners exceed the issuable securities shown for the OTC firm. I’ve seen many OTC company shells with EDGAR information severely at odds with private disclosures. Some of these matters are deferred maintenance, to be addressed with counsel in service of a proposed transaction. Others are landmines and may be intractable.
More discomfiting than any of this, however, is the common situation where an OTC promoter approaches a cannabis business with no idea – or interest, apparently – in whether the cannabis company is even viable. The promoter will want to agree to binding terms having done no diligence on the target. Friends, if the most considered aspect of a proposed deal is the warrants a promoter gets on signing, you’re probably looking at a pump-and-dump scheme.
In an OTC listing the cannabis company “trades up” for an opportunity to be listed on a public exchange and to raise money through that vehicle. Ownership must weigh the probability of successful fundraising against the control yielded to other parties. Those parties may include legacy preferred shareholders, in addition to newly appointed directors and officers, and promoters bringing the deal.
Sometimes (not always), yielding control is required for cannabis company growth. Assuming obstacles like residency requirements are navigable in the new structure, it’s important for the uplisting owners to consider what it would mean to own a smaller piece of a potentially larger pie. This is not just a question of economics, but also decision-making. If the owners lose the ability to direct the company in any sense beyond daily operations, they may determine the prospect of additional capital isn’t so attractive.
This may feel frustratingly obvious after the closing of an uplist transaction. A standard scenario sees the OTC stock spike, dive and inevitably flatline. At that point, uplisting owners will be left wondering why they went to all the trouble. If you lose control of your company only to make some money for stock promoters, then you’ve really lost.
The post Cannabis Companies and the OTC Markets appeared first on Harris Sliwoski LLP (Formerly Harris Bricken).
Twenty strains across 20 states win Leafly's first Budtenders' Choice Awards; from Devil Driver in Maine, to Holy Moly! in California.
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The race is on—Leafly Strain of the Year 2023 Permanent Marker has become a searing hot commodity. Supplies will not last. How do you get your mitts on it? First off, Seed Junky Genetics grows Permanent Marker and its crosses for the legal markets in California, Michigan, and New Mexico—so start there. In California, Seed […]
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A mix of human and machine—here to terminate the boof.
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Cannabis companies that need more money than they can generate through sales generally have two options: borrow money (debt) or solicit investments (equity). Over the years as the industry has constricted, equity finance became less of an option. I recently predicted that equity investment will reignite when cannabis is rescheduled. But that hasn’t happened yet, which means that cash-hungry cannabis companies need to borrow money. And because of high taxation, overregulation, the illegal market, and so on, many if not most cannabis companies need cash.
Not surprisingly, over the years I’ve seen massive increase in debt transactions as investments decreased – both original financings and refinancing. Today, I want to look at some of the things that cannabis companies should expect when looking for cannabis loans.
Cannabis companies can’t just walk into a big bank and draw a commercial cannabis loan. Many banks (especially the big ones) and institutional lenders are still too skittish to do business with cannabis companies. You can read about that here. This may change if cannabis is rescheduled, but probably not too much. Unless federal law changes to unequivocally treat cannabis as a federally legal commodity, the bigger banks will hesitate.
Because of this, expect to see private lenders, hard money lenders, and all kinds of servicing agreements with companies that loan specifically to cannabis companies.
Cannabis companies that borrow money can expect to see high interest rates – often higher than “normal” businesses would be required to pay. Lenders justify higher interest on cannabis loans because of the increased risks they incur while (a) lending to an illegal business, and (b) lending into a highly volatile industry where businesses seem to go under left and right.
Except for very small loans or loans with related parties, I can only think of a handful of times where I’ve seen completely unsecured debt in cannabis loans. A security interest is a right that the borrower or an affiliate of the borrower grants to a lender to secure payment and performance of loan. It gives a lender recourse in the event the borrower stops paying or goes under, by allowing the lender to swoop in and take the asset that is collateralized. Think of a car loan – if you stop paying the bills, the car will get repossessed. It’s the same thing with cannabis, though on a much larger scale.
The types of security interests I see most in cannabis deals are:
Keep in mind that cannabis regulations play a huge role in determining the scope of security and pledge agreements. Some assets can’t be pledged under state law (depending on the state), such as cannabis licenses or cannabis inventory. Cannabis companies need to be fully aware of what they can and can’t collateralize so they don’t risk their licenses.
Lastly, security interests in general are complicated and can be subject to myriad requirements under Article 9 of the Uniform Commercial Code (UCC) in each state. Security interests in real estate are often doubly more complicated. So it’s key that cannabis businesses understand the law of security interests before seeking out cannabis loans.
Lenders also frequently ask for guarantors on a cannabis loan. A guaranty is an agreement by someone other than the borrower of the borrower’s obligations. Guarantees by natural persons (usually officers or major stockholders) are often called personal guarantees, and guarantees by entities (usually parents or affiliates of the borrower) are often called corporate guarantees. They can also have multiple guarantors and be hybrid personal/corporate guarantees.
Guarantees can be a tall ask because a guarantor will be forced to step into the shoes of the borrower. If the borrower fails to make payment, the lender can simply demand that the guarantor make the payment in its place. And guarantors usually waive a host of defenses to performing on behalf of a borrower.
Personal guarantees are obviously much riskier than corporate ones, because a person risks their own personal assets (cars, houses, art, etc.) if the borrower entity doesn’t perform. Expect a lot of negotiation by cannabis companies concerning who must serve as a guarantor, the term of any guaranty, and related issues.
A common misconception is that loans are purely between a borrower and lender. But that’s rarely the case. Expect to see one or more of the following in most commercial cannabis loans:
The above is a summary of some high-level things that cannabis companies can expect when trying to borrow money. As you can see, lenders really do have the upper hand in these transactions. That said, there are always grounds for borrowers to negotiate for better (or at least more palatable) terms in cannabis financings. We’ll be sure to keep writing about these topics, so stay tuned for more updates.
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2023 is coming to a close—but don't fret, Leafly nation. We've curated the cannabis best strain for each star sign to carry them through the transition to the new year and make the most of the last month in personal and professional spheres.
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Here’s to a relaxing holiday with family and friends.
Enjoy the holiday! We will be back next week with our regular programming.
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One of the main reasons why I am such a vocal supporter of written cannabis contracts is allocation of risk and liabilities. Parties to a cannabis contract have a number of ways that they can allocate risks and liabilities that they just won’t have in a “handshake” deal. Today I’ll explore six of the top ways to allocate risk in a cannabis contract.
If you’ve ever read through a cannabis contract, there’s a good chance you’ve seen disclaimers of representations, warranties, or guarantees. By making a disclaimer, a party is refusing to make an express or implied warranty (promise) about a certain condition. If a seller sells a piece of equipment on an as-is basis and disclaims all warranties about the product, then if the product does not perform as desired, the buyer may not have recourse (except for warranties that can’t be disclaimed by law). Without the disclaimer, there may be implied warranties that give the buyer recourse against the seller.
Disclaimers can be general, such as a disclaimer of any warranty not specifically made in the contract. Even more generally, “as-is” language can serve as a disclaimer of sorts (i.e., “buyer acquires the asset as-is, with all faults, and without any warranty from seller”). They can also be specific, such as a specific disclaimer of the implied warranty of merchantability. In many cases, you’ll see both the general disclaimer, followed by non-exclusive carveouts of warranties.
A savvy counterparty will often push back against one-sided disclaimers. In most cannabis contracts where cannabis products are transferred (intellectual property licenses, white label contracts, distribution agreements, manufacturing agreements, supply agreements, etc.), the buyer or transferee will insist that the manufacturer/supplier/seller makes certain representations explicitly, such as that the products will be fit for human consumption, comply with applicable laws, and so on. I see lots of negotiation around these provisions, as they can make or break a cannabis contract.
Cannabis contracts can also force certain parties to assume specific risks. Risk assumption comes up frequently in contracts with percentage splits. Imagine a cannabis distribution contract where a distributor agrees to sell a manufacturer’s products in exchange for 15% of the profits. Usually, when the distributor sells the goods and is paid, it pockets its cut and remits the rest to the manufacturer.
These kinds of arrangements involve some deal of trust by the manufacturer – trust that the distributor will sell the goods, will sell them at the desired purchase price, will promptly collect payment, and will promptly remit payment. Most of this can be dealt with in a contract. However, the first part – making promises about sales levels – obviously is a risk for many distributors.
I have seen plenty of cannabis contracts like this where one party assumes the risk that some of the above things will not happen right. For example, if the distributor has to buy the cannabis goods from the manufacturer, it will assume the risk that it won’t resell the goods. If the contract is a consignment arrangement, the manufacturer may take the financial hit if the manufacturer can’t sell the goods.
Often, risk assumption is not expressed affirmatively but happens by virtue of assignment of specific obligations to a specific party, or even through warranty disclaimers as noted above. To really do a good job here, the parties will need to think of every step in performance of the contract, what could go wrong at each step, and who should be on the hook if/when things do go south. I’ve been writing these kinds of cannabis contracts consistently for more than five years now and can tell you that there are tons of blind spots that can lead to massive financial hurt if parties don’t consider these impacts early on.
Related to the last point, in purchase and sale or commercial-type contracts where products are sold or transported from one party to another, the concepts of risk of loss and transfer of title are immensely important. Our firm does a lot of international work and has seen first-hand the massive adverse impacts of failure to address these provisions in international shipping. But because cannabis deals don’t involve international (or even interstate) shipment, cannabis companies overlook these basic concepts, often to their downfall. I’ll go over why they are important now.
First, let’s talk title. Title to a good means ownership of that good. One can hold title to a good without being in possession of that good. If you lend your friend your phone, your friend possesses the phone but doesn’t hold title to it (you do). In some distribution contexts, the manufacturer may hold title to the good, while the distributor transports it to a retailer. This is consignment. In the consignment cannabis contract, the manufacturer will sell the good directly to the retailer, at which point title will transfer from the manufacturer to the retailer. The distributor will never hold legal title, will only possess the good while performing services, and will generally be paid as a service provider. Keep in mind that the parties can negotiate a different transfer of title, i.e., upon pickup by the distributor.
Second, let’s talk risk of loss. This just refers to who bears responsibility if a good is stolen, damaged, destroyed, lost, etc. In the foregoing example, let’s assume that the manufacturer and retailer sign a sales agreement before the distributor picks up the good for transport. The manufacturer may want risk of loss to transfer to the retailer upon the distributor’s pickup, whereas the retailer will want risk of loss to transfer upon delivery. The reason for this should be clear – neither party will want to bear the risk that the distributor loses the good. But, somebody will have to. One way to address this is to pick a time to allocate risk of loss between manufacturer and retailer, and separately have distributor bear responsibility in the distribution contract.
Third, let’s talk about acceptance and rejection. These concepts are not the same as risk of loss and transfer of title, but often are mixed in and/or in the same part of the contract. In the example I’ve used, when the retailer receives the goods, it will have some fixed period of time (say 48 hours) to inspect the goods, and will be able to reject the goods for a specific set of reasons within that period. Title and risk of loss likely would already have transferred to the retailer, but upon rejection, the goods will be returned to the manufacturer.
As you can imagine, there are endless possibilities of ways to allocate risks and liabilities in the context of risk of loss and title. Inspection and rejection adds far more criteria. Cannabis contracts that are silent on these provisions are just begging to wind up in litigation.
I explained indemnification in an earlier post, which I’ll quote here:
If you’re not familiar with indemnification, let’s go back to the purchase example. Say a retailer purchases edibles from a manufacturer, and customers get sick when they eat the edibles. And say those customers sue the retailer. The retailer didn’t make the edibles, so it would want the manufacturer to foot the bill for its defense and any damages that are awarded. This is called “indemnification.”
Here’s another example: Party A licenses its trademarks to Party B, a manufacturer and distributor, to make and sell branded goods. Party C decides that it is the real owner of these trademarks and sues Party B. Party B is going to be upset because it did not intend to infringe Party C’s trademarks and was probably promised in the cannabis contract that Party A actually owned the goods. With a good IP indemnification clause, Party B can force Party A to engage defense counsel and pay any costs associated with Party B’s defense.
Nobody wants to get hauled into court because the other party to a cannabis contract did something wrong. Indemnification is the gold standard for dealing with risks caused by a contracting party.
I also explained these clauses in my earlier post:
If you’ve ever looked at a written contract, you’ve probably seen a provision about halfway through in all caps with a heading that reads, “LIMITATION OF LIABILITY.” As the name suggests, these provisions are intended to narrow or eliminate liabilities of one or both parties. They generally include provisions that carve out things like consequential and incidental damages (i.e., damages that are not a direct result of a breach) and punitive damages (i.e., damages that are intended to punish a wrongdoer). But limitations of liability may also place caps on one or both parties’ damages, which can be a big advantage in a dispute.
Generally speaking, contract disputes do not lead to punitive damages, which are damages that are intended to punish a wrongdoer. These are usually reserved for certain “torts” like battery, interference with a third-party contract, etc. Some cases may involve both contract and tort claims where punitive damages may be on the table. A carefully crafted limitation of liability clause in a cannabis contract may be able to touch on both (depending on applicable state law).
That said, even if punitive damages are not available in contract disputes, incidental and consequential damages may be on the table, though they are often hard to get. Imagine that a cannabis company has a water leak and hires a plumber to fix it. The plumber does not perform work in accordance with the contract and the business floods overnight. The business is forced to shut down for a week and loses tens of thousands of revenues. The direct damages in the dispute will be fixing the negligent repair and maybe even some of the damage to the premises. The incidental and consequential damages may be the loss of revenue. While again, this can be hard to prove, it is very easy to disclaim those types of damages in a written contract so as to never need to worry about complex battles over damages.
Caps are also a great way to shift risks. Caps can be used in all sorts of contexts. Limitation of liability clauses may have caps on damages in addition to damage carve outs. For example, a distribution contract may provide that except for certain cases of willful misconduct, the distributor’s maximum liability to the manufacturer may be the amounts paid by the manufacturer to the distributor in X period of time.
Indemnification provisions also often have caps. This comes up a lot when buying and selling businesses or business assets – and it’s usually the seller that pushes for them. Imagine selling a business for $750,000. If indemnification clauses are unlimited, and a dispute arises that requires seller-side indemnification, the seller may end up paying the buyer more than it was paid for the business. So as you can imagine, sellers will often push to cap indemnification at some percentage of the purchase price. In my experience in non-cannabis deals, the percentage is often relatively low. In cannabis deals, I often see a much higher percentage. That tends to be due to the fact that there are often (not always) many more potential issues for buying a cannabis business than most other kinds of businesses.
As an aside, M&A transactions sometimes also include deductibles as well. In those cases, a party seeking indemnification won’t be entitled to indemnification unless it has some minimum threshold of losses. If that number is $50,000, and the buyer seeking indemnification only had $40,000 in damages, it won’t be indemnified. Once it hits that $50,000 mark, it can either (depending on the cannabis contract’s terms) be indemnified for the entire basket of damages, or only for what’s over the $50,000 mark.
Parties to cannabis contracts have myriad tools at their disposal when it comes to shifting risks and liabilities. Of course, this can really only be done well in a written contract.
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A common way to get and retain employees is to issue them options or equity securities like corporate stock. But like with everything else, issuing securities is heavily regulated. Today, we’ll look at a few key issues for cannabis businesses that want to offer equity incentives.
There are two common ways that cannabis companies offer equity incentives: First, companies may create an equity incentive plan (or EIP). Second, companies may offer equity incentives via a written contract, such as an employment or consulting agreement. In either case, the company will, if done right, use the plan or contract to detail things like:
When employees terminate their relationships with a company, things can often sour quickly. Equity incentive plans or contracts can get incredibly complicated, and we have seen things go south quickly with poorly drafted plans or agreements that did not contemplate common employment issued.
Any time equity incentives come into play, cannabis companies must be cognizant of federal securities laws and registration exemption. Fortunately, when it comes to equity incentives, the federal exemption tends to be a lot simpler than other exemptions (such as Regulation A or Regulation D). Securities and Exchange Commission (SEC) Rule 701 provides the key exemption to registration for equity incentives, and states in part as follows:
This section exempts offers and sales of securities (including plan interests and guarantees pursuant to paragraph (d)(2)(ii) of this section) under a written compensatory benefit plan (or written compensation contract) established by the issuer, its parents, its majority-owned subsidiaries or majority-owned subsidiaries of the issuer’s parent, for the participation of their employees, directors, general partners, trustees (where the issuer is a business trust), officers, or consultants and advisors, and their family members who acquire such securities from such persons through gifts or domestic relations orders. This section exempts offers and sales to former employees, directors, general partners, trustees, officers, consultants and advisors only if such persons were employed by or providing services to the issuer at the time the securities were offered. In addition, the term “employee” includes insurance agents who are exclusive agents of the issuer, its subsidiaries or parents, or derive more than 50% of their annual income from those entities.
That’s a lot to chew on, but it essentially says that certain equity incentives are exempt from the federal securities registration requirements. Rule 701 goes on to say in part that it may extend to persons other than just employees:
This section is available to consultants and advisors only if:
(i) They are natural persons;
(ii) They provide bona fide services to the issuer, its parents, its majority-owned subsidiaries or majority-owned subsidiaries of the issuer’s parent; and
(iii) The services are not in connection with the offer or sale of securities in a capital-raising transaction, and do not directly or indirectly promote or maintain a market for the issuer’s securities.
So, Rule 701 may provide an exemption for a consultant’s equity incentive, if the consultant is not an entity, provides real services to the company, and doesn’t act as any kind of securities broker.
I should mention though that Rule 701 is limited to the issuance of restricted securities, meaning that the securities are subject to resale limitations.
Rule 701 does not preempt state law. States are free to impose additional requirements on the issuance of equity securities, and many do. When determining which state’s law applies, a company will need to look at the state of residence of each applicable employee. This makes life more difficult for companies in the remote work era.
State laws can be vary widely here. Some states have no specific notice requirement. California requires companies to submit a form to the Department of Financial Protection and Innovation within 30 days after the initial issuance, whereas Washington has different requirements depending on whether the plan meets certain Internal Revenue Code provisions. This can all get incredibly complicated.
One other thing to point out here is that while Rule 701 itself can exempt transactions with consultants (in qualifying situations), state law does not have to do that. An equity incentive plan that meets the Rule 701, in other words, may not meet the requirements of each state. That’s yet another reason why companies should consider state law well in advance of the issuance.
Equity incentive plans and contracts are immensely popular. Like all companies, cannabis businesses that want to follow the law should be aware of the filing requirements and understand what needs to go in a contract well in advance of any actual issuances.
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We are helping build out another marijuana banking program here in Oregon. My law firm has done a series of these for credit unions (“CU”s) and other financial institutions (“FIs”) going back to 2014. We have also handled a good bit of hemp banking work– mostly in 2019 and 2020 before that industry cratered. In this post, I’ll sketch out some considerations for FIs looking at banking marijuana-related businesses – or, as they are known in the common parlance, “MRBs”. And I apologize in advance for all the acronyms. That’s banking.
The term “MRB” is used pervasively in cannabis banking, yet this term is not defined in the moldering 2014 Financial Crimes Enforcement Network “FinCEN” Guidance. It’s also not defined in the 2020 National Credit Union Administration Guidance on banking hemp-related business (“HRB”s) (which we helped write) or the 2020 FinCEN Guidance on that related topic.
The lone federal definition we have is from a 2018 Small Business Administration (“SBA”) Policy Notice, as revised, which categorizes MRBs as “direct marijuana businesses”, “indirect marijuana businesses”, and “hemp-related businesses.” Here is my shorthand:
I have written on this blog that “all businesses are marijuana businesses” in the MRB context. In that piece, I also explained that FIs don’t really use the SBA definitions set forth above. Instead, early, state-chartered CUs began using a three-tiered system to analyze potential MRB clients within the FinCEN framework. That system was first expounded in 2016 by Steve Kemmerling of CRB Monitor, before “hemp” was removed from the definition of “marihuana” under federal law. The CRB Monitor system involved the following categories (which SBA probably referenced):
It’s worth noting that CRB Monitor revised and further parsed its definitions in 2020, but in my experience, most FIs keep it simple with the legacy framework or something similar. It isn’t a legal framework, after all. It’s just an expedient model that has been adopted widely by FIs given the federal leadership vacuum.
The bottom line here is that any FI looking at banking MRBs – or HRBs, for that matter – needs to come up with definitions and criteria for what an MRB or HRB actually is and does. That criteria can be shared with potential clients, or not, during the screening and ongoing KYC processes for industry accounts. In my experience, drawing lines around “indirect marijuana businesses” / “ancillary businesses” / Tier III MRBs is the most challenging area here.
Inside and outside the MRB context, FinCEN requires FIs to track and report “beneficial owners” of the businesses they bank. Beneficial ownership reporting is a core industry requirement, with a new rule coming down the pike January 1, 2024, in fact. A “beneficial owner” for FinCEN purposes is anyone who: (a) has significant responsibility to control, manage or direct a legal entity customer; or (b) directly or indirectly owns or controls 25% or more of a company’s equity. (Again, my shorthand.)
In the MRB context, FIs often hold clients to a heightened disclosure standard. This isn’t merely due to the nature of the industry. Most state marijuana programs have ownership disclosure standards which require disclosure of anyone: (a) with control over the cannabis business, or (b) who owns equity in a cannabis business. The thresholds tend to be lower than the “beneficial owner” numbers– sometimes 20%, 10%, or even lower. Disclosure doesn’t always mean vetting, but the names must be surrendered.
An FI should want to know at least as much about the ownership of its member or customer as state cannabis regulators– especially in the absence of federal industry regulation on that topic. Typically, the FI will shortcut this inquiry by requiring the MRB to produce its application and license records with the state. And the FI will not open an account until the state has actually issued a marijuana regulatory license, in most cases. Which brings me to my next point.
FIs that wish to bank MRBs need to request and receive records from state regulators on a regular basis. This ties into KYC considerations, which include not relying on the customer (or member) representations to the FI. In the cannabis context, FIs have an obligation via FinCEN to double-check state regulators’ work, essentially.
State regulators do tend to publish basic information on their licensees: the company name, type of license it holds, license number, and sometimes published decisions or disciplinary proceedings. However, I don’t know of any state that publishes information on the ownership structure of its cannabis licensees. This means that information which isn’t statutorily subject to redaction (e.g. social security numbers, site security plans) will be available only via a public records request.
Public records requests can be time-intensive and expensive. From experience, cannabis regulators may struggle to fulfill them regardless of legal requirements. Thus, FIs that wish to bank MRBs generally enter into information-sharing agreements with the relevant state regulator(s). At this point, many state agencies are accustomed to such arrangements.
FIs will have various intake forms for all potential members and customers. These forms must be tailored for MRB and HRB applicants, and supplemented to boot. Here’s a typical universe of forms an FI will send to any cannabis industry applicant:
The forms, in turn, will require various submissions by the applicant, from regulatory license packets on down. Here at the law firm, I expect we will revisit many of these forms for FI clients in the near future, owing to changes in the hemp space under the 2023 Farm Bill. And perhaps again with respect to marijuana if moved to Schedule III.
The federal government has put FIs in a truly awkward position on MRBs. Bank Secrecy Act / Anti-Money Laundering (“BSA/AML”) compliance is a significant undertaking for FIs even outside the cannabis space. However, the FinCEN Guidance bumps things up a level by essentially deputizing FIs as federal law enforcement auditors. FinCEN requires FIs to monitor their MRB customers and members perpetually, including what they sell and to whom, and to watch for indicia of adverse information.
These FI obligations commence immediately and ensue perpetually. Specifically, the FI is required to file an initial SAR within 30 days of onboarding. The FI must also file continuing SARs every 90 days after that, in addition to “marijuana limited”, “marijuana priority” and “marijuana termination” SAR filings, as needed, based on any number of events – or suspected events – set forth in the 2014 FinCEN Guidance. To say nothing of all the currency transaction reports (“CTRs”).
These filing obligations, and all of the software and training that goes with them, are frequently cited by FIs as a primary justification for the increased fees paid by MRBs. Law enforcement may hardly be acting on them, but FIs need to comply.
Most FIs that work with MRBs offer limited services, or basic depository accounts. That said, we’ve worked with a couple of CUs that offer a full suite of banking and lending services. There are limits, of course, to what even the most enterprising FIs can do. They cannot offer bank card transaction processing for cannabis purchases (at least, not anymore). If the FI is smaller, like many state-chartered CUs, it will be limited in its deposit carrying capacity; this makes for an awkward constraint in a cash-laden industry.
Many FIs that get into cannabis banking are pulled into the space by one or two high-net-worth customers. Then, they will slowly branch out to a wider client base and often a wider suite of offerings. Others are more intentional, and set out to target the industry.
I mentioned the Farm Bill is up for renewal this year, directly affecting banking for HRBs, and that “marijuana” may also move to Schedule III sometime in 2024. In addition, the specter of legislative reform is forever hanging about the industry (via the SAFE Banking Act, though I’ve called it oversold). Locally, new state cannabis programs continue to come online. This sometimes results in modest state-level legislation to insulate FIs from local prosecution for banking cannabis, even if such changes do not create a federal safe harbor or touch on BSA/AML strictures.
Overall, any FI that moves into this space should be prepared to roll with some changes over the next couple of years. Those changes are happening, however, because the cannabis industry is growing. It’s not a bad time to get in right now. It’s probably better than ever, in fact.
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